Toby Mathis and Jeff Webb of Anderson Advisors answer your tax questions and provide the psychology behind it all. They help you understand why the laws are written the way they are, so you can be a better steward of your money. Do you have a tax question? Submit it to [email protected].
- When can I pay family members employed by my corporation – annually or regular intervals? Depends on federal and state laws, but no IRS rule regarding pay schedule
- Should an LLC or individual lease car used primarily for business; what are the tax consequences? Brings liability to business; have appropriate and adequate insurance
- What are bookkeeping and tax implications of LLC being taxed as C Corp? Bookkeeping is the same for all business structures; LLC is state designation, but doesn’t have stock
- Should I use Quicken or QuickBooks for bookkeeping? Software doesn’t always need to be purchase; go with QuickBooks or use spreadsheets
- Can I deduct my real estate training seminar costs? Depends on where you want to deduct it (if on Schedule C, then no) and if you’re already in the real estate business
- Are you a real estate professional, if you have a property management company? Possibly, if you have 750 hours of real estate professional time and material participation
- What’s the best way to utilize a 1031 exchange? Sell and buy real estate
- Can income from self-employment be offset by Tesla tax benefit/credit? Yes
For all questions/answers discussed, sign up to be a Platinum member to view the replay!
Go to iTunes to leave a review of the Tax Tuesday podcast.
Full Episode Transcript
Toby: Hey, guys. This is Toby Mathis. There’s Jeff.... Read Full Transcript
Toby: I was gonna give some intro. We’re not sitting in the same room for a change. Usually, we’re sitting eyeball to eyeball but today I’m over in Cleveland, Ohio, and Jeff is back in Los Angeles.
Toby: You’re in Summerland?
Jeff: I’m in Summerland so neither one of us are in our usual spot.
Toby: Wow. You went over there to hang out with the tech guys. I know what’s going on.
Jeff: I do.
Toby: Anyway, this is Tax Tuesday. I wanna make sure everybody can hear, so this is just a quick sound check. If you can hear us, say yay. You can ask questions via that question and answer. I probably shouldn’t have done that. We’re gonna get a hundred yays. We’re going to jump on in. We have a lot to go over. We try to shoot for an hour, but I can’t remember the last time we actually did an hour. I think it was probably some other decade than now.
Jeff: I got nothing.
Toby: You got nothing. I know that we have a bunch so we’re just going to jump in and we’re going to start off. First off, the rules because there are rules. If you ask live questions, I’m gonna be taking them as they seem relevant. Understand that Jeff and I, are literally, taking these questions and reading through which ones are relevant, and which ones are relevant to a question that we just covered, or which ones we can wait, and we can answer before the end. If you have specific questions, you can always ask them anytime at [email protected]
What we do is we read through the convoluted long questions. We try to make sure you’re a platinum client and get you an answer there. If they’re shorter questions, then we grab them and make them part of the show. That’s how we grab those. We always get hundreds of questions. We always try to grab the ones that are the most relevant, that are succinctly asked, they’re not specific to you. That’s even better. Meaning that you didn’t share a bunch of personal information because we don’t want to disclose your personal information during our webinar.
It’s about fun, fast, and educational. We try to share, not just answers, but give you the psychology behind it all. I don’t want you just getting some sort of yes or no, I want you to really understand why the laws are written the way they’re written, so you can get your own answers much easier. Also, the whole idea is to save money at the end of the day, that’s what we really want. You’re a better steward of your money than the government, so if you can keep on to it, keep holding on of it for as long as possible, that’s usually the best.
Other fun stuff to go over. You can always go to our Facebook page or YouTube channel. If you go to our YouTube channel, there’s a little icon right next to where you subscribe. If you click on that little icon, it will give you an automatic update. When a new video comes out like, if there’s new tax law, if the regs come out like they did on 199 or on the Qualified Opportunities Zones, and we put out videos, you’ll just be notified the next time you log in to Youtube that there’s new content. It doesn’t hit you at home, it doesn’t hit you on your texting or anything like that, it just says, “Hey, you have a new video.”
Not a bad idea given that we have significant law changes, probably the most significant in the last 30 years that were passed during the Tax Cut and Jobs Act. They’re still reading through it, trying to make sense of it. Questions were gonna be going over tonight, and there are a ton of them. I’m just going to start off.
“What are the advantages and differences between the C-Corp, S-Corporation, and LLC? How do you know which one is best for you?” We’ll go over that. “Our tax is filed quarterly for a C- Corporation.”We’ll go over that. “Can I pay family members who are employed by my corporation annually with the amount paid depending on revenue or do I have to pay in a regular intervals throughout the year?” We’ll give you the rules on that, that’s a little convoluted. “Are there ways to handle the sale of a personal residence that has significant appreciation in order to reduce capital gains or the gains tax on gains that exceed $500,000?” They said married exemption but it’s the capital gains exclusion is I believe what we’re talking about. “We formed a corporation in 2014. We only started taking reimbursements within the last year. Can we go back and recapture them from the prior years?”
Next one, “Should an LLC or individual lease a car if it is to be used primarily for business purposes? What are the tax consequences between these types of ownership? What are the bookkeeping and tax implications of an LLC being taxed as a C-Corp? Can I deduct my real estate training seminar cost? We took the full depreciation for a lawn mower my husband purchase for his business, the following year we decided to dissolve the business. How does that affect our taxes?” That’s really interesting one, by the way. There’s going to be lots of different rules on that.
“For an investor planning on buying and holding real estate, do you recommend cost segregation?” That will be a good answer too. “What is the best way to utilize a 1031 Exchange? Can income from self-employment be offset by the Tesla tax benefit? I am currently a W2 employee as well as real estate investor, right now my properties are in schedule E, how does the tax return and tax rate change once I become a full time real estate investor?” These are all good questions. Let’s see if we have any more. We’re just going to dive right on into the first question.
First question is, “What are the advantages and differences between the good old-fashioned C-Corporation, S-Corporation and LLC? How do you know which one is best for you?” Jeff, with your permission, I’m gonna jump right on this one.
Toby: First off, I have to understand that there’s federal tax and there’s state tax, they don’t always align. There are also state entities and then there’s federal taxation of those state entities. They’re just corporations and they can either be taxed as a C-Corp and S-Corp, and technically, you could be taxed as a nonprofit—there’s really three types. They always say there’s two types of for profit, S and C. A C-Corporation pays its own tax, it’s a flat 21% right now from a federal standpoint, states are gonna burry.
If it’s paying out profit then the C-Corporation pays tax and then it pays out what’s called a dividend to its shareholders and they pay long term capital gains tax on that. That’s the dreaded double tax. The issue with C-Corps is that usually you’re not paying anything out of them. 80% of them are usually just going to zero out, they’re using it to run a business and not generate a bunch of profit out of that particular business. Usually, they’re finding other ways to get the money in including wages and things like that.
S-Corporations pass the tax down to you. The reason people like the S-Corp and the reason the accountants like S-Corps is because you avoid self-employment tax or what’s called social security tax—FICA, old age, death and survivors, Medicare, it’s all the same thing. It avoids that on its profit. You have to take a small salary, but after that you get this money out that ordinarily, if you were making that money in your name as a sole proprietor or as a partner in a partnership, you would be taxed with that self-employment tax on top of it. It doesn’t sound maybe a ton, it’s 15.3%, you get a partial deduction on some of it. It really pencils out to about 14% on the first $230,000 and then 2.9% after that […] make about 3.8%. It means that you avoid that whole issue if you’re in S-Corporation.
And then there’s this LLC. That LLC, it does not exist for federal tax purposes. You actually get to choose whether you wanted to be a C-Corp, and S-Corp, partnership or a disregarded entity. Whenever I see this question, I always think, “This is a great learning opportunity for everybody.” I’ve been saying this for 27 years, but those LLCs, you set them up by the state and you could pick however you want it to be taxed subject to a few little rules.
If it’s you and spouse, you really have your choice as to how you wanted to be taxed. You could say, “I wanna be a C-Corp. I wanna be an S Corp. I wanted to be a partnership. I wanted to just be ignored depending on where you live.” Even a husband and a wife in some states could be treated as a single taxpayer if you’re in a community property state, that’s the trick, and you don’t even have to file a tax return. It really does become fun when you start looking at these things.
How do you know which one is best for you? It’s facts and circumstances. It’s impossible to know without knowing whether you need the money out of it, whether you’re a high-income earner, maybe it’s a couple spouses,and one of them is a, I’ll an example that I just came across with a doctor, high-income earner. The last thing they want is more money of their tax return. In that particular case, I’m gonna look at them and say, “Probably the C-Corp is gonna be your friend because we don’t need the money. You don’t need it to live off of, maybe we’ll just pay a lot less right now and keep more of it with the idea that in the future they could start trying it out as a salary or things like that.”
How do I know which one is best for you? You get someone who knows what they’re talking about to apply facts and circumstances. There is a really critical component that a lot of accountants miss, they’re so focused in on the tax that they don’t focus on what it means to grow as a business. I’ll use the example of somebody who’s building a real estate portfolio, a wage becomes your friend. W2 income becomes your friend when you’re trying to build up the ability to borrow money to leverage into more real estate.
If you take all your income away, nobody’s gonna loan you money so we have to be cognizant of that when we’re deciding on an appropriate entity. If that’s the case, then all of a sudden, conventional wisdom goes out the door when we’re talking just tax. All of a sudden, you’re weighing another component, “Hey, I could get my taxes down to zero, but that just means nobody’s gonna loan me any money and I can’t grow my business very fast. Maybe I should pay some tax, maybe I should be paying some wages, so I qualify for more ,so I can actually acquire more real estate.” I hope that made sense. Jeff, do you have anything you wanna throw?
Jeff: I agree with that. We often see clients making business decision based solely upon tax. Tax is just one factor in that decision making process of which will I try to accomplish. I agree with you completely.
Toby: Lots of questions are already coming in. Jeff, can you see the questions, by the way?
Jeff: Yes, I can see some of them.
Toby: Because I’m gonna read them more often.
Jeff: They have […] so I can see them.
Toby: Alright. I’m gonna look and see if there’s anything here. There’s nothing that’s really relevant to that one. Our tax is filed quarterly for a C-Corp. Jeff, I know you wanted to answer this one.
Jeff: Taxes for a C-Corporation, you’re filing a return annually, it’s due 3½ months after your fiscal year end. When we talk about quarterly, what we’re talking about is paying estimated income taxes for that corporation, if the corporation is profitable. If you have a loss, if you have no income for the year, you’re not required to make quarterly estimates. Again, those are just estimates towards your annual tax return, the part of that computation of what you’re gonna owe at the end of the year. That’s really all there is to that. It’s similar to that of a 1040. Some people have to file quarterly estimates for personal reasons.
Toby: I was looking at this as the tax to mean as a pay as you go taxes. Do you have file quarterly? It depends on whether you’re gonna owe money. If you don’t owe any money, […] C-Corp, then no, you don’t have to. If you are making a bunch of money or you’re planning in making a bunch of money, then you’re supposed to be paying as you go, you’re supposed to be paying quarterly taxes. There might be some penalty for not doing it, but I always look at the penalties, and this is just me, so I don’t wanna impose this on anybody but they’re pretty low interest loans, they’re 6% annually.
I don’t get too worried about, perhaps maybe not hitting a deadline or two. Some people get really mad at them but I don’t. I say, “At least I have the money so I can keep growing.” It’s always up to you, if you have a bunch of cash sitting around, then pay your tax on time. But if you’re really like, “Hey, boy, I could turn this money into more money,” then you may want to take that and say, “Hey, there’s a little bit of […] but it’s not draconian.”
“Can I pay family members who are employed by my corporation annually with the amount paid depending on revenue or do I have to pay them at regular intervals throughout the year?” First off, you have federal laws and state laws, and there’s no IRS rule or federal rule on how often you have to pay. I tell people, if it’s your company, you could pay out of an S-Corp ones a year, if you really wanted to. I tell people though, “You know what, take a small amount and then bonus yourself at the end of the year.”
If you’re just […] in it, and you just don’t wanna pay for running payroll, then don’t incur a bunch of extra expense. That $100, whatever it is, is gonna really break it then say, “Pay less often.” If you have a family working for you, that’s the big thing. They’re usually exempt under state law as to whether you have to pay on certain portions. There are laws on the books that say you have to pay invoice on a regular basis in many, many states. If that’s the case, we don’t want to run or file state laws if someone’s gonna sue us but there are exemptions when it comes to many family members. Is that the way you understand it too, Jeff?
Jeff: Your immediate family members—your children, your spouse, your parents—those are all specifically exempted under the wage in our laws, so you don’t have to pay feudal tax on your children or your spouse. I don’t think they come under the IRS rules where if they work 40 hours, they have to be paid that rate for the 40 hours.
Toby: I know that there are some rules with the IRS that say, “Hey, you can’t unreasonably delay making payroll.” Again, I tell people, if it’s me, I’m taking a small amount. I might take it monthly, I might take it quarterly as long as I’m doing it some regular basis. That might be $1000 a month or something, if I know that I’m gonna take at least that. If I’m running an S-Corp and I’m making $100,000 a year, and I know I’m gonna be paying somewhere in the neighborhood $25,000 to $35,000 out of it, that’s just I know it is. I’m gonna pay $1000 a month and then I’m gonna bonus myself at the end of the year. Then you can play with the revenue a little bit.
Technically, you’re not supposed to be looking at this and making it merit-based simply because compensation’s supposed to be tied to, “Hey, this is tightening your term.” If the IRS was to be really evil and try to audit the heck out of you, they’d wanna see, “Alright, what did you do? Do you have any proof for what you did?” They may take the other tactic. When it’s an S Corp, again, it’s really not gonna matter, even the court cases. It tends to be about one-third is the magic number for payroll. There’s no set rule on it, that is a reasonable pay, but every time you see one, it always seems to be about a third.
But if it’s taking out of the C Corp, again, I have probably, 80% of our C-Corp zero out. It’s like we’re taking it out on other forms that are nontaxable like accountable plans and 105, the medical reimbursements—just reimbursing typical expenses that you have—the administrative office in your house, cellphones, internet, even car, all those things are coming out to your tax free, so you’re not really worried about running a few payroll.
If you wanna pay somebody a payroll, if you’re coming at it, somebody has asked, “What is the one-third rule?” In an S-Corp, if you make $100,000 and you take it all as a distribution, you just avoided paying 100% of social security taxes, they don’t let you do that. They say, “You got to take some payroll.” It’s a reasonable amount. But the court cases seem they come around to this one-third. We always say, the rule of thumb, and this is not just me, but it’s just about every accountant out there, it’s gonna say, “Hey, when in doubt, just pay yourself a third.” That means if it’s profitable, make sure a third of that comes out.
That’s technically not even the rule, the rule could be, if you’re making way more than that, then it’s just whatever you could pay somebody to do your job. That’s what it is. That’s the only portion that pays social security, but it’s also the portion that you could use to fund the 401k, defined benefit. You could do some really cool stuff.
Jeff: I wanted to hit something else you talked about in the past with salary from the S-Corporation. If you don’t have the income, you are not required to have salary. If you don’t have distributions, you are not required to have salary.
Toby: That’s a fun one. I think we asked our staff that probably about two or three months ago, I like catching people with a, “Got ya.” You can make $100,000 in an S-Corp and if you don’t distribute it you’re not required to take a salary. It’s only when you distribute money. If you make money in an S-Corp, it doesn’t mean you have to take payroll, in fact there’s a lot of accounts on […] made money […] payroll. Technically, it’s only a few distribute money than you’re supposed to be making sure. If you’re stuck piling cash, then technically you don’t have to.
I think we beat that one to death, so let’s go on to the next one. This is an interesting one as we’ve written on this a lot and we’ve done some videos on this. “Are there ways to handle the sale of a personal residence that has significant appreciation in order to reduce capital gains tax on the gains above the $500,000 married exemption?” They said the marriage exemption is really section 121 which is, I’ve lived in it as my personal residence during the last five years. As a single person, I can avoid capital gains or tax on $250,000 capital gains. As a married couple, I can avoid tax on $500,000 of capital gains.
The reason I say capital gains is because technically, there are people that rented their houses out before that have depreciation recapture, this does not cover that, this only covers capital gains. I buy a house for $100,000, I sell it for $500,000, I’m married, filing jointly, but I’ve lived in it during the last five years, I pay zero tax. What these folks are asking about is, “What if I bought in let’s say Seattle Bellevue or The Bay Area or Manhattan, some place where everything just run up in value?” Let’s say that I bought a house for half a million dollars and ten years later, I’m selling it at $2 million. I have a $500,000 exclusion so there’d be $1 million of taxable gain. Before everybody starts crying and say, “Well, if you’re in California, that could be 13% state capital gains plus the 20% or above $250,000 so we have the net investment income tax.”
When we add all those things up, it comes out to about 37%, that would be $370,000. That’s a pretty sizable chunk out of that amount because you only have this $500,000. Then people say, “What do I do?” Well, the easy thing to do is to say, “I wanna take the $500,000 but I also don’t wanna pay any tax on it.” If you’re gonna be buying more real estate, then what we need to do is convert that personal property, which is your house, into investment property which means you need to rent it to somebody, then you can qualify for a 1031 Exchange.
If you exchange it, then you don’t have to pay any tax, you’re deferring it into a new property, but you still capture the $500,000. People know what 1031 Exchanges because they say, The basis rolls forward, so if I’ve had property and I’ve depreciated half of it, I’m gonna sell it and buy a bunch of more properties because it’s gone up in value.” You’re just taking your basis from the first property and just rolling it into the new properties that you’ve exchanged to it for. In this particular case, we wanted to get the best of both worlds, we want that $500,000 capital gains exclusion, and we don’t wanna pay tax on that extra million.
Again, my example is $500,000. Let’s say we have $500,000 basis then we want our $500,000 of exclusion so we have $1 million. We want that first million dollars to come away tax free and roll onto the new property. But then, since we’re selling it, since the sale price is $2 million, then we have an extra $1 million of gain and this is what you can 1031 Exchange. All you have to do is convert that personal property into rental property, there’s no hard and fast rules. In fact, there are cases where somebody wasn’t able to convert it, they never got a renter but they tried. They could show that they made a good faith effort to actually convert it into investment property, but they could not find a decent renter that was willing to pay a fair market rent.
I would say don’t do that, just know that the case is out there. It’s not a draconian rules, these are pretty straight forward. You put this thing and you rent it for a few months, is it worth $370,000 to convert that and then go buy? You still qualify under 1031 Exchange. You still have to take that $2 million and buy a real estate, but it could be a bunch of investment property, it doesn’t have to be another house that you live in. You could go buy an apartment complex or go buy a bunch of single family residences.
Somebody might be asking, ‘What if I want to live in it?” Buy it first as an investment property, leave it that way for at least six months or so, and then convert it back into your primary residence. The rules do contemplate that. Even under the 121, it says, “If it had been part of a 1031 Exchange within the last five years, you don’t get that $500,000.” It already knows that people are gonna do this. By the way, where do we get that strategy? From the IRS, this is actually black letter law so we don’t have to.
Somebody just said, “Can you 1031 Exchange into a REIT?” Technically, not really. You can do a Delaware trust and you can go into a TIC, but they don’t let you just do something where it’s managed by somebody else.
Jeff: I think something similar to that where they use 721 Exchange into a partnership that ultimately becomes part of a REIT later on. Usually, I’m only seeing that in commercial buildings, and things of that nature.
Toby: I just know that it has to go entity to entity. If I am in a REIT individually, I have to buy individually. I can even 1031 Exchange a REIT. In fact, I don’t even know how that would even be possible. I’ve seen people do deals where they’re doing a TIC with somebody, a tenant in common, but it specifically says it can’t be a partnership. I think it really has to be your real estate, I don’t think that REITs can qualify that.
Jeff: I’ve never seen it done directly. I don’t think that works.
Toby: There’s a bunch of other questions. Somebody just asked, “Primary residence in a foreign country.” I think the 121, I believe it’s US properties only, I’m not sure. Do you know that one off the top of your head, Jeff?
Jeff: Not off the top of my head, but I’m pretty sure that’s what it is.
Toby: I know 1031s are US property only, but I’m pretty sure that this is just on US capital gains because we don’t know what going on in all those other countries. “Does the conversion from a primary residence to a rental property impact between the last five years to get the 500,000?” It does, but remember, I lived in it the last two years, it’s two of the last five years, so I could rent it for up to three years and still get my $500,000 exclusion.
Jeff: On the form 1031, you can do a Foreign 1031, but it has to go into another foreign property. You cannot 1031 into a domestic property from a foreign property.
Toby: US property, US property Foreign. Somebody says, “Installment sale part on the proceeds?” Now, you’re gonna draw me back in, this is where it gets really fun. Let’s go back to this. Someone just emailed in, “What about the 1031 Exchange into a Delaware Statutory Trust and you can […] recapture, true or not?” Yes, you can go into a Delaware Statutory Trust, it’s considered real estate. That would be, I’ve said Delaware Trust but it’s Delaware Statutory Trust. The IRS ruled that real estate in a Delaware Statutory Trust is real estate, so you can Exchange into that if you really want to.
Let’s say we go back in time and you’re in that same scenario where the person bought the house for $500,000 and the house is eventually gonna be worth $2 million. What they really wanna do is keep it as an investment property, you can sell it to an S-Corp that you own. In that particular case, you can do an installment sale back to your sell from the S-Corp and then opt out of the installment sale rules out of the S-Corp so you can take the entire $500,000.
Let’s say we sold it $1 million, we have $500,000 of gain. You could actually up your basis to $1 million, not pay tax, and then you have a great little rental property there that has twice as much basis as if you just turned it into an investment property. There are some little moving pieces here, it gets fun when we’re talking about these, we’ll have to keep going. Next one, “We formed a corporation in 2014, we only started taking reimbursements within the last year, can we go back and recapture them from the prior years?” Jeff, what say you?
Jeff: If you’re a cash basis corporation, I will suggest that you reimburse in the current year for those invest years that you’re just now reporting the expenses, you would actually be deducting the expenses in the current year. A lot of these plans has specific time period that you can reimburse in, particularly like that medical reimbursement, I believe usually has pre-reimburse within the next first quarter of the following year, so you can’t go back referring somebody’s expenses. I believe for other expenses, whether it’s mileage or some of those maybe home office, you could probably do that pre-reimburse currently for past years’ expenses. […], Toby?
Toby: When I first read this, I looked it in in a couple different ways. First off, maybe we have a bunch of expenses and maybe we should be capturing them. If it’s 2014, maybe we should be capturing them as loans to the corporation, corporation should be writing it off. It depends on whether it made money or not. Corporations are generally gonna be a cash basis taxpayer if it’s a small one. If you’re making a whole bunch of money then it makes no sense not to have reimbursed yourself, maybe it makes sense to look at those and call them loans, and get some interest out of that, the company to yourself as well.
A shoestring corporation just probably zipping along and you just don’t have the money right now to reimburse, then I would say whenever that corporation can actually reimburse you is when it actually gets to write it off. I use Krispy Kreme in all my examples. But if I went in and I brought Anderson in an event, and I brought in a bunch of Krispy Kreme and it owed me $100, Anderson can’t write off the $100 until it pays me, but if it goes from one tax year to another, then it writes it off when it actually pays me. I don’t know a better way to put that. I like Krispy Kreme.
Jeff: You got to go with donut.
Toby: “What about education mentorship for trading futures from the previous year?” Again, it’s whenever you write the checks. Somebody asked, “What if I incurred a bunch of expense last year and I’m just now making money?” Yes, you can write it off now, you could go past a tax year. Just keep in mind that you’re tax year is not necessarily your corporation’s tax year. A C-Corp could be September year end, and your year ends December. We always have to look and say which tax year are we in and when did they actually pay, those are really important. That’s the kind of things that you look at. We’ll go back in and get it. Unfortunately, the answer is always gonna be it depends, you gotta make sure you have people that actually know the rules and then you go back.
Somebody says, “What if I don’t make money for a few years?” Jeff, how would you handle somebody that you know for three years, they’re just gonna be reinvesting every dollar and dumping in some extra cash? Are you gonna take the loss and carry it forward? That’s if it’s a C-Corp. If it’s an S Corp, depending on what your basis is, you may be taking that loss and taking it personally.
Jeff: I would like to capture those expenses as soon as possible. I think the closer to the date that they actually happened, the better off you are.
Toby: Technically, an accountable plan says that there needs to be a payment within a reasonable time. They usually say, “Submit it and pay it within 90 days.” You go beyond, it’s not like it’s a death note, but you probably should be saying, “I gave you this money, to your corporation, you now owe it back to me but you spent it.” Today, capture the expense but the C-Corp, it just shows it’s a loss and they carry it forward.
Jeff: James says it was a substantial amount. That’s something that in 2015 probably would have been capitalized and amortized. Meaning, we did not take the whole expense in the first year. I don’t think we can pay it three or four years later and then just expense the whole amount. I think that presents its own issues.
Toby: I agree. Let’s jump onto the next one, we have a whole bunch of questions coming right now. You know what, I’m gonna go back to that because it seems like we’ve gotten a couple. Somebody spent $30,000 in education, they said, “What’s the last year I could do it? What if I don’t make money for a few years?” Then I would make sure that capturing that, it depends on when you’re going through it.
It goes like this, if I do a mentorship when I’m starting up a company, before I actually form it, then I’m capturing that as a startup expense. If I form a company, and I do mentorship to help me in the company, that’s a current expense. I’ll be writing that off as what’s called a 162 expenses, an ordinary and necessary business expense that I would just be taking now even if I can’t pay it. If I paid it individually, I would just call that a shareholder loan. I would take the $30,000 loss on the books of the entity so that when I make a $30,000 in the entity, it’s not paying any tax on. It’s the same difference, but I pay myself back. We get to same place, I get to write it all off. I’d rather do it sooner than later.
Somebody else asked, “If one pays for education in 2015, when is the last year to take it off on taxes?” Unfortunately, it depends, Catherine. There’s really not a timeline. Everybody talks about startup expenses and they say, “Go back twelve months or this, that, and the other.” There’s no hard and fast rule, it’s anything in the investigation starting up a company. If you spend a bunch of money, I’m still grabbing it even if it’s a few years later if I can show that there’s a line between what you’re doing, and what you’re doing right now, and formalizing that business, I’m still gonna go grab it, I’m just gonna capitalize it.
If, on the other hand, I had an existing business and I spent money in that business, let’s say I’m a plumbing and I go to my plumbing internship course, and I spent $30,000 and I did it a few years back, I really should be expensing that when I actually incurred it. But if it still owes me the money and then I finally paying it back, I’m writing it off in the year that I pay myself back. Technically, you should’ve been carrying that on your books, the IRS is gonna say, “What the heck? Did this really occur?” You’re gonna have to prove it.
I think it’s after three years, you’re not going back in and reopening your books, you’re outside the audit category. Realistically, you’re just want to grab that whenever it pays you back and expense it in that particular year. Again, it’s much easier if you had an up and running business as opposed to if you’re preparing to do one. Jeff, do you have anything else you wanna add on that or we’re good?
Jeff: We’re good.
Toby: This is a question we get, some version of it, just about every time which is, “Should an LLC or individual lease a car if it is to be used primarily for business purposes? What are the tax consequences between these types of ownership?” A lot of times when the lawyers look at things, it’s different than the way an accountant is gonna look at it. I’m gonna give you the attorney’s standpoint which is, whenever you bring a car into a business, you’re bringing liability into that business because the car doesn’t actually drive itself, it’s always the driver who creates the liability.
If that driver is not driving a company car, it creates the inference that the company is now responsible for anything that driver does. You always want to make sure that if you’re bringing a car into a business that you’re carrying a right type of insurance, so that if you do have something bad happen in that vehicle, it doesn’t toast your business. The company car that you’re presumed to be on company business.
Somebody just said, “Automated cars could be changed in that.” Who’s responsible for the automated car, then it gets even more fun. You’re pretty much guaranteeing that it’s gonna be the business. The reason people liked to put vehicles in businesses is because they think it’s gonna give them a huge tax benefit. Sometimes, that’s still depending on the vehicle, there are different rules for different sized cars whether it’s a 6000-pound gross vehicle, weight or not. Then you make it to right off the purchase phrase which is great, congratulations. When it’s a one time, that’s it.
Now, you’ve created more than likely a taxable event for yourself every year beyond that and this is why. When a business has a car, first off, it has to make sure that it’s more than 50% business usage oherwise you don’t get to do those types of write offs. If it is greater than 50% business usage, then whatever portion you use individually is taxable to you as wages, not just, “We’re gonna have to allocate some money to you.” No. It’s like if I gave you a car and said, “You’re gonna work for me, I’m gonna give you a brand new Mercedes that you get to drive as part of your employment.” You’re paying tax on the lease value of that vehicle. There’s gonna be a tax to you including the social security and withholding. People don’t realize that quite often, so they’ll stick that vehicle in a business and they’re not paying tax on it. The IRS still wants you to track the mileage which I would suggest using MileIQ.
Then it’s gonna look at it and say, “By the way, did you ever fall below that 50% because now that’s personal property. You need to recapture all that depreciation you took.” If you’re head’s going what the heck? Then this is why we tell you not to do it, it’s complicated and there are unintended consequences. The easiest thing to do is just reimburse mileage. It doesn’t matter what vehicle you’re driving. If you’re in the vehicle and you’re driving it, I mean it’s your car, it doesn’t matter whether you lease it or own it, whether you paid cash for it or whether you’re financing it. I think it’s 0.58 cents a mile, it just reimburses you. It doesn’t care which vehicle you’re in. If you have a Jeep and the Mercedes and a 1996 Ford F-150, it doesn’t matter, still 0.58 cents a mile is going to be reimbursed. You never have to report that in the company, it just gets to write it off. Now you’re not messing around with this depreciation and writing it off. Again, I always say, sometimes we make messes for ourselves because we’re trying to write something off.
Somebody says, “Can we rent our own car to ourselves to justify not having personal use?” Erick, no because it’s you. If the company is renting it to you, then you have to pay the company. Otherwise, it’s below fair market value lease. Not only you have the state tax on it, but you also have income tax on it too. It’s no Bueno. It’s as my wife would say. Anything you wanted to add on that, Jeff?
Jeff: No, that’s fine. The only thing I was thinking of was, IRS considers company cars as low hanging fruit. It doesn’t make an audit risk in themselves, but if you do come out under audit, they’re going to look really hard at your vehicles that are company owned. They’re gonna ask if you have other vehicles you drive and the mileage on those vehicles. What they’re ultimately trying to come to is that, “No, that vehicle wasn’t really 100% business use or even 80% or 90% business use.” You don’t really come under that when you’re reimbursing for that business mileage. You do have to have records, but that’s about it.
Toby: You’re always required to keep a mileage log. People that buy a company car and say, “I’m using it for business.” It don’t matter. You better be able to show that you have another vehicle that you’re commuting there, there better be a car yard where all the cars reside otherwise they’re gonna say you went home with it. Everyday you’re driving it, that’s personal use. If it’s sitting at an office like in a yard, for example, construction yard, and you only drive it when you’re at the office, but you have a vehicle that you drive there everyday, that’s different case. You might be able to get away with the 100% but you’re gonna have to show that that’s actually it, that you’re not taking it home.
I’ve seen these people spaces more often than once, I wish I had a nickel for everytime I saw 100% business use vehicle that was the only vehicle that the person owned. I’m like, “Yeah, they’re just not gonna buy it. You better have two cars. If it’s a family, you better have three. You better have one that’s just dedicated. Otherwise, save yourself to headache. You can have three cars so you can reimburse them all, 0.58 cents a mile. It doesn’t matter which you put the mileage on.
Jeff: That’s right.
Toby: “What are the bookkeeping and tax implications of an LLC being taxed as an S- or as a C- Corporation?” This is a fun one because we touched down it earlier, that the LLC is a state designation, you file that with the state. It always depends on how expensive it is. For example, in Nevada, the LLC is cheaper than the C-Corp, so they’ll probably go with the LLC. If it’s a professional organization where they require that you’re a certain type of entity, we’ll look at that.
But if we’re just looking at it from a tax end point, let’s forget all of that stuff and say it’s an LLC and we elect to tax it as a C-Corp, tax and bookkeeping implications are the same as a C-Corp. Literally, the IRS looks at it and says, “We expect to see a C-Corp tax return.” The bookkeeping requirements are the same no matter what you are, whether you’re a sole proprietor or a partnership or an S-Corp or a C-Corp, you are required to keep books and records. Good luck getting a definition of what that means out of the IRS. They’ll say, “Record of your income and expenses, and records of your assets and liabilities.” That’s about all they’re gonna give you.
Jeff: The only difference I’ve ever seen with an LLC being taxed as a C-Corp is an LLC taxed as C-Corp, it’s not going to have common stock. It means virtually nothing to you. Whereas a regular corporation, it will have a common stock. It’s just an equity account, everything else is pretty much gonna be the same between LLC and corporations.
Toby: The place that’s gonna come in, that common stock, is something called a 1244 stock loss. Here’s the difference between the two. Let’s say you’re getting into a business where you may or may not make money, your intention is to make money, but there’s a good chance you’re gonna get slaughtered, you’re going into a high risk profession or something. Let’s say you’re married and filing jointly, you know you’re gonna spend $75,000 trying to get this business off the ground and after $75,000 you pull the plug on it. If it’s a C-Corp, I can write that off against my ordinary. If it’s an LLC, that’s a capital loss, and I’m still getting to write off the $75,000, but I’m only gonna be writing it off as a stock loss.
Jeff: Because what 1244 says is, it’s an election you make when you form your corporation. Say that I’m trading my stock as a small company stock. Well, an LLC doesn’t have stocks so they’re not subject to that 1244.
Toby: That’s the only thing that I’ve ever noticed as being the big difference, people are used to nomenclature of a C-Corp, board of directors who are the officers, when in an LLC, it could be manager-manager or member-managed. You could still have President and Vice President, you just have to choose […].
Jeff: But as far as bookkeeping and tax, the only other difference is gonna be probably more influenced by what you’re actually doing, your industry, your business rather than what type of entity it is.
Toby: Fun question, good question, we’ve gotten a ton of questions that […] as a result. Because we’re talking about bookkeeping, somebody says, “Quicken or QuickBooks.?” Quicken, I don’t think you can use it on a C-Corp. Can you use Quicken on a C-Corp, Jeff? You may know that.
Jeff: It’s based on small companies. Like you said, your Schedule C, if you have a balance sheet, it’s not really good for it. QuickBooks is a far better software, it is also more expensive. It’s hard to compare the two.
Toby: QuickBooks is the gold standard, everybody uses QuickBooks. It does the stuff, but that’s just because it does so much, it could be overkill. If you’re doing little stuff, a small little business or if you have a rental business, you might wanted to just use spreadsheets. You don’t need to go on and buy this software. The tax laws are written at a time before QuickBooks existed, you used to write down in a ledger. Jeff, didn’t you use a slate tablets with chalk?
Jeff: No, they were stone and chisel. They have to be finally fixed so if the dinosaur stepped on it they wouldn’t break the tablets.
Toby: Somebody says, a question similar to getting a car into your LLC, “Can you use your LLC for getting apartment as I have to do my work research at home?” That becomes house hacking. Anytime you’re getting a value, like an LLC, yes, it can have an apartment. If you’re using one of the units, I guess there’s nothing against you using it, you’re carving out that, you’re not depreciating that one particular unit. The great example is if you have a duplex, you live in the one-half and the other half is for a rental, you’re not writing off 100% of the depreciating, you’re cutting in half. When you do this and you actually occupy a portion yourself, there’s a tax implication to it. That’s all I can say. It’s still an investment property, so it doesn’t really change that. Jeff, do you have anything on that?
Jeff: Once you start adding personal use to that, that becomes complicated.
Toby: You have a 20 unit, and you just 120th of everything, now it becomes personal expense, you can’t write it off.
Jeff: You might have a superintendent or an office that they’re working out of in, that will be a deductible expense, but it can’t be for your apartment. Again, that’s personal use, the whole 120th.
Toby: If you’re using it all for business, you have a personal use unit that’s 100% for business, it could still write it off, it’s just writing it off as a reimbursement to you. You’re still saying, “This is my apartment, this is where I’m residing for just my business.” Maybe you have another home, this is not your personal residence, but this is a residence but it’s 100% being used for the office, then they can reimburse you. It’s even reimbursing you the depreciation and everything else, it’s still going back in your pocket. It’s still gonna be a deduction.
People tend to get an idea that, “Hey, I can get this free money and it’s this depreciation and all that stuff.” It’s not quite that way. When it’s personal property, there is no such thing as depreciation. That gets us back to this fun stuff. Somebody says, stock loss in LLC, I’m not a corp, I thought that C-Corp loss can be written off as ordinary income, LLC can be written off as stock loss. Did I get that backwards?” You got that right. LLC is written off as a stock loss. The ordinary income of a C-Corp, when you dissolve it is 1244 stock loss. You can get to write off up to, for married filing jointly, $100,000 of your wages or any other income. Somebody says, “Quicken is for personal, not for business.” I think that’s sole proprietors.
Jeff: It’s similar to my Microsoft Money, the old program. I used it for personal and some business. Going back to what you said about the spreadsheets. If you have, say, half-dozen rental properties and that’s all there is, it’s sometimes easier to do the spreadsheet than try to make a work in QuickBooks.
Toby: I look at it and say that there’s no reason for you to invest in software if you can track your expenses pretty easily. The reason you use software is either you’re doing books for somebody else or you have hundreds of transactions that you’re tracking on a monthly basis. I don’t want to use the rule of thumb, but let’s just say less than a hundred, you can probably track them on the spreadsheet just through your bank statements, you could figure it out, and you accountant is the one that has to read through that. But you’re just keeping a track of, “Here’s where I spent it on.” It doesn’t have to be all these crazy columns and look all pretty.
Somebody says, “What type of business equipment can you totally write off in the year you put into service?” Anything that’s less than a 20-year useful life is under bonus depreciation so you can write that off. It’s not just equipments, it’s literally just about everything right now that’ll shift in the next couple years when start to face out, but right now we have 100% bonus depreciation. Somebody says, “Can I do that to my real estate training seminar cost?” Jeff, do you wanna answer this one because I’ve answered this one on the previous. I’d like to hear your verbiage.
Jeff: “Can I deduct my real estate training seminar cost?” As we discussed previously, are you dealing in real estate before you took the training? That’s a pretty big factor. It also depends on where you want to deduct this. If you’re wanting to deduct this on the Schedule C, we’re probably gonna tell you no.
Toby: There’s a really a good case, somebody who went through one of our classes. Their accountant didn’t agree with us and then we see them a few years later and they’re are tax case. It was the situation where he was gonna get into real estate, he was gonna flip. His accountant said, “No problem writing it off on his personal return as a Schedule C deduction as a sole proprietor.” We said, “No, that’s not our reading of the code. We believe you need to be either in that business or you need to grab it as a startup expense which means you’re amortizing it over a period of years.” The accountant didn’t agree. The taxpayer ended up paying the price because he was disallowed all these deductions because they said basically what we told them which is, “Either you’re already in the real estate business, you already own a property, in which case, now you can write it off. If you’re not, best is as a startup expense. You’re not taking that personal, you’re not allowed to.”
Jeff: I’ve seen several cases in past two years where people have attempted this on deduction on Schedule C and it has not ended well for them. They’ve had to pay back taxes in the thousands of dollars.
Toby: You guys have heard me say this before on this, if you’ve never been on a Tax Tuesday, you’re gonna hear me say this term accountable plan. You can only have accountable plans if you’re an employee of an organization and get the benefit. In other words, the company can only reimburse you as an employee if you’re actually an employee. There’s only two types of organizations that you can be a part of as an individual where you’re the owner and be treated as the employee, which is a S-Corp and a C-Corp, that could be an LLC taxed and S-Corp or an LLC taxed in the C-Corp, it doesn’t matter. Those can have accountable plans.
If you’re a sole proprietor, I’m sorry, you’re not an employee. A nonprofit can do that too. For a for profit entity, we’re trying to make money for ourselves then I need to be treated as an employee. There are folks out there that will say, “Maybe your spouse could be an employee if you’re sole proprietor.” Yes, they can and then they can try to cover you under a medical plan and stuff. Your expenses that it’s reimbursing, that’s what we care about. It needs to be you, and it needs to be paying it back.
You wanna make sure that you’re in a situation where it’s reimbursing you your expenses. If you went to a class, let’s say that you worked for Boeing, the reason I say this is because I went to school with a whole bunch of Boeing folks going to get their MBAs. You’re coming in a pocket, you’re driving there, you’re buying books, you’re paying the tuition. Boeing is reimbursing you, that’s how they did it. They reimburse it or they paid it direct, but if you came in a pocket, they just wrote you a check.
You didn’t report that on your tax return, Boeing wrote is off as an employee expense, that’s what you want. An accountable plan is any reimbursed expense, it is not included in your wages, it is not included in your taxable income, it is not subject to withholding and it includes a whole gamut of things. Somebody just said, “Is it a healthcare?” No, it’s anything that you pay out of your pocket that’s for the benefit of the company including having administrative office in your home. It could reimburse you for all the expenses associated with that office. Everything you’re driving around and doing from that point forward, you’re living in office when you have an administrative office in your house and everything becomes business mileage.
That’s why it’s so critical to actually have an S- or a C-Corp floating around out there […] nonprofit, just having a corporation, let’s just put it that way. An LLC taxed as a corporation or a corporation. You have to have one of those because nothing else qualifies, it makes life really easy. When we see people try to get around it all the time and it’s like, “Why? It’s black and white. Make it really easy. Why make it so hard?”
Someone says, “What’s that bonus depreciation?” That means you can write off anything that less than 20-year property in the year that you put it into service. We’ll get into this when we talk cost segregation here in a second. It’ll be fun. Now you have something to look forward to. “We took the full depreciation for a lawn mower my husband purchased for his business, the following year we decided to dissolve the business, how does this affect our taxes?” This is so exciting. Jeff, do you wanna go first or do you want me to hit this?
Jeff: I can do this. This is an example of the bonus depreciation, one of two things possibly happen. If this business was profitable, they could’ve taken section 179 and deducted the whole amount for the purchase of the lawn mower. If it wasn’t profitable, then it was more likely bonus depreciation from 2018 and they just depreciated the full amount. Now the difference between the two is bonus depreciation, if you shut down the business, it doesn’t get recaptured as income. The equipment can be distributed to the owners assuming this is either most likely a Schedule C, it could be distributed to the owners with no tax implications.
If it’s section 179, then the entire amount of deduction is recaptured as income. The reason for that is section 179 is a deduction for what normally would’ve been seven years to depreciate this equipment, they’re letting you have it all upfront. If you don’t keep it for the whole seven years, then IRS wants their money back. That’s the primary difference between the bonus depreciation and the 179. Again, it’s gonna depend on how this was originally depreciated. It might not have any tax implications, it might have quite a bit of tax implication.
Toby: There are couple things they’ve said here, first off they bought a lawn mower. Let’s assume that it’s a real estate business and they’re writing it off as an expense associated with that business. By the way, they used the modified accelerated cost recovery system, the MACRS that you always see. Somebody will say it’s a five-year property or a seven-year property. Let’s say that lawn mower will probably a five-year property. What that means is that you write it off over five years.
If you spent $300 on it, you’re gonna take one-fifth every year so you’re take about $60. If you had a 179 deduction which is a section that would say, it used to be $25,000 a year, you can immediately expense and they jump all the way up to $1 million. If you wrote that off, you just couldn’t create a loss with it, but you can write off any equipment that you bought and put into service that year. People would do this, they would buy something and finance it so they could create a big loss in the year that they put it into service.
Let’s say that you bought that lawn mower on a credit card, even though you haven’t paid for the lawn mower personally, the business is now obligated on that credit card. You may be obligated to pay on the credit card,but the cash doesn’t come out of your pocket but you’ve obligated yourself, you would get to write that off in that year that you bought it. The catch is that if it fell below the 50% use for business threshold, you have to pay tax on it all as though you never expensed it in the first place or you’d go back over to that five-year.
In this particular case, let’s say the individual used it for one year, dissolved the business, which means they wrote off five years in one year, they would only get $60 of deduction. They would have to recapture the $240 as taxable income if they took it as 179. If they took it as bonus depreciation, different story. Would there be any tax implication to them having received that lawn mower, Jeff?
Jeff: No, because they’re assuming it on a zero basis. Technically, if they turn around and sold it personally for $1000, their basis would be at zero, and at that point, they’d have to recognize a gain on the sale of that mower to third party.
Toby: They were assuming that this business is a flow through. If it’s a C-Corp then we have a little bit of a different animal. Again, I don’t know what you do with things that are written off completely, but if you’re handing out assets to shareholders after the fact, and I guess if there was a…
Jeff: An S-Corp runs into the same thing that you have to distribute things at fair market value, not at their cost. Partnerships work differently at that, they distributed at cost, not fair market value.
Toby: They get to distributed at cost, is there a tax on it or they get it because they paid $300 for the lawn mower, let’s just say, so you’re getting $300 worth of value?
Jeff: Right, that’s already been written off.
Toby: Would there be a tax on the $300?
Toby: They’re just considered a distribution. It could be part of their capital account calculation, I assume.
Jeff: Robert has a good question, ‘What about if the lawn mower was expensed maybe under de minimis safe harbor rules?” The de minimis safe harbor rule say that you can do repairs and maintenance per invoice per item up to $2500 and immediately expense it as repairs and maintenance. If this lawn mower—I was thinking this was probably was a heavy duty lawn mower—but if this was, say $500 lawn mower, they could write this off under the de minimis rules. Expense it as repairs and you’re done.
Toby: Because you’re just going out there and doing a lawn?
Jeff: Yeah, because you’re immediately writing it off as a repair or maintenance. It’s not an asset anymore.
Toby: You can see, that’d be interesting. That’d probably the best route to do, wouldn’t it?
Jeff: Right. If you’re talking about, I’ll bring up my mother again, the $5000 mower.
Toby: Your mom does not mess around. Your mom has a $5000 mower?
Jeff: She’s got a 30-acre farm that she has to take care or so.
Toby: We’re going to make fun of you so badly. No I’m just teasing. I’m thinking of all the horrible things you could say.
Jeff: You should see her with her chainsaw. If it’s more expensive, you’re not gonna fall into this de minimis safe harbor. “Can bonus depreciation only be taken when you’re running at a loss for a C-Corp?” Bonus depreciation have been taken on any entity including personal as long as the life of the asset that you purchased, the equipment, land improvement is 15 years. But as long as it’s under 20 years, you can take up bonus depreciation.
Toby: The accountable plan is when you’re giving yourself back money as your expenses. Like you have a cellphone, let’s have the business write you a check for all your cellphone expenses if it’s for the benefit of the business. You’re in real estate, you need to have a freaking cellphone. It can reimburse you 100% of your cost on that cellphone, but I have to be able to do an accountable plan in order to that otherwise,it’s a proportionate amount. In this situation where you have depreciation, that is just any taxpayer as long as you’re getting an asset or if it’s depreciated.
Jeff: Some of these items that look like real estate really aren’t. My primary example is a swimming pool, it’s not a real estate, that’s a 15-year land improvement. You put up pool in […] able to take bonus depreciation.
Toby: We have a bunch more. How do we go over already? Is it already been […] 30 minutes in.
Jeff: We got a little windy in some of them. It was me.
Toby: “Foreign investor planning on buying and holding real estate, would you recommend cost segregation?” This is interesting. When you say investor, you’re buying and holding real estate, this is long term, this isn’t a flipper. Cost segregation just means this, I’m gonna write this up so you guys can follow along. If you have rental, we’ll just call it residential, single family residence. You write off the value of the house, the improvement on that property over 27.5 years. Let’s say that you buy a house for $350,000 and the land value is $75,000, that means the improvement, the house itself is worth $275,000. You would divide that by 27.5 which is gonna give you $10,000 a year of depreciation. That’s standard depreciation, this is the modified accelerated cost recovery, whatever that is matters. Correct me if I get anything wrong, Jeff, you’re the accountant.
Jeff: I’m watching you.
Toby: Let’s say that we have rents coming in at $10,000 a year, we just wouldn’t pay any tax on it, we’re talking net rental. But what if we have net rent coming off of this of $30,000 a year? We have $30,000 a year coming in, positive, minus the $10,000, that gives me total taxable income of $20,000. When does it makes sense to try to jump this number, this $10,000 up, what if I can make that higher? That’s when you do the cost segregation. Let’s say I’m in the highest tax bracket in the state like New York, Connecticut, California, something with a high state tax Baltimore, you name it, or Maryland. $20,000, that’s gonna get hit pretty hard, in some cases 50%. I don’t want that $20,000 to hit me.
I may look at this and say, “Hey, instead of looking at it and taking the traditional MACRS sense, I’m gonna break this down into items that are less than 20-year property and the structure of it.” For example, if I walk into a house and there is a chandelier in it, that chandelier is part of the structure. I could break it off and write it off over a shorter period time or there is heater covers or Everything from HVAC to your boiler, you name it, whatever is in that house, appliances, everything else. You break these things out, they’re not part of the structure.
If I break those out, I can write those off right now with bonus depreciation all in the first year. The rule of thumb, I’m just gonna say rule of thumb, is 20%, is about what you’re gonna get in that first year. Rule of thumb, as I would get an additional, just multiply that by 20%, so $55,000. I would get an additional $55,000 so I wouldn’t pay any tax on that. Let’s say I’m making $20,000 a year, it would be a good 2 ½ years before I’d be looking at a taxable event. By that time, maybe I bought more property, and I keep bonus depreciating.
That’s the classic sense when you do a cost seg, is when you have either too much money coming in or there’s a flip side. If you have one spouse who is a high net income earner, so they’re making a lot of money, one spouse is making a lot of money, spouse one, spouse two can qualify as a real estate professional. Then you can create losses through the use of cost segregation to subtract from this so you get a loss, so you can lower their income. That’s the typical times when you’re doing cost segregation. That was in English so you guys could follow it.
Whenever you’re buying and holding real estate, it just becomes what’s your tax appetite. If you’re already creating losses and you’re just carrying them forward because you’re not a real estate professional, a real estate professional is when you hit 750 hours that you never want use of time and you maturely participate to real estate activities. If you hit those tests, then you could be able to take real estate losses and offset active income with the real estate loss. Louis, you can do cost seg for both commercial and residential. It used to be just commercial, now you can do it against a single family house. It was never cost beneficial before, but now I’ve seen them done for $1500. You get a big old fat write off if you’re doing the cost seg, it’s whether or not you can get the benefit out of it
“What about renting a condo which has window upgrades, is this cost segregation?” It depends on what the value of the condo is, but yeah, you break it all down and say I just had a whole bunch of windows down. Maybe those aren’t gonna be 27½-year property, that’s gonna be much less. I’ll probably gonna write them off in the year that I did it, it all depends. It’s a little calculation that you do, but I could tell you that the bigger your tax apetite, the better. “If you’re a real estate professional, after you did the cost seg and carry over losses, can you write it off or is it a trapped passive loss?” It’s trapped if you’re an investor before real estate professional […] for the year. Jeff, am I misstating that or is that your understanding?
Jeff: No, that’s correct. The other side of that problem is when you become a real estate professional, you have to aggregate all of your real estate activities together into one activity.
Toby: This is one of the most misunderstood areas because we had a bad court case that came out. They didn’t understand real estate professional and whoever was convincing them, they were all wrong, the court was wrong. There are two tests, there is the 750 hours, number one use of your work time which one spouse has to qualify for. If anybody has ever been to my event, you know what the cat cone is, right? It’s anybody who’s playing with their phone during […] shame on them. They can’t play with their phone.
Jeff: I don’t know whose phone that was.
Toby: Blame it on one of the techs.
Jeff: It was the dog playing. Wouldn’t it even make more sense if it’s commercial property because there you’re looking at 39-year life instead of 27½-year life.
Toby: Absolutely. You’re gonna get much juicier amounts when you have a commercial property with $1 million and you’re able to get an extra $200,000 write off right now. If you’re never planning on really selling it, maybe you’re gonna trade it for more real estate, you’ll never pay tax on that cost seg. All you have to do is eventually pass away in your basis steps up, test for the real estate professional is two requirements. I get loss, sorry guys.
You have the real estate professional which either spouse can pass and then you have the material participation in your real estate activities. Material participation is to combine the spouses’ spend 500 hours or 100 hours, and it’s the most time spent on your properties than anybody else or you did all of the time on your real estate, in which case, we don’t care about how many hours. That’s material participation, but that is per property. When you do the material participation, it is per property unless you choose to aggregate it.
If you aggregate all of your rental properties, then you just apply it to one. Let’s say, I have ten pieces of real estate and I spend 50 hours in each one, and it doesn’t matter whether it’s me or a spouse because we add it all up together. But I would not pass the real estate professional test even if I did this 350 hours because each gets 750 hours per year, but it’s each property I would have to be, either I’m doing all the management or I am doing 100 hours total and nobody else is spending more on each property. Unless, I choose to treat them all as one activity and then I don’t.
I actually make an affirmative election and accountants miss these guys, you wouldn’t believe it. There are court cases where people spent more than 750 hours, and they could show up, but then the IRS looked at it inappropriately said, “But you didn’t aggregate your properties, you had a bunch of properties. Each one, you’d have to meet the hourly test and they had management companies.” You’re basically having to meet the 100 hour test on each property, at least, or you do 500 hours total.
Somebody says, “Are you considered real estate professional if you have a property management company? You still could. It’s 750 hours, any materially participate, that’s it. It’s 750 hours, but it’s the number one use of your time, you can push this 750 hours up. If you spend 1000 hours in your day job, for example, but you spend 1001 hours in real estate, then you would meet the real estate professional standard. If you did 1000 hours in something else, and 750 hours in your real estate activity, you would not make it because it’s not your number one use of time.
“What if my day job is a real estate agent?” Then as long as you’re involved in real estate transaction during the buying and selling of your real estate then it qualifies. You would meet the 750 hour test. We have somebody who says, “What if my day job is real estate agent?” This is a great example. Let’s say that I have three rental properties and I wanna qualify as a real estate professional, you would say, “They meet the 750 hour test.” They may be doing 2000 hours, but then they have to maturely participate in their rental activities too.
Somebody says, “Because that is what I did at the past with the IRS.” Absolutely. You qualified under both test. You still have to spend time on your rental properties. You guys are now jumping all in. I love that. People are out there backing this one. Let’s jump back in, “What is the best way to utilize a 1031 Exchange?” Jeff, do you wanna play with the 1031 Exchange or do you want me to keep going?
Jeff: You’re doing great, I’m just listening here and learning.
Toby: He’s still mad about his mom’s tractor. Your mom drives a tractor. I was thinking back to the elementary school, everybody always say, “Your mom […].”
Jeff: About 1031, the best way to utilize a 1031 exchange is first, have a qualified intermediary, and second, don’t touch any of the cash, don’t touch any of the proceeds from the sale of your what we call the property given up, the relinquished property.
Toby: I’m gonna make this, it’s real estate only. There are no 1031 Exchanges for any things. The best way to utilize a 1031 Exchange is to sell a real estate and buy a real estate. You cannot use it for anything else.
Jeff: That’s new in 2018, it used to be, if you traded in a car from a business, it was a 1031 Exchange.
Toby: You better do inventory and all sorts of fun stuff.
Jeff: It’s all gone.
Toby: It really comes down to if you sell real estate and buy real estate, this could actually go in reverse order. You could actually called the reverse exchange where you buy real estate and then sell it, but it has to be greater than or equal value. If you sell $1 million real estate, you gotta buy $1 million dollars real estate even if it has a debt on it. You gotta replace that debt or you gotta come to the table with some cash. What happens is, the basis of the previous property is rolled into the new property or properties. You could sell 20 properties and buy one, you could sell one property and buy 20. It doesn’t matter as long as it’s real estate. You could buy a land, you could go and buy apartment building, single families, combination, commercial, residential, it doesn’t matter as long as it’s real estate.
Somebody says, “If I were to attend a two-day real estate educational networking event where I have to fly to the event, how many hours count?” She says it’s gonna take 48 hours to get there and back and do it. Are they able to take every hour or they take an eight hours a day, if you know the answer with that one?
Jeff: I would think it would just be their travel and education time. I don’t think you could count all of those hours.
Toby: It’s just gonna be your actual hours because the IRS doesn’t get to tell you, “You have to go the fastest route.” You could actually take a cruise ship to an event if you want to as long as it’s travel, there’s actually rules on that. It’s twice the federal per diem, that’s the maximum amount per day. A federal maximum per diem amount is $400 and you could write off $800 in taking a cruise ship to go to a meeting, not having to be in cruise ship, and going to a place to go […]. You have to use it as transporation.
Jeff: Joshua asked, “I thought we can take the boot? Meaning the cash out of the 1031 Exchange.” You could always take the boot but you have to remember that every dollar of boot taken creates a dollar of taxable gain up to your total gain on the sale. You have to know that ahead of time, that if you take cash out of the steel, it’s probably gonna cause you some tax.
Toby: Or you just wait. You do your deal, you buy something, and then you’re gonna refile it somewhere down the road. They don’t really look at any of that stuff, I suppose. They could always try to argue that somehow that was taxable.
Jeff: I think […] pretty successful at doing the loan after the sale.
Toby: Most of the facilitators I work with, this is always like pigs get fat, hogs get slaughtered. Give yourselves some time, give yourselves some time and then take it out. They’re not in the habit of doing that. If you’re taking the money at closing, then they will have an issue with it, your facilitator is probably gonna be looking at it going, “It’s taxable.”
Jeff: From what I’ve seen, they recommended that you do not refinance before you sell; you refinance after you purchase your replacement property.
Toby: Somebody says, “How do you use a Delaware Statutory Trust to avoid the timelines?” You’re not using it to avoid the timelines, you’re using it to meet the timelines. If you sell and you have 180 days to go close the […], you have 45 days to identify a replacement property and then you have to close within 180 days, and you’re worried about making that because you’re in commercial or something, you’re just, “There’s no way I’m gonna be able to identify and close.” Use a Delaware Statutory Trust and it meets the test and then you’re gonna do another 1031 Exchange from the Delaware Statutory Trust to the new property. If you’re really worried about the timeline, then do a reverse exchange where you use a facilitator to acquire the property that you’re going to sell and go into. Again, you still have 180 days so you still got to get that thing done, I suppose.
Jeff: I know somebody’s gonna ask, how long do you have to hold a property before you do another 1031? We researched this and the courts are all over the place on this question.
Toby: It’s investment property.
Jeff: Yeah, we’ve seen it from a week or days, they disqualify them years after they purchased the second property. It gets a little crazy. There is absolutely nothing that tells us what the real answer is.
Toby: It’s weird, I would think […] investment property can do multiple exchanges into investment property. I’ve actually seen it where we did a shopping center than went into multiple TICs and then they ended up selling multiple TICs to the properties that they actually wanted to acquire, they were parking it for a while. Those lawyers all looked and said, “There’s no hard and fast timeline.” They all said six months is the keep yourself from getting in trouble.
Jeff: That’s pretty much what I’ve seen, that’s recommended.
Toby: Here’s the thing, if you’re gonna do a 1031 Exchange, get a good intermediary. If you need a good intermediary, ask me. I have a couple that I could send over your way that are good, they’re all over the place, by the way. I’ve rarely used somebody that’s in your neck of the woods, it’s probably gonna be somebody that I think is good like […] is one that I use out of Idaho, 1031 Exchange gal. All I know is that whenever I ask her a question she tries to answer the best she can if she doesn’t play games. I’ve never had an issue with my clients, I’ve never had an issue. She’s out there, I don’t even know where she’s at. I just know that she’s good. There are other people that use 1031 Exchanges, find someone that has worked with folks in no nonsense, get it done.
Jeff: […] is gonna keep you out of trouble.
Toby: Somebody says, “What about a real estate that you purchased to fix and flip and you sell the property with the buyer?” No, that cannot be 1031 Exchanged, that is dealer property. You get taxed on the income. The reason, Cathy, is that there are two types of income, there is investment income, and there is ordinary income from development dealer activities. When you buy to sell, you’re a car lot, you’re not an investor. You’re buying cars to put on your car lot to sell, that’s what you’re doing. “Can income from self-employment be offset by the Tesla tax benefit?” Tesla tax, I’m assuming is the energy tax credit which is not as a deduction, it’s a tax credit.
Jeff: Yeah, it’s 3750, I believe.
Toby: Any income can be offset with the tax credit. The way it works is when you do your return, you say this is how much tax I owed and they’re gonna pretend that you paid them 3750. It’s literally dollar for dollar, so I’m not gonna beat up on that one. There are some great things, by the way. I’m doing this during at Tax-Wise as the next one where I broke down solar tax credits. You can get the tax credit for 30% plus you can still depreciate 85% of that […], so you’re getting a double duo. If you have rental properties, it’s time to stick some solar on.
Anyway, let’s keep going. “I’m currently a W-2 employee as well as a real estate investor, right now my properties are on Schedule E. How does the tax return and tax rate change once I become a full time real estate investor?” You wanna play with this one or do you want me to hit it?
Jeff: I’m assuming that we’re talking about becoming a real estate professional that we talked about earlier.
Toby: I don’t know. Let’s just say it’s a real estate investor. “Hey, I now I decided to become a full time real estate investor.” There’s literally no change.
Jeff: I’m gonna say there’s no change there.
Toby: Let’s say they’ve become a real estate professional, they’ve spent all of their time doing real estate, and they qualify as a real estate professional. Are there any special things that you have to do?
Jeff: Yes, real estate professionals don’t have to mess with the passive loss rules which means that if I have losses in my real estate rental activities, I get to deduct them on my 1040.
Toby: Is that coming off your Schedule E?
Jeff: That is coming off my Schedule E.
Toby: Is there a special box you have to check for aggregation or is there a special form?
Jeff: There is an election that you make, you need to make it every single year.
Toby: Where do you make that election?
Jeff: It’s a statement that gets added to the return saying, “I’m electing the aggregate on my properties.” I believe you actually list out what the properties are and you say, “These activities are being combined into one activity.”
Toby: If you don’t do that, you’re gonna be very sadly disappointed. Alright, fantastic, we just got through a whole bunch of questions. I’m gonna go back to a few of your live questions, we’ve been answering a lot of them, but I know there’s a couple of that snuck through. I’m doing the Tax-Wise on June 13th and 14th. If you wanna come live, you can always talk to your reps and figure out how to get there. Go to andersonadvisers.com, shoot us an email, I’ll give you the instructions how to get there.
If you don’t wanna physically attend, but you want the information that we’ve been doing this year, you go to andersonadvisers.com three-for-one specials. You can actually see the little link there. For $197 you get the recordings of my all three Tax-Wise workshops this year plus you can attend any of them via live stream, live if you want. You’re not physically in the office, but you’re able to chat with the people and watch it live. If you want to virtually be in Vegas on June 13th and 14th and have a fun time, you can absolutely do that. I made it just a monstrous value.
I’m telling you, if you just take one or two things that we teach away everytime you do a Tax-Wise, people say, “Why should I do Tax-Wise twice, three times, four times?” Because the laws are always changing, we’re always going over different topics. All I want is for someone to take two or three things away everytime they attend and build up their repertoire, it’s actually pretty cool. I’m not gonna say a ton on that. I do like three stuff, I would like it if you guys were to subscribe to our podcast and give us some comments too.
We work hard on these things, but you’re gonna see that we, Clint and I and Michael, and bunch others are always working on these. We’re trying to bring relevant content to you, guys. Again, it’s free. You can go to Google Play or iTunes and go to the Anderson Business Advisers Podcast. “I’d rather be in Vegas away from this rain.” Christine, I am in Cleveland, Ohio. It is literally shaking the hotel windows right now, there is so much thunder and rain hitting it. It’s halting, I don’t know if you guys can hear it but I was like, “Woah, is there a […] in this building or something?” It was like rocking here. Jeff is in The Land of Sunshine right now. Is it beautiful there in Vegas or is it gonna rain?
Jeff: It’s another cool day, it’s partly cloudy. […] weather here.
Toby: Cloudy with a chance and meatballs. Fun one, if you want to join Infinity, I’ve been throwing this out there. We’ve had several hundred of you guys join in and go through the Infinity Investing Workshop, I’m gonna give you guys a free code. It’s 11-part series plus there’s even three-part bonus series. You can go there with the little link and type in the code free tax. It’s gonna say it like $1000, then you use free tax and it’s free. Quite literally, probably eight or nine hours.
I know some of you guys are seasoned professionals so you’re gonna say, “I don’t need this stuff.” Have you kids watch it, just have somebody get in and understand the concept of what reaching Infinity is. It means that you have enough passive income coming in where it covers all your expenses. When somebody says, they’re not worth it, and they say, “I am worth $1 million.” I always say, “Yeah, at a fire sale, that might be 700, if you really need to get to the cash, how long is that gonna last?” I’d much rather have something that’s paying me $10,000 a month, if I could live on $8000, I could live forever and I’m never gonna run out.
We can wrap in there. Somebody says that the Anderson Business Advisor app doesn’t show up on iTunes. Patty, we’ll get you hooked up.. If you have comprehensive questions, you go to your platinum portal. You could also see all the recordings there from all of our past episodes, we are getting close to, I don’t know if this is 90 or something like that, but we’re getting close to a hundred that we’ve done. You can always pop in and look at that. Of course, I already threw this out at you to join our YouTube channel and Facebook, just keep up to date.
If you have questions that you wanna get answered, there was a lot that I wasn’t able to get to this time guys. Literally, I know there’s more that they were adding and a whole bunch more questions. I know that next Tax Tuesday is gonna be a rocket ship. I’ll just put it into [email protected] What we do is we kick those off to the accountants too, so that if you have questions, we’re gonna make sure that we get them answered. You can always visit Anderson Advisers, we have a ton of content that’s on our site including a lot of videos. I know that there was a couple of questions that I didn’t get to at the very beginning, let me answer those real quick before we jump off. Jeff, is there anything else you wanna throw out there or are you good?
Jeff: No, I saw a question from Bill […], “Toby why would I use loans?” First is equity contributions in my C-Corp. The main reason for that is once it’s an equity contribution, the only way you get the money back out is a taxable debt. Whereas if it’s a loan, you’ll just repay yourself tax free.
Toby: That’s always the question you guys get. I’m gonna call it equity if it’s 6½.
Jeff: That goes back to the 1244 section. 1244 allows you to convert shareholder loans into a common stock of your corporation.
Toby: Okay. Here we go. “How soon after creating an LLC S-Corp do you have to do a meeting minutes?” Thomas, it’s really once a year. That’s a state requirement, that’s not a federal requirement . they just want books and records. “How much total deduction everybody can take off additional tax just by giving furnitures and other things to probably to charity,” is what it sounds like. You’re gonna have to exceed your $12,000 if you’re single or $24,000 your Schedule A. Your Schedule A is inclusive of your medical deductions, your real estate taxes, your state income taxes with a limitation if they’re capped at $10,000 plus your charitable deduction, and your mortgage interest deduction. You start adding all of those things up and then you’re able to write off if it exceeds that amount.
For a lot of you guys, you probably realized just last year that you didn’t get to take much of a charitable donation. That was the big fear of charity, is that people that were tax motivated to give were not gonna be giving as much just because they may not get the benefit. Somebody says they love Tax Tuesday, great. “I have a C-Corp with multiple distributed LLCs. Bookkeeping had me setup each entity in QuickBooks as a separate company. They have each as a separate file which is odd. I have disregarded LLCs in one taxpayer, I’m probably calling them classes.
My question is, if I pay someone to do odd maintenance such as cutting grass, painting, debris removal and pay him for more than one entity, do I 1099 from each entity or is it a C-Corp? Example, I pay them $500 for each for LLC one and two, and I did not send 1099s because each one of those was below $600.”
Jeff: Technically, it’s by whoever actually paid it.
Toby: You could get away from it. I’m just wondering if it’s truly disregarded which it sounds like what they’re doing is they have a corporation and that’s the manager. I would just pay them to the corporation and just keep it really simple, I’m gonna give my 1099 at the end of the day.
Jeff: I agree with that. You could pay into disregarded LLC, but that might be making it more complicated than it needs to be.
Toby: Somebody says, “If I am self-employed as a realtor and if I sell three homes making $60,000 commission and flipped two homes netting another $80,000, would it be better, tax wise, doing it in my own name with the Schedule C or with the C-Corp or an S-Corp?” I could just tell you right now, Diana, it’s gonna be better for you to be an S-Corp compared to doing all that in your name. You have $140,000 of income, assuming that’s what you’re netting out. That’s all gonna be subject to self-employment tax.
If you were simply an S-Corp, and let’s say we made $140,000, you could pay yourself roughly $40,000. The additional $100,000 would not be subject to self-employment tax, that would save you roughly $10,000 a year. I know that sounds like a big number, it’s probably more than that, but that’s literally what the situation is. When you’re making $140,000 and you pay yourself $40,000, you’re actually gonna get a big benefit as a result.
There are some other reasons why we use the S versus the C in this situation is if you’re living of it, I wanna make sure you still get the 199A deduction which is a 20% deduction. Realtors do qualify, by the way. Rationally, the IRS came out with a guide and saying that they didn’t but the regs have since had said, “Yes, you do.” You can actually get a nice chunk there plus you could always add a 401(k) on this thing, and even reduce your taxes lower if you want to, I always say that’s a big if.
Sometimes you have to figure out what your goal is but you could absolutely, positively increase a large chunk of money to your bottomline just by making an […] solution. That could be an LLC taxed as an S or a traditional S. Jeff, everything else I’m looking at, I see a lot of questions are all distributions taxable, somebody asked. No, distribution implies being taken out of a partnership or an S-Corp and that’s taxable whether or not you distribute or not. Let’s say you have a capital account for a basis and you’re giving yourself back money, then that is not taxable. Is there anything else you wanna hit up on, Jeff, or are we good?
Jeff: No, I think we’re good.
Toby: Jeff loves it when we go really long. This went flying pie and I apologize, Jeff. If you’re good, I’m good. We’ll just say next two weeks we’ll meet back here same bat time, same bat channel, right?
Jeff: Thanks, Toby.
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.