As Americans, taxes are one of our biggest expenses; even more than housing, food, and clothing combined. Taxes are overpaid by about a billion dollars every year. Toby Mathis and Jeff Webb of Anderson Advisors save you money by answering your tax questions. Do you have a tax question? Submit it to taxtuesday@andersonadvisors.
- How many stock option trades must you make in a year to be considered a professional trader by the IRS? Activity has to be regular and frequent
- Is TurboTax comparable to using a certified public accountant (CPA)? No, because tax-based computer systems don’t ask the right questions
- How many rental properties should I own before creating a C Corp? It’s not about how many properties, but how much you’re making/earning
- Can you have multiple 401(k) plans? Yes
- Does a leasing real estate subsidiary pass-through have to pay self-employment tax? When renting real estate, nobody pays self-employment tax; it’s not earned income
- Can you explain the depreciation recapture for a property that was never depreciated? If you can deduct or depreciate, you must recapture (Publication 946)
- What’s the rule for claiming meals and entertainment; is it still 50%? TCJA took away entertainment write-offs, but writing off meals can be 50-100%
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Full Episode Transcript
Toby: Hey, guys. This is Toby Mathis and…... Read Full Transcript
Jeff: Jeff Webb.
Toby: And this is Tax Tuesday, bringing tax knowledge to the masses. Happy Tuesday to everybody. I hope you guys are having a great one out there, having some fun in the sun. It’s only about 110 degrees here in Las Vegas.
Today, we’ve got a whole bunch of fun stuff. We put on a ton of questions, so we’re going to have our work cut out for us today. We got our work boots on, we’re going to dive right in. Just a reminder, you can always follow us on social media. In fact, please so. Like us on Facebook, register and subscribe to andersonadvisors.com/youtube or just go to YouTube and type in Anderson Advisors. You should be able to find us. Myself, my partner Clint, Michael Bowman, a bunch of the tax folks are constantly putting out content and we love it to be used. Share it with your friends. Tax Tuesday rules!
Send questions to email@example.com. That is where we are grabbing the questions that we make part of the event. We’re always looking for good questions and we’re grabbing them. If you need a detailed response that’s very specific to you, you will need to become a platinum or a tax client. We need you to be actually a client before giving you specific advice. If you just ask general questions, just do it during Tax Tuesday or via the firstname.lastname@example.org and we’ll just get you a response.
This is fast, fun, and educational. We want to give back and help educate. Taxes is one of those areas where it’s our biggest expenses in America, even more than housing, food, and clothes combined, so if we can do something to help bring down some of the unneeded expense, taxes overpaid to the tune of about $1 billion a year, it would not hurt the country by doing it and keeping it in your pocket. Frankly, it’s better off for the country if you keep it because you’ll be able to use it to make money, especially if you’re a good investor.
All right, let’s jump in opening questions. These are the questions we’ll be answering today. “I am 21, in college, work for my parent’s corporation,”—way to go—“How can I maximize taxwise strategies to help with retirement in college?” Wow, I like that. Someone’s smart, so we’re going to go over that.
“How many stock option trades must one make in a year to be considered a professional trader by the IRS?”
“Is TurboTax comparable to using a CPA?” Well, it’s TurboTax and we’ll answer that.
“How can I pay my daughter who works for the corporation a salary to help her buy her own rental property?” We’ll answer that.
“I’m currently an employer contributing 401(k)s. Can I still start a self-directed 401(k) to use for investing in real estate?” We’ll talk about that.
“Does a leasing real estate subseries LLC passthrough has to pay self-employment tax or will its holding company pay the taxes?” That’s going to beg a larger question which we will get to as well.
“How can I set-up bank accounts for LLCs and have funds disclosed to the holding corp? How do I report the income for tax purposes?” We’ll go over that with you.
“I’m a subcontractor. Do I need a corporation to protect myself?” We’ll go over that.
“I own rental property as an individual. How could I deduct interest expense on this property?” I know Jeff is going to want to dive all over that one for you.
“Can you explain the depreciation recapture for a property that was never depreciated?” Yes, we will.
“What is the best structure to protect against the IRS piercing the veil and establishing a lien on funds?” We will dive into that.
“I have a large amount of capital losses. Are there any creative ways to reclaim these loses faster than the $3000 a year standard?” So, if you have some capital losses. We will go over that.
“When currently buying properties at Arkansas with an LLC, should I register as a foreign entity? Are there better incentives by doing so?” We’ll go over that.
And then, “I have a C Corporation. Can I deduct long-term care premiums as an expense?”
Jeff: That’s a lot of questions.
Toby: Well, we’re not done yet. I told Susan in our marketing, I said, “Hey, you call this the super massive Tax Tuesday.” It’s because we’ve got so many questions, but don’t worry. I’m going to talk fast to make it go.
All right. “What’s the rule for claiming meals and entertainment. Is it always 50%? For example, can I take my real estate broker to lunch?” No. What you should do is just take this right out and then you’re going to say, “Attorney to lunch.”
“Do I need to pay taxes for my new corp if I have not generated income yet?” We’ll go over all those.
Let’s just dive right on in because we have a lot to go through, guys, and we are going to have to keep on tax today because we have so many questions. It’s always fun that way.
All right. “I am 21, in college, and work for my parent’s corporation. How can I maximize Tax Wise strategies to help with retirement in college?” Wow, you’re already doing it. You are a rock star in my world. Here’s what you do. First off, if you have a corporation, if you have your parent’s corporation, then you need to make sure that they have an accountable plan, which means they reimburse anything that benefits the corporation. They reimburse those expenses. That’s number one.
Make sure you’re getting tax-free money. The way it works is with an accountable plan, you pay nothing on the money you receive for things like your cellphone, your computer, anything you’re using for that business, internet, mileage, anything that you’re doing that benefits the company can now reimburse you. That’s first off.
Number two, at 21, in college, and you’re working, you would just file your own tax return and the first $12,000 you receive is not subject to any taxation. It is the standard deduction. It’s tax-free for Federal income tax purposes. Most states follow that and the only thing you have to worry about is social security.
If you’re getting paid a salary, they’re already taking that out and that’s the only thing you pay, which is old age, death, some survivors, and medicare. That is a fantastic way to get money to pay for college. If somebody else paid for college for you, for example your parents paid for, it’s coming out of their tax bracket.
Let’s just say, I just had my daughter go through college—she graduated last year; all you guys know that—and I always said, “Hey, instead of me paying for your tuition, how about we set something up and you make money, even if it’s from my company or even if I’m paying it and you pay for your tuition, it saves thousands of dollars in taxes. It’s massive.”
Just by saying that you work for your parent’s corporation, that’s the key. It’s getting all the benefit out of it, letting the corporation pay you back for anything that you’re using for that corporation. An administrative office, even if it’s in your dorm would still work, as long as it’s a scenario that you’re using for the business exclusively.
There are ways to get you money. If you’re not living in a dorm but you’re living at a house, it’s even easier. If you have a two-bedroom apartment and one of the bedrooms is being dedicated to the business, that’s even better. You can write-off literally half of everything. It’s a lot of fun.
Let’s see. “How can I write-off current college tuition expenses of my children through my existing LLC?” First off, an LLC is not a tax category. A lot of you guys hear me say that. What is means is, an LLC we got to figure out how that’s taxed. If it’s taxed as an S Corp or a C Corp, then the way you do it is you reimburse them expenses and you pay them a salary if you have to. It works out great and it taxes an S Corp perfectly.
So, Craig, you want to make sure that you have an accountable plan and then you want to make sure you’re reimbursing them for everything, from their cellphone to their computers, as long as it’s being used in the business, and if you’re going to pay them, pay them out of that company. Pay them a salary.
If you don’t want to do withholding, there’s a little workaround. I’m assuming that you’re married, but if you’re not, then you just have to go right to the salary or wages. I guess you guys are married, so if you’re married, what you do is you have your wife, for example, work as the contractor for the company. Pay her as a sole proprietor. It sounds weird, but you’re going to zero this thing out, and have her pay the kids.
The trick is that they have to do work for the S Corp, so don’t think this is just all freebie. They have to actually do something. What you do is you have them do marketing. With kids, it’s really great to use them for social media because they actually understand it, a lot of times we don’t, and you literally just pay them.
For example, you have two children, then they would each be able to do their own tax return, they would each be able to get $12,000 tax-free, and on top of that, you’d be able to get them their reimbursements for things like your cellphone and everything from the medical, dental, vision, perhaps even the S Corp, we’re going to get a little issue with that. We won’t be able to do that, but you’d be able to get them the things like your computers, your internet, and things that are used for the business.
Jeff: Actually, deducting the tuition is very difficult through an entity, especially if it’s a related person. There are a couple of ways to do it, but even the most lean way is going to require to be a working condition fringe benefit that is closely connected to the business and what that person does. They don’t make it easy to reimburse for education.
Toby: But what you do is you get tax-free money out and you use it for education. So, I don’t care about writing off education as much as I care about getting tax-free money for it.
We’re going to jump into stock options. “How many stock option trades does one make in a year to be considered professional trader by the IRS?” Very interesting question. The answer is, do you want to say it?
Jeff: The activity has to be regular and frequent. You need to be trading almost everyday.
Toby: First off, there’s no such thing as a trader in the Internal Revenue Code. They don’t define it. Somebody started calling people a trader, where it said basically, “My activity is in stocks and options. Rise to the level of it is my primary source of business and I qualify as a business.” But unlike other businesses where you actually have a test, these guys just say, “Hey, it has to be frequent, regular, continuous, and you need to be doing the daily swings. How do we get there? We go to the courts and we try to figure this thing out.”
Jeff: We’re going to be looking at the individual trades. Like Toby said, you’re looking for the short-term swings if you’re a trader. These are not long-term holdings. As a matter of fact, a person can be a trader for some securities and an investor for other securities.
Toby: There is an answer, though. This is weird. As a primary source of income, the IRS has come out and said 720 trades is enough. But there’s been people that did not qualify with over 1500 trades. We’re talking round trips here. It’s a lot more activity than what you might be thinking. It’s a lot of trades.
Jeff: One of the big things to look at is what’s your purposes in trading? What you’re actually seeking to do with each trade.
Toby: What we know is that from a number of the cases, if you have a W2 job, it’s probably not going to happen for you. But there’s a work-around and it goes like this. I’m just going to do this really quick because the guy has so many questions. Your trading account needs to be a partnership. If you’ve heard me talk about this for many sessions, you heard me say, “It can be an LLC taxed as a partnership.” That’s more than likely what we’re doing.
The easiest thing to do then is to hang a corporation and this would be a C Corp as its manager. We’re doing this for two reasons. Number one, we’re going to capture all of our expenses right here at the corporate level and we don’t have a problem with that. A corporation set-up as a management company is immediately in business as soon as it has a management agreement. Partnership agreements and LLCs require a manager. You have to decide whether it’s going to be managed by members or managed by a manager. You’re just going to say, “Hey, it’s managed by a manager.”
We actually want that corporation to be a partner. It’s going to receive a K-1, but it’s also going to receive something called guaranteed payments to partners. You want it to actually receiving that, the reason being is because Schedule A expenses are gone. I’m not going to get into the technicalities of it, but if you pay a third party to manage your trading account, you cannot deduct it. Some people are going to say, “That’s not true.” It used to not be true. The Tax Cut and Jobs Act eliminated it completely, so it’s no longer a miscellaneous itemized deduction because there are no longer miscellaneous itemized deductions. That’s gone.
This is the game in town. You could potentially put the trading account inside the corporation because corporations are businesses just when you set them up. You’re going to be doing one of those two things. Frankly, if it’s an account of any size, you’re using the C Corp. The reason being is that when you’re a trader, you’re filing your expenses on Schedule C and your gain is on Schedule D. You have zero income showing up on Schedule C. That kicks you out and makes the IRS hate you, and the IRS likes to audit.
Some people said, “Hey, would futures fall under that?” Yeah, futures. Any sort of trading, any sort of securities, and if your under a C Corp, your golden. Just know that when the money is made, it’s not long-term gains or short-term gains. It’s just income to the corporation. That’s not a problem. Usually, you’re using it to grab expenses.
Jeff: We also have the mark to market action.
Toby: That’s a big one on trader. You’re required to do the mark to market action.
Jeff: Right, and at that point, your gains and losses also switch […] Schedule C, which basically says every year you’re recognizing gains and losses.
Toby: And here’s the thing. Mark to market in a nutshell. You treat everything you have as though you liquidated them on the last day of the year. Here’s the problem. We’re just going to date this a little bit. Remember Qualcomm?
Toby: There was a year when Qualcomm went up $600 at the very end of the year. It was going up $30 a day, it was crazy, I had leads on it, I thought I was a genius. There were days when you make a couple of hundred thousand and you think, “Ah, this is easy. Why doesn’t everybody do this?” and then you learn the lesson of why doesn’t everybody do this? Because the market beats the hell out of you every time you think you’re smart.
What mark to market does is it treats is as though you sold it, even though you didn’t. Then, Qualcomm takes its dive. This is the reason that I never tell people to do trader. You have to force me to make you a trader. It’s because I got to watch people who could not sell the stock and get enough money to cover the tax bill that came due. In other words, they treated it as though it was sold on December 31st and then it took a nosedive. That’s all loss that you can’t write off. The gain was in the previous year. The loss is now in the year that you’re selling it. Even though you never sold those stocks, you have to pay the gain as though you did.
Let’s say you had $600 on a share and you owe $200 of it. Come March or whatever it is, that stock is worth $200 and you’re selling it hopefully just to pay the tax bill. There’s nothing you can do about it. You have to and then if it creates a loss, you can’t write off that loss. You only get to take $3000 a year, so we stop people just get torn up.
Cher, you’re right. Mark to market is the worst thing you can do and it’s only for people that are losing money and not making money. Amen. That’s exactly right. I just don’t do it. If you force us to, then we’ll do it, but we’ll put in the beginning a big old disclaimer saying there’s a better way. Isn’t that fun?
“If I use my C Corp as the manager for my flips, can I also trade within that same company or does that complicate up things?” Kim, in a C Corp, you wouldn’t necessarily be trading. You can have that managed by another partnership. In my little picture here, you would just create one of these and even though the C Corp is managing another LLC, it’s okay. We don’t care. We’re just using that C Corp because we want to create a management entity, we want to be able to write things off, and we want to get all of our expenses created into one thing.
“Is there a way to structure my business so that I’m able to write off business expenses against the interest payments received?” Deborah, it’s interesting you say that because that could be that same entity. Whenever you had income coming in, you could have a rental LLC—I’m just going to say rents—you could have an interest LLC that’s where you’re loaning money, and all of those can be banished by a corporation.
Jeff: Going back to what you’re saying about the corporation being a partner and receiving a K-1. This corporation is also a very small partner in the partnership. It’s not seeing a lot of portfolio income coming across, but mainly, there’s guaranteed payments for managing the partnership.
Toby: Spoken like a true accountant. Love it.
Somebody says, “Hey, could a C Corporation have a different year-end?” Yeah, Jimmy. Quite often we make this guy a different year-end than you so that if we get to the end of the year and we need to push some money in the next year, we don’t want to pay tax on it now, we can do it.
For those of you guys we lost, it’s okay. You’ll get it. We teach classes on this. Some of you guys already get it. You’re already there. If not, I’m going to give you guys some offers, come and get some education. Make it really painless and so much fun. Taxes should be fun. Once you start realizing you put money in your pocket, you’ll get jazzed about it.
All right. Somebody says, “If the LLC is an LLC and not a partnership, how does that work?” LLCs are not a tax designation. We have to know how that LLC is taxed. An LLC could be taxed as a disregarded entity, which means it’s ignored. It could be taxed as a partnership, S Corp, C Corp. Literally, it doesn’t exist to the IRS. They just say, “Hey, how do you want us to treat it?” So, that’s perfect. Disregarded then. Then we might want to change that.
If you have an LLC that’s disregarded flowing down to you and you just want to write-off expenses to that corporation so it goes back to this, then we would just need to give that corporation a little bit of the interest, maybe 1%, 2%, whatever and change this. We could do that easy. You can still do that?
Jeff: Absolutely. We just don’t want to pay management fees to that corporation if they’re not a partner.
Toby: Yeah, there has to be a guaranteed payment to partner.
Somebody sent me this in. “Is TurboTax comparable to using a CPA?” The answer is no. The reason why and I’ll just show you a couple of things. First off, this is a life lesson that you could tell anybody that you want to harass, but if you teach this to your kids and they get it, then you just did yourself a huge favor.
Poor people tend to focus on price. Rich people tend to focus on value. I could pay $100 to get my return done, but it cost me $10,000. Price was low, value not so good. Or I could pay $10,000 to somebody but it saves me $100,000. It’s quite literally a 1000% higher price, but the value is even more. That’s the way I look, but we want to see if that’s actually the case with TurboTax.
I just pulled up there a little complaint board just because it’s fun. You can go on the internet and type in ‘TurboTax complaints’ and you can see the problem with using computer programs. When you complain to it, it doesn’t do anything. You could see there was 183 complaints that is 0 rating, had a 1 star on 183 reviews. The reason being because it’s not really going to respond to you and people get mad because frankly, it’s not your accountant.
Better than that, I actually found a newspaper article, somebody who wrote on this, and I thought it was pretty fun. Somebody says, “You can’t put a price on Scott.” Yes, we can. So, here’s TurboTax. They actually get a whole bunch since I’ve been describing the highlights. They did the same set of facts to a bunch of different people.
The cost for TurboTax for online in business was $111.90. Tax refund they got back was $3491. So the total savings, you subtract those, you got $3379.10. Not going to feed all the stuff. They said, “Hey, that’s cool.” Then they went to their neighborhood accountant. The neighborhood accountant said, “Hey, it’s $400,” and they said, “Hey, that seems really high because I could get it done for $100 from my software,” but then let’s look at the total savings. The total savings after paying $400 to the accountant was $3431. There it is. TurboTax. That was $3379.
I know what you’re saying. Robert says, “Hey, your tax refund is not a saving.” No. It’s what you get back. I gave money to get something done. All we’re doing is comparing the total amount that I actually received, get to keep. If I pay $111 and I get a refund for $3491, the total amount of all that money I get to keep is $3379. In other words, you have a tax obligation and yes, you can ask questions here. So, Robert you can ask questions.
The cost for the accountant was $400 but you got a larger refund. Chances are because he’s looking for things. It’s not as easy as just using a computer program. So, it’s basically the same thing.
Somebody says, “I will get the same money back. […]” What we’re talking about is the accountant. The answer is no, actually, and the newspaper article you just google this stuff yourself. They were looking at the actual tax refunds back and it’s undeniable when you’re doing the free systems. The thing is that I have problems with H&R Block and Intuit have an agreement with the government. Sixty percent of the returns are supposed to be free. Sixty percent of the returns done in the United States are supposed to fall under the free, but they’re not letting you do it for free. They’re charging you.
This was something that was just in Congress and they renewed this agreement to these guys even though they found that they were hiding the free system. In other words, they’re trying to charge you, even though it’s supposed to be free.
For somebody who’s doing a free return, it’s probably not going to do too much for you to use an accountant. For somebody doing a return that has any bit of complexity—that would be investors, anybody with a Schedule E, D, or C—do not use tax software. It does not know what to ask you and what it’s asking you are conclusions. There are three or four ways to get to a conclusion. It’s not asking that. That’s why you use a CPA.
The other reason you use a CPA because you can blame them for stuff. I say that not in jest. If you have penalties, if you ever find you have penalties and you did it yourself, you’re not getting out of that penalty. You have penalties and you relied on a tax professional, that is a reason to get out of the penalty. So, I’m just going to tell you guys again. At the end of the day, we’re all looking at dollars, but there are some people that look at price and not on the total value. That’s all it is.
The answer to somebody, “Are all the Anderson people CPAs?” No. We have EAs, CPAs as accountants. CPAs are a state designation, EAs is a Federal designation, accountant is a degree. About 80% of the preparers out there are non-licensed preparers, non-credential preparers.
The Government Accountability Office actually did a study on this. This is going to freak you out. They did a study on the chain preparers and they gave them a set of facts. Do you know what the accuracy rate for chain preparers was? I should actually make this a question. I should have done this. This is fun because everybody’s guesses are wrong. The chain preparers, the accuracy rate on business returns was a whopping 0%. Chain preparers. That was the Government Accountability Office. It’s crazy.
I just look at it and say, “Hey, you know what? If I want it done wrong, I can go to a chain preparer. If I want to do it myself, I could probably do a better job than just having somebody who doesn’t know what they’re doing to it. If I want it done right, then I’m going to have a much greater likelihood that I’m going to get it done if I’m using a professional.
That said, use a professional who actually knows your industry because it’s way different. If I am a dentist, I want to use professionals that work with businesses. If I am a real estate investor, I want to work with professionals that actually do investment because the same office did studies on small accountants, too, and when it came to Schedule E’s and C’s, it was like a 4% accuracy rate. It’s really complicated stuff. I wish it was easy, but there are a hundred ways to do something. Getting to the right answer just means that you have to deal with somebody who’s actually done it a few thousand times.
Jeff: Several years ago, the IRS ac4tually wanted to test preparers who are CPAs, EAs, or attorneys. It was like you said. The chains and the independent accountants tax preparers who pushed so hard against it and that finally got thrown out, but the plan was to make sure that preparers knew what they’re doing, so be careful out there.
Toby: Yup. This is what’s interesting. With us, in most cases you’re just checking up on something, you’re defending the audit. You want to have some of that connection to defend. If you are dealing with a lot of preparer’s data, they’re not licensed to do anything in front of the IRS, so they can’t defend you even if they wanted to. Even if they really could.
The other thing is, the PTIN test? There wasn’t actually a PTIN. They actually tried to do a two-day exam and they got beaten in Federal court. The court said the IRS didn’t have the authority to police examiners or the preparers. Chains means they shall block you out. Any chain preparer is the Liberties and the Jackson Hewitts and all that stuff. I’m not defending them. It’s a Government Accountability Office report. You can go and look at it. “I’m telling the truth,” is always the defense, although they don’t like it when we talk about it.
Jeff: And I’m shaking my head in disgust. You can’t see that.
Toby: Yeah. It’s not that we don’t like the chain preparers. It’s just that a lot of people work for the chain preparers that shouldn’t be doing your return because it’s a hard time help. Everybody that does preparer’s return test to have one, if they’re getting paid for it. The problem that you have is only four states actually have any licensing requirement for paid tax preparers. I know Oregon is one, Maryland, I think California, I’m trying to think what the other one is, I can’t remember, but almost no states require any sort of actual credentials, so it’s freaky.
“Do you need a CPA?” You don’t need a CPA to do your returns. Now, Jeff here is a CPA for, how many years?
Toby: Twenty-nine years. He’s been doing it for a long time. He’s going to always say you’ll need a CPA, right?
Jeff: No, actually I’m not because I work with very smart people who are not CPAs and I work with CPAs that couldn’t find a way out the door.
Toby: That’s the thing. CPAs are a state-designation. It’s not necessarily a preparer designation. Do you even go over tax prep during…?
Jeff: Yes. Some part of the CPA exam is tax law.
Toby: If you’re an EA, then you actually are with a Federal license to actually practice in front of the IRS. Actually, I like the EAs quite a bit. A lot of them are very knowledgeable. But again, it always depends. A lot care about the experience of the person who’s making the ultimate decision. I don’t care who prepares my return. I care who looks at it and calls me when it’s done right.
All right. “How can I pay my daughter, who works for the corporation, a salary to help her with buying her own rental property?” This gets really interesting. When you start paying your kids, here’s the fun part. I would pay them a salary through the company. I would have them work for it. But since they don’t own it—I’m assuming they don’t own it—they just have W-2 income and it helps them qualify for literally everything if you’re going to use credit.
If you’re going to buy rental property and you need a loan, then you go to the lender and you ask them what she needs to make to qualify for certain loans. If you want to buy rental properties, I would say always make sure that you have cash flow rental properties and factor in the cost of the debt. I use 50% as an expense ratio, so if I have $500 coming in a month, I want to make sure my debt is below that. I’m not using the gross amount that I’m receiving.
Let’s say I’m renting a house for $1000 a month, I’m only going to assume that I’m going to be able to keep $500 of it, just because I need to make sure that I’m doing repairs, maintenance, I’m going to have vacancy. I need property managers and things like that, but I would just make sure that you’re factoring that in. If your debt is more than $500, don’t do it. You’re going negative.
You would just ask them what they need to see and then you can make your daughter look the way that they need to see. Again, her tax bracket is probably going to be less than yours unless she’s a thriving adult, maybe married, or something where the income’s really high. Otherwise, you just look at it saying—let’s assume it’s my daughter, she’s 21—I’d say, “Hey, I want to make sure she qualifies for a loan. I’m going to ask what kind of salary do they need to see and for how long?” how long do you look back. This is […] issue.
Somebody asked, “I have two businesses in different industries. Should I get two different CPAs, each with experience in a different industry or one one CPA?” It really depends on how big those businesses are. If they are less than $1 million, I’m probably going with one CPA. If they’re both over $1 million, then I may say, ‘Hey, I need to have one for each business,” and you could pick one to do your personal return. What say you?
Jeff: I feel like you should have all of your accounting business in one place. It goes into the tax planning and certain other planning. It makes it much harder if you have multiple CPAs.
Toby: What if the businesses are in different places? I don’t want to disagree with you, but if I have a business in Hawaii, then I might want to have a local if I’m doing over a certain amount. I’m over $1 million, I’m probably having somebody local there.
Jeff: I’m thinking when you’re talking about big strategies, whether it’s going to be planned and stuff like that.
Toby: Agreed 100%, then you need to have a planner. That’s actually a really good point. You have tax prep and you have tax planning. Don’t confuse them for each other. Your preparer should know your industries so that they’re preparing the right return and they know how to capture it.
For example, if you’re a real estate professional and you don’t make an aggregation election, which is just a simple line item on a Schedule E, it could cost you hundreds of thousands of dollars. Knowing to put that one line on there requires somebody who actually does it. That is a preparer issue.
A planner is somebody who looks at the 10,000 foot view and says, “If you’re making money over here and you’re making money over here, here’s where you’re going to be personally, we need to be worried about qualifying for 199A, we need to be looking at whether we’re exceeding our standard deduction on things like charitable giving and stuff like that, we need to be looking at would it make sense to qualify as a real estate professional? Should you be looking at cost segregation? What other things should we be looking at to find benefit plans as opposed to standard contribution plan?” You need somebody who understands that, looking at it from that angle. That said, you could still have different preparers but you really need a good planner.
Jeff: And let me add one more thing. If you have a large company or especially multiple large companies, at that point you need to think about having good people inside your company. At that point, you may want to get a CPA or somebody at least have a strong full bookkeeper or knowledge […] the company.
Toby: And I will say this. This isn’t really related to this question at all. You’re bean counter—no offense, Jeff—should not be writing your checks. This is going to trip out some of you guys. Everytime I see theft, it’s usually because you’ve given somebody authority that has the ability to manipulate your books at the end of the day. When I say bean counter, it doesn’t mean the accountant. It means your bookkeeper.
You always want to have somebody there that’s able to look over the shoulder, but they shouldn’t be able to change the information, if you know what I mean. If I say, “Oh, you only made $10,000 this year,” and that’s because I’ve been feeding the money to myself on the side, because I have access to the accounts and they have access to the end numbers, you look and you say, “Man, I only made $10,000. I can’t believe that. That doesn’t seem right. That’s horrible.”
Chances are because you gave control to somebody to give you the final number that also have the ability to manipulate that number. When you have an accountant, 99% of the time, they are not having any access and they’re not really looking at that business other than from the 10,000 foot view.
Jeff: Let’s talk about internal control […]. What internal control is about is you can’t necessarily stop all threat, theft, and fraud, but you don’t have to make it easy.
Toby: And you want to be able to catch it before it gets out of hand. I had a very good friend and he had, again, that one person he that he really trusted was doing all the books and had access to the checks. $110,000 over two years, just drained the company, and was completely unaware because when she was given the books, she was like, “Oh yeah. Okay, that looks good,” but he wasn’t going and looking at the accounts and making sure that they tie it in.
That’s what a really good accountant do. They say, “All right, let’s look at the balance sheet.” people are going to say, “Why do you need to see the balance sheet? Why not just the P&L?” “Well, I need to see whether these things tie in. When you have profit, then it should be existing in that asset sheet somewhere. Let’s see where it ties in.” You’re going to watch people get very nervous if they have bad books or if you have a bad bookkeeper, they will not be able to pass that. You will catch them in about five seconds because they won’t tie.
All right. “How many rental properties should I own before I create my own C Corp?” This goes back to a previous question. It’s not how many properties. It’s how much you’re making.
“My mom wants to move to Florida. She’s keeping her real estate investment in Texas. Should she retain a CPA based in Texas or Florida to prepare her annual return?” For her personal return, it might be where she’s located, although nowadays, you can just pick wherever. It’s frankly whatever works for your mom.
When I was talking about aggregation on Schedule C where you’re referring to cost segregation, no. Aggregation is a term that you use for all of your rental activities, your real estate activities. An aggregation election means treat all of my rentals as one business. That’s different that a cost segregation.
“I am currently an employer contributing 401(k),” it means it’s probably an employer match, they’re making contributions on your behalf, “can I still start a self-directed 401(k) to use for investing in real estate?” The answer is…
Jeff: Absolutely yes.
Toby: Absolutely smoothly. You can have as many 401(k)s are you want. I can have three employers, frankly all contributing to a 401(k) on my behalf as long as I’m qualified for them. It’s going to be tough to do it for more than two, but you could. There’s no rule preventing it.
Here’s the big thing. You just can’t go above the maximum amount per year for the employee deferral section. Everybody else, you’re capped at the contribution limit, per 401(k). What is it this year? It’s $57,000?
Jeff: That sounds a little high, but say around $55,000–$56,000. There’s a couple of contribution limits. One is how much you can defer from your salary and the other one is how much everybody can defer to. But this limit apply to you as an individual. It’s not per plan. It’s per everybody.
Toby: The $56,000 is per plan.
Jeff: No. That’s total.
Toby: No. I promise you.
Jeff: The 415 limit?
Toby: Yup. This is how it works. My $19,000 is my employee contribution amount. I am aggregate amongst all my plans. I can only defer my personal salary up to $19,000. My employer can contribute based off of my salary up to 25%, defer it, but I can have two or three plans. The example that the IRS gives is you have two plans, each contributing $50,000. Can you do it? The answer is yes, actually I can. I promise you. I bet you a dollar on that.
Jeff: I’m going to look this up.
Toby: Look it up. Ask Cory, too. He’s pretty knowledgeable. But anyway, you can have multiple plans. I promise you can have multiple plans. I want to contend this since we disagree with it,
Jeff: Ah, yeah. Definitely, yes, you can have multiple plans. I’ll agree with that.
Toby: All right. “Does a leasing real estate subsidiary pass through,” this is going to be all you, let me get this one because you love this, “have to pay self-employment tax or will its holding company pay the taxes?”
Jeff: If you are ringing real estate, nobody pays self-employment tax because that is not considered earned income.
Toby: See? Isn’t that wonderful? Don’t you love having accountants here? Nobody pays any self-employment tax.
Jeff: Self-employment tax is that tax on earned income like your Schedule C income, sometimes your partnership income depending on what it is, but the passive LLC is not going to pay any tax. You will pay tax on any earnings from that LLC, but it won’t be self-employment tax.
Toby: See? Now, here’s the one thing. The lawyer in me can’t help this. There’s the leasing real estate subsidiary. If you are the manager that is active, then I’ll flow it, throw to you, it’s whatever’s passing the income to you, but if you own real estate and you’re just leasing it—for example, I have a bunch of real estate companies, so I have a bunch of properties who’s called real estate one, two, three, and they’re all held by a holding LLC—there is no self-employment tax on rental income. Rents, royalties, dividends, interest, and capital gains do not pay self-employment tax.
“Is trading options stocks considered an income?” No because it’s capital gains.
All right. Let’s keep jumping on. Oh, I forgot to do this. This is where you can continue to educate yourself. We’re calling it the Bulletproof Investor. What that is, is something really cool. It’s an online course, that’s a three-part video series. It’s tax and asset protection for real estate investors that’s by Clint Coons, my partner, spoke very, very good. It’s two tickets to tax and asset protection workshop. That’s a three day event. It is a strategy session with one of our professionals going in creating a wealth-planning blueprint for you. It’s all of that and it’s $197.
But because it’s two for Tuesday, then you also get the Tax Wise Workshop. You get access to all three Tax Wise Workshops. You can get all the recordings for the previous two and the last one was really awesome, I’m going to say. The January one was great, but the one in June was really amazing. Thirty-one strategies we hit during that. It was just cool. It’s two days of nothing but tax.
You get access to all the recordings and you can live stream. We have one coming up, I believe it’s in November for two days. We’re talking about five days of workshops. Come out to Vegas if you want to hang out with us on all of this. In the Tax Wise, you get the live streams and the recordings. On the Bulletproof, you’ll get an online course and a book, and you get to have it at the meeting. It’s all $197. I think that’s pretty amazing. There’s a link that Patty will send out to everybody if you want to do that or we’ll just follow-up. Not going to spend more time on that.
All right. “How can I set-up bank accounts, LLCs, and have the funds flow to the holding corp? How do I report the income for tax purposes?” Number one, you don’t have to have bank accounts on all of your LLCs, especially if you have a property manager. It is a factor having a bank account that is corp can look at to see whether they are going to acknowledge the existence of that LLC, but it is not what’s called a dispositive factor. In other words, it doesn’t employ if it doesn’t have it.
Let’s say the same scenario that I just mapped out before. I have a bunch of real estate, I have three rentals, they’re held by a holding entity, and I have a property manager (PM) out here. The tenants are all out there paying the property manager and the property manager is netting it out and sending it to a holding. The only bank account really needs to be that holding. There’s no other reason really to have those three. They’re disregarded for tax purposes anyway. Makes life easier.
Jeff: And it’s not unusual these property managers usually have accounts to hold your cash in until it’s distributed to you anyway. If they’re collecting all the rents and paying all the expenses, they could just hold this money until opportunity.
Toby: This is cool. Somebody just said, “If you’re the manager of the holding LLC for your rentals,” and we do know the manager for the properties, we don’t have to pay self-employment tax, “you would have self-employment tax.” You are the PM. The only place where there’s self-employment tax at all is right here, but you’re zeroing it out. All of the income that’s flowing up through here to you—according at the tenants, we don’t want them to get the money, we want you to get the money—is not subject to self-employment tax.
Somebody says, “Should the holding LLC be an S Corp?” No. If you are in this type of rental real estate, it should be either a disregarded entity or taxed as a partnership, depending on whether you’re borrowing money at all. If you are using commercial property like you’re doing apartments, then you are more than likely need to be able to sell it, no need to see a separate tax return for it. That’s going to be a partnership. If it’s all you, it’s all cash, we don’t care about loans and things like that, we’ll probably make it disregarded.
“What if you have a corporation that is acting as a property manager, can we pay a percentage to the corporation?” Yes, exactly. That’s exactly what you do. Usually, the corporation’s accepting the funds, handling all the expenses, netting it out, and sending it up to the holding company. You get it.
“So, the holding company LLC is not attached to the C Corp?” Correct.
“The holding company LLC is managed by the C Corp—9 times out of 10—but what if the real estate is short-term? For example, vacation property?” All right, so Airbnb. Here’s the rule. Seven days or less equals active. That’s no longer passive real estate. You are now a trader business. If you do an Airbnb, the way you get around, getting hit with any sort of monster tax, is to do the Airbnb through a corp, S or C works, but you have the rental, let’s say that this is a rental property. It leases long to your little corporation.
This is why you do a blueprint. Your facts and circumstances are going to dictate you. If you step on that landmine, you be really upset and the problem that you have is most people don’t understand the difference between Airbnb-type income and long-term lease income. They just put it all together and the next thing you know, you play self-employment tax. You lose a lot of benefits, you can’t do depreciation. If you sell it, you’re not going to be able to do your 1031 exchange. You lose a whole bunch of benefits.
Somebody says, “Can I repeat that again?” We actually did a video series on it. What you do is, in a nutshell, here is my rental. I have a rental property, I’m going to put that in an LLC, and I’m going to lease it long, meaning one year to two years I’m going to lease it to a corporation. This is the corporation that is the host and it is going to do all the short-term leases.
If you’re familiar with Airbnb, you know that these guys are called. They’re called guests. The money comes into the corp. Let’s say that I’m leasing this at $3000 a month. I’m leasing a house. Then this is rental income. This is passive and my guests pay me $4500 a month total. You look at the average stay, what they do is they look at the total days that was rented and divide it by the guests, the bookings.
If I’m seven days or less, then I’m active. Again, if you’re even close, don’t mess around with the days. You just say, “Hey, you know what? Let’s say I’m bringing in $4500, I immediately pay my rent of $3000 which gives me a net of $1500 and I have all the expenses associated with the property. I have to do the linen, I have to do the other stuff with that extra money, I can get it out to myself. I hope that makes sense.
Jeff: We actually write into this very recently. Only the rental property was a portion of their house. It was separate entrance and all that. What they hadn’t taken into consideration was they had to rent that portion of their house to the corporation to make this work.
Toby: Yup and it works. It works absolutely.
Somebody said, “Thirty days or more is okay.” Yeah. If you have more than seven days at your average rental, then you’re fine. You’re passive. You don’t have to worry about the corporation. Just write it out of that LLC. Anyway, hope that answers that question.
“I’m a subcontractor. Do I need a corporation to protect myself?” The answer to me is always going to be yes. Here’s what we have. We have two types of liabilities. Always. And this is more of an asset protection questions, but there is some tax reason, too. First off, if you are a sub, then you are an active business. The nude IRS data came out. If you don’t want to get audited and lose, then you make sure that you are an S Corp as the sub.
On the first $100,000 it’s going to save you about $10,000. That’s the typical savings just because the self-employment tax is greatly reduced when you use an S Corp. You’re taking a small salary and the profits flow out to you without being taxed on self-employment, which is old age, death, and survivors through Medicare, it’s 15.3%, but the actual tax ramification is 14%. On $100,000 I’m probably paying myself $30,000 and I’m going to just 14 times 6, whatever that is, it’s going to save me some money.
That’s number one, but the risk is on the inside. This is called inside risk. I’m going to give you the two-minute version. Imagine that this was your luggage and you were going on vacation. You have a whole bunch of nice clothes that you were taking with you. You threw your toothpaste into your luggage, but you didn’t put the toothpaste into anything. You just threw the tube in, you get on a plane, what’s going to happen when that pressure gets it? It’s a good chance you’re going to get some toothpaste on your nice stuff.
That’s called inside risk. If that tube of toothpaste explodes, you’re going to get it all inside the suitcase. If as a subcontractor, one of your jobs explodes and it’s not even something you necessarily did. But they say, you could be 1% at fault and none were joint and several liability, you get to be 100% responsible for your 1% at fault.
There was a ladder left out, it fell and hit somebody in the head and caused them serious pain, nobody knows who put that ladder there, but you were there. You get to endure that. If you don’t believe that happens, we just had one happened in Vegas. Somebody was rehabbing a house and the carport just fell in and killed the guy. Just squished him. You know that everybody and their mother is getting sued on that one.
So, that’s inside risk. We want to keep that risk from coming out and following you the rest of your life, you get to be garnished all over the place. Say you have a really rich spouse or let’s say you just had some money tucked aside. We don’t want them to be able to come and get that. That’s inside risk.
Then there’s outside risk. That’s you and your family. Let’s say you have a wonderful teenage son who loves to drive fast. You don’t want them to be able to take your business away. That’s called outside liability because of something that happens.
When you’re a subcontractor, there’s really two sides. I’m worried about the business from you. I’m worried about you from your business. I’m just trying to keep the likelihood of threat. It is not like everybody get sued.
Jeff: And the other aspect of being an S Corp, 20% deduction.
Toby: Oh yeah. You get the 199A deduction. I forgot all about that. It’s good that you’re here to remind me.
Jeff: That’s the accountant in me. I can’t help it.
Toby: Yeah, under the Tax Cut and Jobs Act, that’s the big benefit for being a business. You get to take that, too. Anyway, there’s a whole bunch of reasons. What we always like to do is look at your facts and circumstances and we can compare. Let’s say you made $150,000. I know the numbers because I was looking at the IRS Data Book, the recently released data because everybody loves that—not. It’s 1200% more likelihood to be audited if you’re a sole proprietor than an S Corp under that circumstance, and the sole proprietors are losing a whopping 94% of the time. You might want to be a corporation. Plus, corporations can do an accountable plan. There’s huge tax benefits to using an accountable plan, and you can file your 401K.
“I own a rental property as an individual, how can I deduct the interest expense on this property?”
Jeff: The first thing you’re going to deduct is any mortgage interest that this property is secured by.
Toby: And it’s on your schedule…
Jeff: Schedule E.
Toby: So it’s your 1040 Schedule E.
Jeff: Right. And you’ll get a 1098 if you have mortgage interest. You might have other interest that you can deduct.
Toby: This is a big one, I know where you’re going. Let’s say you have a house… are you talking about your primary residence?
Jeff: Right. Mhm.
Toby: Right, so this is your primary. It used to be that you can write off the mortgage interest that was off of that primary, no matter what you used it for. Now, it has to be used on that piece of property. And, it’s subject to the standard deductions, so it’s schedule A. But if you use part of that equity…
Jeff: So I could refinance my house and got an extra $100,000 out of it.
Toby: Just an example, you took $100,000 out of the house, equity. Let’s say it’s an equity loan. The mortgage interest, you could report it under Schedule E, so you don’t have to worry about the standard deduction, you don’t have to worry about the new rules, and you don’t have to worry about missing out on a bunch of money. TurboTax couldn’t tell you that.
Even if you do a cash out refinance, yes. You got to make sure that you’re putting it towards something. If I take money out of my house in order to write it off on my Schedule A, it has to be purchased or being put back into the property. Acquisition indebtedness is what they call it.
Jeff: To be able to deduct that interest on Schedule E, you have to put that money into that rental property.
Toby: Somebody says, “But isn’t cash out refi already included on the 1098?” Yes, you’re getting to this side where you’re going to take the deduction. Somebody says, “If you put it into the financial markets, you cannot write it off in your Schedule A. If you take it out, put it in the financial markets, then that interest would be…”
Jeff: Would be investment interest.
Toby: “It would be investment interest against the gains that you make. The problem that you have is if you’re putting the financial market trust, if you lose.” Somebody says it depends.
“What if I’m using home equity loans to buy properties and my LLC is rentals?” Perfect question, and that goes under your Schedule E. It’s either going on your Schedule E directly on your 1040, or it’s going on Schedule E via if you have a partnership, it’s going via the K1, it’s going on H2. But either way, it’s on your Schedule E. Yes, you get to write that off. Very good question.
This is a big one. “Can you explain the depreciation recapture for a property that was never depreciated?” This is where it really sucks. The IRS has this funky rule. I should say it’s the tax code. Do you know what publication it is? 946 or something like that.
Jeff: I am not sure.
Toby: The rule is that if you can deduct or depreciate, I’ll even say it more succinct, if you can depreciate, you must recapture.
Jeff: 946 is right, by the way.
Toby: Oh, cool. Publication 946, I think it’s page 12. I bet you I’m right, I bet you another dollar.
Jeff: I am not looking.
Toby: You must recapture.
Jeff: Form 47-97 which is where you report a sale of this type of property actually says how much depreciation were you able to take, not how much did you actually take. Allowed or taken.
Toby: Yup. If you could have done it, you have to recapture it. Recapture is called a 1250 Recapture. It’s maxed at 25%, it’s your ordinary tax bracket maxed at 25%.
Jeff: But will not exceed your total gain.
Toby: That’s correct.
Jeff: If you have $80,000 of depreciation but only a $30,000 gain, your recapture is only going to be $30,000. We see this quite a bit. It’s surprising how many accountants don’t do depreciation.
Toby: You can have the second house and it was your second property, and you’re renting it out. Maybe you rent it to a kid. You don’t think about it, they’re going to pay me a thousand bucks, they’re giving me something. It’s an investment property. All of a sudden, you’re entitled to depreciate it.
Jeff: You haven’t depreciated this for 5, 6, 10 years. There’s a way to fix this.
Toby: That is to take a depreciation, one year, take it all.
Jeff: We do what’s called a change of accounting method. I know we talked about this before. You’re actually changing your accounting method for depreciation from zero to this is the way it’s supposed to be done. You report all that back depreciation that you should have taken in the current year. It does need to be approved by the IRS, but it’s usually an automatic approval.
Toby: Yup, what Jeff said. Change of a tax, take it all in one lump sum. I just know you just take it all in one big lump sum. Wording that authorizes your escape from depreciation recapture is found in the last sentence of 1250 B3 which states, “If the taxpayer can establish by adequate records and other sufficient evidence that the amount allowed as a deduction for any period was less than the amount allowed or the amount taken into account for such period, it shall be the amount allowed.” I have no idea what that means.
Let’s take a look at examples. You claim zero for home office depreciation for the last five years, how would you prove the zero easy your tax range for the zeroes you claimed the home office deduction on IRS? You wouldn’t do the home office on a 88-29, we do it as administrative office where you don’t actually have that.
Jeff: Yeah, with reimbursements you don’t have to take depreciation.
Toby: Yeah, but on the rest of it I don’t know how you’d be able to do it. Let’s take a look at zero depreciation, void your evidence, how you claim. You’re doing Bradford, amazing guy, Bradford Taxes. You’re talking about the depreciation recapture on a home office which we don’t want to do. We want to do it as an administrative office, and you want to do it as an accountable plan reimbursement where it’s not actually depreciation. I know what you’re talking about. You would take all the depreciation in the same year that you recapture the depreciation if you did it the way that Jeff just described it.
How do you find out if your family CPA understands tax for real estate? What I would say is do they own any real estate and have they been doing this for themselves? Or is it something that they do, do they have a bunch of real estate clients? You don’t want to be 1 of the 10 people they do that has real estate. You want to be one of the hundreds of people they do that does it. I will check that out.
Email me, I’m curious, I want to see. I believe that’s only on the home office, I don’t think it’s if I have an investment property. If I’m able to depreciate my investment property, I must recapture that. If I didn’t take depreciation on a home office, then there’s a way if I didn’t take it and I had a home office. You’re right, it would be the zeroes.
“This is not on the topic, so I can wait. Healthcare gives credit…” I’ll take a look on this one.
“If the IRS has to approve the recapture, how long does that take?”
Jeff: We usually follow it with the return, and they usually accept the return right away. It doesn’t really take a long time. Often, we’re doing this in the same year as the sale, primarily to prevent long term capital gains as being treated as ordinary income. It’s kind of a switch off.
Toby: But hey, we’ll take it.
“I did a cash out refi in a home with a wrapped mortgage.” They’re owner financing. “What form would I be able to deduct the mortgage interest if I’m paying the mortgage loan?” In that particular case, it sounds like they did a cash out and they’re selling it to somebody else. It sounds like an investment expense because it’s an investment property.
Jeff: One of the possibilities that you recognize the interest that you’re receiving on the front of your 1040, and you’re recognizing the interest expense that you’re paying. You could take a beating, but I don’t know that you can net those amounts out.
Toby: I could cash out refi, I’m still on the hook, I’m not paying tax on it because I have risk. Ordinarily, if you take cash out of something… You passive investors out there that put money into a syndication and they re-fi that property and hand you a bunch of cash, if it’s more than what you put in, you pay long term capital gains on that. Here is somebody, because they’re not at risk on the loan. In this particular case, if you’re not at risk for the loan, you’re fine. You should take the cash out and you’d be putting it on your Schedule E as an investment expense. I’m pretty sure I’m understanding it correctly, that’s probably the answer.
“What is the best structure to protect against the IRS piercing the veil and establishing a lien?”
Jeff: I’m not sure that they can go past the entity.
Toby: This is the thing, the tax buries the taxpayer to the IRS. When you talk about veil piercing, it’s a civil claim, it’s an equity term where somebody is basically saying don’t recognize this entity, we want you to ignore it so we can go after assets. Veil piercing is really an asset protection term. What is boils down to is if you’re doing things in such a manner to where you don’t respect the entity, and your state law allows them to, they will say hey, you didn’t do what you needed to have the veil. We want you to ignore it, pierce it, and let me go get money.
But the IRS doesn’t necessarily get that. The IRS is looking at you as a taxpayer. Here’s the sad truth, there’s always a responsible taxpayer on every company. When you do your assets and get your tax identification number, there’s always a responsible party that has to go on there. If that’s you and the company doesn’t pay its taxes, guess who they can go after?
Jeff: That’s particularly true on payroll taxes. Payroll tax, they can actually go after any officer.
Toby: If you sign that return, they can nail you.
Jeff: Yup. If you’re responsible for it… It’s not just the IRS, I actually just dealt with this. I was a nominee officer on a company that didn’t pay a bunch of simple fines in the city of Cleveland. Who do they try to get to pay? They go oh, your name’s on there. They come knocking on my door and I have to show that I wasn’t involved with the transaction. They ended up honoring it of course, but it’s still one of those things where you want to make sure that you’re showing hey, this is separate from me.
Toby: The one time they will certainly go after the individual is if they feel the individual is hiding the entity’s assets. Such as you received a notice that you owe IRS $100,000 and you clean out the bank account. They’re going to follow that money.
Jeff: They’re going to say that you took it. At that point, you’re making the company absolve it. You’re the one who’s receiving the funds and they’ll go right after it.
Somebody says, “Hey, I don’t understand why if you cash out refi on your property, it’s not income yet. If you’re an investor in a syndication and you cash it out, that it is. This is fun. A lot of people don’t realize that there are rules about this. You are a partner in a partnership and you have a capital account, you have bases, you have inside bases and you have outside bases. Let’s just say that I put money in, I’m just going to use raw numbers.
Let’s say that you’re part of an investment group that put in a million bucks. You bought an apartment complex for $7 million. You borrowed $6 million, you fix it up, it’s worth $10 million. You refi that now at $10 million and you pull all the money out. It hands all the investors back the original million dollars they put in, that’s not taxable. But anything over a million dollars is considered return in excess of your bases, and that is taxed as long term capital gains. You are not at risk to pay back that loan.
If that company, let’s just say you default on that loan and nobody ever pays it back. They foreclose on that apartment building, you’re not at risk, you already got your cash. The second you pay that out and you weren’t at risk, was the second you had a transfer of wealth that’s taxable. Luckily, they tax that as long term capital gains.
Jeff: This is where we run into debt financed distributions, which can become taxable just from the aspect of it’s not money that the company has, they borrowed the money.
Toby: If you’re on the hook for it, you borrowed it and you’re the guarantor on it, they you have to pay it back anyway. You didn’t really get the money, you got the money and the debt. When I look at your balance sheet, I’m looking for two things. I’m looking at the asset and the liability. If the liability is not there but you got the asset, chances are you have a taxable event.
Somebody says, “Can you do a webinar or short term rentals?” We already did. Patty, if you could kick Denise that information, it was so much fun.
“What if you do cash out refi on a gifted property?” Well, somebody’s on the hook. If you got the property, you get the bases of whoever gifted it to you. If you are on the hook on that loan, then you wouldn’t have a taxable event. It all matters whether you’re at risk.
There’s a lot of questions. We’re going to have to ignore some of them so we can get through some of these. Don’t worry, we’ll get back to your questions. You can always ask to come on the Tax Tuesday at Anderson Advisors too.
“I have a large amount of capital losses.” Chris, you’re up there in Minnesota, right? You’re having to deal with all that insanity, you got some weird legislatures out there, we’re just going to have to have a little chat about that someday. “I have a large amount of capital losses. Are there any creative ways to reclaim these losses faster than the $3,000 a year standard?”
Jeff: My number one way of doing this is if you have other investments, liquid investments that have gains on them, sell those investments. Sell those securities. If you have […] and you want to dump it, you can buy it back the next day. You recognize the gain, you apply it against the loss.
Toby: Wash sale is only for losses.
Jeff: Yes, wash sale is only for losses.
Toby: If you’re harvesting your gain, then absolutely, that’s what you do. You take the gain–because I have losses that are carrying forward and I know I’m not going to pay tax on it, great. Then, you buy it back and you have new bases.
Jeff: Which is higher than the ones before.
Toby: You’re really smart, that’s really good. But yeah, there’s really no other ways to do it. There’s no other really cool ways, you’d have to have capital gains to offset. This is why that example I gave you about market to market earlier in the Tax Tuesday, this is why this hurts. I’m forced to recognize a bunch of gain on something that I didn’t actually sell, and then it drops like a rock, and then I have losses. I have gain but I can’t offset that gain with my losses because it’s forward.
Hopefully, some of you guys are getting that, but I saw that and I watched that happen to so many people that I’m traumatized by it. I don’t ever want to see market to market. It’s like putting a rule on yourself in a football game. It’s like alright, you’re not allowed to tackle the quarterback, but the other side can still do whatever they want. You just put an artificial rule on yourself that’s going to increase your likelihood of losing, and I just don’t know why people do it. I guess there’s some good reasons.
Somebody says, “Yes, market to market is stupid.” That’s illegal.
Jeff: This $3,000 limit has been around since the 60s.
Toby: They never indexed it. It’s been $3,000. That year, by the way, that was 1999 if I’m not mistaken. It was 1999 or 2000.
Jeff: The 29-18 winners I think was the […], the drugs therapeutic company. Their technology didn’t work at all.
Toby: Again, because they want to take the losses.
Jeff: Depends on how good you are.
Toby: I noticed on the 1099B to do the market to market on futures. You can do that too, futures are taxed really well though. That’s 60-40, 60 long term capital gains, 40… yeah.
“I’m currently buying properties in Arkansas with an LLC, should I register as a foreign entity? Are there better tax incentives by doing so?” Tax wise, not necessarily. You may be required, if you’re buying properties and you’re renting them, and you’re renting them in the name of the LLC, then you should be registering it.
A lawyer that I respect once said, “It’s better to ask for forgiveness than information.” If it’s going to be really expensive, then you just got to hang it out there. If you ever do get sued or something, then you just register it after the fact and say sorry. There’s usually a cure period, I remember the last time I dealt with this in any real setting was in California, two-year cure.
What you’re trying to do is if it’s going to be prohibitively expensive to be there, then you keep it out. The other way you do it is not to own it in the LLC directly, you use a land trust then have the LLC be out of state. If you’re in Arkansas and it’s not an Arkansas LLC, let’s say that it’s a Wyoming LLC or something along those lines. Then, you may not want to have to register, it might be easier just to do a line trust, unless it’s really cheap. In Arkansas, probably it isn’t super expensive.
Jeff: I don’t know off the top of my head what it is.
Toby: Somebody says, “The webinar for short term rentals…” Patty, if you have that, what we’ll do is we’ll put it in the follow up email. Just remember to do that, it is kind of a hot topic because a lot of people are doing the AirBNB VRBO and HomeAway. Just want to make sure that you’re doing it right. There’s some asset protection reasons, there have been fatalities on those properties. You want to make sure you have the right type of insurance, your normal insurance won’t cover it.
Finish up on that, this one with the Arkansas, there’s really no tax benefit to doing so other than if you have a management company, and I say you’re a management company, you could pull cash that would have ordinarily hit your return, then put it into a corp.
“I have a C Corporation, can I deduct long term care premiums as an expense?” This is actually pretty easy. The answer is yes. The issue is how many employees do you have? If it’s just you, then you can reimburse 100% of your medical, dental, vision, and long term care. As an individual, if you called up the IRS and say can I deduct long term care, they’re going to say sure but you have to exceed 10% of your […] income, and then there’s a monetary limit.
Jeff: The younger you are, the lower that limit is.
Toby: Somebody says, “Can you write off health care costs? Wife is a realtor and I’m a social security beneficiary.” Yeah, you still can write off health care. If your wife’s a realtor, then the issue is going to be what portion is deductible versus what portion you’re going to have to pay tax on. If she’s a realtor, more likely than not she’s going to be an S Corp, she’s going to be required to be a pass through. And then if you cover your healthcare cost, it’s considered wages but you can write off the insurance premium on page one of your 1040.
All that means in English is that you can write off the premiums, you wouldn’t be able to write off the deductibles. If you want to be able to do that, you need a C Corp in the mix. You can still have a C Corp that manages the S Corp. Actually, what I like to see it is it hires out the people and does all the marketing. Then, you have a little bit left over at the end of the year coming through that S Corp and you pay yourself a salary out of the S Corp. The C Corp usually zeroes out, or if it has a lot of extra income, it’s going to pay 21% on it.
Jeff: We want this S Corp not only to be reimbursing for health insurance and medical expenses, we also want them reimbursing you for your medicare.
Toby: Anything that comes out of your pocket.
Jeff: Even though it’s coming out of your social security check, the corporation can still reimburse you. That gets included on that self employed health insurance.
Toby: I’m not real good on the math, you’re talking medicaid?
Jeff: Like the medicare that’s on social security.
Toby: You’re paying it, it’s after tax.
Jeff: But the S Corporation has to reimburse you for it.
Toby: If the S Corp did it and you’re a 2% shareholder or your wife is, then that’s income to you. But if it’s a C Corp, it can reimburse.
Toby: See Mr. Ron, this is why you come to us. What state are you in? There’s a work around. New Jersey, alright. New Jersey says broker can’t pay an entity, usually that’s what they’re doing. They want the individual licensed. But since you’re dealing with the IRS, they don’t really care about New Jersey. What you do is you have to have two pieces of paper. You have to have an employment agreement between your wife and her S Corp, and you have to send a letter to your broker saying, “Hey, I know you’re going to pay Mary individually, but she works exclusively for this S Corporation.”
Now, the IRS will allow you to treat that money as though it was received by the S Corp. That’s the way to do it, there’s actually a decision on it. I can give you those documents, no problem, just make sure you’re a platinum client. That’s a whopping $35 a month.
Jeff: There’s actually several industries that this applies to. Real estate brokers, security brokers.
Toby: Yup, anybody that’s doing it, and again, we can get it in there. I can show you how to do it, but there’s a right and a wrong way. What you look at are the tax court cases and you look at the way the IRS treats it. I believe that’s the case.
That was a case where it was a securities broker. He never sent the letter to the broker. He never said by the way I’m working exclusively for my S Corp. He just said I’m just going to put it in there, and you can’t assign income. There’s a way to do it.
“Can a C Corp reimburse medicare for my wife and I paid W2 wages?”
Jeff: Yeah, absolutely.
Toby: Is that medicare?
Jeff: That’s medicare on the Social Security.
Toby: Medicare that you’re taking out of a W2 can be reimbursed.
Jeff: Oh, that medicare. When I’m saying medicare, I’m talking about the deduction that’s reported by Social Security.
Toby: When you’re talking about medicare withholding, no, you can’t reimburse yourself.
“Can my C Corp reimburse my out of pocket health insurance premium cost for insurance to my employer?” Yes. At Anderson, we pay for the employee. We have a really good benefits plan, let’s say it’s $500, $600 a month. But if you want to add your family, you pay that portion. Still on out plan, and it’s taken out of your paycheck. We pay for the employee, and the employee says hey, I have two kids and a spouse, and it’s now $1,000. That gets taken out of their paychecks.
They still have the really great insurance, but they paid after tax $500 a month. You can reimburse that. Plus, you can reimburse—if it’s through a C Corp—[…] and deductibles, non covered procedures, things that aren’t covered. What’s the weirdest one you’ve seen recently? You had a piano guy. Spa, pools, we’ve seen all sorts of funky stuff.
Jeff: The key being that your doctor has to prescribe it.
Toby: One of my favorites was it was a child that had hand eye coordination issues, disabilities that they said they can fix. The treatment that the doctor recommended was piano lessons.
Jeff: A treatment we saw in Kentucky was horses for people with people with muscular problems.
Toby: That’s coming out more and more, actually, especially for veterans. We have a bunch of nonprofits, we worked with one of them, that’s just amazing. When you’re providing service animals, the animals for veterans, it virtually reduces the suicide rate to zero. The dogs are actually attuned to when somebody is depressed. There’s so many little things that are going on after you come out of that situation. I think that’s amazing.
All that stuff may not be covered by insurance, they may say no. Anything out of pocket, you can cover. Some of you guys were there, horses are awesome for the kids too. “What is the service dog charity?” I have to go look up the name. If you would email me, I’ll put you in touch. They’re out of Arizona. Service animals cost about $50,000 to train and they were getting them done for about $5,000 with all their volunteers and everything else. I’ll get you that information.
“What’s the rule for claiming meals and entertainment? Is it always 50%? For example, if I take my real estate broker to lunch,” again, we have to change this.
Jeff: I was just waiting for you to do that.
Toby: I’m just going to put CPA. You got to take your CPA to lunch. I’ll save it for Jeff. Here’s the first one, there’s none of this. There’s no more entertainment. The Tax Cut and Jobs Act did away with entertainment. It no longer exists, you cannot write it off, ever. It’s out of the code. For claiming meal, it’s not always 50%. It’s 50% if you’re taking your CPA or your broker out to lunch, but if you have a group of CPAs, let’s say you’re doing continuing education or you’re selling a product, you’re doing a presentation, then it’s 100%. Or if you do a holiday party for your office, or your corporation, then it’s 100%. It’s like thank you, congress.
Jeff: Yeah, they were actually going to restrict it even more than that but they gave back some of the different deductions.
Toby: This is interesting. Somebody says I’m just starting to have rental properties in LLC cash flow managed by a C Corp but I’m afraid […] and if I reimburse my medical expenses. Don’t worry about becoming insolvent through your corporation. The corporation just takes those losses and carries them forward, it doesn’t hurt you. In fact, if you do take the expense and you create a loss on your C Corp, it just never is making money and you dissolve it, you can actually take those losses individually up to $50,000. $100,000, Mary filing jointly.
“280A is 100%.” Oh yeah, absolutely. If you did a holiday party with a 280A, then it’s 100%. Or if you’re doing 280A and you’re using your house to do presentations, a lot of people do that especially in home businesses. For example, I have awesome clients. Some do makeup, some do health products, and you have it in your home and you order up food, it’s 100% deductible.
Jeff: You might have an open house for a rental property or a flip, that’s 100% deductible.
Toby: Yup, perfect. If you’re doing an open house for your real estate, that’s great too.
“Can I write off travel? I trade stocks, I have family members who trade stock, we meet and discuss trading strategies when I go to visit them. Can I write off my travel and meal expenses when I go?” Absolutely, if that’s your primary reason. You just have to be careful, there’s lots of fun stuff that you can do to make sure that it’s covered. And the IRS by the way cannot tell you to go to some place that’s more convenient. If it’s in the North American region, if you live in New York, it’s the same as if you go next door versus if you go to Seattle. IRS can’t tell you to go to what’s closer.
“Do I need to pay taxes for my new corporation if I’m not generating any income yet?” This is a trick one. You do not have to pay taxes if you don’t make any income, but you have to file a tax return. You do not need to pay taxes. This is the trick, the answer is no, but file your 1120 or 1120S. One of the first things we want to do is we want to capture all our startup expenses on that first year return even if you lose money, you just want to capture it in your first year.
Alright, fun stuff. We’ve gone way over. I’m just going to throw this back up at you, it’s two for Tuesday, which means we’re giving you those two offers. Love that.
Jeff: Can’t believe we’re going two of these.
Toby: Tax Wise Workshop, and Bulletproof. One of the reasons that we do this and educate is because you become awesome clients. I don’t like clients that leave, I like clients that stay. The smarter you are, the more educated you are, the better you are as clients, which is awesome. If you have questions, please do Tax Tuesday at Anderson Advisors or visit us at andersonadvisors.com.
“How about a meal where a lender makes proposal to a potential borrower?” You can write that off 50%. Just remember when you write things off, if you write it off on your individual return, it’s your tax bracket, that 50%, that is not deductible. If you do it at the corporate level, it’s flat 21%. Be smart about who’s reimbursing.
“Can the expense of an LLC, C Corp, and S Corp that do not make much money offset the taxes for W2?” Yes, of course they can. It depends on the business. That’s a lot of what we’re looking at. In fact, if you’re a real estate investor, it gets really cool. Literally today, I was sitting there having lunch with another cost segregation company. It’s an accounting firm that does cost segregation where we rapidly depreciate rent from real estate. The average amount that they were getting on residential real estate is about 30% of the improvement value in year 1.
What that means is they’re creating big, fat, huge deductions. If you have a house that’s worth $300,000, they’re getting somewhere around $100,000 of first year deduction. If your brain just popped, well, that’s because there’s all sorts of nuances to these things. If somebody’s a real estate professional, either spouse, then we take that. There’s some great things you can do, absolutely.
Anyway, that is so much fun. You can always contact us if you want to have a free consult. By all means, do the Two for Tuesday special. We’ll do a full blueprint for you. We’re going to save you some money. If you don’t like it, I’ll give you your money back, but I’ve never had a single person in 27 years who came through and didn’t say dang, I didn’t know that. We’re going to get you on something, it’s just how it is.
Jeff and I sit here and play this game, we’ve been doing this, he’s 29 years. I sit here and I’ve been doing this for three months, I’m a lot younger than Jeff, just graduated again. We still find stuff all the time to look at and research. There’s nobody that knows it all, it’s good to have a team.
“Is the full blueprint included in the platinum membership?” Absolutely. Platinum is five steps. It’s risk reduction formula, we do the blueprint, we do a tax analysis called the keep more, we’re looking for keep more solutions, how do you keep more of your money. We look at your compliance to make sure what’s due when, then we do advance strategy analyzers every year where we’re looking at it saying are there any things that we can do that are going to save you chunks of money?
It’s awesome. If you’ve already purchased the Tax Wise, is Bulletproof available? For you, Kimberly, absolutely. You tell Patty. We’ll make it work for you, because it’s Two for Tuesday. Jeff, anything else you want to add?
Jeff: No. Answer to a previous question, if your accountant says they know it all, run. They don’t. They’re too stupid to know they don’t.
Toby: You treat them like a bear, you throw a scat in their face. That’s what an Alaskan told me. You throw a fresh scat in their face. If you don’t know what a scat is, I’m not going to tell you. Where do you get the fresh scat? I said don’t worry. If you run into a bear in the woods, there will be fresh scat. Will it save you? No, they’re going to still eat you. At least you have a good story. Looks like the hiker pissed off the bear by throwing scat in its face, that’s what’s going to happen.
Anyway, we’ve gone too long. You guys have a good one. We will see you next time. Mr. Ron, how much does it cost? Do the Bulletproof, that will get you in the door. $197, we’ll get you started. Alright guys, it was fun, we’ll see you next time.
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