Do you have enough money saved up for your retirement? Do you feel good about your golden years? The good news is that legislation was passed recently called the Setting Every Community Up for Retirement Enhancement (SECURE) Act. However, it means saying goodbye to stretch IRAs and age limits on IRA contributions. Toby Mathis and Jeff Webb of Anderson Advisors answer SECURE Act and other tax questions that may impact your financial future. Do you have a tax question? Submit it to taxtuesday@andersonadvisors.
- I am trying to qualify my wife for real estate professional status, and she will go part-time next year. She is a physician. How will IRS treat her on-call duty hours? Only count hours she is actually working on real estate, not her on-call duty hours
- I have significant start-up costs for training prior to the establishment of my LLC (C Corp). Are there alternatives to recapturing the start-up costs in less than 15 years? No, but you can write off $5,000 for up to $50,000 in start-up costs the first year
- I am interested in providing a Wellness Plan for my employees. How do we structure it, so it isn’t taxable income for employees? Non-taxable benefit to company, and non-deductible benefit to employees
- Is gap lending income passive or active for a 401(k)? Gap lending is lending and passive/interest income; not an active business
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Full Episode Transcript
Toby: Hey, guys. This is Toby Mathis.... Read Full Transcript
Jeff: And Jeff Webb.
Toby: And you’re listening to Tax Tuesday. The first Tax Tuesday of 2020.
Jeff: Happy new year.
Toby: Happy new year to you. We have a pretty action-packed episode, we have a lot of questions. What’s interesting, I didn’t see a lot of Secure Act questions. We did have legislation that passed right at my […].
Anyway, we had a whole bunch of stuff gets passed at the end of the year under the Secure Act that’s supposed to help people save for their retirement. I didn’t get a lot of questions on that, I’m sure we will. I may hit on a few of those items. It’s not anything earth-shattering, but it certainly going to change the dynamic. We don’t have stretch IRAs anymore and we don’t have age limits on computing to IRAs anymore.
You can always send in questions to email@example.com. We are almost up-to-date on all of those questions, so if you haven’t got an answer, you should have and you could just send it back in or email me or any of us. Or if you haven’t gotten a question, you can actually just type it in now and we’ll flag it, and let people look over your questions.
If you need a detailed response, you’ll need to be a Platinum or a tax client. If you’re asking for specific advice on your situation and it’s not a general question, but you’re asking for consulting or tax advice, then we’re going to need to have you as a client. It’s not expensive, it’s very easy.
This is fast, fun, and educational. We want to get back and educate. The whole idea here is that we’re going to answer all your questions, no holds barred. We’re not going to sit there and send you a love letter with a bunch of numbers on it, also known as a bill for asking your question.
Let’s jump into the questions that we’re going to answer today. There’s a lot of them. I’m just going to throw and then Jeff and I will knock them out at the park, and he will be answering your questions as well.
“I have a single-member LLC in the state of Texas. I want to change to a multi-member. How easy is that to change?” I will answer that.
“I am trying to qualify my wife for Real Estate Professional Status and she will go part-time next year. She is a physician. In order to keep her below 750 hours, do I count the hours she’s on-call? She sometimes works 12 hours and sometimes all 24 hours when she is on-call. How will IRS treat her on-call duty hours?” We’ll go over that. It’s actually some law on that.
“I have a significant start-up cost for training prior to the establishment of my Texas LLC, which is taxed as a C Corp.” If you’ve been listening to us, you know that LLCs are not tax status; they don’t exist to the IRS. We have to tell the IRS what they are in terms as what kind of taxable entity it is. Disregarded C Corp, S Corp, partnership, what is it, so this Texas LLC is taxed as a C Corp. “Are there alternatives to recapturing these startup costs in a shorter period of time other than 15 years?” That’s a startup expense. We’ll go over that.
“I have a management company that manages another LLC. Can I hire my kids to help me with documentation and back-office administration work? Can I give them on the company’s payroll and can the company contribute towards their Roth IRA? How old do children have to be hired by the company?” We’ll answer that.
“I opened a new backdoor Roth this week at Vanguard and funded it with a $3000 transfer from an old non-deductible Vanguard traditional IRA opened 10 years ago with after-tax dollars.” We’ll go over what all that means, by the way. “My max allowed contribution for 2019 is $7000. Does that mean I can only contribute $4000 more of new funds, or may I still contribute $7000 more? Since all these funds came from my checking account after-tax dollars, what is the basis or will I be taxed again?” This is going to be fun, Jeff, because you get to have your accountant title […].
“I am interested in providing a wellness plan for my employees. Our company has multiple employees working in five states. How do we structure the plan so that the benefit does not become taxable income for the employee? Items we had I mind are gym membership, athletic classes, yoga classes, meditation training, nutrition consultations, et cetera.”
“I have owned a rental townhouse since 1990. In 2017 we moved in to make repairs but stayed there until now. I know I can’t claim it as a rental for 2017-2019, but I have almost $40,000 in deferred losses that I don’t want to lose. I’m planning on moving back to my primary residence in 2020 and returning the townhouse to a rental. What are my options?” We’ll go over that. That’s interesting.
“My friend and I bought a single-family house,” that’s what SFH stands for, “five years ago and sold it this year. We split the profits from the sale without regard to federal taxes. We bought the property in a family trust in her name with me as a trustee. Am I liable for her portion of unpaid taxes from the sale of this property?” We’ll answer that.
“If I claim 50% bonus depreciation on a rental property on my federal income tax return, do I need to add that back against regular depreciation on an Illinois State return?” We’ll go over that.
“If you rented out your primary residence and took the tax depreciation for two years but later sold it as a primary residence because you had lived there for two of the last five years, is the capital gains based on the difference between the sale price and the original purchase price or is it the sales price less the depreciated value?” This is a 121 exclusion question and whether or not that depreciation is part of it. We’ll go over that.
“Is gap lending income passive or active for a 401(k)? Does the term ‘less than a year or more than a year’ affect taxes for C Corp?” I think we have two questions buried in there. We’ll unpack that one. As you can see we have a lot of questions.
Jeff: We have a lot of questions.
Toby: “My business is an LLC that files as an S Corp. No employees, just me. At the end of 2018, I signed up for an HSA-approved health insurance plan (which went into effect as of 01/01/2019). My deductible is high ($6000) but I am fairly healthy, so my analysis at this time concluded that it would be better to pay the lower monthly premium and pull all of my qualified health care expenses (doctor visits) from the HSA fund (Health Savings Account), which should be tax-free. I still have not funded an HSA ($3500 for 2019) because I’ve gotten mixed messages from two different great accountants. What is the rule?” We’ll go over that one. Based on what you just wrote, I could see why they are probably confused, but we’ll unpack that one.
“If I currently hold rental property in my individual name, what are my options to transfer title out of my name to an alternative entity to reduce legal exposure?” You’re talking about how do I keep from getting sued. “Is there a way to avoid being noncompliant with covenants that prohibit the transfer of title?” I’m talking about the lender. We’re going to go over all those.
Here’s an easy one. “Can you please provide enough data on the change in age for required minimum distributions to 72 that is effective 2020? Does this mean that you have to take the RMD when you turn 72 or does it allow you to take it in the 12 months after you turn 72? Does it include all retirement plans? And IRA specifically, does it include 401(k)?” The question out there is under the Secure Act. They changed the required minimum distribution age to 72. For people that are hitting that age, after (I believe it’s) January 1st, 2020. Have you taken a look at that?
Jeff: I have not looked at that.
Toby: I believe it’s going to be for anyone turning that age after. It’s going to be during the tax year that you have to take their required minimum distribution. I hope that answers the question. It’s when you hit 72 then you’re required to start taking RMDs when you hit 70½ (the old rule), then you have to take a required minimum distribution for six months?
Jeff: Yeah. You always have the option on the old rules to defer until next year, but then you had to take two RMDs in the next year. I would think under this new law, if it starts in January 1st, probably that year and there’s not going to be that deferral.
Toby: We’ll take a look. There’s a lot of questions that have already popped up here, so we’ll take a look at those.
“I have a single-member LLC in the state of Texas. I want to change to a multi-member. How easy is that to change?” Whenever you have an entity and especially in LLC, remember that LLC is not a tax designation. We have state and federal that we’re going to worry about. Because the LLC is not a particular taxable entity, we don’t have to do anything with the LLC except perhaps update the operating agreement and say, “Hey, we’re bringing in a member. Make sure that you comport with the operating agreement.”
Most operating agreements say that when you bring in a new member that the existing members have to agree. You want to make sure that you document the paperwork to bring in a new member, and you’re documenting their capital account. Which is how much money they’re putting in.
Once it becomes a partnership, now we’re dealing with the feds. When you’re a single-member LLC, you have the option of treating it as a disregarded entity, which means you have really no choice. You’re either using your social security number or if you set up an LLC and you get a tax identification number for it, it’s going to be ignored and go to your tax return. You’re going to need a new tax ID when you go from a disregarded entity to a partnership. According to the IRS and according to under the SS […] rules, you would want to apply for and receive a brand new EIN and start filing a partnership tax return.
It’s actually really easy to do. You have to go in and just get the new EIN, update your bank account information, and then start filing. You wouldn’t have a partnership tax return for the year 2020, until 2021. You’re not going to be worried about that until March 15th of 2021. It’s very easy to do, you just want to make sure that you’re covering your backside with a little bit of paperwork.
Jeff: And you become that partnership the moment you add that new member. There’s also an option, you may (for some reason) want to become an S Corporation or a C Corporation, where you won’t have to file additional paperwork with IRS, but otherwise, it’s fairly simple to become that multi-member LLC.
Toby: All right. “I am trying to qualify my wife for Real Estate Professional Status and she will go part-time next year. She is a physician.” She already works her butt off. She wants to be a real estate professional. The big issue is the hour requirement because it’s not just 750 hours. It’s 750 hours plus it has to be more than 50% of your personal service time. For physicians, this might be interesting.
Basically the rules go like this. If one spouse qualifies as a real estate professional, then the entire jointly filed return qualifies. One spouse qualifies for the 750 hours and more than 50% of the time, both spouse’s times get added upon the material participation. We’re just going to go straight to the 750 hours with 50% or more.
If you spend 12 hours in a part-time job, then you have to do 1000 hours plus 1 hour, so 1001 hours on your real estate or 1000 and 1 minute. Whatever it is, you’re going to want to make sure that’s more than 50% of your time is spent on real estate. And obviously the fear here is, “She’s on-call, do I count all those times?”
Jeff: I come both ways with this because if she is on-call, she may still be available to do her real estate activities. I don’t know if I count those times that she’s on-call or those times that she’s actually actively participating in this on-call time.
Toby: There is an opinion on this, and it’s the reverse. They looked at the time that they were on-call with real estate, saying they wanted to add the hours that you’re on-call that, “Hey, every day I’m on-call for my tenants. I have to be here and they could call me at any moment so I have to be available because I’m fixing their toilets, everything else.” And the IRS said, “You do not count on-call hours as personal service hours.” I’d say that’s pretty clear that the IRS says you don’t count the time you’re available to work. You only count the hours that you’re actually working.
Jeff: And I agree with that. If you’re on-call for 24 hours, you’re obviously not working that entire time, unless you’re a medical intern.
Toby: That would be it. I would not count her on-call hours. I think that we have some authority to back that up because they can’t have it both ways.
Somebody asks, “Do I lose the seasoning of the LLC when you switched?” We’ll go back to that first question. This is just relating to this question here, “I have a single-member LLC.” No, you do not lose the seasoning in any way. Become a state standpoint, that LLC started the day that you filed it. From a federal tax standpoint (which doesn’t make a difference on the asset protection), unless you’re on a state where they don’t give asset protection to single members like Florida, for example, the old homestead case or you have Colorado, some of these states where they have weak asset protection for single members, then it helps to have that partnership, but it does not affect the seasoning of the entity.
Jump on your other one. “I have significant start-up cost for training prior to the establishment of my Texas LLC. Are there alternatives to recapturing these startup costs in a shorter period of time other than 15 years?” What say you, Jeff?
Jeff: Unless it’s something very specific. I honestly don’t see a way of going shorter than the 15 years for startup cost.
Toby: Yeah. Startup cost, there is one little niche. You get $5000 startup cost if you want to take it in year one. If it’s $5000 or less, you can write the whole thing off, you don’t have to worry about the 15 years. If it’s more than $5000 and less than $50,000, then you can take the $5000 and then you take the rest of it over 15 years.
The other little niche is if I haven’t used what I bought. Startup expenses and expense that would’ve been deductible, had I established the entity already, but I did it reverse. I did all the cost, my travel and setup and everything else, my investigation into that business, everything and I created this business and had the business been in existence it could’ve written it off, now I’m just going to grab it and I’m going to write it off over a period of time.
Jeff: I think a good example of that is travel that you may pay for in advance with incorporating, but the travel actually takes place after incorporation, and it’s a business expense.
Toby: That’s a good example. If the date that you incorporated is the date that that expense becomes and ordinary necessary expenses this year. If it was something that you incurred and did prior to the date of incorporation, you paid for something and got it used before you are set up, it’s a startup expense. An example would be like if I bought a computer, it was new in a box, before I set up the corp, and it was only used for the corp, then my argument would be, “Hey, I would just reimburse you for that. I would write it off as a current expense. I wouldn’t use that as a startup expense.”
It sounds like they already did the training, they did everything ahead of time. Realistically, you’re going to have that $5000 rule and then you’re going to take the rest over 15 years. If it’s more than $50,000, you’re just taking the whole thing under 15 years. I don’t know another way around that.
Jeff: But you bring up another good example. Any equipment that you may have purchased before the corporation existed, but wasn’t used until you incorporate it could still be depreciated under a probably much shorter life than the 15 years.
Toby: There are certain items that have all their value given to the entity. I’m going to treat that as an ordinary. The other one is some people buy a training and they incorporate right in the middle of it. They’re in real estate, they’re honing their skills, maybe they’re doing flipping and stuff like that, and they set up their corporation in the middle of all these things, they did half the classes before, half the classes after. There’s a good chance I’m just going to say, “Hey, half the classes is a startup expense. The other half is an ordinary necessary expense and I’m just going to treat it as a capitalization to the company or as a loan to the company with a payback.”
Again, this is why you have an accountant because they’re able to help you dig through these, but you have a few options and yeah, there are little tricks here and there that you might be able to deploy that go along.
Somebody asked a question that still relates back to the LLC question, so we’re going all the way back to the very beginning. “If you want to create a disregarded LLC, does it have to be a single-member LLC or can I have my spouse?” The answer to that is it depends on your state. If you’re in a community property state, you can have your spouse. If it’s a separate property state, then it’s a partnership. Don’t you love that answer?
Single-member spouse is considered a single member if you’re in a community property state, like Nevada, Washington, and California and few others. If you’re in a separate property state like Illinois or whatever, you’re going to be Pennsylvania, New York, all these states that are separate property then you’re considered a partnership.
“I have a management company that manages another LLC. Can I hire my kids to help me with documentation and back-office administrative work?” The answer is yes. “Can I add them to the company’s payroll? Can the company distribute their Roth IRA? And then how old do the kids have to be?” Do you want to whack this?
Jeff: I agree with your first answer. The only exception is the company doesn’t contribute towards the Roth IRA. The kids contribute to a Roth IRA from the pay they earn from the payroll.
Toby: The only way that the company would be contributing towards anything that says Roth is if you have a Roth 401(k), but the Roth IRA is an individual retirement account so the kid would be taking that money. If you guys have heard my story, I did this with my daughter and we contributed to IRAs when she was working while she was still in her teens.
As far as how old do children have to be, it depends on what they’re able to do. We have cases where kids are doing things when they’re in the single digits. There’s case law of a child at nine who got SAG rates for basically doing all the advertising, being in all the advertising pictures and things like that. They were given Screen Actors Guild rates by the company, and that’s what the IRS determined it had to be. It’s a reasonable amount. So yes, you can absolutely put your kids on the payroll.
When you do them on payroll over S Corp, C Corp, then they’re going to have withholding if you are paying them and you are a sole proprietor or a single owner LLC that is disregarded, then you do not have to do withholding. There is a little bit out of nuance that is much easier if you’re a sole proprietorship to pay your kids, but there are always bad things that come along with the sole proprietorship.
What I have seen (and it depends on how complicated you want to get), if you have company number one and spouse number one is running that company (maybe it’s an S Corp), and then you have company number two with spouse number two that’s doing part-time to almost no time work and it’s that entity that hires the child.
When the kid’s working on behalf of the company, they’re actually working on behalf of company number two, and company number one pays company number two, which basically goes to the child. Now you don’t have the withholding. It just depends on how complicated you want to be and how cheap it is to have an LLC in your state.
For example, I wouldn’t do that in California because its $800 a year to have an LLC. I would that in Indiana where it’s like $50. It all comes down to it.
Jeff: And as far as labor laws go, most of the states in the federal government are very liberal on family hiring of children. The children are usually exempt from worker’s comp, premiums are usually exempt from unemployment. You do save a little bit by hiring your kids.
Toby: I did my situation a little bit differently. I actually had my daughter when she hit 18. There’s somebody that said, “What if the child’s 36 years old?” then you pay them through payroll or you pay them through a separate entity. I’ll have them set up their own company, be their own sole proprietorship.
Somebody just said, “I pay my kid from the single-member and I pay less than $12,000. Should the single-member LLC issue W-2?” If it’s a single-member LLC, then you’re doing a W-2. You just don’t have withholdings. “Are you still doing a W-2?” Absolutely, Patricia.
Jeff: Single-member LLC can pay other people. They just can’t pay the owner.
Toby: Somebody just says, “Could you explain a disregarded entity?” I throw that phrase around. Disregarded means the IRS ignores it. Who the owner is, is who they look for their tax. If I have a single owner LLC and it’s me, then they’re looking at my tax return. It’s going to go on my schedule C. If I have a single owner LLC and it’s owned by a corporation, then they’re looking at the corporation’s tax return for their reporting. That’s all it is. In other words, you’re just telling the IRS to ignore it and giving it a different tax ID of somebody else or something else to report the taxes.”
“I opened the new backdoor Roth”—I’ll have to explain what that is for those of you guys who are not familiar with that—“this week at Vanguard had funded it with a $3000 transfer from an old non-deductible Vanguard traditional IRA opened 10 years ago with after-tax dollars.”
Let me hit on that real quick so you guys understand what this is. First off, a backdoor Roth is a fancy way of saying, “I put money into a traditional IRA that I could not deduct. I have another retirement plan through my employer, I make too much money, and I may not be able to put money into a Roth IRA because I make too much money. Instead, I put money into an IRA that I can’t deduct and then I convert it to a Roth. I just put money into a Roth and I exceed the income limit, but I managed to get it in there anyway, I didn’t write anything off.” The IRS can’t stop you, that’s called a backdoor Roth.
That’s a fancy way of saying, “Hey, I wasn’t able to contribute directly to the Roth so I did a traditional IRA and then converted it to a Roth and I can do that.” That’s called a backdoor IRA. Really cool, funky names. It’s not a legal name. It’s just because you’re going through the backdoor.
“And I funded it with a $3000 transfer from an old…” It sounds like you moved the money into the Roth. It sounds like you converted an old non-deductible Vanguard traditional IRA from 10 years ago. The problem that I have is not the $3000. You always get that $3000 tax-free. It’s the growth from the $3000 that probably accrued over 10 years that you got to be worried about. Can you do that? Absolutely. Does it affect your allowable contribution for 2019 at all? No. You can put it under $7000.
Jeff: That $3000 is actually a rollover, not a contribution. You’re rolling over that $3000. It’s got the basis of (say) approximately $3000, you may have a little tax that you have to pay. Usually, when you do a Roth conversion, you’re going from a traditional IRA with no basis and it’s going to get taxed when you do the conversion. In this case, he’s rolling over something that he has a basis in. He’s got to pay probably a little tax, but not a tremendous amount.
Toby: We got a bunch of questions coming up off of this, and I’m going to answer. Somebody says, “How is that different than a non-deductible IRA, the Roth?” When a non-deductible IRA, if I put, let’s use the example of $3000 into a non-deductible IRA and it grossed to $5000, when I take out my required minimum distributions, ⅗ of that income is going to be tax-free, but a portion of it is going to be taxable. If I put that same $3000 and roll it into a Roth and it grows to $5000, none of it is taxable. That’s the difference.
By the way, somebody says, “Hey, I hear people recommending Roth versus IRA.” All things being equal, they’re identical. When you actually run the numbers, what it really makes sense is when you are in a low tax bracket, you’re better off putting money into a Roth because you’re paying such a low amount, but if you expect your tax bracket when you retire is going to be less than the amount that you’re doing now, then you should do a traditional.
You’re going to be better off letting traditional grow all that time and paying a lower tax amount and taking the tax right off right now versus if I put money into a Roth and I’m in 39% or 37% tax bracket, I really didn’t do myself any favors. That Roth may be tax-free, but I didn’t get any benefit for it. I’m getting a 37% return the day that I put it into a traditional retirement fund if I am getting a tax deduction.
If I’m in the 0% tax bracket, by all means, please put it into a Roth because now, you never pay tax. Your total tax bracket is zero. But if you actually do the math (I’ve done this), and you do it over a 30 year period or 20 year period, it’s identical. If your tax bracket is 25% now and 25% when you retire, there is no difference, zero, zilch.
Jeff: I think one of the other issues here depends on what you believe the market is going to do. If this market is going to be flat for the next 10 years than the traditional, definitely have a better deal. If the market is going to soar, then the Roth is the better deal. Unless you have a crystal ball, you’d have no idea where it’s going to happen.
Toby: Here is a good question for you, Jeff. Do you have to pay state income tax on Roth?
Jeff: No. I don’t think any of the states tax the Roth.
Toby: Nope. They’re tax-free. They’re pretty cool, but again, think about it like this. If a dollar that I’m putting into a Roth cost me 37¢ to put in, so my net that actually is going in because I had to pay tax on that. So, even though I got a dollar in, I have to pay 37¢ to the feds. That grows to $2 over a period of time and I start taking it out, I don’t pay tax, I still paid 37¢. I have $2 and I still paid 37¢. I divide that into and say, “All right, $2 I paid 37¢.” My aggregate tax bracket is whatever that is, about 20%, it’s like 18.5% versus if I’m in a really low tax bracket and I paid 20% to put it in, where I never have to pay tax out, then I’m going to be much, much better off.
But if put money into a traditional IRA, I would actually have a $1.37. If I got the 37¢ deduction, then I actually have a $1.37 and that grows a dollar. Let’s just say that we’re not being completely fair. So now I have $2.40 or whatever it is left, then I have to look at what that tax bracket is. If when I retire, I’m in a 12% tax bracket, a much better off having done the traditional IRA. That’s why I’m […] in. I probably shouldn’t keep talking about that. I like math.
“I am interested in providing a wellness plan for my employees. Our company has multiple employees working in five states. How do we structure the plan so that the benefit does not become taxable income for the employee? Items that we had I mind are gym membership, athletic classes, yoga classes, meditation training, nutrition consolations, et cetera.”
Jeff: I have good news and bad news. The good news is IRS is happy to let you reimburse your employees for their wellness plans and programs. The bad news is, is none of those is deductible to your company. It’s a benefit that you’re to your employees, and that’s about it.
Toby: That would be called a non-deductible benefit to employees. That’s non-taxable to the employees.
Toby: This is where it’s helpful if you have a C Corp or something where you’re in a 21% tax bracket. Maybe if it was a non-profit or something like that, there might be some benefit, but this is probably not something that’s going to be of great benefit to you if you’re for-profit entity.
That said, if you’re doing a 105 plan or you’re doing a medical reimbursement, you do HSAs or health reimbursement plan in HRP—which are now pretty beneficial and there are some new rules that came out under the new tax laws, too. I think that there’s under 50 employees. It’s going to be a little different if you’re over 50—you may be able to put money aside for health reimbursements and then you get a deduction. But the employee would not get reimbursed for a gym membership unless the doctor prescribed it. Then it actually has to be a medical expense.
If you don’t know the difference (it’s weird), a gym membership or membership to clubs or things like that are never deductible unless there’s a different reason other than you want to go to the club. It has to be a medical necessity so that the doctor prescribes it for an actual diagnosis that you have, hypertension, so they’re prescribing you to go to your athletic club and do yoga and go sit in a hot tub or something. Now, it’s a medical expense.
Jeff: Why would you want to do this if you can’t deduct it? You may find that this is something you can do for your employees that help retain those employees because replacing employees can be very expensive. Little things you do like this can be very helpful for employee retention.
Toby: Yeah, that’s why you’re doing it. There’s a lot of reasons you do things that are not tax-related. You’re able to get more money to your employees and maybe at a lower tax rate depending on the type of structure you have. If you’re an S Corp and you’re in a high tax bracket, you’re probably not so pleased about this, but if you’re C Corp and you don’t really care, or if you have paper losses, great.
Somebody says, “Putting money in the Roth,” this is on the last question, they said, “Hey, Roth grows tax-free,” but just remember, John, that you have less effective money. If I got a tax deduction, I put a dollar in a traditional and I get a 37% tax benefit, then my actual benefit to me is $1.37. Just call it a dollar. If I put money that’s after-tax into a Roth and I had 37% tax, then the actual net that I can actually put in, because I had to pay the tax, would be 63¢. I’d have a dollar growing versus 63¢. Yes, the 63¢ growth on in this tax-free, but I’m going to have more money in the traditional. At the end of the day, you have to add that into the calculation.
Let’s keep jumping through these. “I have owned a rental townhouse since 1990. In 2017 we moved in to make repairs, but stayed there until now.” They’ve lived in this house to do the repairs. Would that be considered personal use, Jeff?
Toby: You move in to make the repairs as opposed to just fixing it up and it’s not rented, but it was available. When you’re doing repairs, it’s still available. But if you’ve lived in it, let’s just call it personal use. “I know I can’t claim it as a rental for 2017-2019, but I have almost $40,000 in deferred losses that I don’t want to lose.” The question really becomes, was the deferred loss from the rental use or is this $40,000 in improvements that you made in the last two years. “I’m planning on moving back to my primary residence in 2020 and returning the townhouse to a rental. What are my options?”
Jeff: We’ll answer both ways. If the $40,000 was from a previously […] you have $40,000 from rental losses, those losses stay with the house until you either have passive income or you sell the property. Now let’s say the $40,000 came from the repair, as you have to do an extensive renovation.
Toby: To your personal residence.
Jeff: Correct. You would actually add those back to the basis of the property.
Toby: Can you depreciate it?
Jeff: I think I probably would as improvements.
Toby: How does that work when you go from personal property to a rental? They always look at its fair market value, now we paid for it. They’re not going to look at the fair market value. It has to be less.
Jeff: If the fair market value is less than your cost, then you have to go with fair market value.
Toby: In this case, it’s not going to be the situation, they’ve owned it for a long time. I would think that you’d start re-depreciating the $40,000.
Jeff: I’m thinking you’ve replaced the kitchens, the bathrooms, things of that nature, and maybe ran up to $40,000 bill. I would probably depreciate those once the property is back in service.
Toby: Once you put it back in service. It wouldn’t be immediate. You put it over the timeline that it’s on. You might want to know a good tax person who would understand what cost segregation is. He might just break that down and be able to write it all off in year one.
Jeff: Especially when you’re doing kitchens and bathrooms, a lot of that’s going to be short-term depreciation, not 27-year depreciation.
Toby: Absolutely. I’m saying that tongue in cheek. I think you’ll be able to get the $40,000. You don’t want to lose it, I get it. You’re going to get it, and then it depends on what you’d actually be able to write it off. If you have other rental properties, you can offset some of those rents, otherwise, you just carry that forward until you either have passive income or you sell that property, in which case, then you get to take that loss. To take all your deferred losses against your active income if you want to. A lot of people don’t realize that. That’s why you sell passive assets if they’re buried. They have lots of losses and deferred losses.
“My friend and I bought a single-family home together five years ago and sold it this year. We split the profits.” This is where it gets weird. “We split the profits from the sale without regard to federal taxes.” If you bought this together and you’re both on tight, then you’re a partnership or you’re tenants in common, one of the two. But then it gets weird. “We bought the property in a family trust in her name,” which is weird because there is no such thing as a family trust in her name with you as the trustee. It’s the trustee’s name, period, with her as a beneficiary is what I’m assuming. “Am I liable for her portion of unpaid taxes from the sale of this property?”
This is where it gets weird. It sounds like the property was in the trust with a beneficiary being one person. They are the legal owner of it. The legal owner chooses me as the trustee, but the beneficial owner is that individual from a tax perspective. And also it was an irrevocable trust. A responsible party is actually your friend, which means how do you allocate in the profit to yourselves? That would probably be ordinary income. They just paid you something.
Jeff: I even wonder, it says, “My friend and I bought a single-family home together.” Did they both contribute to it equally?
Toby: There’s a lot of unanswered questions. And then, did they live in it? Because if they lived in it, there’s a good chance during the last five years, then you may have a 121 exclusion. But then, to qualify for the 121, which is this $250,000 or $500,000 exclusion that’s available to people, if it’s $500,000 you’d have to get married, you have to both be on title and live in it with a few inclusions if you are married. But it sounds like you’re not married. Then it would be this individual that her, she would have a $250,000 exclusion from capital gains. There are a few questions that we have floating around out there on this one.
Jeff: One other thing I would caution on is it said that this person was a trustee and you have to be very careful about dealings with a trust for which you have fiduciary […] responsibilities, because your job to be trustee, to have a fiduciary responsibility trumps any profit mode that you have in dealing with that trust. I think we talked about this earlier that it might even better to do a partnership between the one and the other or tenants in common.
Toby: On title, they’d have to be tenants in common. He’d have to be on the title, both she or whatever they are. We have one she and we have one unknown. Whoever it is, they would both have to be on title. Otherwise, I’m with you. I’d probably file it as a partnership. The problem you have with a partnership is it started five years ago. The penalties will be absolutely enormous.
Or you just say he/she sold it and paid me and I would deduct the payment to that individual and that individual probably have ordinary income. Would you be liable for the taxes? Most likely, no. She’s the beneficiary. She’s the one responsible for the taxes on the sale no matter what.
Somebody says, “As a friend, how could they be trustee?” You can have anybody as a trustee on this thing, whether they’re friends or not.
“If I claim 50% bonus depreciation on a rental property, on my federal income tax return, do I need to add that back against regular depreciation on an Illinois state return?” The answer is no because Illinois accepts and follows the federal rule.
There are plenty of states that do not and that you’d have to add it back, like Hawaii, California, among others. There’s a whole bunch of states. You’d have to look at it and say for state taxes, can I take the bonus depreciation? But in Illinois, you’re in the clear.
Jeff: Ohio has a really weird calculation for adding back bonus.
Toby: They have some funky stuff. States are kind of annoying.
Bunch of questions, I’ll get to the questions here a little bit. You guys are inundating me with questions. “If you’ve rented out your primary residence and took the tax depreciation for two years but later sold it as a primary residence because you lived there for two of the last five years. Is the capital gains based on the difference between the sales price and the original purchase price or is it the sales price less the depreciated value?”
Jeff: Your total gain is the sales price less the depreciated value.
Toby: Adjusted basis based on all the improvements you did on the property and all that fun stuff, yup. And you get to this gain.
Jeff: However, your capital gain is the difference between your total gain and any depreciation recapture.
Toby: You got it. Let’s just use easy math. I bought it for $100,000 and sold it for $300,000. I depreciated a portion of that $100,000 and I took a total $10,000 depreciation. What do we well it for?
Toby: $300,000. I have $200,000 of gain minus $10,000 of depreciation. So I have $190,000 of gain that I don’t have to pay tax on. I have $10,000 of depreciation recapture, which is taxed at my ordinary bracket, maxed at 25%. Don’t you guys love taxes? That’s actually the rule. I just espoused it out there.
What the deal is and for those of you guys who are confused about this, how can you do that? You can rent it and you can still get your 121 exclusion. The 121 exclusion again is this rule that says I don’t have to pay tax on capital gains only, not deprecation and capture, but capital gains only on my residence, a primary residence that I lived in two of the last five years. Not the last two years, but the last five, so I could live in it for two years, rent it for three, sell it, and still get this huge capital gains exclusion. But that depreciation that I took over those three years or two years in this case, I have to pay a little bit of tax. That’s not too bad, especially if you know how to control your tax bracket.
If you’re at a low tax bracket that year, intent that you sell it, this is when you want to take your accelerated depreciation or other things to lower your taxes. You’re going to use all the deferral techniques, you’re going to maximize all your retirement plans and do all that fun stuff. This is the year we do that because if we didn’t get our tax down to zero, that’s the year that we don’t have to pay any tax on the sale.
Somebody says, “There’s a 1031 exchange, excluding tax on depreciation recapture?” Yes. It defers it into the next property. You’re right.
“Is gap lending income passive or active for a 401(k)?” Let’s just answer that first.
Jeff: That one threw me at first and it’s really not the right question.
Toby: Gap lending is lending. The income that you make is considered passive. It’s interest income. It’s not active. For a 401(k), the reason that this is important is that if you have unrelated business income from running like a McDonald’s in your 401(k), that would be taxable. But this does not rise a level of an active business. This is not a 401(k) doing things that an active business does. This is a 401(k) lending, which is absolutely fun.
“Does the term less than a year or more than a year affect taxes for C Corps?” Let’s say the C Corp is the lender. The answer is no, because it’s just income to a C Corp. A C Corp doesn’t care. It just says, “Hey, yeah. It’s income or it’s not.” It’s still interest. If it was you, and you made interest income, it’s passive which means it doesn’t have to pay social security tax, old age, death or survivor’s, Medicare, any of those things. The C Corp doesn’t care. It just pays 21%. If you have income, it’s income, and of course that’s great. I have income. Sorry, I just hobarted that.
Jeff: No, that’s all right. It’s funny that you have to report long-term versus short-term capital gains on the C Corp, but it doesn’t care. It just mushes it all together.
Toby: Yeah and this isn’t even capital gains because it’s interest income, so it’s just ordinary. Even to you it’s ordinary, it’s just passive.
“My business is an LLC that files as an S Corp.” All of you guys are starting to figure this out. LLC is a feature of state law and from a federal tax standpoint, we get to choose what it is. This is an LLC and it says, “I am a corporation taxed as making an S election. Has no employees, just me.” Well, you’re an employee. “At the end of 2018, I signed up for an HSA-approved health insurance plan.” This is a health insurance plan and it’s an HSA-approved, which means it’s a high deductible plan. That’s all you did. It’s an insurance plan. “My deductible is high, but I am fairly healthy. So my analysis is at the time concluded to be better to pay the lower monthly premium, pull all my qualified healthcare expenses from my HSA fund, which should be tax-free.”
What you have here is two things. You have insurance and you have a health savings account. I want to make sure that we’re keeping those two things separate because they’re treated differently in an S Corp. “I still have not funded the HSA.” So there’s no deduction for the HSA for 2018 or 2019, period. Although for 2019 you actually could. You could do an HSA up until April 15. You still haven’t funded it. 2018’s out the door, but it went into effect on 01/01/2019, so you still have a little bit of time on the HSA. “But I’ve gotten mixed messages from two different great accountants, what’s the rule?”
The two questions were actually there. One accountant said said that it was insurance and that you had your include it as taxable and the other said something about the HSA not being taxable. They’re both right. The insurance from an S Corp to you is added back into your wages, but then you write it off on your 1040 as self-employed insurance. It’s a quote and above the line deduction, which means it’s just a deduction against your income. It comes right off the top, you don’t have to mess around with adjusted gross income and all these other things. So, it’s deductible. Your HSA, when you contribute to it, is deductible to you.
Jeff: That’s also an above the line deduction.
Toby: Yup. Again, it’s the HSA the deduction and you don’t have to pay tax on the reimbursements.
Jeff: Now, a couple things with these HSAs. To contribute to an HSA, you have to have a high deductible health plan.
Toby: Yup. So they said this is qualified.
Jeff: But they said they were thinking about switching to a lower monthly premium.
Toby: At the time I concluded, it’d be better to pay the lower monthly premium because it’s a high deductible plan. High deductible plans are cheaper.
Jeff: Oh, okay, I got you.
Toby: No, this is perfect. Somebody asked, they said, “What?” One said you can deduct the premium on an individual return. Right, when you are an S Corporation, you get to deduct only the cost of your insurance that the company provides you when you own the S Corp. If you’re greater than 2% shareholder, you have to include the insurance in your wages, but then you get to write it off on your personal return.
Jeff: Here’s what’s really confusing about it. On the S Corporation side, you’re including it in the owner’s wages, but you’re also deducting that on the S Corporation. The income coming from that S Corporation has a zero effect. But then, you turn around and deducted again on your 1040 as self-employed health insurance. That’s where you get the deduction. At some times, it seems like, “Wait, what am I doing? Taking money out of one pocket and put it in the other?”
Toby: The corporation gets a $10,000 deduction, but you have to add the $10,000. If it was $10,000 of insurance, you get to write that off in your personal return. At the end of the day, you get to write it off. Somebody says, “What if the S Corp pays the HSA contribution?” That just flows down to you. It’s the exact same scenario, except now you’re writing it off as a contribution. You get to write it off. That’s the good news.
So, both accountants are right, but they just needed to separate their brains, so they’re great accountants. They actually got it and nailed it. It’s still taxed because you have health insurance and you have an HSA, which would also be probably a taxable benefit with the deduction to you. Whether you do it through the plan or you do your own HSA, I don’t think it really matters.
I can never really understand why people do the HSA through their employer. That’s a complete aside. I have to look at that. I remember there was a reason why some people do it, but for the most part, I couldn’t understand why anybody would do the HSA through their employer. Seems like just let the employee do it.
Jeff: Yeah. I’ve seen when the employer’s making contributions for multiple people.
Toby: Somebody says, “What if I pay the premiums directly instead of the S Corp paying, do I get a deduction on my 1040?” I assume that they’re saying the premiums to avoid the FICA, I guess if it’s S Corp, it’s not going to matter. Or maybe the payment for the employee, I guess that what they’re saying is maybe you’re going to avoid the self-employment tax or the FICA on an employee.
Jeff: I don’t think there’s any FICA.
Toby: No. I’m thinking what they’re saying is I put money into an HSA for an employee.
Jeff: Are they talking about the health insurance premiums?
Toby: Let’s just say the HSA. That was waxing philosophical. Why would anybody do it? I guess because it may be a taxable benefit, but it may not be included in social security. It’s like an executive compensation plan where I’m giving them something without having to get hit with FICA.
Jeff: Usually when an employer’s making the HSA, it’s already pre-tax so there’s not benefit on the employee side. There’s no deductibility.
Toby: No deduction. And then the other person said, “What if I’m paying the premiums individually?” You have to get reimbursed to the S Corp.
Jeff: Yeah. The problem is that the S Corporation has to pay.
Toby: Yeah. The question is, “What if I am buying the insurance? Can I still write it off?” The S Corp actually has to reimburse you. You include it and then you write it off […].
Jeff: Same thing for your Medicare. If you have Medicare and you have an S Corporation, make sure your S Corporation is reimbursing you from Medicare payments.
Toby: Two people asked this now, “If I pay for the premiums on an individual,” just make sure you’re being reimbursed by the S Corp. It used to be that. It actually had to be in the S Corp name. They changed that. In order for you to write it off as self-employed insurance, the employer has to actually be reimbursing you.
Jeff: You just need to be prepared with document that when it comes up.
Toby: Yup. “If I currently hold a rental property in my individual name, what are my options to transfer title out of my name to an alternative entity to reduce legal exposure? Is there a way to avoid being non-compliant with covenants that prohibit transfer title?” I think what you’re talking about is can I move a rental property from my individual name into something else. The answer is yes. The question then becomes what should I move it into and that’s where you get into these covenants that prohibit transfer title.
That’s usually a “due on sale” clause in a mortgage. What we suggest that you do at our firm is that if you have one where you’re concerned, you use a trust to hold title. The reason being is that the mortgage company is very used to seeing trust and there’s even something called Garn–St. Germain Act that says if you transferred into a living trust or grantor trust, they can’t call the “due on sale” if your personal residence is the deal.
The mortgage company is just get used to seeing trust and they’re like, “Oh, it’s trust.” They don’t have a problem. You put it in directly into an LLC, then I’ve only seen it once in 27 years, they may do a “due on sale.” Most of them are pretty cool. I usually just don’t tell them and you just keep paying it. You ask them then they get lawyers involved and the lawyers never understand the stuff. They’re always like, “Oh, don’t do anything. We want it in your name,” where you’re an easy target. They usually don’t want to see an entity unless you’re dealing with a commercial lender.
Here’s the deal. I still want the protection of the LLC. So I put it in the land trust and then like our question earlier about those two individuals where one was the trustee, but the other partner was the beneficiary of the trust, we make the LLC the beneficiary and the trust. They are the ones with all the rights to occupy, with the rights for rents and everything else, and that way it’s not you. If anybody ever sues, the way they would have to go after it is they’d have to go after the trust and they’d be going after the beneficiary, not the trustee. They have to sue the trustee in name only to try to get to the beneficiary.
It’s a nightmare for people to try to go after these things. When you see a land trust, when you see an LLC around a rental property, most people look at it, most attorneys are going to look at it and say, limited recovery. If I see an individual’s name on a property, I’m thinking, great, I have a whole bunch of stuff that I could start and look at, including their ability to make money over time, which is garnishment.
“Could the trustee be my name?” It can, or you can use an entity or somebody else. Most states have these laws that say, “Hey, you’re not supposed to use an entity,” but the right is for the beneficiary to argue, not for anybody else. We do it just to annoy the heck out of them.
“What kind of deed do I use so I don’t lose my title insurance?” You use a warranty deed. You don’t do a quit claim to a land trust. You use a warranty deed to a land trust. Keeps your title insurance all safe and sound.
Anyway, that’s that for the prepared questions. Now, we have all these chat questions. And we do have a ton of them. We’re going to start coming back in.
“We formed a new C Corp at the end of the year,” It looked like it was in November, “embody franchise with a ROBS transaction.” For those of you who don’t know what a ROBS transaction, it’s Rollover for Business Startup. It means you partnered with your 401(k) or IRA. It’s one of the few ways that if you did this right (hopefully you did), then the money is safe and you can actually run a C Corp. Sounds like you’re doing things correct. “The company will not be opened for business until we complete our franchise training on 01/17/2020. How do we get credit for the startup expenses if we had no income in 2019 to offset? FYI the fiscal year for the company ended 12/31/2019.” You could change the fiscal year. Even though you set it up in 11 of 2019, I might make my year-end September 30th of 2020.
Jeff: I know you felt the SS4 for your EIN and you felt this. Your first-year end is not determined until you file that first tax return and that’s what determines your year-end.
Toby: David, you could actually pick a different year-end or if you felt like it, you just capture your startup expenses on that one month return, for that one month that you were open in 2019, you just carry it forward. You don’t lose it. The good news is you’re good. The bad news is don’t use your 12/31 year-end, use a different year.
“Is it okay to invest in different asset types using a single LLC in my checkbook IRA?” Someone mentioned you shouldn’t mix asset classes when a checkbook IRA. It depends on the type. If you’re doing risk or non-risk, that’s what I would say. I don’t want to put a bunch of stock in publicly-traded companies and with a bunch of real estate. I wouldn’t do that with the checkbook IRA, which is basically an IRA that owns a single-member LLC. You don’t want your risk assets being mixed in with non-risk assets. I’m not going to be sued because I own some stock. I might get sued if I own a rental property and I don’t want that tenant that sues me for mold to be in there with the whole bunch of Microsoft stuff, for example. I would not put those together.
But you can have multiple properties in an LLC. Again, it depends on how much separation you want, but if I own a couple of small rentals that are cheapies, I may not be too worried about it. My entire exposure is whatever is in that LLC.
This is an interesting one. “What kinds of expenses can I write off in my LLC that is taxed disregarded aside from meeting meals and accounting costs? I do not have any LLC income this year.” It depends on what the LLC is doing. If it’s doing an active business, then all business expenses can be deducted.
Jeff: And what the tax code says because of the expense ordinary and necessary.
Toby: Yeah, Section 162. You can write off everything. The big difference is that when you have an LLC if it’s taxed as an S Corp, the reason people do that is because the profits are not subject to self-employment tax. If you are single-owner LLC, every dollar that you make that’s profit is going to be taxed as old age, death and survivors, and Medicare, which adds up to 15.3 % part of it is deductible. It’s actually 14.1% the math. Use an S Corp because it’ll save you about $10,000 a year if you’re making somewhere in the $125,000. That ends up saving you a bunch of money. The audit rates are also a lot lower when you’re at the $100,000 mark for S Corp versus sole proprietors. They’re literally a 1000% or 1200%.
Jeff: They love auditing them schedule Cs.
Toby: You save money with an S and you don’t get audited as much, but that’s only if you’re making money. If you’re losing money, then you’re okay for a couple of years, don’t go more than two or three years, because you have the hobby loss rule, Section 183. If you’re going to lose money for a while, you got to make sure you have an accountant that’s backing you up, saying you’re operating at a business like fashion because you may have to defend that.
“How does an HSA plan work and how does it save me money on taxes?”
Jeff: The HSA, assuming you have a high deductible health plan, your L204 this HAS plan, you put money into what’s basically a bank account, that’s your HSA fund. Depending on how set-up you may use a charge card or just get reimbursed by that HSA for any of your medical expenses.
Toby: Yeah, it rolls forward.
Jeff: Correct. You have to have a high deductible health plan. However, if you get ready for your high deductible health plan and you have $10,000 saved up and that HSA, you can continue to use that for your medical expenses.
Toby: Yup, and it doesn’t mean that you have to use it right now.
Jeff: Correct. Unlike the Flexible Spending Account (FSA), it’s not use it or lose it.
Toby: All right. “Happy new year. Thank you for taking in listener’s questions. I like your advice on how to file an LLC. My siblings and I inherited a few properties, about 12, which include rental properties and some land. The properties are not worth very much. $40,000-$65,000 each, that’s a guess. It’s to be held in a trust. We plan to sell most of them at some point, starting with the ones that don’t generate much income. These properties are at a small desert town in California. How do you suggest the LLCs be filed?”
You’re in California. This is where it gets really interesting. LLCs are really expensive in California so I’d probably structure this a little differently. I will probably be looking at Wyoming just to be cheap and I’d be using a land trust for the properties. It’s up to you if they’re not really worth that much and you’re not worried about losing them, then the most conservative advice I would give you is to have each property in its own LLC. You need to use a land trust to hold the property, the beneficiary be an LLC. And you’d have one entity that you and your siblings own as a partnership that would file in California. Meaning that it would pay the franchise tax, a minimum of $800.
The least conservative advice is to put it into one LLC and you could probably just have one LLC. Under those circumstances, I may just set it up in California if that’s where the properties are held. It really comes down to you have the full gamut, depends on what your risk tolerance is. If it’s not making much and you’re not really worried about losing them, then you say, “Hey, I’m willing to lose them. I […] put them all in one.”
What you don’t want is to have them in your names (you and your siblings) to where if one thing happens on one property, and somebody sues the lighting out of you, that you guys have to worry about being on the hook for that liability, which is exactly what would happen. Believe me, I’ve seen the $7 million recoveries on mildew cases out of California. And there’s a lot of letters in the seven figures, but there are some big ones. I don’t want to put myself in the crosshairs in one of those lawyers that make the living going in and convincing juries that you’re the boogie man and they should hand over all your money to that poor tenant.
Jeff: One thing I look at and how many LLCs I need is, how much am I willing to lose in one bite?
Toby: 50%? Then use two. 20%? Use five.
“What’s the difference in transacting short-term real estate deals in a C Corp and an LLC with the C Corp election?” There is no difference there. Basically, if you have an LLC taxed as a C Corporation versus a C Corp, what’s the difference? If you lose money in a traditional C Corp and you make a 1244 election, you can take that loss as an active loss. If it’s an LLC taxed as a C Corp you lose a bunch of money in it, it’s going to be a capital loss. That’s the difference.
“Benefit of a limited partnership over an LLC?” If you’re a limited partnership, you can have partners that don’t have any management rights. You could be the same thing in an LLC. Really, what an owner partnership does is you have passive partners. If you’re doing an active business, it’s better to be a limited partner in that, so you don’t have a self-employment tax on it. Otherwise, we’re always using LLC. In fact, almost always it’s an LLC.
“Can de minimis safe harbor be applied retroactively? If so, you have items under 2500 that you began to depreciate. Can you expense the remainder and disregard them as any captured gain?”
Jeff: You can, but that’s going to be a conservative change of accounting method. There’s a special form for that.
Toby: You can do that within three years, right?
Jeff: Oh, yeah. Within three years, you could go back.
Toby: The de minimis safe harbor is whenever you have an expense that’s less than $2500, your safe harbor is I can treat that as an expense that is deductible now. Otherwise, I’m depreciating it over the useful life of that asset. It’s a repair versus an improvement. It’s a repair if it’s less than $2500 and I like to treat it as that way. Usually, you do that in a year that you incurred it and you want that $2500 deduction, otherwise, you’re spreading that $2500 over the useful life which is—
Jeff: Five or seven years.
Toby: Well, if it’s residential real estate and you don’t do a cost seg, it’s 27½ years, if it’s commercial it’s 39 years, right?
Toby: You’re spreading that our over long time.
“If a non-profit reimburses the executive director for medical, dental, 401(k), and disability, do all these costs get added to this W-2 wages?” John, the answer is no. You wouldn’t reimburse for a 401(k), but the medical, dental, vision, disability, those types of things, assuming that there’s a 105 plan in place, a medical reimbursement plan, then no, it wouldn’t be added into their wages at all. It’s tax-free. You wouldn’t have a 401(k) in a non-profit. You’d have what, a 457?
Jeff: Yeah. […] 403. It’s one of those numbers that start with 4.
Toby: 403B is government, 457.
Jeff: It’s non-profit. Just keep in mind if you have more than just that one employee, then you have to treat everybody the same way.
Toby: You can’t discriminate.
“I personally paid expenses in 2019 for properties in my QRP. Can a QRP directly reimburse me?”
Jeff: No. That’s actually a contribution to the QRP.
Toby: Yeah. You want to contact us on that one. That is something where you did a little bit of a no-no. You’re much better off putting the money into the QRP and letting it do its thing.
Jeff: Anytime you buy a property with a QRP, you have to make sure there is money to maintain that property and all its bills within the QRP.
Toby: Or the company, if it’s a company plan. Then the company could incur the expense. But on an improved property, no. Even that I think you have an issue. This is weird because the individual can’t contribute to the 401(k). It has to go through the company. I hate to say this. This sounds like a prohibited transaction.
Jeff: I kind of think so, too.
Toby: That amount may be a problem, that may be a taxable amount. We’d have to take a look. That’s why I say contact us.
“In April 2019, I bought a rental rehab in my active entity because I didn’t have a passive entity at the time. The rehab was completed in December. The plan was to refinance it into my passive entity once completed, but then it’s not yet happening. What happens to the depreciation? That’s allowed to be recaptured in the first year since the property is still my active entity.”
You bought it, you crossed over a tax year and what really depends is whether that property is available for rent and whether it’s actually, because even though you’re in a corp, the corp doesn’t really know whether you’re active or passive. The corp just has income. The problem that you have is if the property is now worth more, you don’t want to distribute it to yourself. I have to see what type of corp is this. The active entity, I don’t know how it’s taxed. This is another one where you go want to email us in and […] probably note that or Patty notes that because depending on how that’s taxed, that’s just going to be the answer.
“I want to create a disregarded LLC. Does it have to be single-member LLC or can I add my spouse?” It depends on your state. Susan, it depends on where you live because if it’s community property, then you both can be. If it’s just a separate property, it’s just you then I would just make it you.
“Does a specific rental property need to be in service at the end of the year for the rental income to qualify as qualified business income? Or can it still qualify if it sold during the year? Is it specific to each rental property or can an individual entity qualify if continuously owning the rental property?” It sounds like they’re talking about the 199A deduction and it’s really weird rule, the 199A. You have commercial, you have residential, doesn’t matter. Even the same entity, if you’re going to have both classifications. And then you have this triple net leases in commercial.
Jeff: Which I don’t see as often as I used to.
Toby: I see it periodically, but yeah, not a lot, especially not in single-family. The rental property does not have to be in service. What we care about is when the income is actually here. What it is, is that’s that 20% deduction on qualified business income. You still qualify. There is an hour limit. I figured what the hour is like, 250 hours.
Jeff: 250, I believe.
Toby: Yeah, for rental property that you have to meet for it to trigger that qualified business income.
“My kid is in college and helps my disregarded LLC for software. Is it okay to pay them using 1099 miscellaneous as a contractor?” Yeah. I don’t see why not.t They’re in college. Assuming that’s active income regardless.
Jeff: If the year wasn’t already over, I will consider putting them on wages instead of 1099, but 1099 is fine.
Toby: If you just did a software task and you didn’t control them and the hours that they worked, and all that stuff, then I have no problem. If they’re working for you continuously, then you’re probably going to have a little bit of an issue.
“On a single-member LLC with S election, what is the best way to decide on the proportion of wage versus shareholder distribution?” The question is, “Hey, if I have an S Corp, how much do I have to pay myself from salary?” The rule of thumb generally is a third, but that’s just because the tax cases, they usually find out around the third, but it’s actually whatever you’d pay a third party. At arm’s length transaction is technically what it is. But there’s no math. Most practitioners would just say a third.
Jeff: If an S Corp didn’t make any money, there’s no reason to pay yourself a salary.
Toby: Somebody says, “Is there tax consequences or corporate rental consequences for taking money out of your Wyoming holding company and using that money for personal reasons?” No. It’s your money. Assuming that that’s an LLC that’s either taxed a partnership or disregarded, it’s safe. You can take the money in and out as long as you’re keeping track of it. If it’s a corporation, a little bit different. You want to make sure you’re not just taking money out, but you’re running it through payroll or distributing it to yourself depending on how it’s taxed. But if it’s your typical run-of-the-mill holding entity, you can take money in and out all you want.
“When itemizing and deducting investment interest expense, is it only interest deductible or can the cost of obtaining the loan to also be deducted?”
Jeff: For investment interest expenses, only the interest you pay on investment. The other side of that is you have to have investment income to offset that.
Toby: Yeah. That’s investment interest. If you’ve got a loan, that sounds like they’re trading on margin, is that what you’re thinking? But that may not be what they’re thinking. This might be real estate, too. Maybe they can quantify that. If it’s real estate, then you get to write off the whole gamut. If it’s investment expense, like borrowing money to buy stock, then no. It’s only the interest and it’s only against the investment.
Jeff: Interest, dividends.
Toby: Yes, the money you’re making.
“I will be 70½ in five months. I loan my daughter $40,000 to cover a foreclosure.” Sounds like a prohibited transaction. This is what we have. A daughter would be a disqualified person, unless you did it individually. “I used to […] a set of payments over tenure period. How do I set up the distribution for the remainder IRA?” That’s really interesting. What they probably did is had you borrow the money out of the… it can’t even be an IRA.
Jeff: If it’s an IRA, it would’ve been a distribution.
Toby: Yeah. This is going to be a really bad answer, if it’s an IRA, the entire IRA was disqualified. If it’s a 401(k), you can borrow up to $50,000 and then if you want to loan that to your daughter (I you suppose you can), I wouldn’t tie those two together.
Jeff: If the money went to the daughter and she’s not on the account, it will never be a distribution to her. It will always be a distribution to you.
Toby: I think that’s a disqualified person. I think that’s not good.
This was another one, please let us know, the email is sent because you’re going to want to have an actual question. “Does a Nevada disregarded LLC need to be registered in the state it does business as well?” It depends on the type of business, but yeah. All entities have to be registered in the state whether doing business and it’s a statutory definition of doing business. If it’s owning real estate, for example, that’s generating rents, then you’re supposed to be registered there. Yeah, absolutely. But if it owns an entity that’s doing business in that state, then no. Just owning an entity does not.
“I started an LLC, but I haven’t generated any income yet. When can I start up a solo 401(k)?” You don’t have to make money to do a solo 401(k). In fact, a lot of 401(k)s are just funded through rollovers. You can do that.
“How many months per year must a rental be actively rented to get renovation to write off?” It just has to be available to rent. Technically, it doesn’t have to be rented, and though it certainly helps. When you do a renovation expense, it depends on whether it was already in service beforehand.
Jeff: And you also have to determine whether it’s a repair or an improvement. It depends on how you expense it.
Toby: Yup. This is funny. “I bought a condo for $325,000 15 years ago and converted it as a primary residence for 15 years. If I sell this condo as a primary residence then I can’t take a loss for my personal returns. My question is, if I rented this property for the time being and then sell it, will I be able to deduct the loss?”
Jeff: This goes back to what we’re talking about earlier, that if he places it in service and it’s worth less than he paid for it, it’s going to be placed in service at the lower amount.
Toby: I would still do that.
Jeff: And this is the very reason why that rule exists.
Toby: Yeah, and just gone down the value at $50,000.
“We purchased rental property and had to do expensive rehab before renting it. Are we able to deduct the expenses or depreciate?” If you’d rehabbed it, then chances are you’re depreciating a portion. If you’re fixing things, then you write them off as an expense. The whole deal is does that improve the value of the property, is it structural things like that versus did I fix the problems? The classic example is I have a hole in the roof. If I fix the hole, that’s a repair. If I replace the roof, that gets added into basis, although I take a deduction on any portion of that roof that I haven’t depreciated at the time. And you have the safe harbor of the $2500 on an invoice on a particular area.
A whole bunch of these are about medical expenses. I think we’re going to have to wrap up here in five minutes. I’m just going to zip through and see if I see a really cool question. If you don’t get your question answered, then just shoot us an email, we’ll make sure that we get an answer.
“I have an LLC in real estate. Should I change to a C or S Corp? I cannot remember which and why.” It depends if you’re inactive. I would not change anything unless you talk to somebody and they say, “Hey, here’s the good, the bad, and the ugly on it.” If you’re a realtor, then I’d more than likely want it to be an S Corp from a tax status. If it’s rental real estate, then I don’t want it to be a corporation, I want it to be disregarded or a partnership.
“I just started a religious corp in Arizona. I have a lot of literature books to sell and expect to make some of what is a profit. How should I file my federal taxes?” A religious corp, that’s interesting.
Jeff: First thing I thought of was do we want to make this a non-profit?
Toby: Yeah. There’s no such thing. A religious corp is a corporation that’s engaged in religious activities and that’s sort of non-profit. If you want to make a 501(c)(3), you don’t have to pay taxes, you don’t have to file a tax return, and technically, you don’t even have to obtain the exemption letter that we recommended. “How should I file my federal taxes?” If you’re a religious organization, you don’t have to.
Jeff: I would only say if you’re in it for the sole purpose of profiting from it, that may cause issues with it being a non-profit.
Toby: You have to be in a religious organization. It has to be set up for the purpose of religion. This one was weird things that churches are the outlier. I would just make sure that you are a minister or something. If you’re just selling books, then you’re a bookseller. You’re going to have a little bit of an issue. But if you’re preaching and doing religious activities, then that’s a good chance that you wouldn’t have to file a tax return.
Somebody says, “There’s no need to file 1128.” This is going back to the question of the individual who filed in November and then had a one month year end. We said, “Hey, you don’t have to change, you just file your tax return. You don’t have to change the file […].
Jeff: Yeah. That 1128 doesn’t have to be filed unless you’ve already established by filing another return.
Toby: Yup. You don’t have to do it, David. You’re good.
“Deed in hand, heading to Arizona, transfer title as single-member Arizona LLC. Member managed by a Wyoming C Corp.” That’s interesting. “For the first 14 days, can I take a 288 exclusion on cleaning, managing, and marketing the short-term rental.” In an opportunity zone. No. You’re either renting it or you’re not. If you rent it to somebody, meaning like yourself, that’s not the reason you’re renting it, to clean it, manage it, and market it. You’d rent it because you’re going to use it. It has to be a residence to qualify. I think we’re mixing two things.
“Can you write off all the expenses associated?” Yeah, absolutely. The bigger question is, what you’re going to do with that property? It sounds like you might be renting it and is it a short-term rental? That sounds like maybe they’re doing an Airbnb or something.
Toby: What I would actually be doing is I would be renting it. I have the Arizona LLC, BEU, and I would rent it too your Wyoming C Corp. Not the Wyoming C Corp do the Airbnb. There’s a bunch of stuff on our website if you want to look at Airbnb. Just because short-term rentals is considered active income, the way around having your rental real estate treated as an active rental or active activity like a hotel, is if your average rental is seven days or less, it’s a hotel.
What you do is you rent it long to your C Corp, or your C Corp rent it short. You rent it on an annual basis to your C Corp and your C Corp’s the one that posts it. That way, your single-member LLC, you get passive treatment, your depreciation and everything else in your corporation are paying rent, you really should have almost no income and then the corporation generates its profit, and then you can’t expense that, then you’re doing something wrong. We’ll find a way to get it back up.
“Are meeting meals deductible?” Yes. If the question is whether it’s 50% or 100%. Open to the public, yes. If it’s a meeting meal while you’re having a meeting, no unless it’s included in the cost of the facility. If I pay $500 to a hotel and they bring me food as part of that deal, then it’s included, then I get to write it off 100%.
“Can you define an active LLC? I have an LLC with several rentals in it. I don’t flip. Is that considered an active LLC?” No. That’s a passive LLC. “Can an active LLC is something that’s engaged in active trade or business?” That’s like running a business. If I’m using real estate, a builder would be an active LLC. Renting would be considered passive.
Jeff: My accounting firm is an active LLC.
Toby: If I do short-term rentals, Airbnb for four days active rents all the time, my average rental, then that’s an active. If I rent it on a monthly basis, that’s passive. That’s kind of weird.
“I paid to my ex, 46% of our joint residence market value in 2007, and then the title is transferred to me. Do I get a step up in basis from the date of transfer when I sell the company today? It will be over $800,000 increase from the original price now.” You do not get a step-up in basis for paying off your spouse on there. You didn’t buy it from, you just paid them on a property settlement. Unfortunately, you don’t get to step up in basis. I’m sorry.
“What qualities should one seek when hiring a CPA? Also should the CPA handle both business and personal financials?” I always say they should be doing what you’re doing and then that’s it. All I care about what CPAs. Sorry, Jeff.
Jeff: I was going to say maybe somebody older, with a goatee, and […]. Maybe a little overweight.
Toby: His name is Jeff. Better if the last name is Webb. Whenever you’re hiring any professional, make sure they’re doing what you do, because the only way to learn to do something is actually to do it. And all these people they say, “Hey, I’m a real estate CPA.” Unless they own a real estate, they don’t really get it.
“Why LLC when I put all properties under an umbrella LLC policy and never rely on insurance?” Umbrella policies have exceptions and they also run out. The world is full of wonderful people that thought that something was covered by insurance, later find out that it wasn’t. My favorite example is a company that is doing over $100 million a year and the policy was written screwy. They ended up going bankrupt over an earthquake and a disputed policy on a business that got flooded.
[…] times somebody says, “Insurance!” and I had one of my first come to God moments in 1998, I believe it was, but it was a gal, she was in her 70s, she was going back trying to build up her portfolio. She lost all of her properties because of window washers on one commercial property. They caused electrocution. So many guys have heard the story and her insurance denied the claim because the guys who had their licensing and their bonding had let the bonding lapse. So they said it was a non-compliant contractor working on the building and they refused to pay. It was such a huge claim anyway, exceeded the umbrella. So, you used both. Use an umbrella policy and then make sure that you don’t have to worry about it.
Jeff: You never know what the jurors are going to do, and they may come up with some outlandish…
Toby: Yeah. You just don’t want the one that takes everything away. There’s no reason for it. And what you find is that, like our clients tend to never get sued. We almost never see audits, and that’s because you’re operating in the right way. If an attorney is going after people and they see a bunch of properties in your name, they’re not going to be very sympathetic, they’re going to go after you. If they see the property as an LLC, they’re going to go after the insurance.
Jeff: I call that low hanging fruit.
Toby: Yup. I think we’re well over. I’m just going to look and see if there’s anything hanging out there. “I have a short-term rental. Can I […] outside management company?” Yes.
“What is the rule of thumb for capitalizing renovation repair expense on a warehouse piece of property?” If you capitalize, you want to break it. If you have a warehouse, you’re going to want to do a cost seg anyway, but if you’re just fixing things up, use the $2500 safe harbor. Make sure that you are with your contractor.
“Are S Corp trading in the stock market, active or passive?” It’s passive. It’s still passive activity but you’re in an active trade. You’re still able to get your write-offs, but the capital gains flow through you.
“How can you withdraw money from a 501(c)(3)?” You either reimburse yourself, regular expenses or you pay yourself a salary. You can do that, or you just leave it in there.
“I received my EIN number. I’m not making money, we don’t expect to make money this year. Do I have to file for a tax return for business in 2019?” If you got your EIN but you didn’t do any business, then you don’t have to file a tax return. If you got your EIN and you did anything, then I would always say, that at a minimum, you’re going to grab all your startup expenses.
Jeff: If you’re a C Corp or an S Corp, you have to file for every year you’re in existence.
Toby: “I have a new California S Corp, and it is the advertising face of my real estate business. We do flips and wholesale, and we have a holding LLC. Should the corp be paying the holding LLC?” Usually, the holding LLC is paying the corp. I make that real easy.
I think we are well beyond. What I’m going to do is if there are questions that I didn’t get answered, I apologize. There’s a lot of questions in here. “Do you have to make an election of de minimis safe harbor?” I’ll answer that last.
Jeff: There is an election that’s made.
Toby: And you say here’s what these are.
Jeff: And you have to make it every year.
Toby: “If no step in basis, what’s the best strategy to avoid the capital gains taxes on the $800,000 gain?” If you sold it, and it’s a personal residence, you would have a $250,000 exclusion. You can 1031 exchange that if you want. You’d make it into a rental right before you sell it. I recommend six months of rent, but it’s not technically. You can rent it for one month and then sell it as a 1031 exchange. You could still take a 121 and your 1031. You could defer a portion, you could step up your basis on $250,000 and avoid the tax. If you’ve already sold it, you could still do a qualified opportunities zone if you really want to, and you still, if you live in it two in the last five years, get the $250,000 exclusion. If you got remarried and you live in it for two years with your new spouse, you’d get a $500,000 exclusion. Isn’t this stuff fun?
I know what I forgot to do. Please go on and subscribe to our podcast channel and you can always listen to these. What a lot of our listeners do is they go in and they say you subscribe and they just go listen to the podcast, whether working out. Go to iTunes or Google Play. Lots of fun stuff. Go on our social media, we have a really active Facebook group and our YouTube, where we have quite literally a lot of your questions are answered in some of these videos in our YouTube. We have well over a hundred videos.
I was just looking at Coffee with Carl which has over 30 videos up there. A lot of these questions are answered right on those videos. If you want to watch replays, you always have access like the last month or two, but if you’re in the platinum, you can go back, we have over a hundred of these. You can always go back in and listen to the previous Tax Tuesdays. If you have questions, please send them in via Tax Tuesday Anderson Advisors.
We pick out of that the questions that we put on the actual Tax Tuesday, when we’re actually going into them in the live. Those ones that are on the slides, those come from firstname.lastname@example.org. Those are the email in ones. We don’t actually make these up. We pull them from the clients. Sometimes we clean up the language a little bit. Some of them also are really long, but for the most part, you’re seeing a lot of unedited questions or slightly edited questions, the gist of it’s always the same.
“When will we get the book?” I could send you out the PDF right now. We’re going to be sending those out and then you also get the hardbound book. It’s been set to the printer so hopefully, they are all good and dandy. We had a few last-second changes since Congress is still active at the end of the year and nothing that caused us to make any edit. We’re going ahead and going to print, so you’ll get those pretty quick. Again, we’ll get you the PDF right away. That’s already been approved. We’ll get you the eversion. I’m thinking we’re going to do the audio version, too. For those of you guys who preordered, we’ll probably give you guys a whole bunch of stuff.
All right, hopefully, that was good to go. First Tax Tuesday of the year. How do you feel, Jeff?
Jeff: I don’t have to yell at you about you going long.
Toby: Did I go long? I think we’re right on time. Until next time, guys.
Jeff: See you next time.
Toby: All right, guys.
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