Did you vote and submit your ballot for the U.S. General Election on Nov. 5, 2020? Then, your focus may have shifted to taxes. Toby Mathis and Jeff Webb of Anderson Advisors answer tax questions related to personal and professional matters. Do you have a tax question? Submit it to taxtuesday@andersonadvisors.
- If a new C Corp is started and the owner is the only employee during the initial years, does the owner/employee still need to draw a salary, even if the C Corp is not profitable for the first few years? With a C Corp, there are no salary requirements; compensation is anything of value, such as a salary or car or you may not be paid at all
- Does the IRS consider your business a hobby if you have not turned a profit within five years? Three of 5 years is presumed to be a hobby
- How can I live in a home owned by my LLC that is not producing income? Putting your primary residence in an LLC is a bad idea; may cost you an unlimited exclusion (equity) or effect your 121 exclusion
- Real estate investor start-up expenses on education, classes, materials – can I write all that off my taxes once my LLC is formed? Put those expenses in a corporation, not LLC, because the corporation has to make money before expenses can be deducted
- I am a physician and work for a university hospital. During the pandemic, I have been working from home. Can I get a deduction for rent? If you are a W-2 employee for the university hospital, there is no reimbursement for rent; if you are a 1099 employee, you can get a home office deduction
- I used the HELOC of my primary residence to purchase an investment property. Any tax deduction/advantage I can take? You can’t use HELOC interest as mortgage interest on Schedule A; can only be used to improve or buy your house
- I have insurance policies in India and would like to bring the money once they are matured. Do I need to pay taxes on this money? Depends if you are a citizen or resident of the United States; use designation 15CB from chartered accountant in India that states money has been paid
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Full Episode Transcript:
Toby: Hey, guys. This is Toby Mathis.... Read Full Transcript
Jeff: And Jeff Webb.
Toby: You’re listening to Tax Tuesday. We got a pretty jam packed one. Somebody picked 15 questions, I don’t know who.
Jeff: Man, that person.
Toby: We thought we were going to be done in an hour. I don’t think it’s going to happen. We’re going to do our dang just try. Good old thing.
Anyway, ask any questions you want live. We’ll answer them before the end of the webinar if we can get to it here. We have several tax professionals, including Eliot Thomas, Piao Sam, Davia Harter, a bunch of […], bookkeeping. We also have Susan and Patty. Who else is on the line?
I guess that’s it. We have one, two, three, four, five, then you and I, six, seven. There’s seven of us to make sure that we get your questions answered. If we can’t, see that little email address there that says firstname.lastname@example.org? By all means, send in something. We’ll do what we can to make sure we get you a response.
If you need it super detailed, if you’re asking questions about your specific scenario where we’re going to do work, if you want something that’s specific to you, you’ll need to be a platinum client. It’s a whopping $35 a month. I know it seems like a lot, It’s cheaper than that gym membership you don’t use.
This is fast, fun, and educational. We have a lot to get over. I’m not going to goof off with you guys too much. We have a bunch of questions.
“If a new C-Corp is started and the owner is the only employee during the initial years, does the owner-employee still need to draw a salary even if the C-Corp is not profitable for the first few years?” We’ll absolutely answer that.
“I earn bonuses on a quarterly basis as I work in a sales organization. Since the bonus is treated as supplemental income by the IRS, it’s subject to a higher tax. How do I reduce the tax hit on my bonus? What is the strategy to keep or protect that bonus income?” We’ll answer that.
“How can I live in a home owned by my LLC that is not producing income?” I don’t know, we’ll have to answer that.
“Real estate investor startup expenses on education, classes, and materials. Can I write all that off my taxes once my LLC is formed?” We’ll go into that.
“I’m a physician and work for a university hospital.” Thank you for your service during these times. “During the pandemic, I have been working from home. Can I get a deduction for rent?” We’ll go through that as well.
“I use the HELOC of my primary residence to purchase an investment property.” This is actually a really good question. “Any tax deductions or advantages I can take?” Really good question. We will answer that.
“I have insurance policies in India, and would like to bring the money once they are matured. Do I need to pay the taxes on this money?” We’ll answer that too.
“If I buy office supplies and inventory for my business with my personal credit card, can that be the owner’s equity?” I’m assuming that means you as the owner, we’ll go through that.
“Could I take out $100,000 for my current 401(k) according to CARES Act and roll it into a different QRP without tax consequences?” We’ll answer that, too. I don’t think it’s going to matter about the CARES Act, but we will absolutely go through it.
“If I used a credit card to purchase stock, can I write-off the interest I’m paying on the credit card if I incur losses?” That’s interesting.
“If Biden gets in, how far back can they go with tax changes?”
“What happens for tax purposes if I want to sell a property that was in an LLC? Do I need to transfer it back to myself?”
“Do capital losses offset capital gains in a 1:1 ratio no matter what your earned income level? Would $1 of capital loss offset $1 of capital gain in the same ratio, regardless of the gain being short-term or long-term?” Great question.
“My son and I both have solo 401(k)s. How can we partner in a buy-and-hold real estate investment without violating disqualified parties rules?”
Then, the last one is, “I have an HSA—Health Savings Account—from my employer. The IRS maximum contribution amount for 2019 was $3500 and my employer contributed $1500. The IRS maximum contribution for 2020 is $3550 and my employer will contribute $1500. Am I allowed to contribute this November for both 2019 and 2020 tax years, the remaining $2000 and $2050, respectfully?” We’ll go through all those.
Let’s just jump right on in because we don’t want to be here all night, Jeff. You’re just talking way too much. If you guys haven’t been around us, Jeff is a Chatty-Cathy and I’m very, very quiet.
Jeff: You can’t shut me up.
Toby: “If a new C-Corp is started and the owner is the only employee during the initial years, does the owner-employee still need to draw a salary even if the C-Corp is not profitable for the first few years?” What say you, Jeff?
Jeff: Well, this is a difference. I think we sometimes confuse people because we talk a lot about the S-Corporations and the need to pay salaries. Actually, with a C-Corporation, there’s no requirement to pay a salary.
Toby: Zero. Zilch. Your accountant will tell you otherwise. They’ll just let you know that this has been going on for 20 something years, we’ve been fighting with people over this. Compensation is anything of value. They could pay you with a car or they could just not pay you.
The issue you have, like what Jeff said, is with the S-Corp, only if you take distributions out of the S-Corp, so if I take money out of it, then I have to make sure I pay a reasonable salary.
Jeff: Unlike those S-Corporations, you can be a shareholder, you can be a director, but that doesn’t necessarily make you an employee of the corporation.
Toby: That’s right. I can own Microsoft stock and they’re not going to pay me. It just seems wrong. I need to get paid, but Bill, you guys got so much money, put me on payroll.
What oftentimes happens is you’ll set up a C-Corp then it’s zero out. I think 80% of C-Corp is actually zero out somewhere around that number. It’s a pretty high percentage.
Jeff: I’m not sure what that number is.
Toby: Maybe they don’t pay you salary, maybe they don’t pay any tax. A lot of them aren’t making a profit. The best example was Amazon, which was losing the first seven years. I don’t think it turned a profitable quarter until year eight.
The only time you have to pay somebody is if they’re doing work and you’re giving them some sort of compensation. You don’t give compensation to people if they’re not doing the work. That’s a good one.
A few questions will go to the Q&A. These are some of the live questions. Our guys are pretty good about answering all your questions. You’ll see them answering them to the right of your questions, if you write stuff in. Let’s see.
“I just created a Wyoming Holding LLC. I have an existing Washington LLC. To fund a real estate investment deal through the Wyoming LLC, I need to move money from Washington to Wyoming and then to an LLC. Is this the most tax advantageous way to do that?”
Steve, he’s asking about a loan, so really what we’re doing is we need to look at to say who’s the ultimate taxpayer. From what you’re explaining to me, it is more unlikely that Washington LLC is owned by Wyoming LLC. The Wyoming LLC is a partnership that’s owned by you, so there’s no tax ramifications.
What you could do, if you want it to follow the chain of money exactly, you go from Washington to the Wyoming to the new LLC that’s buying a property. You could just do that electronic transfer. There’s nothing tax wise that’s wrong with just going straight from Washington to the new entity. It doesn’t impact you at all. There’s no tax trap. There’s no got you. That makes sense?
Jeff: Yep. We’ve done it where it’s either a direct loan, but in this case, if they’re owned by each other, everything in that Lower LLC is owned by the Upper LLC.
Toby: Yeah, it’s just you at the end of the day.
Let’s say that we have the holding and it’s a 1065. It’s giving K-1, arguably, to two parties. That could be a husband and wife. That could be a single 1040. All of these we’re talking about here is, is this Washington? Then, the new, they’re just owned underneath this holding. At the end of the day, it all ends up on the same tax return.
Now, I’ll do it a different way if they are a different ownership group. Let’s say that you have Wyoming and it has its partners. Again, we have an entity down here. We have over here a different company, an LLC, even if it’s down here owned by you. Then, the most appropriate route probably will be to either have the money go from the Washington to the Wyoming, out to yourself, and then into the new guy. That’s going to be the best route. Technically, you could skip the Wyoming and go straight to yourself. From a book standpoint, though, those two LLCs right there are treated as one. There’s no difference between them from a tax standpoint. Makes sense?
Toby: All right. This is a good one. “I earn bonuses on a quarterly basis as I work in a sales organization. Since the bonus is treated as supplemental income by the IRS, it’s subject to a higher tax. How do I reduce the tax hit on my bonus? What is the strategy to keep or protect that bonus income?”
Jeff: Well, supplemental income is taxed in one or two ways. One is the percentage method, one is the aggregate method. If you’re getting pretty large bonuses, you probably don’t want to use the aggregate method.
It means you get paid once a month. They’re going to chunkin’ that bonus with the rest of your pay to calculate what your total tax hit is. You could find yourself in a really high tax bracket that way.
Toby: That’s for the withholding.
Jeff: That’s for the withholding. Well, that’s what he’s talking about, it is the withholding part of it.
Toby: I just want to make sure. Since the bonus is treated as supplemental income by the IRS, it’s subject to a higher tax. It’s not a higher tax, it’s a higher withholding. The tax is the same.
Jeff: Yeah. The withholding rate, if you just do the percentage method, it’s 22% which, for me, is not a bad percentage for withholding on bonuses and stuff like that. It used to actually be around 27%.
Toby: What’s that called?
Jeff: The percentage method.
Toby: He may be getting the aggregate method?
Jeff: Like Toby said, remember this is withholding. If they withhold too much over the year, you get that back when you pay or file your tax return. It’s just like any other withholding.
Toby: Yeah. You’re going to get it back. What would I do? How do I reduce the tax hit on my bonus? Is it you telling me to go the percentage method? What is the strategy to keep or protect that bonus income? Well, you’re going to have the usual suspects. You’re going to have retirement accounts.
401(k), if your employer has it. If it’s coming out to you, then you’re going to have things like charitable giving. You’re going to have conservation easements. You’re going to have oil and gas, which scares me right now, but usually it’s pretty good. You’re going to have a real estate professional if you qualify and create loss. You’re going to have ordinary losses from another business that you materially participate in. You have all those things. Anything I’m missing there? You have your standard deduction, obviously. What else do we have here? Your mortgage interest.
Jeff: It’s going to be all those usual deductions that you would have on your return regardless. Maybe the bonus is also being grabbed, like you said, by the 401(k) contribution. Yeah, you’re getting a smaller piece of it because you may be putting 10% away into your 401(k), but it’s also not getting hit with taxes when you do that. If you put $1000 into your 401(k), it’s going to save you $220 just on that bonus.
Toby: Yeah, but again, it depends on the employer and if you’re the employer. It sounds like you’re not the employer, you’re getting paid through an employer. You’re not going to have to go to the employer and say, hey, what do you have? Otherwise, your shelters are pretty much what I listed up there. In oil and gas, somebody says, “Why does it scare you?” Because energy has been getting that snot beat out of it during the COVID crisis because Russia and the Middle East are producing lots of it. We’re producing lots of it and demand is down. At one point, a barrel of oil was negative.
Jeff: You actually had to pay people to store your oil.
Toby: Yeah, it was getting expensive.
Jeff: Right now oil is trading at $42. At its height, it was trading at around $140 a barrel.
Toby: Yeah. Until it gets normalized, once the plague is over, and we’re getting back to normal, then I’ll look at it. Right now, it’s a little bit shaky. When you’re doing oil and gas, it’s called the intangible drilling costs that you’re looking at. You can write that off as an ordinary loss against all your other income. The problem is if I’m trying to extract oil—oil is cheap—it’s not going to be cost effective to do it. You’re not going to end up operating the well.
Jeff: Yeah. You got to keep in mind that intangible drilling cost, if you put in $100,000 and $80,000 goes into the hole, that $80,000 is gone. You can deduct it, but you’re not getting that money back until you start producing oil.
Toby: It says, “Is buying oil and gas stocks the same?” No, you have to be a general partner, you have to be at risk for the loss of the endeavor. You have to be personally at risk for an intangible drilling cost to come down as ordinary. One I didn’t list up there, you can get into solar.
I did put it in there for conservation easements. Right now, the ones I’m seeing are between $1:$4.5 to $1:$4.70 which means for every dollar I put into a conservation easement, I might get $4.70 of deduction, which is reasonable. That’s underneath the threshold for a listed transaction with the IRS, actually. It means you don’t have to do anything special, you just get the deduction.
What else am I missing?
Jeff: You also have to be a little careful that if your itemized deductions before any of this is actually fairly low, then you’re married filing joint, you have to come up with $24,000 worth of deductions before any of these start decreasing your tax.
Toby: Oil and gas would offset.
Jeff: I’m just talking about itemized deductions for charitable contributions.
Toby: Yeah, all these other ones. Health, mortgage interest, and state and local taxes, stuff that I have to worry about. All right. Lots of questions coming in.
Somebody says, “Could it be said that the bonus is being treated as 1099?” You’re not supposed to do W-2 and 1099 for the same work.
I can be a W-2 employee and a 1099 contractor with the company, but I’ve got to be doing different things. Like Jeff, he might be a W-2 as a CPA, but if Jeff had a catering company and we hired Jeff to do catering, I could pay him as a 1099.
Jeff: Right. It’s got to be for things that are outside your normal role.
Toby: All right. “Are there any firms you work for that have connections with easements?” Leo, yes. I work with a really cool guy, Tyler. He is an alternative energy guy. He installs and puts on solar units in Colorado, but also has, for years, done the conservation side. He has one main company that he works with. They do have one conservation investment still open. They’re the only ones that I work with because they’re actually doing conservation work. It’s not just for the deduction, they’re actually putting aside large swaths of land from development that can be developed as all the development plans. They’re coming in and rescuing the property.
All right. Somebody says, “Does the IRS consider your business a hobby if you have not turned a profit within five years?”
Jeff: Well, the general rule of thumb is 3-5 years, but this is a subject of test. There’s actually a number of tests that go along with that.
Toby: Three of five years is presumed to be a hobby.
Now, there’s a really good case. I’m going to ask you guys. He says, Jeff Bezos didn’t make a profit for 20 years in Amazon. My brother works for Jeff so I can’t make too much fun of him. It was seven years that Amazon didn’t make any profit. They just ate a lot of money when they first started to get that market share.
That presumption is Section 187 and it’s a rebuttable presumption. There was the guy, what is it called? Peaches & Herbs?
Jeff: Oh, yeah.
Toby: Clive Parker? Am I wrong? Midnight Train to Georgia? Who knows out there? We’ve got to have some music fishing for us.
A question, “Does this five-year rule apply to C-Corp?” No, it does not.
“Ashford?” No, it can’t be. “Is that really Gladys Knight & The Pips?” No. The guy that wrote it. “Herb Alpert?” “Toby on the pitch?” No. “Clive Davis?” There we go. It’s Clive Davis. Somebody gets it. Who got it?
Look at Seth. Seth, you got the singer of it, but you didn’t get the writer of the song. Peaches & Herbs’ guy was Clive Davis.
His kid, he started a music label and lost money. Like, $38 million dollars just trying to make his kid famous. He lost money for more than a decade. I want to say it was even longer, like some ridiculous amount of money over a long, long period of time. The IRS said, you were a hobby. What they look at is did you act like a business? Did you try to make a profit? Did you use professionals? They always look to see if you hired a lawyer or did you have an accountant?
Jeff: Yeah. If you read all of 187, it quickly becomes obvious through wanting to know if you’re really trying to make a profit.
Toby: He did fine. He ended up winning. His winning was, can I actually write off all this? He was getting all these huge royalties from his music and he ended up writing it off.
You guys are still awake? “Jim Weatherley?” No, it’s Clive Davis. Somebody says Jim. No, I don’t think so. I think it’s Clive Davis. He is a musical producer. Maybe he produced it. All right. It’s Clive Davis, I’m pretty sure. I’ll go look it up. Next time, we’ll have some fun with this one. It’s a really weird case and it’s such a huge amount of money, like you dumping millions of dollars into it and never making this kid famous. All right.
Somebody says, “I’ve done conservation easement. I understand that all conservation easements are under scrutiny. You mentioned that $4.70 is under the radar. What’s the top level that will not be questioned?”
It’s a listed transaction if it’s more than 250%, so five times. You go over five times, you have to let the IRS know that I’m investing in it. They’re auditing what they called syndicator—it puts it together. There’s nothing wrong with it.
In fact, you want them to audit it because sometimes the audits are in your favor because they’re saying, hey, what’s the fair market value? If you’re doing it right, you have all that information before you even start. Like the ones that I send people to, they’re buttoned down and they already have the development.
In this particular case, the one that’s open right now, it’s in Vail, Colorado, and they have all the development plans. They actually have the memorandum to actually do the development. They’ve already developed other lots. They’re just taking a big chunk of it and offering it for conservation. The fair market value of that deal is worth about $40 million developed. It’s worth about $10 million something.
Let’s see. Somebody’s saying that it was performed by Jim Weatherley and then he recorded it online. Okay, maybe Clive is the producer. You guys got me on that one, Clive Davis. See, now, I went down a path of no redemption here.
“How can I live in a home owned by my LLC that is not producing income?”
Jeff: I just think putting your primary residence in an LLC is a really bad idea. You can do it, but it doesn’t really mess with your 121 exclusion.
Toby: If it’s a disregarded LLC, it doesn’t hurt your 121 exclusion. What an LLC can cost you depending on the state—there’s only two states we really worry about—is whether it’s going to cost you an unlimited exclusion. The equity in it, the unlimited homestead. That’s Texas and Florida that we don’t want to mess with.
We know the living trust is fine, but Florida, I think we screw it up if we go the LLC route. It’s one of the two.
Jeff: If it’s owned by a husband and wife, does that make a difference?
Toby: As long as that LLC is disregarded for tax purposes. It’s disregarded for tax purposes, for all federal tax purposes.
Jeff: If it’s been the husband or wife, would both have to be owners of the LLC?
Toby: Correct. Husband and wife would have to be owners of the LLC, but they would have to be living in a community property state. If you put your house into a LLC that is owned by husband and wife and a separate property state, you’re going to want to have a living trust and one of them as trustee being the owner.
Then, the living trust would be the owner and we converted inside the living trust back to community property. You’d have to have some pretty serious equity.
I’ll give you the examples. If you’re in California with $2 million of equity in your property, you don’t have much of a homestead exclusion. It’s less than $100,000. You have $2 million exposed to whomever might want to try to come after it.
Then, I might see somebody putting in an LLC. Realistically, we’re probably going to use a land trust so that you’re not putting anybody unnoticed in your privacy trust.
Jeff: We don’t talk about the QPRT much.
Toby: Qualified Personal Residence Trust?
Jeff: Right. Do they offer any kind of protection?
Toby: Yeah, QPRT is I give you my property. I give the trust with you as the beneficiary, my property with a lifetime right to occupy it. That way, worst case scenario, I get sued for everything and I still get to stay in the house. It’s your house, nobody can take it away from you. You use those a lot when they’re trying to get properties out of an estate.
Somebody is asking about the 121 exclusion. “I have lived in my property owned by my LLC which I am selling. Is there any problem with claiming personal residence exclusion?” You shouldn’t. You shouldn’t have an issue because when it’s disregarded for tax purposes, it’s disregarded. The IRS says it doesn’t exist. If it doesn’t exist, then it’s you.
For you, all you have to do is make sure you lived in it as your personal residence two of the last five years. Anyway, when people use it, you don’t have to be renting it or anything like that. As long as it’s you, then you as the LLC, are just a taxpayer. If that LLC is taxed as an S-Corp or a C-Corp is a complete different story because that’s a different taxpayer. We don’t like your home to be owned by a corporation.
An LLC, if you remember, does not exist to the IRS. That LLC, the IRS says, what is it? Then you say what it is. You’re going to say either partnership, it’s a Corp, it’s a trust. You’re going to tell the IRS what it is.
All right. What do we get? We got a bunch of questions here. By the way, Wyoming LLC is disregarded. Okay, that was from the previous one, which means there’s no tax. Our previous answer stands.
“We recently formed a C-Corp to manage our existing LLC. Is there a compelling reason to create the C-Corp bank account at a different bank where we have our LLC and personal bank accounts? We have a great relationship and services with our current bank.”
Chris, the only compelling reason you’d ever have, when you have cash at an institution from not necessarily having it at the institution, is if you have a loan with that institution.
During the Great Recession of 2008, there were a few banks that when they would get nervous about a loan not being paid, they would just grab your bank account, whether you were late or not. That happened to plenty of our clients where we would see it. Then, they’d fight and they would go after the bank, but it took months. They’d have to get lawyers involved. The bank was just scared that they were going to walk out of their house.
In Nevada, it was rampant here. I had friends that have it happen to. If you’re sitting there, you have $100,000 sitting in your bank account, you have a mortgage of $300,000, and they could just grab your bank account. If you’re worried at all or if that’s all your cash, you may want to spread it between a couple institutions where you don’t have debt. That’s the only thing.
Somebody says, “Don’t you have to pay back depreciation?”
Jeff: “We’re only talking about depreciation.” No, we weren’t.
Toby: Yeah. You don’t have to pay back depreciation. They might be thinking of a home office or something. No, you recapture depreciation. In that particular case, maybe it was going back to the house, you’re not renting it, so you’re not required to do depreciation on the previous question.
Yeah, there’s no depreciation on this one, just so you know. You only charge depreciation when it’s an investment property. If you’re living in it, it’s not an investment property. If you are renting it, then it becomes an investment property. You may take depreciation, but you must recapture depreciation as though you took it. It could be really brutal and it could be pretty darn ugly.
Some people have a second property and they’re leasing it to a child, to a friend, or to a relative. They’re charging a little bit and they don’t take depreciation. Maybe they’re not even charging for it. They just say, hey, you’re staying in it. The IRS has the right to come through and say, that’s an investment property. Just because you were gifting them the lease, that was put into service to a third party, that wasn’t your home. We’re going to treat it as though you depreciated it and force you to pay up to 25% on the amount that you could have depreciated, whether you did or not.
Fun stuff. Another question, “Real estate investor startup expenses on education, classes, and materials. Can I write all that off my taxes once my LLC is formed?”
Jeff: If you’re investing personally in real estate, I’m not a big fan of taking those startup expenses there. What you end up having is this Schedule E that has your rental income expenses on it and then these humongous educational expenses that stick out like a sore thumb.
Toby: Where would you take it?
Jeff: I would actually have a corporation managing my rental properties and I would take those types of expenses in the corporation.
Toby: Yeah, that’s generally how we teach it. When you’re an investor, it’s a different world. There’s actually a case. I think it’s Woody V Commissioner, that was somebody that we actually consulted with before they ran off and did what their accountant told them to do anyway.
We told them, you better set up a corporation to grab your expenses because they become a startup expense, the corporation has to make money before it’s going to get to write it off. When you’re an investor, you’re not in business until the day you start that little thing called rents. Everything before that, no business. You get no deduction for it. If you had a bunch of educational expenses, you’re not going to get it.
With the corporation, you can look back and you can go back in time where you can grab all the expenses. Then, you’re paying them out of money that comes in the future. A little nuance there, we don’t want you to goof around. The only other way that I would answer this differently is if this LLC is taxed as a corp. You wouldn’t be doing that if you’re an investor and you’re putting the properties in it. I’m just going to put how it’s taxed as a kind of a question mark.
Jeff: We’ve also seen people try to do this on Schedule C, their self-employment income, put their education costs. I’ve seen a lot of them audited. I’ve yet to see anybody with one of those cases.
Toby: There’s a difference between being a trade or business or an investor and there’s a distinction between it. If you’re an investor, if you’re already in real estate, you already have a bunch of rentals, and you go to a course, by all means, feel free because you’re already in service. You’re already in business. If you haven’t started, then absolutely, I wouldn’t be trying to write that off of my personal return.
Jeff: I agree.
Toby: You’d wind up going into a corporation. Just because the corporation, if it’s a management corp, it’s in business the day that it starts. Whereas you, as an investor, until you have the items in service, they’re not going to consider you in business.
“How about a licensed broker continuing education?” Then, you’re fine—your business. You can write off your education. As long as it’s in line with what you’re doing.
Jeff: We’ll see that on Schedule C where a guy may run a HVAC business and he sends all those people off for training on new systems. That’s all fully deductible because you’re in that business.
Toby: The example is, let’s say, I am in the real estate business and I go to law school. I can’t write off the law school because that’s not in my line of business. It’s preparing me for a new line of business.
Somebody says, “If you already have a rental, I’m not an LLC, is it okay to write off real estate related training?” Yeah. You’re just writing them off on your Schedule E at that point.
As long as you already have rentals, you’re going to be fine. I still tend to take them in the corp, just me, because I don’t want to fight with the IRS because you’re kind of putting a bull’s eye on your forehead. I don’t want a bull’s eye on my forehead.
Jeff: No target on my back, no bullseye more for him.
Toby: The safe bet is to use a C-Corp. Somebody says, “Can I use an S-Corp or C-Corp?” I would say the C-Corp. The C-Corp is not subject to 187 which is the hobby loss rules. It’s a business just because it is. The losses stay inside the corp. The corp also only pays 21%.
“Can a C-Corp manage rentals held in the owner’s name? Or do they have to be inside of an LLC?” Technically, it could manage properties in your name, but I wouldn’t do that. You’re always going to want an LLC around rental properties, so it’s not a technical requirement. Our recommendation is don’t own investment properties in your name, period. You’re inviting troubles.
The biggest vicious takings that I’ve ever seen, almost all of them happen to be with real estate in individuals’ names where they would lose everything. It’s because they own something in their name and they said, it’s just one little piece of real estate.
Jeff: Yeah. Putting the property in your name makes your deep pockets just a little deeper.
Toby: Deeper, and you never know when you’re going to have that situation. We’ve seen fires. We’ve seen trees fall on things. We’ve seen electrocutions. We’ve seen carports fall on workers. You’ve seen so much stuff. You just don’t want to be sitting there messing around with it.
Even when you have a $3 million umbrella and they sit there and say, oh, I’m still covered. No, you wait. The big ones where I’ve seen people lose everything, it was almost always the insurance company was denying. Actually, I saw just the biggest bankruptcy I’ve ever seen. We had to sue to get some of our assets back out of it. It was a company and it got bankrupted by an earthquake. It was making over $100 million a year. Their building cracked, the water shot into the building, and the insurance company denied it. The cost of fixing it, in moving their staff, and continuing to operate caused them to go into bankruptcy and lose everything.
Jeff: Toby is the new farmer’s insurance spokesperson. That’s happened. We’ve seen it.
Toby: We have seen it. That was the weirdest thing. That was in Tukwila, Washington. A property line or the water line broke and shot up into the building—a four story building—and just decimated it. Then, the insurance company declined, saying that the $6 million policy was really a $600,000 policy and it moved to $0. The agent was like, no, it was $6 million.
They ended up fighting it, but they ended up fighting it in a bankruptcy court. Don’t do it. Please, put your rental real estate in an LLC. If you’re flipping properties, keep them out of your name too.
I got to be working with the client who was going through the litigation of having been 11th in line on a property. He had flipped it years prior. The property had flipped and flipped and flipped and flipped. He was number 11. They sued him and named him in the lawsuit over something that was wrong with the land. They sued everybody that was in the chain of title.
“How do we get it inside the LLC?” Reach out to Patty. Have somebody sit down with you and go over it. It’s not that hard. Depends on whether there’s debt. Usually we’re going to use it depending on the state. Some states, it’s not a big deal. If you’re in Pennsylvania and putting in an LLC is a taxable transaction. Everywhere else it isn’t.
If you have a loan on it where you usually use a land trust to keep the loan from being called, we actually teach this in the Tax and AP course. They’re free. You might want to go to a Tax and A.P. course. You guys are on Tax Tuesday. Patty, if you could share a link.
We have an event coming up the Saturday after this one. If you really want to learn this stuff, you want to learn how to structure your real estate, that’s a great place to go. You can learn a bunch of taxes anyway. They’re one day right now, we’re doing them via Zoom.
“I’m a physician and work for a university hospital. During the pandemic, I have been working from home. Can I get a deduction for rent?”
Jeff: Unfortunately, if you are a W-2 employee of the University Hospital, there is no deduction for unreimbursed employee expenses.
Toby: All right. Question, are you W-2? Well, if you’re 1099, yes. Your 1099 can decide, hey, we’re going to have an administrative office in the house. If your 1099 is in a sole proprietor, you just can write off a home office, which will be a lot less. The best route is if you’re 1099, you’re going to want to be an S-Corp or an LLC taxed as an S-Corp, or a C-Corp or LLC taxed as C-Corp. Your personal situation would dictate which one is going to be the best for you.
“You mentioned a tax seminar on Saturday for struction.” Okay, there’s the event. Actually, we have a few different ones coming up. I just had a really cool one on Saturday. We did residential assisted living for senior housing with Gene, which is always fun. I’ve done that twice with him now. We have been working with Gene for years. This year, we’ve been really zeroing in on trying to help the seniors out.
There’s Tax and AP. I also have Tax-Wise, which is all tax, coming up on December 1st. You have to have The Tax Toolbox to get into that or you’re paying for that separate. Some of you guys may actually have purchased it last year and be entitled to all of them for this year. Anyway, that’s always fun.
Q&A, lots of questions, did I even answer this one?
Jeff: Yes, we did.
Toby: All right. Sometimes I forget. “We received an email today regarding our SBA loan stating, ‘Your business was recently approved for an Economic Injury Disaster Loan for the US small business. The executed loan authorization agreement contains a requirement for collateral which requires written consent on the collateral securing this loan. Requirement has been determined by the estimated to be unnecessary and as a result, has been removed.”
Some of you guys know this, there’s the Economic Injury Disaster Loans, which are the EIDL loans you hear about. Imagine that you had a hurricane hit you and it messed up your business. The SBA has disaster loans.
Well, when the pandemic hit us, it messed up our businesses. The SBA said, we’re in a national disaster area, the whole country, and we’ll give you loans up to $2 million, which quickly became $150,000 because everybody wanted these loans. The 30 year loans for profit was 3.75%. The not-for-profits got 2.75%. The cool part was there was no personal guarantee. They did have the right, if the loan was over $25,000, to request collateral. They said, hey, we want to be able to file your UCCs against your assets in your business.
What they’re sending you, Angela, is a form saying you don’t have a bunch of assets. They’re going to look at your balance sheet that you provided and they’re going to say, is there anything there that we want to secure? No, I doubt they’re going to secure any loan. There’s too many of them.
Get this, they did more loans in 14 days than they had done in the previous 14 years combined, this year, the SBA. I was actually shocked that the SBA processed the EIDL loans. They were really, really slow. They were supposed to be getting stuff turned around in 72 hours and it’s taken them months.
We got millions of dollars for our clients and now we were working that. Our guys were working I don’t want to say 24/7, but they were literally working all weekend, working late at night. We had teams working on those things pretty much around the clock. Early until late, constantly trying to get our clients money because we know it is really important to you all.
While you guys have been shut down, while you guys have been going through financial turmoil, we’re trying to get that money for you. We were really good about getting the advances. The advances were $1000 per employee up to $10,000 that you don’t have to pay back. We were good at getting people the money. It sounded scary because the EIDL loans, typically, could be a $2 million loan with security. Well, we didn’t have to worry about the personal guarantee and the security was just there.
They’re just letting you know, don’t worry about it. That was a long winded answer.
Jeff: It’s great.
Toby: All right. You can do this one. “I use the HELOC of my primary residence to purchase an investment property. Any tax deductions or advantages I can take?”
Jeff: Well, I’ll start with what you can’t do. You can’t use that HELOC interest as mortgage interest on your Schedule A. Yes, it’s secured by your home, but it wasn’t used in the home.
Toby: It used to be, you could use it for anything. Now, it has to be used to improve or buy your house.
Jeff: What you would do, say you bought an investment property. You would apply that mortgage interest—a HELOC interest—against that investment property. I’m supposing that you’re renting it out and have rental income. Well, now you have a mortgage interest to apply against that. That’s where you’re going to take it.
If it’s some other kind of non-income producing property, you can still take it on Schedule A under investment interest that becomes a little harder to deduct because you have to have investment income to offset it.
Toby: You can just put this on your Schedule E?
Jeff: Yeah, I would definitely. If it’s a rental property, I would definitely put on my Schedule E.
Toby: Make it easy. Save yourself a lot of heartburn. Even though it’s a HELOC, you can’t write it off. Just like if you’re paying for your kid’s education and stuff like that, you can’t write off the HELOC interest anymore. If you put it back into your house, you can, or if you use it for investment property.
A lot of accountants don’t realize this. You treat it as an investment expense, even though it’s a HELOC on your house. It’s just a loan. It’s just secured by your real estate, that’s all.
There’s lots of commercial loans that you get that they’ll say, hey, I want to be able to put a deed against your house. If I was private lending to somebody, I might say, I want your personal residence. I don’t even want to put a mortgage against the property I’m loaning on.
Jeff: The one thing you’re going to want to do when you’re ready to file your tax return, you’ve got the 1098 for this HELOC, you’re going to want to write on there, or at least let your accountant know that this interest is for that investment property.
Toby: Somebody just said, “What if I did it? What if I used it for a flip?” The interest on a flip would be deductible. The interest would be, but they’re not going to have income until they actually […].
Jeff: Correct. Normally, we would apply that to the cost of goods sold. You will get to deduct it when you sell that property. It’s going to increase your basis in the property.
Toby: A flip is just like owning inventory in a mini-mart. It’s Cheerios. You put in boxes on the shelf and somebody is buying it. It’s no different than your grocery store buying things on credit. You wouldn’t put it in as far as part of the basis, you’d put it in as a cost of goods.
Jeff: Most of the time we do elect to treat it as a basis.
Toby: Really, even the interest?
Jeff: It all works out to be the same way.
Toby: Yeah. What if you didn’t sell and you want to write off the interest?
Jeff: We could do that.
Toby: Yeah. It depends. Maybe you’re just flipping a whole bunch.
Jeff: Since we’re usually flipping in C-Corporations, there’s usually no advantage to that.
Toby: Somebody says, “Is it better to use a HELOC to buy investment property or should I go with the lender?” You’re going to get a much cheaper interest rate on a HELOC than you are if you’re doing an investment loan. Right now, investment loans are still 5%. On a HELOC, you’re probably getting it cheaper.
Jeff: As long as you’ve got plenty of equity in your primary residence, I think I’d go with a HELOC.
Toby: Somebody said, “If I sell my rental property, how do I optimize my tax deductions?” You 1031 Exchange it Cindy. Don’t pay any tax. Roll it forward so you don’t have to pay taxes, you have to buy more real estate. Or, if you take that money, you could also put it in a qualified opportunity zone or you find other real estate to offset. Well, this would be capital gains. You’re going to find something else, capital losses to offset.
Jeff: That’s one of those cases where you want to talk to somebody before you actually do it. You can misfire on that sale and disqualify yourself from certain things like the 1031 Exchange.
Toby: Somebody says, “What form should I use to loan to the LLC if I use money from a HELOC to buy investment rentals?” Technically, it’s all going to end up on your tax return. Your HELOC, you’re just taking that money and it’s going to be part of your capital account that you put into an LLC if you’re using it on that property. Any interest on it, it’s just going to be an expense that’s going to be the LLC’s.
Jeff: Yeah, we don’t want to bifurcate that interest into interest received and interest paid.
Toby: All right, that was a good question. “What is the cost of setting up a qualified opportunity zone?” Well, you’re not actually setting it up. It’s an opportunity zone fund that you set up. Then, you invest in qualified opportunities zone property. Talk to one of our guys. I think it’s less than $3000 to do the fund. What you’re really doing is you’re setting up an LLC and you’re making a tax election. You’re doing two things.
Somebody says, “For investment property, are HOA fees deductible?” On investment property, that’s an expense so yes.
“Should I use my HELOC for a downpayment on investment properties?” Cheap money. Your investment properties, especially if you’re a real estate professional, this is the year. You have two more years of this where you’re living in the vida loca of all great real estate.
Real estate markets are going nuts. There’s no inventory. The cost of wood has gone through the roof. It’s up more than double digits, it’s up 30%. There’s a lack of housing, the poor are getting hosed, elderly are getting hosed, people with disabilities are being hosed, veterans are being hosed, transitional housing people are being hosed. We need to help those folks out. That’s a big part of what I do in my investing, it’s just huge.
Then, you have this 100% bonus depreciation until the end of 2022. There’s never been a better time to buy real estate than right now. The numbers are ridiculous. If you ever come through, I teach a class. Actually, I’m teaching it on Saturday, The Infinity Investing. If you ever want to dive into the numbers, if you’re a numbers geek, then at the beginning of every one of those, I break down the numbers from the Fed. We go through the Federal Reserve Economic Data numbers and it’s ridiculous right now.
There’s no pre-foreclosures because nobody can. People are not missing their payments because they’re not spending a bunch of money on credit cards. Rents have gone through the roof. Real property’s gone through the roof. There’s no inventory. It’s never been more expensive to buy a house. It’s absolutely nuts.
Jeff: How do you feel about selling in this market and sitting it out until the next great real estate collapse?
Toby: There’s no end in sight of this growth. Somebody says, “Are negative rates coming to the US? How would that affect borrowing rates?” We’re already at 0%. We’re at 0%-25% and I can’t see us going negative, like Japan.
I actually had a buddy. His company was acquired by Japan and they shuttered it—his division—because it was cheaper. They made more money off the negative interest than they would make on actually running the business. It’s weird. I can’t see us going negative.
Jeff: Yeah, I have a hard time seeing banks going negative.
Toby: Somebody says, “What’s the current definition of a real estate professional?” I can just point you right to the Section, it’s 26. US Code 469(c)(7).
There’s two. There’s part one and part two. Part one is your primary work for one spouse. The way that’s defined is 50% or greater of their personal service time. The second part is 750 hours or more. That just means in real estate, not on your real estate, that can be any real estate, that’s development construction, you’re a broker, you’re an agent.
Brokers and agents had been used synonymous in that setting via the tax courts. They said that you could be a real estate agent if you qualify in 750 hours. If you have two jobs, one of them you’re spending 800 hours and your real estate meets that 50% requirement, you’d have to be 801 hours. Which is more than 750 hours, so you’d qualify.
If you were at 800 hours in job one and 775 hours from all your real estate activities. By the way, if you’re an employee, you can’t use those times unless you’re 5% or greater shareholder. If you’re a partner in your real estate company or something like that.
Part number two is you materially participate. It’s not just one spouse, it’s both. That’s right, both spouses. This is the least understood of all, there’s nine different tests. The easiest one is you spend 500 hours managing or working on your properties together. Each spouse could pay 250 hours or one spouse could spend 500 hours. Then, you don’t have to worry about it.
Technically, there’s no hour requirement on material participation if you self manage, for example. Get this, this is per property, so you have to spend 500 hours per property unless you aggregate.
Jeff: You make an election saying, I’m going to treat all my investment properties as one activity.
Toby: Yup. You guys just got more than most accountants now and it’s not a hard test. You just keep your time. Again, somebody who works in real estate—it’s easy. You’re going to hit that part one and then your spouse may manage your other property. You’re good.
If you’re single, if you’re in real estate and then you have managers that manage, technically so long as you spend at least 100 hours a year, nobody else is spending more than 100 hours on your property by themselves, then you’re good. You’re going to be a real estate professional. All that does is it locks your losses, it makes all your passive losses into ordinary losses from real estate activity so you can depreciate the heck out of your properties, offset all your income.
Somebody asked their CPA and they want continuing education. Yes, we do qualify. What I would say is when you are going to come to a course, you let us know because we have some hoops to jump through to get your hours. On some of them, all you do is you report, give the syllabus, and they’ll credit you the hours. A lot of them we already have pre-approved. You just have to let them know prior to you attending that you’re going to attend.
“Can you talk about the downside of aggregating properties?” Yeah, the downside, if you have a bunch of rental real estate and you have a bunch of losses that are locked into a property, so let’s say you have a bunch of loss carryforward and you’re not a real estate professional, and you decide to aggregate all of your properties together, then those losses are locked until you dispose of all of your properties.
Jeff: That’s the one downside I see. This is usually happening once you already have a bunch of passive losses and then decide to become a real estate professional.
Toby: We would be looking at that. Before we ever make the election, we run the analysis. You’re going to do that.
Somebody says, “I am a single owner LLC that owns a property in a land trust. What are the options for me to sell the house to get the $250,000 exclusion?”
The question really is, did you live in it as your primary residence two of the last five years? If not, then it’s an investment property, you can 1031 exchange it. You can 1031 exchange and do a 121 exclusion on the same property.
It’s kind of fun. For guys who like this stuff, you’ll like Tax-Wise. I’m not pitching it today. We’re not talking about it. If you like everything from the solar to the real estate professional, to how to use non-profits, and all that fun stuff, the Tax-Wise is actually really fun. I teach it twice a year and we record it. We’re already going later on.
Jeff: It’s just now four o’clock. We’re going well.
Toby: Jeff is like Biden. In the middle of the debate, he’s looking at his watch and he’s tapping it. He’s looking very impatient.
“I have insurance policies in India and would like to bring the money once they are matured. Do I need to pay taxes on this money?” That is the most funky question I’ve had in awhile.
Things that you have to know, first of all, it depends on where you’re a citizen and whether you’re a resident of the United States. If you’re not a resident of the United States, you don’t have a green card, or you’re not a citizen here, it really doesn’t matter, it’s up to India. Otherwise, you just bring in money in the United States and we really don’t care.
Jeff: You need to add a graphic that says it depends.
Toby: It depends. If you reside here, then the US says we’re going to tax all your money anywhere, but insurance proceeds or loans are not taxable. Bringing cash in the United States, if you’re here, you have to be careful because the IRS might say, hey, it sounds like income.
I actually had this happen to a client and he was a very large distributor of hardware, goods, and other materials. What had happened was a couple of million dollars got parked in his company because he worked with Lowe’s. He won’t say all the stuff he supplied. The IRS tried to tax him on and he said, it wasn’t mine. Basically, it was a deposit that was sitting here because they didn’t want to deal with the transfer money all the time.
It was just kind of silly. We won, it wasn’t all that hard, but it was still annoying. Here’s what you do if you’re bringing nontaxable income. I’m assuming that when you say that they’re matured, they have cash value and you want to borrow the money from the cash value. There’s a designation that you can get from a chartered accountant in India that says that the money has been paid. Actually, I know where it is. I can actually look it up real quick. What is it called? I was just looking at this because you would have a non-resident Indian and a person of Indian origin, there’s actually a document. It’s 15 CB. That basically says, hey, all the taxes are paid on it, we’re good.
Anyway, that was really exciting.
Jeff: I looked at that question like, what?
Toby: Yeah, I get it. The other thing that you have to look at is when you’re a non-US citizen and you pass here. You’re leaving it to somebody if you have assets in the United States, there’s only a $60,000 dollar exclusion. The United States is going to tax the heck out of it.
What you do is you loan the money from offshore and you make sure that the asset isn’t here because you don’t own the loan. You’re just borrowing it. The asset that’s in the United States becomes substantially less.
We would deal with this a lot when foreigners buy real estate, for example, we tend to say don’t just come over here and buy it. It’s a $3 million property. If you pass away, they’re going to take a million bucks out of it. Loan the money, buy it, and then you only have to worry about the appreciation because the loan always gets repaid.
Toby: I’ve been really being bad. We’ll go a little long regarding this comment about concern of blocking up PALs. “I’ll now declare I’m a real estate professional, what if I file 2020 and 2021 taxes as a real estate professional and then file 2022 as a passive investor? Would it unlock my PALs in 2022?”
Jeff: No. I say no, but that election to aggregate your properties is typically irrevocable unless there are substantial changes to your circumstances.
Toby: We looked at this. You have to see a material change in circumstances. I remember, we just did that. What was it? Yeah, it was a substantial change.
Jeff: It was somebody on a professional maternity leave who did not work many hours in the past year.
Toby: Yeah, so you have to show something changed. A material change as being said, I’m not just doing this for tax reasons. Actually, something switched that caused me to lose my real estate professional stance.
Jeff: It’s possible to be a real estate professional. If you only own one property, there’s no aggregation happening.
Toby: Now that you’ve got to work your hours on that one property.
Jeff: You do have to work your hours on that one property.
Toby: Participation, or you’re self managing that one.
Jeff: You’ll find that’s a lot of hours to put in.
Toby: Let’s just say that I have one rental property as a realtor. I’m meeting my 750 hour test and more than 50% because I’m a realtor. Then I have this property, but I’m self-managing the property. I meet the material participation test without having any hours. You won’t have to aggregate, nor would you ever aggregate one property.
Now, if you have somebody managing it, let’s say I own two properties out of state, then I have to spend a 100 hours total on the management activities of those properties and nobody can spend more than 100 hours on those properties, cumulatively. You’re not going to have a problem with the property manager. They’re probably going to spend about 10 minutes on it.
“What if you work in the construction industry, does that qualify as a real estate professional?” Yeah, Greg. It’s almost always going to. If you’re in construction, it’s just construction, reconstruction, development, redevelopment, anything. The guys that actually thrive the hardest because they’re making it six. The law was changed that made PALs come about when all the people that actually worked in real estate said it’s not fair to make all real estate passive when that’s how we make our living. They carved it out. Construction guys are number one.
Jeff: The biggest areas I see that are disqualified are usually real estate financing lenders and stuff like that. They usually don’t qualify.
Toby: They don’t count, right. You have to be involved in the sale. There was a lender that did. It was weird though because they were actually working on the transactions and stuff. If you’re just a lender, no. But if you’re involved in the transaction, then maybe.
“What form should you complete to show that you’re making an aggregation election?”
Jeff: It’s not a form, it’s actually an election that’s an election statement. You state that you’re making that election to aggregate your properties, and then you list what properties you’re aggregating together.
Toby: Going back to our friend Lily who is saying, “Hey, I’m a single land owner.” If you lived in it for two of the last five years, then you qualify, and if that was your primary residence, not just living in it. There are some people who have two and three residences. Jeff has his six mansions all around the country that he lives in. He had to pick one of them as a primary residence. That’s the one you can 121.
You can do a 121 exclusion every two years. If you lived in it for two years, it’s not the last two years either. I could 121 something and I could have rented it out two years since I’ve moved out and still get the 121 and the 1031. If you lived in it for two years, this is something you should be talking with us about. We can make sure that you won’t get dinged with the tax.
An example I sometimes give is, let’s say that you’re in the Bay Area, you bought a house for $500,000 and now it’s worth $3 million. Let’s say that you’re married, filing jointly so you have a $500,000 basis, $500,000 capital gain exclusion—that’s your 121, this is your basis—which means your total tax, you’re going to have tax on $2 million. That’d be 20%, plus 3.8% net investment income tax, plus 13% state. You’re going to pay about $720,000 tax which equals ouch. That would suck.
If we don’t want to pay any tax at all, then what we do instead is we still get the 121 exclusion but we make it into a rental property before we sell it. Then we 1031 that into something else. Maybe we 1031 $3 million, our basis moves up to $1 million so we get the benefit of the capital gain exclusion, if you know how 1031 exchanges work. We rent this one to somebody else for usually 3–6 months and then it becomes your personal residence.
What we did is we just saved $720,000. You have to do it in that form. You have to do it systematically and the IRS is fine with it. What they say is if you 1031 into a primary residence, your intent has to be to make it an investment property first, then show that intent by renting it, but then you can’t do another 121 on that property for five years.
“Will Biden be able to remove the 1031 exchange opportunity?” No, Biden can’t write laws. You’re going to have more likely a split Congress so they’re not going to be able to do anything. They’re just going to sit around and yell at each other and do nothing. Biden can’t do anything. The President cannot write laws. He can do executive orders and pretend, but it doesn’t count.
“If I buy office supplies and inventory for my business with my personal credit card, can that be the owner’s equity?”
Jeff: If you buy supplies and inventory with your credit card, that’s going to be a deduction for the business. You’re going to want to give those receipts to your business and they’re going to reimburse you for the difference, or like you said, you could put it into some kind of owner’s equity, or you could make it a loan to the business. There’s a couple different ways you can handle this, but it’s always going to be an expense to the business.
Toby: Can reimburse you?
Toby: Somebody says, “Thank you for the Coffee with Karl YouTube video recommendation. Karl is fantastic too.” That was to point you to Tony Talks. Tony is fine. Tony started with us, got out of the military. She comes in and I don’t want to say she was a receptionist years and years ago.
Over the years, she became an administrative assistant and a coordinator, moved up, got over certifications, became an enrolled agent and now oversees our professional tax department, the guys who do all the planning. She gets it and she’s worked quite literally just about every position here. She does a really good Tony Talks.
If you ever get a chance, go to her YouTube channel. These guys put their hearts and souls into those things. That’s a CA because it’s really nerve wracking to record or to talk in public.
The first time Karl did it, I remember he sweated so bad. They just put him on camera, there’s literally pouring off his head. It was pretty funny because he’s a really large person. He’s a big guy. He’s like a lineman, I wanted to put a sponge on his head. That was fun. I think he would’ve crushed me if I did. He’d probably just sit on me or something. I’d be no more.
Somebody said, “On the 121 exclusion, do the two years have to be consecutive?” No. It’s 24 months out of the last 60. It can actually go to days. I think it’s months but technically, the IRS will go all the way down to days to count.
Somebody says, “What is the amount I can charge off for a truck used for business? Can I use 179?” Any thoughts on that being available in 2021? Yeah, 179 is fine. You also have a bonus depreciation.
Jeff: Bonus is probably better.
Toby: Because 179, if you drop a little 50% use for business, it becomes all taxable to you.
Jeff: There’s also repercussions if you sell the vehicle.
Toby: It’s income or ordinary income back to you.
“September 30th is the ending, in which year do I file under 2020?” I have no idea what that means. Oh, I know what that is, that must be your corporate tax return and you’re filing for the year that it starts. For this year, you’d be filing for 2019, right?
You get into those arguments with people. I had one guy yelling at us, he couldn’t figure out which tax year. It was what year you could’ve started even though the business started. It was just crazy.
Jeff: Going back to the question about the 121 cannot be broken up, I’d say the only thing you don’t want to do is have the periods be too short because then the IRS says, well, that’s not your primary residence.
Toby: Yeah, you could get into those situations. There are exclusions for people that travel for their work or that are doing military. You could have periods of deferment, you could go up to 10 years.
Jeff: There’s also going along with that, if you’re forced to move because of job relocation or something, it can be shorter than the two years.
Toby: Somebody says, “What about S and C Corp, is it good for flipping the houses I have now?” Absolutely. That’s what you wanted.You want it in a separate taxpayer. It could be an LLC taxed as S Corp, LLC taxed as C Corp, it could be a limited partnership that’s disregarded to a corporation—which just sounds crazy but is actually a thing. We’re starting to use those in California because they just came up with a ruling that allows us to do it and report some of the excess tax. There’s some crazy stuff.
What we know for sure is that you don’t want it on your personal 1040 or as a Schedule C on your flipping houses. You don’t do that.
“Do you guys specialize most in real estate taxes? What about stock trading?” No, that’s where we started, as a stock trading. Stock trading has literally one way that I will tell you to offer. I would say, if you’re just getting started and you’re making less than $10,000 a year, you can put it in a C Corp or an S Corp. Otherwise, you’re always going to put your stock account into a vehicle that is a partnership for tax purposes, in an LLC taxed as a partnership or the corporation as its general partner. You cannot write off anything on your personal taxes anymore because miscellaneous itemized deductions went bye-bye.
Somebody says, “Can I claim 121 in two properties if I lived in two properties within the last five years and two years in each?” You can claim one 121 exclusion every two years. If you lived in one property, you would sell it, the one that’s the longest. Otherwise, you could possibly lose.
If I lived in a property four years ago and I sold the one I moved out earlier now, I’m going to be in my sixth year when I sell the last one so I would be able to do it.
We can map that out for you if you’re having trouble with it.
“Could I take out $100,000 from my current 401(k) according to the CARES Act and roll it to a different QRP without tax consequences?”
Toby: I’ll make it easy. What I’m thinking is maybe they do the early distribution so they take this out and they’re going to pay it back in three years. You could put that into an IRA or QRP and they treat it as a trustee to trustee transfer. It’s not like you’d even put into your name.
Somebody says, “I put my house in a non-revocable trust. Does that affect my tax base?” It depends on whether it’s intentionally defective for tax purposes. If it’s in IDIOT, intentionally defective for tax purposes or in intentionally defective grantor trust technically, then it doesn’t matter.
Jeff: There’s my buddy, call them an IDIOT trust based from the ‘Ssippi.
Toby: I don’t know why but I think of The Waterboy. That was Louisiana. My brother lives in Louisiana, he drives over the Mississippi all the time. He’s always going and doing those car things on the sand there and in the GolfBoard. I immediately started making bad accents and I apologize, it’s probably wrong of me.
Jeff: I’m from Kentucky, I got relatives from Tennessee and I’m always throwing an uhm.
Toby: You’re an idiot, Jeff. You have intentionally defective grandparents. I did that at a work party.
Jeff: Usually, with that irrevocable trust, unless it’s got that paragraph in it, that stuff now is owned by the trust itself.
Toby: “Can I do a QRP plan in 2020 and then take out a non-interest loan payable in three years?” You have to do it this year, yeah. You’d have to put the money in and then take an early withdrawal. I think you can. I don’t know why you wouldn’t. The law is pretty straightforward. As long as it was because of COVID.
Let me rephrase this. If you roll over an existing plan, I don’t think you have a problem. If you make a contribution this year, you’re going to have an argument. I think you’re violating the spirit of the law which is, hey, you can take money out of your plan because COVID’s still tough. But if you’re putting money into the plan after COVID, it defeats that argument.
What I’d more likely do with you is if you put money into it, I’d borrow half of that and you have a deferment period for the rest of the year. Then you have a five-year pay back and pay it at 4%, you’re paying it to yourself anyway.
This falls under the adage, pigs get fattened, hogs get slaughtered. Don’t violate the spirit of the rule. Technically, I suppose you could but I don’t think I’d do it.
“If I use a credit card to purchase stock, can I write off the interest I’m paying on the credit card if I incur losses?”
Jeff: When I read this question, I was thinking I don’t know that I would ever do this because most credit cards have an extremely high interest rate.
Toby: Not only that, it’s not just the credit card, it would be considered investment expense. You can only write it off against investment income so you wouldn’t be able to write it off if you have losses.
It makes me immediately think of a case that was on Trader Status where the guy was buying on margin. He was paying interest and he was disallowed his interest deduction because he didn’t qualify as a trader. He needed $15 million for the transactions. I think that’s Frederick Meyer’s case if I’m not mistaken. I could be. I’d messed up the midnight train to Georgia thing.
Jeff: To answer your question, yeah, you could do this.
Toby: You could do it but you’re not going to get to write it off if you have losses. You have to have investment income. I don’t know, I think I’ll probably carry it forward until you do have the income. I don’t think you’d lose it, I just don’t think you can use it.
Jeff: We’ve had the same issue with a margin account rather than a credit card, but I would think at least the interest rates would be lower.
Toby: Yeah, but still, don’t do it. Well, the credit cards could be zero or it could be some really low amount, but I still wouldn’t do it.
Jeff: And you get the miles.
Toby: I still wouldn’t do it because you’re gambling. I’m all for investing, I’m all for these things, but the only time I’m going to use credit on something is if the asset itself is going to be paying off the interest.
If I had a really low interest in a credit card, let’s say I had a 2% credit card and I had a 3% dividend-paying stock, maybe I would do it. But I can’t see that thing as a situation.
Jeff: We do leveraged investments. We have a lot of real estate and so forth.
Toby: But the real estate needs to pay for the interest. If it doesn’t, then you’re running a huge risk. Again, I’ve never seen a foreclosure that didn’t have a loan. I’ve never seen somebody go bankrupt that didn’t have a debt to somebody else. So if you can keep the debt to a minimum, you’re going to be fine.
I know you think you’re going to take it and you’re going to make 30% interest. You might, but there’s a good chance you’re not. On average, you’re going to make somewhere around 7%–10% a year so don’t screw around with it. Your credit card, the average interest rate is 18%.
I remember looking this up for one of my classes. It’s really high. It sucks, don’t do it.
Alright, somebody says, “What is the CARES Act’s schedule for repaying the $100,000 401(k) withdrawal?” There’s two of them. One of them phased out in September which was the loan. That’s a five-year payback with a year deferral, so six years. The early withdrawal, you have three years from the withdrawal. I think it might be the tax year so it might be 2022, December 31st.
I have to really nail that thing down because I’m still not 100% certain on it. Is it three years from the withdrawal or is it the third tax year?
Jeff: I would say some of the others said it was three years from December 31st of the year you took it out.
Toby: Yeah, I think that’s what it is. It’s three tax years.
Jeff: You’d still count 2020.
Toby: You take it out on 2020.
Jeff: You have to have repaid at the end of 2022.
Toby: Yeah, you have to have it back by 2022. You’re going to pay tax in 2020, 2021, and 2022 which is stupid.
Jeff: And then we get to amend all your returns.
Toby: I’d probably just report it, but that’s me. It makes me mad that they’re doing that. I don’t think the IRS is right.
Jeff: I don’t either.
Toby: I would say, Patricia, I would email and then we’ll give you a written response so I can look it up. But I think it’s going to be December 31st of 2022. That’s my understanding.
Somebody’s asking a crazy question about boot. “Can I take boot on a 1031 exchange for the expenses with the tax with a large charitable donation, or a 529 plan?” The 529 plan is not going to give you a deduction. The large charitable contribution though absolutely would. In fact, you can donate up to 100% of your adjusted gross income this year.
Somebody says, “Is there a difference in a loan to your corp versus a capital contribution?” Yes, Jeff.
Jeff: A loan to your corporation, you can get back tax free. A capital contribution is now the corporation’s money and the only way to get it back is through dividends or salary.
Toby: You can buy back your share and it’s return of basis, right?
Toby: But it’s easier to do a loan. If you loan money to your corp, you’re supposed to charge interest if it’s more than $10,000. In fact, they’re going to pay interest to you if it’s more than $10,000.
“If Biden gets in, how far back can they go with tax changes?”
Jeff: I don’t think they can go past 1950.
Toby: It can’t go back retroactively, guys. Everyone is always worried that they’re going to do stuff that’s going to affect us. No, they can’t do that.
Jeff: The times I’ve seen it go retroactive are the things that benefit the taxpayer.
Toby: Yeah, you’re allowed to do that. They can’t do a governmental taking. Hey guys, if you sell all your capital assets, it’s 20% and then say, no, 40%, 50%. You all know they can’t do that.
Somebody says, “I thought you mentioned it but I wasn’t writing fast enough, $10,000 options earning. If under $10,000 option, I don’t know what that does. Maybe I was going crazy.” No, if it’s more than a $10,000 loan, you have to pay interest on that loan. It doesn’t matter who it’s to. If I loaned money to Jeff, even if I say, oh, it’s free, they don’t let you do that.
Jeff: IRS actually calls that gift loan. The $10,000 you’re off.
Toby: But […] pay taxes though I received interest. If it’s less than $10,000, they let you do it. If it’s over $10,000, then they say you have to pay interest.
Jeff: I think the reason they named that a gift loan is because every commissioner has had one of their kids ask to borrow money that’s never been repaid.
Toby: They’re still stuck on this 121. “Can I claim 121 in two properties if I lived in two properties within the last five years, two years on each?” Yes but you can’t do more than one. I can do 121 in 2020 and then I cannot do another one until 2022. I have to wait two years.
I’m going way over. Everyone’s going to get mad at me because I told them I’d be done at 4:00 PM or something. I’m pretty close. There’s a lot of questions coming in. I don’t feel guilty.
“What happens for tax purposes if I want to sell a property that was in an LLC? Do I need to transfer it back to myself?” This is going to be cool because I’m going to play a lawyer on you. What do you say?
Jeff: I’m going to say no, you don’t have to transfer it back. You’re selling it in the LLC.
Toby: Except an LLC isn’t a tax designation. What if it’s a corporation? I just love this stuff. What if that LLC is owned by a 501(c)(3)? That’s just being evil.
Let’s just assume that this is flowing to your 1040, then you don’t have to worry about it. I’m just being mean. Everytime I see an LLC, I think of all the lawyers out there. There’s a list served where we literally make fun of judges that call them limited liability corporations. It’s just brutal. Every time there’s an opinion, they go, look at this gal. I’m like, they’re probably divorce lawyers, they don’t know any better.
Somebody says, “A relative loaned $10,000 in 2017, paid it back in 2019 without interest.” I have no idea what that means. You’re okay, I’m sure.
“Is essential duty pay taxed for COVID crisis?” Do you know that one? Is there any exception for them?
Jeff: I don’t know of any exceptions for that. I’m thinking of first responders or something like that.
Toby: There’s some weird little things where they exempt certain types of pay from taxation. I don’t know if this is one of them so if you could email that in, let us take a look and we can read it up. I know Piao would love to research that.
“Do capital losses offset capital gains in a 1:1 ratio no matter what your earned income level is?” Yes.
“Would $1 of capital loss offset $1 of capital gain in the same ratio regardless of being short-term or long-term?” Yes. What that means is if you have short-term capital gains and it’s taxed to your ordinary rate, and you’re in the highest tax bracket, you could be looking at having a tax on that of 20% plus 3.8% plus your state. But if you have $1 of capital loss, even if it’s long-term capital loss, short-term gains would be 37%. Would you still be in the net investment income tax on it, 3.8%?
Jeff: You could be if you’re over $200,000.
Toby: So you could be looking at 3.8% plus your state. You could be looking at a big shot-term tax but your long-term capital loss would offset it.
Even though it’s being taxed at twice the rate of the long-term capital gains rate, that long-term capital loss still offsets it. Which is why when you have short-term capital gains, you’re going to see people saying do you have any losses anywhere? Do you have anything that has a non-recognized loss, long-term loss?
Jeff: The one thing I don’t like about this is that $3000 of losses they allow you to take every year, they take it from the short-term losses first, when I would rather apply the short-term hopefully against some short-term gains in the future. I’d rather take my long-term losses, they’re worthless.
Toby: Here’s another one. Let’s say that you are husband and wife or just a single person—it’s whatever the rates are—but husband and wife making less than $80,000, plus you have a standard deduction of $24,800 or something like that. I’m just going to call it $24,000. We know that we have at least $24,000 where your long-term gain rate is zero for at least that $24,000. Your long-term capital gains rate is up to $80,000. Now we look around, we see unrealized gains. You look at your stock account and let’s say you have unrealized gains of $20,000. What we do is we sell it and buy it right back.
Jeff: Somebody’s going to ask, wash sales do not apply to gains.
Toby: Yeah, the wash sale loss rule is for losses. We get $20,000 of gain that gets added to our deal. We now have $20,000.
Our total income for that year is going to be $76,000 and a big chunk of that is going to be 0% from long-term gain. Your ordinary taxes are going to be on $56,000.
You just got tax-free money of $20,000. You’re going to say, why would I do that? Because it resets your basis. That $20,000, you’re never going to pay tax on it. When you sell that stock at a gain later, it’s going to be better off, or if it loses money, you’ll be able to take the loss. Whatever the case, we’re now making sure that we never leave that money on the table. That goes whether you’re in the 15% tax bracket either. You want to make sure.
Somebody says, “I’m also a first responder.” Thank you guys for doing that. We’ll definitely talk about it next Tax Tuesday for sure. Patty, you can make sure. If nothing else we’ll give you a response, I’ll go dig up on it.
“My son and I both have solo 401(k)s. How can we partner in a buy-and-hold real estate investment without violating disqualified parties rules?”
Jeff: You invest in your 401(k) with your son’s 401(k), they are not disqualifying parties. They are totally separate entities. You can form a partnership like Toby’s drawing up now. We got an LLC taxed as a 1065. The partnership’s going to have to file a return. It’s going to issue two 401(k) plans and they’re going to put them in a file cabinet somewhere. One thing you need to remember anytime you invest with a 401(k) or an IRA, you got to put enough money into that investment when you get it correct.
Toby: What Jeff says is actually 100% correct. You’re not a disqualified party because it’s not a party. It’s another qualified plan. If the question is, is there any provision on qualified plans co-investing and working together, no.
Somebody says, “Capital gains count your income first to not capital gains.” I think that’s what we did.
“Capital gains is now 0% if you make $38,000 something.” If you’re a single person, what is it going to be? Maybe close to $40,000, up to $40,000.
Jeff: I’m going to be updating those soon. Our cheat sheets, we’ll be getting those out.
Toby: “Is there a prohibition of the father-son working actively on the real estate investment from the retirement funds?” Yes, you can’t pick up a hammer. You can’t use your personal service to make it more valuable. That’s a good one. But they can invest together, passive investment, better way to put it.
Last question, I know we’re over. I’m going to say, we’re going to answer this one and then we’re going to be done. For those of you guys who ask questions, I can see that they’re catching up to you guys. There’s a few that are hanging out. What we’ll do is we’ll continue until I answer the questions and make sure we get them done.
Here is the last question. This is the last one, no more questions, guys.
“I have an HSA account from my employer.” It’s a health and savings account. “The IRS maximum contribution for 2019 was $3500 and my employer contributed $1500. The IRS maximum contribution amount for 2020 is $3550 and my employer will contribute $1500. Am I allowed to contribute this November for both 2019 and 2020 tax years?” You won’t get any benefit for 2019.
Jeff: HSAs and IRAs share the same deadline for making contributions which is the original due date of your 1040. This year was a little weird because it put it back to July 15. To make a contribution like Toby said, you had until July 15th to make that contribution to your HSA for 2019.
Toby: For 2020, you could do it. But for 2019, you couldn’t.
Jeff: You could only put in an additional $2050 and that would be for 2020. You would have up until April 15th of 2021 to do.
Toby: Unless they can provide you something that’s weird that I’ve never seen before. It’s 2020 only.
Jeff: People are asking questions, Toby.
Toby: Stop it. Alright, Anderson podcast, if you like listening to this stuff.
“Can father and son, the 401(k) have a C Corp as an entity manager?” No, they can’t be doing anything personally to benefit themselves. They could have a C Corp but they can’t be doing it. Realistically, they would violate the heck out of it if they were an owner in the C Corp.
“Could they use a third party C Corp?” Yes, but nothing else.
Alright, we’ve had enough.
Jeff: Toby had a long day.
Toby: I was on a webinar all morning. But it was fun. Tom is a really smart guy, I was scribbling stuff down. He thinks the same way that I do on the way that we process data. It was weird. It was like, wow, he thinks the same way that I do. You’re like a number cruncher. It’s nice to see someone who’s very focused on a systematic process like that. There’s a reason why he’s successful.
Alright, andersonadvisors.com/podcast. You go there, you can always take a look at the replays at the Platinum Portal. When you go to the podcast, you can go to iTunes or Google Play as well. See Anderson Business Advisors Podcast. We have a whole bunch of really cool podcasts that we’ve done recently.
Clint does a fantastic job. Michael does a fantastic job. There’s so many that are in there that are just really, really cool. I like to stick around with the guys that are bleeding hearts out there that are doing some of the non-profit work. We’ve got some other ones in there too, plus you get all your Tax Tuesdays.
If you have questions and especially if you didn’t get your question answered, by all means, send it in. You can send it in Tax Tuesday. I’m going to do my last little star here. Tax Tuesday, you can always go to Anderson Advisors as well but if you want a question answered, by all means, just grab that email@example.com.
Jeff, thank you.
Jeff: Thank you, Toby.
As always, take advantage of our free educational content and every other Tuesday we have Toby’s Tax Tuesday, another great educational series. Our Structure Implementation Series answers your questions about how to structure your business entities to protect you and your assets. One of my favorites as well is our Infinity Investing Workshop.