Toby Mathis and Jeff Webb of Anderson Advisors encourage you to look at taxes as something that’s enjoyable because it’s a very rewarding subject. Learn how to use tax laws to your advantage and put money in your pockets. Do you have a tax question? Submit it to [email protected].
- What happens if I forget to submit Form 8606? You don’t have to file a return if you let the IRS know there’s something you put in, but you are not taking a tax deduction for it
- What principle assets should I use for my LLC, if I work from home? Depends on where you set up the LLC; a physical address, but not your home address, as principal address
- Can paying my minor kids for their work in my business offset taxes? Yes, if they do something of value; shift money from a higher bracket to someone in a lower bracket
- How can we pay kids? Is there a limit? If you’re a sole proprietor, you don’t have to put them through payroll; if you’re anything else, you do put them on the payroll
- Can I pay my parents for babysitting? Yes, but you’re not going to write that off because it’s not an expense
- Do I have to file tax through each state where I own a rental property? If you’re making money in a state, you must report that income somewhere
- Can a self-directed 401(k) invest in an opportunity property? Self-directed IRA means you don’t have to have a custodian; you can be your own administrator or trustee
- Can I invest in opportunity property? Yes. Opportunities zones and opportunity funds get the tax exemption; you can invest in those areas and defer capital gains
- What documents need to be filed for a C Corp? Depends if you’re filing it with the state, then there’s three areas to be aware of: State, third parties, and federal government
- Do you need a real estate license to be considered a real estate professional? No.
- What is a good IRA platform to use, has the lowest fees? IRA Club
- Is partnership income in an IRA required to be income taxed? No. An IRA owning a partnership doesn’t pay tax on that income
- Do you lose long-term capital gains being a real estate professional? No. Capital gains are capital gains; you don’t lose them because the losses aren’t considered passive
- Do kids pay FICA taxes? If it’s payroll, yes; they’re not going to pay on employment taxes
- What are the main tax advantages of a C Corp? Separate tax bracket and fringe benefits that are not taxable to you and not available through others
- I have a home office in the basement. Is that basement going to be deducted? Yes, if you’re a sole proprietor; have an accountable plan and reimburse yourself by determining how much square feet of the house you’re using
- I formed a single-member LLC. What tax form do I report? You don’t; it’s disregarded
- What’s the best bookkeeping system for real estate investors and financial services corps? QuickBooks
For all questions/answers discussed, sign up to be a Platinum member to view the replay!
Full Episode Transcript:
Toby: Hi guys, this is another Tax Tuesday. This is Toby Mathis and…... Read Full Transcript
Jeff: Jeff Webb.
Toby: All right. We’re just going to dive right in. We have a lot to go through. There always seems to be more than we can actually seem to hit in one show. That’s a good problem to have because it means there’s lots of people asking questions.
Let’s just dive right on in. I do Google over most just about anything I can get unless you write me a book. I’m going to try to knock out your question. If you do write me a book, we’re going to say, “Email it in.” If your Platinum, we’ll answer it, if you’re not Platinum, then we’ll have somebody contact you to see what it would take to become so we can give you very detailed fact-specific responses.
This is supposed to be fun. You’re supposed to be looking at taxes as something that’s enjoyable because it’s a very rewarding subject. If you learn how to handle your taxes, you can put a lot of money in your pocket. Folks that really understand tax, including—whether you like him or not—our President happens to be very good at understanding tax and has used the tax laws to his advantage, probably to the point where he doesn’t want you to see his tax return. Because most people would say, “How the heck did you do that? That’s not fair.” Anyway, we won’t get into all that fun stuff.
It is what it is. The tax laws are written. I take no stance on them other than we’re going to take advantage of the ones we can and use them to the best advantage as we can. It should be fun. It’s like a Rubik’s Cube, unless you hate Rubik’s Cubes.
Opening questions, we have a whole bunch to go through. “Property aggregation, what is it and why would I want to do it?” The next question is, “What happens if I forget to file a Form 8606,” which has to do with a nondeductible contribution to a retirement plan, aka a Roth. Is there any other one that you’d be doing?
Jeff: No, you can make nondeductible traditional.
Toby: Yeah, that’s right. You can do non deductible. “Is acting as a partnership representative a prohibited transaction that’s put in some of the new tax laws?” “What principle address should I use my LLC if I work from home?” “Can paying my minor kids for their work in my business offset taxes?” “Do I have to file returns in each state where I own a real property?” That’s always interesting. Of course, you guys can ask questions live. Let’s dive into these ones first. “Property aggregation, what is it and why would I do it?” You want to knock this one out?
Jeff: Property aggregation, this has to do with the participation rules. Material participation and active participation. Same basically that you have enough hours. The material participation rule says, the primary ones says you have to have 750 hours and an activity.
Toby: Material participation or the real estate professional? Material, I think is 500 not to mince words.
Jeff: No, that’s fine.
Toby: You always have two things. You have, “Hey, I’m a real estate professional,” and you actually have to meet both the material participation and real estate professional, the 750-hour. Would it being more than 50% use of your working time?
Toby: You have to meet all those. It’s per property unless you make an aggregation election.
Jeff: Or as I say per activity.
Toby: Per activity, that’s a good way to put it. If you’re going to be a real estate professional, since we deal with a lot of real estate investors, you have to make a property aggregation election. There’s actually a court case on this where you’d have to qualify and spend the time on each property.
Now, the court case screwed it up because they did 750 hours on one property. I think it’s actually 500. Neither way, what you look at is, you have to meet the time test. If you don’t want to do it per property, make an election to treat them all as one activity.
Jeff: The whole idea behind this is to convert from passive income to non-passive income. The one problem you may run into is if you have a bunch of passive losses built up and then you aggregate the property.
Normally, when you sell a property, you release all the losses from that property. Once you aggregate all your properties, you can’t release any of those losses, until you sell everything—all the properties.
Toby: It’s all one activity. It’s one property as far as the IRS is concerned. All right, “Why is it and why would I want to do it?” If you’re a real estate professional, you could write off the passive losses against your active income because it’s no longer passive. It’s deemed passive unless you meet the exception, which is real estate professional status. “When does somebody use it?” You use it when you’re a real estate professional. When you’re part of the stature.
Jeff: And can have a substantial effect on income.
Toby: “What happens if you forget to Form 8606?” The IRS beats you with a stick. Actually, they let you go back whenever. In fact, you don’t even have to file a tax return. We’re just looking at this about an hour ago, digging into it. Jeff and I were kind of like, “Hey, maybe we have to follow a return,” and, “No, you don’t have to file a return, you don’t have to do anything as long as you’re letting them know.”
I know we’re doing a saying, “Hey, I made a nondeductible contribution.” The idea is you’re letting them know that there’s something in there that you put in that you are not taking a tax deduction for.
Jeff: Right. The one other time you use this form is if you change your traditional IRA to a Roth IRA. That also runs through the 8606.
Toby: When you took a traditional…
Jeff: …because you have to recognize the income.
Toby: All right. But they’re letting you go back. Again, there was this, “Hey, what happens if you don’t?” The IRS is glad you’re filing it and you could lump them up. I’ll tell you what, this is one of those plugs of why you use the tax professional because the software will trigger this thing and create it for you. Most people have no idea that there’s this form even exists. In fact, there’s a bunch of folks asking, “What the heck is it?”
If you make a contribution to a Roth, you’re letting them know, “By the way, I put money into this thing.” That way, when you take that money back out, it offsets that amount. They know that you can always take that money out anytime you want. There’s no five-year test, there’s no waiting till you’re seven and a half, you just take the money back out. I hope that makes sense.
Jeff: This form is important. If you’ve done a Backdoor Roth IRA, where you’re making too much money and make the Roth contribution, you’ve got to file this form to get that basis in that Roth IRA.
Jeff: The Backdoor IRA, I’ve always thought of it as something else. You’re talking about, “Hey, I am phased out of being able to do a Roth IRA.”
Jeff: So I do a traditional contribution and then convert it.
Toby: There’s no limitation on what you can convert so you do that. Again, that’s interesting. There you go. I always look at it as when you’re dumping money into the solo and using that but it sounds so sorted we do the Backdoor IRA. There’s just something odd about that.
“Is acting as a partnership representative a prohibited transaction?” Do you want to knock that?
Jeff: No, this is on you.
Toby: No, I’m going to push back, let me throw this at you. Okay, a partnership representative, there’s new rules on what used to be a tax matters partner, which means somebody who is responsible to deal with the IRS in the event they’re auditing a partnership.
Because for those of you who pay great attention to partnership taxation, partnerships don’t pay tax, they pass the tax down to the owners. If you have a partnership, which is two or more individuals or entities acting in concert for business purpose, if you meet that test, you have to file a 1065 every year, which is an informational return. What this says is, “Hey, we now have one party and we’re going to assess the tax at the partnership level.” So this is weird.
Now, certain people can opt out. But I can just tell you, none of our clients can because of you’re entities. You’ll have to be individually owned and quite often you look at that and has to be less than hundred people. They could say, “Hey, we’re going to opt out of this and still use a tax matters partner.”
All this fancy way of saying is, who the IRS deals with. Who’s the party that they deal with? Now, this is why it’s important. When I see prohibited transaction, I’m now thinking you’re dealing with somebody who is investing through their IRA or 401(k) in a partnership.
Let’s say that you have two IRAs investing together in a transaction. Or better yet, actually, the IRS uses an example. You have company one and company two. Company two is an exempt organization as an IRA, or an LLC owned by an IRA or 401(k). You could just fill in the blank.
That party doesn’t pay tax on receipt of the funds unless it’s something called a UBIT. But we’re not going to worry about that. What they’re saying is, “Hey, let’s say their owner is in a building.” The reason it comes up is because when the partnership is being audited, you could say, “Hey, you shouldn’t hit us that hard because part of us is owned by an exempt organization.”
Now, we’ve gone through two different levels. We have the partnership, we have the owner of the partnership, and now we have the participant and the owner of the partnership when that participant is an IRA or 401(k). So we’ve broken it down into pieces.
They are prohibited, disqualified person, as far as self-dealing with that or entering into transactions with that exempt organization, the IRA or the 401(k), with very few exceptions. Are they a prohibited person from being a partnership representative? The answer is no, not as far as we can tell. There’s nothing out there. In fact, if your IRA was audited, you’re allowed to defend it. If your IRA is ripped off, you can you can start a lawsuit against the party who ripped you off and all those things. You’re allowed to do administrative activities on behalf of your IRA.
Jeff: You did really good on that one.
Toby: All right, that was a break down into little pieces. Lots of questions have been coming in. “Is a partnership income in an IRA required income tax to be paid on that income?” I’m going send you guys all to English school. I’m just reading some of these questions. I’m just teasing on you guys but some of these are really bad. No, the income flows through to the IRA and keeps its character. If it is unrelated business income, then you possibly could. If the IRA is getting active income, it’s an active partner, then you might have an issue. If it this owns an interest in a corporation, interest in a passive activity, then we don’t ever have to worry about that.
Jeff: That IRA is going to get K-1 from the partnership, but you just file it. There’s nothing else to deal with it.
Toby: You are exempt for the most part. Somebody says, “Real estate professional,” we’ve gone over real estate professional in the past, but I’ll just tell you again. I think I already said it once before, but I’m just going to go through it again very quickly.
There are two pieces of real estate professional status. You have to qualify as a real estate professional, which requires that you spend 750 hours and it is your number one use of your work time. Whichever one is greater. You have to spend at least 750 hours and it has to be the greatest use of your business.
If you spend 751 hours being a therapist, boom, you lose. You’re not a real estate professional. If you meet that test, then you also have to be a material participant in your real estate activities. That’s a much lower test. That could be just a few hours up, but it’s automatic if you spend over 500 hours. You have to aggregate all your activities into one. Our first question was about property aggregation. That’s about as much as I’m going to say. That converts a passive activity into where you can actually write it off against your ordinary income.
Now, here’s the big one. If you are filing a joint return with a spouse, only one spouse has to qualify and all activity is treated as one. Basically, you could be some executive somewhere making a million bucks and your spouse spends enough of his or her time on real estate and they meet the test and it offsets your income because you have a bunch of material participation. This means you’re participating in any activity involving your property. It could be the manager, it could be looking for property, whatever, there’s a list.
There’s a bunch of videos that I’ve done on those and you can look at some of the past Tax Tuesday’s as well. People are asking about opting out. “If you don’t opt out from the central audit regime, are you required to pay tax at the partnership level?” No. This is what it is, they can assess the unpaid tax. They audit the partnership. The partnership now owes the tax. In other words, normally, when they audited a partnership, they would just go and audit each of the partners. Now, they don’t have to do that anymore. They can just basically audit the partner.
Jeff: These aren’t all that different from the old TAFTA rules. You got companies and all kinds of stuff. You’ve got over 100 partners. We’re just going to tax the partnership so you don’t have to reissue K-1s to everybody.
Toby: Let’s see. “If you are a counselor consultant, do you need the same 750 hours?” No, you do not have to. This is only for real estate and because real estate is deemed to be a passive activity unless you’d meet this exception.
We got lots of questions to hop through. “What principle assets should I use for my LLC if I work from home?” It depends on where you set up your LLC. If you set up your LLC, generally speaking, you need to have a physical address. I’m just going to say, for our purposes when I work with LLCs, I use the physical address as the principal address. It should be something different than your house. I don’t like people showing up at folks homes. I don’t know how to put this.
Jeff: Serving papers or…
Toby: Service of process is always one but what you don’t realize is that once you register a principal address for business, everybody pulls that information and start sending you stuff. Unless you love piles of paper, don’t do it. Unless you want somebody showing up on your doorstep door-to-dooring you for business services, don’t do this.
What I would say, if you work from home use a different principal address, use a physical address. You can have more than one address for business. What you use with the state and for people that you don’t know could be different than the one that you use for your main office, for example, you could have multiple offices. You could have multiple principal places of business. I hope that makes sense.
Last but not least is the good old fashioned P.O. Box. Most states are going to require that you have a physical address and then you could always have a P.O. Box listed as well in different correspondences so that you don’t have people again, showing up at your house. I would just never use a home address in anything that would be a public record. Unless you really like people showing up at your house or just getting lots and lots of mail.
“Can paying my minor kids for their work in my business offset taxes?” Absolutely. They have to do something of value. This is one of my favorite techniques, it’s called income shifting. You’re shifting money that would have been in a higher bracket to somebody in a lower bracket. If you know anything about me, I love that stuff.
Somebody just asked from that last thing. “But what about the IRS business address?” It’s whatever you use to file your SS for. That one, I don’t care whether it’s your home really.
Jeff: Yeah, they don’t particularly care as long as they have a place to contact you.
Toby: It’s not what you’re putting out in the public. Just remember, as we’ve learned from our President, your tax returns are not a public record. People cannot just take them and say, give me your tax returns. They are private. You cannot go to the government and say, I want to see my neighbors’ tax returns. You don’t get to.
Back to the kids. Speaking of governments, let’s talk about children because they act that way. “How can we pay kids. Is there a limit?” You them either through your payroll. If you’re a sole proprietor, you don’t have to run through payroll. If you’re anything else, you do. Partnership, you’d have to run through payroll too. For the most part, I prefer to use corporations. You guys know me, I use accountable plans. There’s way too many tax benefits not to do that, including if I’m employing my kids.
Yes, you employ your minor kids. There are cases on the books of companies paying nine-year-olds, where the owner was the operator and they paid young children, as long as the children can actually do the work.
Someone said, “Can I pay my parents for babysitting?”
Jeff: That’s a whole different thing.
Toby: Yeah, you’re not going to be writing that off. It’s not an expense. Yes, you could pay your parents but that’s not a benefit. If you put your parents on your board of directors, they did something, and you paid them. That’s much better because now you deduct it and they receive the income. If they are in a lower tax bracket than you, i.e., what if they are below the threshold for tax, they have a standard deduction, then it’s fantastic. They pay zero taxes. We like that. Don’t you like zero tax?
Jeff: I love zero tax.
Toby: All right. I’m glad that I have a CPA saying, I love zero tax. I get suspicious about CPAs sometimes, as to who they actually work for. Sometimes CPAs that I’ve met, it seems like they’re going out of their way to make sure that their clients pay the most amount of tax as humanly possible. Like, “What the heck are you doing?” and they’re like, “This is the way we have to do it.” I said, “No.”
“Do you have to file tax through each state where I own a rental property?”
Jeff: My feelings on this is, if you’re making money in a state, you have to report that income somewhere. California, in particular, I’m going to point that one out. We tried to set up the LLCs and so forth but they’re not actually operating in California.
Toby: Let’s just talk about state income taxes.
Jeff: State income tax in general. Say, I have a rental back in Kentucky, Ohio, and Indiana. I’m going to have to pay taxes on those rentals. I’m doing business in those states that I have property in those states. I’m going to have to report something somewhere.
Toby: You have to do a separate tax return in each state?
Jeff: Yeah, usually. When we talked about the pass-through entities, each state is different whether you report or not.
Toby: I can say I have real estate in 10 different states. I do not file estate tax return in each state. I only file tax returns in the states that require that I file tax returns based off of a franchise tax or things like that. Otherwise, you’re going to pay tax where you receive the income, as long as it’s passive, you may have to.
There is always two things. It’s just fun to have an accountant because lawyers always say, “Oh, you have to file in this state and blah-blah-blah-blah.” I said there’s two rules. There’s the tax rule, which you don’t have to register there to be subject to the tax. Ask the My Pillow guy whether he has an access to New York because I know for a fact somebody got paid a lot of money for turning him in for not paying the sales tax.
Toby: You can have a tax nexus with the state but not be doing business in that state for purposes of having to register. Now, when you have real estate, it’s real easy. Your businesses is there. Your entity is there. But if it is a flow-through entity, and it’s passive income, it’s usually heading out of state.
You may have a certain situation, for example, again, California. If you’re just there, you’re either registered there, or even if a California resident individually owns something in another state, they consider that LLC doing business. They are for tax purposes, not for filing with the Secretary of State but for paying taxes. It is weird, you have different things. The answer would be, it depends unfortunately on this one.
“Do I have to file returns in each state where I own rental property?” It depends and I would say the general reason, unless Jeff wants to argue with me. The answer is no on rental properties, unless there’s a law that requires that. You’re not paying income taxes in that state. You’re going to pay income taxes in the state where you reside.
Jeff: I think I’d go the other way. There’s a prime type of rental property in Maryland. Maryland is going to want their share of tax from that property.
Toby: They have a franchise tax. I know Maryland could have a bunch of properties there. You can even be exempt from that.
Jeff: Then you have the weird ones like Tennessee, where your entity may have to pay a franchise tax but you don’t personally.
Toby: Right. Tennessee is a great example. They have something called FONCE, which is a Family Owned Non-Corporate Entity. Sometimes this stuff gets stuck in your head and you’re like, “Get it out.” FONCE just means, if it’s you owning it then you have to pay tax there because they actually have two taxes. They have an excise tax and an income tax.
Jeff: Yes, they do.
Toby: You don’t have to pay the income tax but you have to pay the excise tax unless you meet the exception. Every state is a little bit weird.
Someone’s asking, “I own a property in Indiana, I live in California. Do I have to file a state income tax return?” In California, you definitely do. I don’t believe you do in Indiana. Again, that’s why you have real estate professionals. Jeff may want you to file income taxes. Again, I can’t see how you would on a rental property.
Jeff: Sometimes, I like doing it just to capture the losses, so if you ever sell the property, you have deductions against you.
Toby: I can see that. Chances are, if you have rental real estate, you’re not having income tax because you’re going to be offsetting it. If you don’t, then we need to check because if you’re paying tax on it, then you probably are not taking all the deductions you’re entitled to.
Now everybody’s asking, “What about Colorado and all these others?” I can just say that, like a baseball player who’s actively coming in and actively making money, that’s different. They’re going to be filing tax returns in every state because it’s so much money that they’re making, and they make them do that but based off of how many games they play.
If you’re just doing passive activities, it’s going to flow back to where you live, for the most part. You pay your income taxes in the state where you reside, for the most part. There might be franchise taxes and other things that you have to worry about an estate.
Colorado, I’m not aware of. I don’t know of any property in Colorado.
Jeff: You’ve got to remember, you’re never going to pay taxes in both your home state and the rental state or wherever you’re generating the other income.
Toby: Unless it’s a franchise tax and you happen to be in California or based in it, all bets are off.
Jeff: But you usually get a credit in your home state.
Toby: You get a credit in California? Because they’re going to say $800 minimum.
Jeff: Well, that’s true.
Toby: Yeah, they’re evil. In case you were wondering the franchise tax board is a bunch of vampires. They’re just sucking money out of everybody.
Jeff: They’re not evil, they’re just broke.
Toby: The Board of Equalization in California is not evil. They are great people but they’re very aggressive in their collections. I’m trying to be nice about it.
Tax-Wise. If you guys want to come and join, I’ve been offering this for the last two months. I keep offering it all throughout the year. If you like tax strategies, some of you guys looks like you could probably use some based off the questions, I always get these. You should see the questions we get, by the way. We have a list. I’m looking at the list, and just where we’re at right now is 456 this year.
I put detailed questions. There’s a lot of questions that come flying in here. Some of them are like, “Oh my God.” I think that they went to the anti-tax person, somebody who really thinks that the country needs a lot of extra money. They’re like, “Here, structure it this way. You can pay twice as much.” Don’t do that.
The Tax-Wise course, June 13 to 14, that is the next live one. You can live stream it. You can come and get all the recordings for all three that we did this year. We already did one of them so you get the recording of that one. You’d live stream June and November and get those recordings at all. We make it real easy. It’s $197, all freight included. For live stream and replay access, go to andersonadvisors.com/tax-wise-2019-3in1-offer. I don’t know who makes these things.
Jeff: I was going to say, I think they make these names specifically…
Toby: I think it’s usually a tech guy coming up with the name and not realizing that somebody actually has to type it in.
Jeff: I’m surprised there’s no symbols in there.
Toby: It looks like my password. Somebody said, “Be nice.” I’m an honoree today. All right, $197, come join us. I do about 30 different tax strategies, including real estate professional status, plus using that in conjunction with cost segregation. Let’s lump in some solar credits while we’re at it and accelerated depreciation. We’re going to have some fun. Jim, email us in because we will get you a good deal.
Replay should be in your Platinum portal or we’ll send out a link. If you want to be a Platinum member, Anderson Advisors. If you don’t know what Platinum is, it just means you can ask questions of the attorneys. You get two free tickets to any one event, you get unlimited attorney strategy sessions, and you can ask questions of the tax team. No cost except for your $35 a month. There’s a signup fee, unless you did some sort of structure with us. In which case, we do all sorts of fun deals to make this thing almost free for you.
But if you’re a Platinum member, the way I always look at it, it’s $35 a month. We’re at your backend call because you want to ask us questions before you do something so we can make sure you do the right thing. It’s hard to undo it.
All right. Questions, questions, questions. You’re thinking, “Oh, shoot. I have tons of questions, Toby.” You can always send them in [email protected] If you if you get that, “Oh shoot, I forgot to ask.” You can ask now. I’m going to go through a whole bunch of questions. You could visit Anderson Advisors and just spend time with us on our site.
If you know, Clint, Michael, and I, we love to record ourselves. We love to record lots and lots of stuff. You can spend tons of time watching videos for free. We have a very good YouTube channel and it’s tons of fun. Of course, you could go to the podcast. All of these things that I just mentioned are free. Somebody says, “What’s the fee?” It’s free. Platinum, it’s going to depend, $35 bucks a month.
Now, we have tons of questions. I’m going to answer a few that were shot out in the very beginning just because a couple of them, I want to make sure that I could see somebody going the wrong direction here, first off.
“Can a self-directed 401(k) invest in an opportunity property?” First off, self-directed IRA. That just means you don’t have to have a custodian. Whenever I see self-directed, I want to say self-directed IRA because you have to have a custodian, but they allow you to control the investments. You direct the investments in a 401(k). You don’t have to use a custodian so I never call them self-directed at 401(k)s. I just call them a 401(k) because you can be your own administrator, trustee, whatever you want to call it.
“Can you invest in opportunity property?” Yes, but opportunity property or assume you’re going to be talking about opportunities zones, and specifically an opportunity fund, because that’s how you get the tax exemption. If you guys don’t know about opportunity zones, every state put out a list of zip codes that were approved by the Treasury. All of those zip codes, you could go to opportunity zone, type in heat map and you’ll be able to find a map that you can click on. You can invest in those areas and you could defer capital gains, not just real estate, but any capital gains.
I always use Bitcoin as the example. I sell million dollars of Bitcoin. I could defer it for seven years by investing it in an opportunity zone fund that has 90% of its property in those opportunities zones. Now, the whole idea is to defer your tax. So why would I do that in a 401(k) or an IRA? The answer is, I wouldn’t because there’s no reason to do it.
Jeff: Yeah, you’re not going to pay any tax on that capital gain that you’re putting in this opportunity zone.
Toby: Now, here’s the big reason. In an opportunity zone, if you hold that property for 10 years, you have exclusion of capital gains on any that growth. If I buy a million dollars of opportunities fund, if I defer a million bucks, I will pay tax on that million dollars. I don’t pay tax, by the way, in the full amount. As of right now, you’d be paying tax on 85% of it. I pay tax on $850,000 at whatever it would have been. If it was long term gains it’s still long term gains.
But if that million dollars turns into 10 million in 20 years, you pay zero tax. If I put that same 10 million through my 401(k). I have to pay tax with required minimum distributions and all of a sudden, I took something that would not have been taxable and I made it into something that is taxed at my ordinary bracket and it makes my social security taxable too. I would say that’s a really bad move and I wouldn’t do it, sorry.
Jeff: I’ve seen this happen in the past with people putting municipal bonds and things like that in their 401(k)s and IRAs. There’s absolutely no reason. It’s a low return with no tax benefits.
Toby: Yup. Zero tax. You just put it in an exempt entity. What we know is that the entity doesn’t pay tax but you pay tax when you receive it, unless it’s a Roth or something, in which case, again why would you do that?
Jeff: The Roth, again, there is no tax.
Toby: There’s no tax on it and you pay no tax coming out. Why don’t I just own it? I’m not paying tax anyway. Why do I complicate it by sticking it in there? Why do I take something that would have been taxable and converted into something that is, simply because somebody told me you should invest through a 401(k)? As I soon as I see that, I know somebody’s out there pitching it and it bugs the crap out of me. You’re just taking something that would have been a really good thing for you and you’re making a mess of it.
“How do I know if I’m a Platinum member?” You just have to ask us, Phyllis. Just email on in and we’ll tell you. You should know because you’d have a Platinum portal and we’d invite you, we’d call you, and we bug in, all that fun stuff.
More fun ones here. “We have a management C Corp, manages real estate LLCs. Can we set up a 401(k) in the C Corp for one of the shareholders that will no longer have a W2 job without providing one for the other shareholders? If the salary is about $20,000, can they contribute 100% to the plan or only a small percentage?”
Todd, that’s a great question. Here’s the deal, we have to look at how many employees you have. You can do a solo, if it’s the shareholders. Basically, its partners, it’s a husband and wife and others. I believe you can do a solo, unless you know anything differently. It’s shareholders, they’re actual owners in the company.
Jeff: Just because you’re a shareholder it doesn’t make you an employee.
Toby: Correct. You have to be a full-time employee still in order to be required to be a part of it. Let’s just use this example, they don’t have another job, $20,000, I could defer the first $19,000 if I’m under 50. The first $24,000 if I am over 50 directly into the plan, period. No percentages, no nothing.
In addition, the company can contribute 25% of that amount. Let’s say your salary is going to be $20,000. Out of that amount, I could put $19,000 plus another $5,000. I could put $24,000. This is going to sound weird, but I could put $24,000 into the plan or another company can match. Basically, you can get the whole thing in there.
Jeff: But this is where it’s important to determine who’s an employee and who’s not. If you’re going to make a company contribution, you may find yourself subjected to having to contribute to other employees.
Toby: All right. “Can you tell me what Platinum level means?” It’s just a service and it’s ours. We have we have two main services here at Anderson that we use funky names for, Platinum and Titanium. Platinum is our $35 a month. You can ask any question, get on our calendars, and then you can ask tax questions in writing. The reason we want to ask questions and writing is because we are going to give you a written response. I don’t expect you to remember everything, but I’m going to cite and I’ll usually put in something. The reason I do that is because, guess what? People ask the same question every year right at the end of the year. This way, I can just write at once and say, “Look at what I said last year.”
“I just signed up for Platinum in the corp. What’s the difference in PPT and Private Vault?” Do you know what PPT is?
Toby: That’s PowerPoint to me.
Jeff: That’s what I was going to say.
Toby: I have no idea. Private Vault is what we use as indexed universal life, or non-qualified retirement plans, or whole life. They’re fantastic. It’s using code 26 U.S.C. 7702, not paying tax on growth, and you can borrow it out. The private pension is what they might be thinking of.
Jeff: Personal Property Trust?
Toby: I have no idea. “How do you go about transferring a personal home that is being converted to a rental to an S Corp to increase basis?” If the S Corp has no income, you’d have to give it money, first off, and then you carry it on an installment note.
The next question is, “Would you sell it on an installment note?” “When the property is sold, would it be okay to get interest payment in the meantime?” Yes.
“Why would an S Corp be better than a single-member LLC.” Because an S Corp is a separate tax entity. It is allowed to enter in that transaction. A disregarded LLC is you. A single-member LLC is ignored for tax purposes. You can’t sell yourself a house. You have to use a separate person.
“Is the California minimum franchise tax the same as the 1.5% for an S Corp or 8.75% on profit C Corp?” Yes, the minimum is $800. It’s the minimum. The question is. “Do I have to add $800 to whatever that tax is?” No. The $800 is just the minimum, it’s going to be the higher of. That’s why people always get hit with that $800 because they’re like, “Oh I don’t have any taxable income. I don’t need to pay a franchise tax.” Nope, that’s not how it works.
Jeff, I am whole barding]the heck out of this.
Jeff: No, you’re good.
Toby: I’m just up against the screen. You guys can’t see this. It’s a small little writing here and I’m squinting at it. You do this one.
Jeff: “I received the 1099-C from a credit card company…”
Toby: That’s a cancellation of debt.
Jeff: “…we protested the rate that they were charging and they rebated the interest overcharge and sent a 1099-C for the amount.” The 1099-C, is usually issued for the amount of debt that they write off. They may say, “You owe $10,000 and you pay $4000 to settle the debt.” You’re going to get a 1099-C for $6000.
“How do I deal with this 1099-C without paying the income tax on this amount that was not a benefit and not received or deducted?” IRS is probably going to say for interest. You were charged interest for your credit card and that’s going to be part of the debt that you did not repay.
Toby: They were probably recognizing that income under the accrual basis. So they probably took income and now they’re taking a deduction against it. So they’re going to give that to you and say, “Ha ha.” How do you avoid it? You contest the 1099 and say, “Hey, you didn’t actually give me anything. You just didn’t charge me something.”
Jeff: There is a possibility, if you think that it’s a different amount, you can contest that on your tax return. There’s actually a form to fill out that says that you disagree with an information form that you were given by somebody.
Toby: Isn’t there a 1099-A also? Your 1099-C, which is cancellation and 1099-A. It used to always be which one triggered the tax.
Jeff: Both of them can. The 1099-A is usually for short sales and things of that nature.
Toby: That’s when it’s been sold? Let me just see.
Toby: What does the “A” stand for again?
Jeff: I want to say acquisition but I’m not sure that’s correct.
Toby: No. It’s when you when they’re actually done.
Toby: Abandon, there we go. Now, I remember. You abandoned it. They used to give you a 1099-A and then the question whether that was taxable. The IRS didn’t know the answer. And then “C” is when they cancel it. Somehow, someway, they’re saying that they gave you money. You might be thinking it’s interest and they may be saying it’s principal forgiveness. At which case, now you still owe them the interest and they’re writing down the amount of debt.
You said, they rebated interest. They may be treating it as though they extinguished some of the principal, then it would be taxable to you. It sounds like you guys are on different pages. I would definitely be looking at fighting that one depending on how much it is.
“Hello. We set up a corporation as managers of our rentals. To offset our management income, we reimbursed healthcare and home use. However, we were unable to reimburse our healthcare in 2019. Are there other similar simple expenses because of participating in ACA?” I have no idea. “Are there other similar expenses/items that we can implement offset income?”
That’s a broad question. Yes, there are, there’s tons. We go over them all the time here but, what I would do is I’d point you to Tax-Wise because we’re going to go over all of those there. I would spend some times there. You could just hang out on the Tax Tuesday’s. You’re going to hear about a whole bunch of them, but everything from cell phone, to cars, to computers. Obviously, you’re using a percentage of your home office. You also do 280A, the corporate meetings. Maybe you’re not doing the total home office, which is a percentage.
“What documents need to be filed for a C Corp?” Lawrence, it depends on whether you’re filing it with the state. If you’re filing it with the state, there’s always three areas that you need to be aware of. The state itself, third parties like banks, and the federal government.
When you file a C Corp, you could file it with one, but then you need bylaws for the banks. You need resolutions for the banks, minutes for the banks, some sort of shareholder agreement for the banks. You need to have documentation that gives your C Corp a body, and then you also have to file an SS-4 with the IRS, with the Feds. Also, I’ve been thinking of states because you may have to register with your state from a taxing authorities standpoint. So all of those things.
“What do you file on an annual basis?” If it’s C Corp, you file an 1120 with the federal and then you file in whatever states you’re doing business in.
Here’s another question. “How can I shield money and account from a future audit? How can I have an account to shield from Texas?” That’s interesting. Do you want to knock that one? I love it when they say, “I want to put money aside from a future audit.”
Jeff: Well, I don’t even know what to do with, “How can I have money in an account to shield from taxes?”
Toby: Here’s a hint. The feds are reaching all over the world right now. They are reaching outside of the United States to get money. Usually, what they do is they squeeze the in country entity and beat up on them. If you weren’t familiar with what was going on with the Swiss accounts and all that, it’s really tough.
Jeff: If it’s a US account, IRS already knows about it.
Jeff: I was registering with IRS today and one of the questions was, I had to give them one of my account numbers from a credit card. They knew what it was.
Toby: Yup. They know all about you, unfortunately or fortunately. They make sure that people pay their fair share and it’s just a question of fair. Now, for protecting yourself from audit, just make sure you’re doing business in entities that are low-audit risk and have lots and lots of opportunities for deductions because the chances are if you are audited, if you’re an individual, you lose 95% of the time. If you’re a business, you win 700 times more, so way better.
Jeff: Let me ask one thing, though. I know most times, qualified retirement plan accounts are shielded from creditors, correct?
Toby: Quite often. It’s a creature of state law and then you also have federal bankruptcy protection. What a lot of you guys don’t realize is that even your taxes, you can bankrupt away taxes.
Jeff: Does IRS have access to the QRP funds, the Qualified Retirement Plan funds?
Toby: The IRS will grab anything they feel like. Usually, if you’ve done something funky, they’ll garnish anything that they can get their hands on. I always say, when it comes to the feds, all bets are off. They will go and grab everything. They’ll grab your parent’s stuff. I’ve seen them come through and if you haven’t been paying attention, they will just go and nuke you. Sorry, but that’s just the reality of it.
The feds never want to sit there and then hit them on the head with something. You want to do what’s by the rules. They are very rule-driven and they’re easy to deal with so long as you follow rules. You go sideways with those rules, then don’t expect them to treat your real nice. You shouldn’t fear the IRS or any organization like that. You should respect them and then you should do things legally.
“Do you have to have a real estate license to be considered a real estate professional?” The answer is no.
“If I am showing a loss on my tax return for my C Corp, can I claim that loss on my personal tax return?” The answer is no. With the exception of, if you dissolve the C Corp and you made a 1244 stock election. We do that on all of our companies. So if you have a C Corp set up through Anderson, you could write off up to $50,000 per shareholder of any of the corporate losses.
“What is a good IRA platform to use, lowest fees?” We like IRA Club. Dennis, really nice guy out of Chicago. IRA Club, again.
“Is partnership income in an IRA required to be income taxed.” No. If you have an IRA owning a partnership, then it would not pay tax on that income. There’s a few exceptions, depending on whether it qualifies as UBIT or if there’s debt. If there’s debt on the asset, then it’s called Unrelated Debt Financing Income and there could be tax on that, but a general course, no.
“What are advantages of self-employed trader status?” Oh my God. I haven’t heard that one in a while. Self-employed trader status. There’s no such thing as that. There’s trader status. That is when you meet the test, which is not even a test in a statute. It’s a court test of me to being a trader. You need to be doing hundreds of trades. I think the minimum amount that I would even consider is about 700 trades a year, round trip trades. Meaning, it’s probably closer to 1400.
Jeff: Unfortunately, this is one of those subjective tests.
Toby: It’s a court test and I always tell people to avoid it like the plague. Trade through either a corporation or a partnership and have a corporation manage it. Do not try to be a trader unless you are really active and it’s what you do. If you have a job don’t even pretend.
“What is material participation? How would you document this?” We already answered that.
“Do you lose the long-term capital gains being a real estate professional?” No, capital gains are capital gains. You don’t lose that being a real estate professional, since the losses are not considered passive.
“I have an LLC that organized as a single-member entity and treated as a disregarded entity. If my wife and I obtain a loan for real estate that is held in the LLC, is it still a disregarded entity? We live in a community property state.” The answer is yes. The IRS defaults to your state. If you’re organized as a single member and it’s both you and your spouse in a community property, then you’re considered one person.
Someone says, “What about properties in multiple states?” They must be asking about income taxes on the income. “If you’re a lender and you loan money out to bunch of people in different states, would you file a tax return in each state?” I’d say again, it’s interest income and it’s going to depend.
Jeff: If you loan out money, no, definitely not. Because you’re actually performing your service in your home state.
Toby: You are in your home state. They may be someplace else.
“Do the kids pay FICA taxes?” Yes and no. If it’s payroll then, yes. They’re paying old age, death and survivors, and Medicare. Yes, they would have payroll taxes.
Jeff: They’re not going to pay on employment taxes.
Toby: Yeah. The only way around the FICA is if you are a sole proprietor and you employ your kids. That’s the only exception. And I would say, don’t be a sole proprietor because it’s so easy for them to say, “That wasn’t really a business activity.”
Look at this, “Do I have to file state tax returns if you have rental loss in New York and New Jersey?” You guys have done these.
Jeff: Sometimes those states hunt you down. They know you’re there and they want their tax returns.
oby: Yup, sometimes. If you have a loss, then I doubt it. Again, they don’t have a minor.
Jeff: If you have a loss, you’re not required to file a tax return.
Toby: We may do it just as a matter of course, if we’re doing a return, we may do it just because we want to let them know there’s a carryforward loss.
Jeff: What most of the states say, if you have any income as a non-resident in their state, you’re required to file a return. But if you don’t have any income, you’ve got nothing but losses, there’s no requirement to file those returns.
Toby: Jeff may still make you just because he wants to show loss.
Jeff: It’s just because I’m an angry, old accountant.
Toby: All right. “Can you explain the recapture depreciation? How is it determined?” Yeah, it’s real easy, Lee. When you buy a piece of property—I’m just going to say this is probably going to be for real estate although, it works on any business property—if you end up converting business property to personal property like a car or something, you’re going to have to recapture that depreciation at your ordinary bracket. If it’s real estate, then when you sell you recapture the depreciation and it’s taxed at your ordinary tax bracket capped at 25%. So, if your ordinary tax bracket is 15% or something, actually what are they now? It’s like 14%. Is it 15% still?
Jeff: You got me. I want to say it’s still 15%.
Toby: Then, you’d be capped, it would be the 15%. If you’re at 37% personal tax bracket, it’d be 25%.
“What is the website for opportunities zone, again?” You just type in ‘opportunities zone heat map,’ and you’ll see a bunch.
Jeff: Google search.
Toby: “I am interested in a tax-efficient 401(k) strategy. Clint Coons want to double your real estate investment return as easy as…” Stacy, I’m going to have to look that up and see. Clint’s my partner, great guy, very, very, very bright. What he may be doing is borrowing from the 401(k) but I want to see which one that is. I don’t have time to watch it right now.
Question. “This would seem to be disqualified. Do you still do these?” There’s some of these, referring to our question earlier. What you’ll do is, if you have a serious question about something specifically relates to you, email it in via [email protected] I’m not going to be able to answer it quickly here just because we have people sending in three and four emails since they’ve run out of room.
“I have a real property that I’ve owned for nine years. I lived there the first four years in one of the units. The last five years I didn’t live there. Is there a way that I can avoid the exemption of $500,000?” Avoid it. You can’t have it, so you wouldn’t worry about that. You haven’t lived in there two of the last five.
Jeff: Yes, he has avoided the $500 exemption.
Toby: I think they wanted to find it. Maybe they meant how to get it. The answer is no, but you can still 1031 exchange it. That’s really important.
“Dovetail off the question about 401(k) contributions. If the income the shareholders derives is from their rental property cash flow, can we contribute the max for a year to the solo 401(k) and not pay taxes? We get 1099 from our property management team.” So the answer is, they’re getting 1099 and they want to be able to put money into a 401(k). If you are the manager, then yes, you can contribute that to a solo 401(k).
If you are not the manager, and what they’re doing is they’re giving you the 1099 saying, “Here’s what we paid you.” That is not active income. That’s not the type of income that you can put into it 401(k). What you do is, you have that get paid to an LLC that is taxed as a partnership. You have the corporation, act as the manager to that. Whenever you’re doing anything that is management, you do it through your secret from your C Corp. C Corp charges for that activity with your property LLC.
Yes, you could pay yourself. It sounds weird, but you take money from an LLC, and usually we’re using a holding entity. Let’s say, we have a bunch of rental properties. End of the year, we have $50,000 of positive rents, that’s not being offset with depreciation or whatnot. Let’s just say, I’m charging $2000 a month to manage the whole thing. So, I have $24,000 deduction against the $50,000. Then at $24,000, I pay myself a salary. I could put directly into my solo 401(k), $19,000 of it plus make another contribution from the company. That’s how you do it.
“Do estate plans?” Yes, almost always a living trust unless you beat us over the head just because there’s no reason not to.
Here’s somebody. “I’m wholesaling in Tampa Bay. What is the best structure for protection and tax-wise for holding? I have a two-member Florida LLC. I want to hold properties.” Okay, that’s different. “I’m wholesaling,” That’s an active activity. I would do that to a corporation or LLC taxed as a corporation.
If you’re holding properties for long-term appreciation and rental, then you do that through a separate LLC. Depending on how many properties you have. Our recommendation is to put each property in its own LLC. So if you have a liability occurrence on one, they can’t take…
Jeff: I really like to keep the wholesaling and the investing separate, so they don’t try to group on those same kind of transactions.
Toby: Lee asked, “Can a shareholder of a holding company rent a property owned by the holding company?” The answer is yes, unless it is an IRA or 401(k) that is the owner. If you are a shareholder of a company, you can actually self-deal as long as it is arm’s length. Meaning that you charge a reasonable amount of rent and all that fun stuff. There’s actually lots of cases on that.
People like to ask really generic questions. “What are the main tax advantages of a C Corp?” It has its own tax bracket. It’s a flat 21%. It makes a million bucks as 21%. If it makes $10 million it is 21%. If it makes 100 million dollars it’s 21%. If it pays you that money as a profit, just because you get a wild hair and you really want to pay yourself some profit, you pay that at your long-term capital gains rate, which can be as low as zero and as high as 20.
In addition, C Corps could have medical reimbursement plans, where they reimburse 100% of medical, dental, and vision. You do not have to pay tax on it. You just have to be aware of discrimination rules. Those are the big ones on C Corps. They are separate tax bracket and they have fringe benefits that are not taxable to you that are not available through others, not to SS, at least not to partnerships, and definitely not the sole proprietors.
“What is 1099-A dividends?” There’s no such thing as 1099-A dividends. It should be 199-A dividends. What they’re thinking of is, the qualified business income flowing through to you and it’s a 20% deduction. Go ahead.
Jeff: The REIT dividends, those are also included as 199-A.
Toby: Yes, it has to be qualified business income. You look underneath that definition, certain passive activities qualify certain rental activities do. For example, commercial rentals that are not triple net leases. You spending time and your agent is spending 200 hours a year or more on residential property and makes that residential property automatically qualify or you actively being involved in your real estate makes that activity qualify. It sounds weird but we have regs on this stuff and that’s what they’re giving us.
If you are doing triple net leases, it wouldn’t. If you’re doing a REIT, the qualified dividends do qualify. If you’re doing other corporations where there’s dividends, they do not qualify like an ordinary dividend out of a C Corp. It can’t be a C Corp, it has to be you.
S Corps flowing through to you, usually, you get to write off the 20%. There are some income thresholds and then they have something called a specified activity, doctoring, architecture, lawyering, medical, veterinarian, engineer, and performing arts. All these things are exceptions where they phase you out. If you’re making too much money, then they look at your W2 income from the company, not yours, but the company’s W2 total payout and they put a cap on that.
There’s all sorts of funky rules. I’ve done a ton of stuff on this, both online and then also there’s a big section in Tax-Wise. If you really want to know, what I would do is I’d get Tax-Wise. I think I threw that up there earlier. I’ll do it again. It’s $197. Do that and there’s a big section on 199A.
Jeff: I was thinking the REITs must have some really good lobbyists that they got that they got that plugged in there.
Toby: Those guys are killing it and they have carried interest for its long-term capital, yes.
“I have a home office in the basement. Is that basement going to be deducted?” Here’s the thing, if you are a sole proprietor, then yeah, you can do that home office. I would prefer you have an accountable plan and reimburse yourself. It’s going to be the square footage based off of the total square footage or the room methodology or any number of reasonable ways to determine how much of the house you’re actually using.
If that’s the case, then yeah, you can you can reimburse yourself. Not just the actual space, but your portion of depreciation of the actual house, you get to take the percentage of maintenance, you get to take the percentage of utilities. Even if you have a house cleaner, you get to take that percentage and reimburse yourself that out of your company. It has to be an S or C Corp and you would not be taxed on it and the company can deduct it.
We talked a lot about accountable plans here. Here’s one we’re just speaking of it, “I have an accountable plan. Business ran out of cash and has been paying bills personally without reimbursement. Does the amount due to me convert to shareholder alone at some point?”
Jeff: Yeah, if the company owes you money as a shareholder loan, if you’re paying bills for the company.
Toby: It’s like an IOU, but chances are your company is a tax-basis taxpayer. So you want it to have the deduction. It needs to pay you back, but it can’t, right?
Toby: You’re really not paying the bills on its behalf, you’re loaning the money to it so it can pay the bills. It could pay you that money back and you do not have to pay tax on that. I hope that makes sense.
Lots and lots of questions. We have a whole bunch others over here. “I was told today that my C Corp can’t deduct a director’s gym membership, but can deduct medical insurance even though the authorization’s a resolution.” Literally duplicates of each other. Correct. Do you want to answer that?
Jeff: Well, the gym membership is not a medical necessity. It goes into what we call the wellness plan. This is saying like your vitamins, your over the counter medications. The corporation can pay for this and pay for your gym memberships, your yoga, your massage. They can pay for it. They could reimburse you for those items, but they can’t deduct those items.
Toby: Wouldn’t you be taxed on it? It feels like a C Corp paid for your gym membership. It sounds like a nondeductible.
Jeff: No. Under the wellness program, you can reimburse them. You can reimburse for those items.
Toby: But you can’t deduct it?
Jeff: The corporation can’t deduct them.
Toby: Keep in mind that if it’s a C Corp it’s 21%. It’s reimbursing you, it’s not taxable to you. The corporation can’t deduct it. It’s like meals. I’ve always wanted to say meals and entertainment. Entertainment is gone as of 2018. But meals, it might only get to write off 50%, so it’s kind of weird. You could have a company that has zero money in it and you still have a tax liability, but it’s a much less tax liability than your own tax liability. It always trips people up because they’re like, “Well, I spent all the money.” Yeah, but the IRS doesn’t let you write off.
“I and my wife file on same tax return. My wife doesn’t work. She stays at home and I have some W2 plus rental properties. Can my wife sign up for a Roth IRA or IRA to get tax benefit? If so, how much?” She doesn’t make any earned income? Can she have an IRA?
Toby: How much can she contribute? How much can she?
Jeff: I can’t always remember these numbers but she can contribute to an IRA and I believe a Roth IRA as a stay-at-home spouse.
Toby: That’s the exception to the rule. Normally, it has to be income. But if it’s a spouse, they can actually do it.
Jeff: Yes, as long as the other spouse has earned income.
Toby: See? There you go. So Jeff’s worth is weight in gold.
Jeff: That’s a lot of gold.
Toby: I always looked at it to get that active income but I think you’re right, there’s an exception.
Jeff: There is an exception for non-working spouses.
Toby: “Is there a way to offset long-term capital gains for stock? Can I put it in a trust and take it out slowly? Will this work?” The answer is pretty much, yes, you could. There’s a way to do it. It’s called a deferred sales trust. But unless this is millions of dollars, I wouldn’t touch that. I would just take the long-term capital gains and recognize that as I sell my stock. If you don’t want to pay tax on it, then the only option for you is to put it into a qualified opportunity zone fund or be looking at other ways of getting tax relief.
Jeff: Another way to offset these long-term capital gains is sell some of your losers.
Toby: Yup. Lose money in stock. If you have losses on other companies, sometimes you’re taking them.
Jeff: If you’ve got a bad deal, go ahead and sell that puppy and set it against your long-term capital gains.
Toby: If you have a loss carryforward, take a look too, so you don’t lose them just carrying forward.
This is a very long question. I’m going to skip it. “I have self storage business in Virginia. I’m looking to expand a purchase in other facility in Tennessee. What is the ideal structure I should use for this business and real estate investing?” That’s a very broad question. The answer is, for most self-storage units, they’re going to be in an LLC in the state where they’re located. Since you have two, then what I look at is, it might be time to separate yourself from your businesses by having the businesses in LLCs and then put a holding company in another state that’s not near you. So that in the event somebody ever attacked one of those businesses, they don’t get to come after you.
Now, the Tennessee puts us in a little bit of a interesting position, since it has a franchise tax, the FONCE, and we want to avoid that. In that particular case, for what you’re doing right now, I’d probably just have two LLCs, one of Virginia and one in Tennessee. If it’s just you, then you would be the owner. I may look at adding a holding company at some point.
Jeff: But you would definitely split them between two LLCs.
Toby: I would definitely. In fact, if you have any debt, they’re not going to let you put those two together. The banks, believe it or not, do not like foreclosures.
“I am presently gap funding through my S Corporation and number of residential flips, all of which are expected to resell later this year. Assuming six months or more holding periods, is my income in these deals taxes long-term capital gains?” That sounds like she is the gap funder. If they’re a gap funder through an S Corp, then they’re going to receive that as interest. Thus, it can be ordinary income, it would not be long-term capital gains.
Jeff: This is where I feel it’s important how these agreements are written, to say what you’re receiving in return.
Toby: Yup. This is really big by the way. This sounds like you’re just funding the flip, but if you’re the flipper, it doesn’t matter how long you hold it. We have a little bit of an issue there because if you are flipping then there’s no such thing as long-term capital gains. It’s all going to be ordinary income.
“Does a new LLC, who had to borrow funds, have to file a promissory note in order for the note to be enforceable or legal?” No, that’s really easy. It sounds like you borrowed the money. If I was the party that gave you money, I’d want to make sure that’s documented. If they did give you the money, does it need to be in writing for them to be able to enforce it? No. It certainly helps and they may have issues collecting against you but they can show, you actually gave them money, then they’re going to have various opportunities to come back. Pay your debts.
“I recently entered the real estate business, five properties, 16 units, and learning all the real estate lingo. Should I purchase additional insurance coverage or establish LLC for each of my properties?” The answer is yes to both of those. You want to make sure that you have your regular insurance and you want to have an umbrella insurance as well. I call it lawsuit insurance, in case they exceed the primary. Yeah, you separate an LLC, put each of the properties in its own LLC.
“Should I establish an S Corp and have the S Corp on each of the LLCs?” No, not unless you are flipping. The S Corp is used for active real estate, so real estate agent, flipping somebody who is wholesaling.
“What would be the best option, an LLC or S Corp?” An LLC can be an S Corp for tax purposes, files with the status and LLC. Realistically, what you’re really asking, I think is, do we want to have an LLC taxed as a partnership, disregarded, or an S Corp?
What you’re holding these things, it looks like five properties, 16 units. You’re going to hold these for a while. You’re always going to be better off having it flow onto your personal return on your Schedule E. That’s going to be done via an LLC that’s disregarded or an LLC taxed as a partnership.
“When setting up your initial 501(c)(3), where should the startup funds come from, your personal account or as loan? Or is the startup considered a donation?” Jason, the answer is, when you put money in startup or 501(c)(3), it’s considered a contribution or donation. Could you loan the money? Yeah, but I guess somebody possibly could do that. I wouldn’t. I would just call it a contribution.
By the way, I forgot about this. If you loan money to a nonprofit, it’s considered a contribution and then it’s income to you when they pay you back. The IRS doesn’t play around. They said, if you’re loaning money to a 501(c)(3), that’s a contribution. You just gave them the money. If they pay you back then it’s income to you.
“We own an S Corp LLC and a C Corp. We work out of our house. We do not deduct our office space on our taxes. We are going to the septic system and hook it into a city sewer, which means there’ll be several days where we have…” I’ll just leave it that. “We would like to check into a hotel, can we deduct the hotel expenses business expense?” The answer is no.
Jeff: This is cost of giving up your home.
Toby: Right. What you would do is, you want to have the office space and then what would happen is the company could reimburse you for all its percentage of the cost. Usually, you get a business. You’re going to be somewhere between 10% and 20% of a house, sometimes higher, depending on how big your house is, how many rooms it has, and how big a spot your businesses occupying. But what you would end up doing is reimbursing the percentage of the septic system. The hotel expense, no. It would not be considered a home expense. I guess you could try to lump it in there and say it does.
Jeff: It goes along with the business continuity insurance way of thinking.
Toby: Here’s what you would do. You’d list it down as all the expenses of the house. I’d throw it in there. If the IRS ever audited you, you’d have a novel argument. I could see how you’d work and say, “Hey, this was our cost to run our household.” Let’s say, it was 15% that the company occupied that could reimburse you. It’s not a line item anywhere. For you, you just get the cash. The company writes it off and I’d be doing that through your S or C Corp.
“I have an LLC tax as a partnership with the members 40%, my wife 40%, me 20% of corporation, which manages the LLC. All profits gained by the LLC in trading, considered to be passed immediately to the members.” Yeah, that works. What happens is if you make $10,000, you and your wife would get $8000 of it, and $2000 would go to the corporation.
Whether or not the money is distributed or not, that’s how it works. You could pay the corporation, this sounds like a partnership. Hopefully, you have an agreement that says, the corporation can get paid to manage the thing because it’s going to have expenses too. For example, anything that you’re doing, like computers, cell phone, home office, and all those things. You’d want to make sure that it gets that money as a guaranteed payment and then that would lower your total.
You would take that off the top. If it made $10,000 and you had the expenses of $3000, you’d end up dividing $7,000. You take the $10,000 minus the $3000, you divide that 40/40/20 between your partners. Anything you want to add on that, Jeff?
Toby: “I formed a single-member LLC in 2018. What tax form do I report?” You don’t. It’s disregarded, it’s you. You don’t have to worry about it. Hopefully, if it’s a disregarded single member, it depends on the activity, it would go on your 1040. If it’s an active business then it would go on your Schedule C. If it’s a passive business that goes on your Schedule E, right?
Jeff: Right. The only reason you would follow it on the 1120 is if you actually designate it with the IRS that this entity is filing as a corporation.
Toby: Here’s somebody else, “I am confused on using a Wyoming LLC and it being a disregarded entity. I purchased property using the LLC, which I’m in the process of rehabbing.” First off, don’t do that. You are a dealer. You’re an active business and it’s going to flow right onto your Schedule C, not your E, your C.
“Where do I get to deduct the cost that I’m incurring for the rehab?” You don’t. When you flip it gets added to your basis, period. There is one way, which is to do it through a 501(c)(3). Let’s say that I was rehabbing houses for veterans, or single moms, or any number of the elderly. I qualify my 501(c)(3) in that activity, then I could buy the house in there, and I could give a cash, do the rehab and I’m deducting it as I go. Whatever I put in, cash-wise into that thing, I’m writing it off and then it never pays tax again.
Otherwise, if it’s in my personal realm, you don’t get to do any of that. You are you are adding that to basis and then it’s basically stocking your store. When you sell it, that’s cost of goods sold. It’s the basis. You only pay tax on the difference, but it would be active ordinary income. I’m just going to say, don’t do that.
Talk to us, we need to change the tax of that entity. More than likely, we’re just going to make an S-selection on it, if that’s what it’s doing. It’s a Wyoming LLC. Unless you live in Wyoming, chances are, we’re either setting up a new LLC in your home state or you’re registering that Wyoming that’s doing business in the state where the property is located.
Here we go. “I am getting $80,000 from a Roth IRA from my divorce. How is it best to reinvest it in my house flipping business?” If it’s in a Roth IRA, you don’t want to leave it in there.
“Can you flip inside of an IRA?” You can. You’d want to set up an LLC owned by the Roth IRA. For all you guys who are immediately going UBIT, there’s no cases on it. I would say that if you’re going to do one or two, you’re probably fine. If you’re doing six or seven, you’re probably going to run into a potential of having unrelated business income tax. But even that’s taxed at 21% now, UBIT?
Jeff: Yeah, I believe so.
Toby: Worst case scenario, you’re going to pay corporate rate. Best case scenario, is you never pay tax ever again on underneath those schemes. I want that.
Look at this. “I purchased a commercial office flex building in October 2018. I’m evaluating cost segregation. I would appreciate the following thoughts. As I understand it, there are two gains. With cost segregation, I get the larger tax depreciation in the early years compared to standard property to create depreciation. This can reduce my taxable income for the early years. If I sell the property 10 years, this early deduction has increased value. This is the first gain.” I have no idea what that means. “If I use cost segregation, I will have larger capital gain when I sell the property.” No, you won’t. Let me just explain this. Cost segregation, all I’m doing is I’m rapidly depreciating it. It has nothing to do with capital gains because we always take depreciation out of the capital gains equation. So if you’re cost segregating…
Jeff: It’s going to decrease its basis by taking more depreciation.
Toby: But he’s going to have to recapture it, right?
Jeff: Yeah, that’s true.
Toby: What’s going to happen is, even though I’m getting an earlier depreciation, my capital gains is going to be my capital gains. It’s going to be my basis, period. Then I’m going to have depreciation recapture. I wrote it off earlier. Let’s say that I rapidly depreciate, something that would have been 39 years, I get an extra half a million dollars of deductions in the first 10 years. I’m excited, that saved me a bunch of money.
If I 1031 exchange that, first off, we don’t worry about it at all, it just rolls into the new property. If I don’t 1031 but I sell this thing and I pay tax on it, the maximum amount I will pay on that accelerated depreciation, all that extra money is 25%. This is why it’s so powerful when you are a real estate professional. You can offset 37% tax in some cases depending on what state you’re in, 51% tax and I can cap it at 25% federal and then whatever your state is.
It’s pretty powerful, but I’m not altering my capital gains out of this. My capital gains is still long-term capital gains. I would be paying it at my long-term capital gains rate, which is 0%–20%. If I’m making a lot of money, then I have to add the net investment income tax, so it’s 0%–23.9% plus your state. That’s why 1031s are so powerful.
Somebody just said, “Did I hear that right. If I’m flipping a property, say in Illinois and purchased the property using a Wyoming LLC, that is bad?” Yeah. If you are flipping an estate, I don’t even know how you took title in that. It’s possible you did it but you want to be an S Corp on that or an LLC taxed as an S Corp. Frankly, you’d want to register the Wyoming LLC in that state. You could probably get away with one without registering it there.
Let’s see, somebody just asked a really interesting question. “I formed a C Corp and then I went on this bus tour. They have a lot of expenses. Let’s just say that the expenses are $75,000 after the C Corp was established. Do I list these expenses on a monthly expense report?” Yeah, absolutely. If you paid the cash to it, it owes you that money back. Generally speaking, you’re going to take the expense and you’ve loaned the money and you’re going to be able to repay yourself that money. C Corp needs to make money.
“If the C Corp only collects $10,000 this year, can I write the $10,000 as expense reimbursement?” Well, you’ve already paid the expense. You’re just going to pay off the loan of you giving the money to the company. Is that a fair way to put it?
Jeff: Yeah, what you repay has no tax consequences.
Toby: It’s going to be immaterial from a tax standpoint. But you could just say, “Hey, you owe me this money,” but it was paid somehow or someway it was paid. I like to think that you probably paid that with cash, or check, or something, or credit card. It could just reimburse you. If it goes over at tax year, it looks like this was last year, then chances are, it’s going to be treated as a loan.
Wow. “I have holdings in my self-directed IRA real estate in Brazil.”
Jeff: Oh, that’s not good.
Toby: No. Wow. “Due to currency exchange, we lost more than two thirds. How do I adjust the value?” You don’t. You don’t have to do anything, Tim. Maybe if you’re taking mandatory distributions, you’re going to have to do that for whatever reporting. They have that form on an IRA where you have to report the real estate holdings. I guess, you’d have to do that. That is horrible. You turn it into US cash.
Jeff: I know QRPs, Qualified Retirement Plans cannot hold foreign properties. I’m not sure if that holds true for IRAs.
Toby: They must have a self-directed IRA. They must have a custodian but seems like it’s weird. But whatever the case, that’s really bad. I don’t think you have to do anything.
Going back to long-term gains, “If we are flipping our property, why would it be different as keeping it 12 months?” Capital gains is selling a capital asset. It’s not a capital asset when you buy it to sell it, it is inventory. It’s like this. Let’s say I’m a grocery store, and I buy a whole bunch of Cheerios and put it on my shelf. That Cheerios doesn’t sell for a year. Have I owned it for a year? Yes. When I sell it, do I get long-term capital gains? No, because it’s inventory. When I am flipping a house, I am not an investor. I’m a dealer, it is inventory. It doesn’t matter how long I held it. In fact, there are cases where people held it over 10 years and they’re still treated as an active business.
I may do this one. This is sad. “My parents recently passed and my siblings and I each inherited rental property in California, six siblings, six properties. Since we’ll each own one property, would it make sense to form six LLCs and have a holding company in Wyoming in one name?” Ellie, here’s what you can do. It makes sense to put rental properties in separate entities. But I would say, you don’t want to have six LLCs in California.
What I would more than likely do is I would have them in six LLCs, but I would keep them out of the state of California. I’d hold them in trust in California having the out of state beneficiaries be the LLCs. I would have you and your siblings hold a single LLC in which you each own one-sixth interest and it owns the respective LLCs.
Jeff: So, instead of each of them owning their own house…
Toby: There are six houses in one LLC. I’m sure they’re not all equal value, so rather than dealing with it. That would be my recommendation off the cuff. Facts and circumstances are already different like if you’re siblings, depending on your relationship.
Some people may want to sell something versus holding it. If you guys all want to hold it and you’re just saying, “Hey, we just want to keep this thing together,” then I would probably set up an LLC where you guys all own a piece and you agree to a management mechanism. That’s the easiest, more than likely. You stepped up on basis, by the way. Make sure that that you know that when your parents passed, the basis in those properties stepped up to the fair market value on the day they passed, which means you get to depreciate them again. The silver lining is, remember if there’s someone who passes, the assets steps up in basis and you get to re-depreciate it even if they just depreciated it their whole life.
Someone just asked, “What about asset protection?” A couple ways to look at this. When you have an LLC, there’s more than one way to get a property on LLC. I could put it directly in the LLC or I could put it in a trust where the beneficiary is the LLC. If I don’t like the state, because they’re charging me too much money, I’ll oftentimes use a trust.
So California, I don’t want to have a bunch of LLCs because it’s $800 a year for LLC. If you own the LLC individually, that could be a problem if it’s out-of-state. I make sure that the LLC is on. There’s one LLC that’s potentially doing business in California and that’s the LLC that all six siblings are on. Even then, I don’t know where all the six siblings live. What I care about is that we keep it away. If somebody says, “No way, the franchise tax board, they’re going to kill you on it?” We won that audit. I already know the answer.
They’re going to tell you or they’re always going to say, “Pay us,” even if you don’t have to. I just look at it and say, “I know what the rules are.” I tend to be a little more, let’s just keep it away from them. There’ll be one entity that we pay the $800 on and it will be the one that’s held by all six kids, assuming that there’s children that live in California. Sorry, for your loss, by the way. I know it’s always tough to lose a parent. If there’s anything that’s good, usually it gets the kids together and hopefully you treat it as a legacy and you’ll say, “Hey, my parents worked really hard for this.”
Let’s see, “What’s the best bookkeeping system for real estate investors and financial services corps?” QuickBooks.
Jeff: We always just say QuickBooks.
Toby: You could try other stuff and also REN. Where do you order stuff online? Amazon and then there’s everything else.
.“What is an ordinary income bracket for real estate professional filing together with high W2 who is making over $1 million?” It’s 37% federal plus your state.
I know there’s a couple more questions. We’ll grab those and we’ll throw those into the next Tax Tuesday. Somebody asked about the IRAs and stuff. It’s like $5500. They raised it this year. Today it’s $5500 or $6000.
Toby: $6000 and then you get an extra $1000 if you’re over 50. We can always look at that. We have a tax cheat sheet rolling around here somewhere. As always, a little bit of a tax knowledge goes a long way. Hopefully, you picked up a few tidbits here and there. I know there’s probably some people sitting at home red-faced if they were doing something funky. Just know that the tax laws are extremely forgiving if you take action to fix it.
Sherry, says thank you. It was great seeing you too. Hi, Sherry. A client I had lunch with. It’s always fun. Hey, they’re always cool and they come in town. Sometimes, people reach out and say, “Let’s go have lunch,” I’m like, “Sure.” I’ll meet anybody anywhere.
Jeff: I’m always open for lunch.
Toby: Yeah, it’s always good? It’s always fun to hang out with people. They’re really cool. Sherry, we’ve gone motorcycle riding. If you guys like Harleys, they’re awesome. They are really good people. I’ll say hi. Hi, Sherry and Allison, and all the cool people that are good to hang out with.
That’s the benefit of doing tax stuff guys is we get to see people all over the country all the time. We’ve been doing this so long that it’s cool. You guys didn’t realize but just for this little webinar, we made over 1000 people registered on. You’re in good company.
Anyway, keep learning. Don’t get discouraged even if you have a bad tax mishap. I always look at this like it’s touching a hot stove. Just know, don’t touch it again and don’t put your hand on it and say, “It’s not hot, it’s not hot, it’s not hot,” when your hand is burning. Let’s just use some common sense. A little bit goes a long way in this wonderful world.
If you’re in the realm of entrepreneurship, you should benefit from your activities. The tax laws are written to give you benefit. The one word that I like to hear more out of clients’ mouths or anybody that’s in business is, “How do I write that off?” as opposed to, “Can I…” The answer is too easy to a, “No,” or, “It depends.”
It’s much better when you say, “How do I write it off?” Now, we’re thinking. We’re going to find a way and it may not be the way you think. It may not be the way we think but it always pushes us. If you can’t tell, we’ve been doing this a long time. Jeff, how long have you been a CPA?
Jeff: 27 years.
Toby: Yeah, 27 years plus myself, 22 years. Everyday we learn something new. So we have 49 years. Gary downstairs has been doing it forever. All these guys downstairs have been doing it for 37 years. A lot of these guys, you always learn something new, so don’t be discouraged. If it was straightforward, everybody would do it. A little bit of tax knowledge goes a long way. We will see you next Tax Tuesday in, what two weeks?
Jeff: Two weeks.
Toby: It’ll probably be April. So we’ll see you in April. Thanks, guys.
Toby Mathis, is a founding partner of Anderson Law Group and current manager of Anderson’s Las Vegas office. He has helped Anderson grow its practice from one of business and estate planning to a thriving tax practice and national registered agent service with more than 18,000 clients. In his work as an attorney, he has focused exclusively in areas of small business, taxation, and trusts. In addition, Toby was the past director and host of the longest-running local business radio program on KNUU in Las Vegas “The BOSS Business Brief”. He sits on the board of directors for several companies and was recently appointed to the local board of Entrepreneurs’ Organization, a worldwide association of owners of successful businesses. He has authored more than 100 articles on small business topics and has written several books on good business practices, including first and second editions of Tax-Wise Business Ownership and 12 Steps to Running a Successful Business.