Taxes are confusing and challenging for most people. By answering your tax questions, Toby Mathis and Jeff Webb of Anderson Advisors give and get what you deserve. Do you have a tax question? Submit it to taxtuesday@andersonadvisors.
- What are advantages/disadvantages to lease purchase of vehicle via C Corp? Depreciation and percentage of use restrictions; a better option is to reimburse mileage
- What’s the best tax strategy for a vacation/short-term rental that I own and sometimes use? Can’t deduct certain expenses for personal use; only ⅔ of expenses/depreciation
- What’s the best state to form an LLC for charging order protection? Wyoming or Nevada
- What are two types of liability for a business? Inside and outside
- For tax purposes, should I pull all my 401k money at one time for real estate investing? Depends on several factors, including income and losses
- Can I put rental payments in my personal bank account, or in property’s LLC bank account? Run it through LLC; respect your LLCs for courts to do the same
- Are charitable contributions deductible to a C Corp? Yes, but restricted to 10% of taxable net income; offer sponsorship to make it an expense, rather than a contribution
- I provide gas, food, and lodging to an unrelated person. Is any of that deductible on my personal return? No; it’s considered a gift, if $15,000 or less each year
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Full Episode Transcript
Toby: Hey, guys. This is Toby Mathis.... Read Full Transcript
Jeff: And Jeff Webb.
Toby: And you’re listening to Tax Tuesdays. We’re bringing tax knowledge to the masses. You being the masses and us, hopefully, bringing you a little bit of tax knowledge. If nothing else, you’ll be entertained.
Jeff: That’s the truth.
Toby: Yeah. We’re starting off another Tax Tuesday. First off, welcome. Let’s get everybody in here. I see a lot of questions already being asked. Let’s see what’s on the docket. We have a lot on the docket today. We have a ton. It will be very interesting to see how we get through all these.
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Tax Wise or Tax Tuesdays, let’s go over some rules. Ask live and we will answer before the end of the webinar. Send in questions at email@example.com. If you need a detailed response, you do need to be a client if you’re going into lots of specifics about yourself. If you just want a general one, we’ll probably answer it live. This is fast, fun, and educational. We want to give back and help educate.
We have a ton of questions to go through. We’ll just start off by listing the questions so you’ll get an idea what we’re going to be covering today.
“Is it better to pay myself higher or lower wages from my C Corporation in order to maximize tax benefits?”
“I have a vacation rental I live in about four months per year and rent out the other eight months. What is the best strategy?”
“What is the best state to form an LLC in for charging order protection?” We’ll go over all of those.
“When you have different functions of a business under one entity, how do you write off the expenses if you have one EIN?”
“What type of entity should I choose for my ecommerce business?”
“Is it preferable, for tax purposes, to pull all of my 401(k) money at one time for real estate investing?” I think they mean pulling it all out.
“Is it okay to keep rental payments in my personal bank account or does it have to go into the property LLC’s bank account?”
“I am selling a house to my brother and doing a 1031 Exchange with proceeds. I heard that the IRS may disallow this transaction. Is it true and how can we get around it?”
“Are charitable contributions deductible to a C Corp?” We’ll answer all of those.
“I provide gas, food, and lodging for an unrelated person. Is any of that deductible on my personal return?”
“What are the advantages of switching from an S Corp to a multi-member LLC partnership?”
Here’s a long one which I thought was interesting. I want to go over this with you guys because it’s a very interesting answer. “My partner and I own a lodging business that has broken even over the last few years. There are seven cabins, none of which have ever been depreciated. Next year, the mortgage will be paid off and our K-1s will begin to show income. Will we still be able to take depreciation?”
“I have an HSA (Health Savings Account) with my W-2 job where I contribute the max annually. My wife and I have a separate C Corp. Can I create another HSA through our C Corp and contribute to two?”
Then, the last one. “Can I qualify as a real estate professional even though I have an unrelated W-2 job if I can prove I work 750 hours in my real estate business?”
We’re going to answer all of these in order. We already have a bunch of questions. Let’s take a look at some of these. I’m just going to jump into this because I remember answering these, but sometimes people jump on and off the webinars.
“Advantages and disadvantages of a lease purchase of a vehicle through my C Corp.” First off, you’re either doing a lease or a purchase. If you’re doing a lease where you’re buying out the vehicle less than 10% of it’s fair market value, it’s going to be treated as a purchase or you have the right to treat it as a purchase.
Here’s where you have advantages and disadvantages. First off, if you take depreciation and you rapidly depreciate a vehicle—a lot of people want to write off the car in year one—you’re going to have restrictions depending on the type of vehicle.
Here’s the rub. If you use that thing less than 50% for business, you’re not going to get to use that anyway. If you are using it 100% for business, then I would recommend you actually, possibly, have the vehicle in the business, depending on what type of business it is. Otherwise, I would just keep it where you’re just reimbursing yourself mileage, guys. This doesn’t make a lot of sense to put yourself in a situation where you can have something called depreciation recapture. If all believe that below that 50% threshold you have to track every year.
For example, vehicles are a five year property. If you take that vehicle and you take a big chunk of it, write it off in year one, you’re doing bonus depreciation—it’s a pretty good size chunk of change, let’s say close to $20,000—then you fall beneath that 50% period threshold, you’re going to have to recognize all that as ordinary income. It’s not a good situation. It’s better to just reimburse mileage. We use MileIQ.
All right, that was a freebie. Now, let’s get to the questions that were posed. “Is it better to pay myself higher or lower wages from my C Corporation in order to maximize tax benefits?” Jeff, I know you have some thoughts on this.
Jeff: We’re going to say what we usually say, it depends. The reason it depends is if you’re talking about what benefits such as retirement plans where you want to be able to contribute more, especially if you’re in a defined benefit plan in your corporation. You’re going to want to pay yourself more.
Toby: Yeah. What Jeff is saying is, “Hey, if you pay yourself active wages, you can put them into a retirement plan. They qualify.” You can’t do that with dividends, you can’t do that with reimbursements, and things like that. It has to be actually your wages.
Jeff: But on the other hand, if you’re raising your wages, you’re just increasing a loss on your corporation. That doesn’t make a whole lot of sense because you’re paying more tax personally and the corporation’s not getting a current year benefit out of it. Then, we run into other areas where some people want to be able to show W-2 income for loan purposes or other such things.
Toby: You’re hitting a lot of them. From a tax standpoint, it’s an easy calculation. You say, “Hey, do I need the money? If I need it personally then is it better for me to pay it out as a wage to myself? Or am I better off treating it as a dividend, the profits where it’s going to be taxed at the corporate level than at my level?” It’s almost never better to have it taxed as a dividend. Quite often, it’s much better to have it stay in the corporation in your accumulation phase.
My wages are high, say I’m already in the hotpot bracket. I’m sitting it at 37% for federal plus my state. In some states, you guys are at 50% tax bracket versus letting it sit there at 21% in a corp. You just saved yourself $0.30 on $1 just for leaving it there. You just have to have a justification for accumulating the capital if you’re going to do it year after year.
Jeff: Yeah. Otherwise, there’s no requirement to pay a salary out of your C Corporation.
Toby: Yup. A lot of folks don’t realize that. You don’t have to pay yourself a salary. There’s no technical requirement. There’s always weird ones like that. By the way, your compensation includes wages and fringe benefits. If you’re just giving yourself benefits, there’s nothing wrong with that either, even if they’re nontaxable benefits. It’s reimbursing all your medical expenses. It’s reimbursing business expenses that aren’t reimbursed, but that still benefit the business. It’s doing a home office, it’s doing a 280A, it’s doing a bunch of these things.
It doesn’t have to pay you a wage to do that. Those are technically considered as compensation. It just happens to be nontaxable. If the company gave you a car, like handed you a Lamborghini, that would be taxable. They actually have to do withholding on it. That’s taxable fringe benefit. You always look at those things and evaluate it.
Where I look at the big benefit, when you’re looking at wages, wages always have to be reasonable. You just can’t go willy nilly and say, “This year I’m going to give myself $1 million. Next year, $0.” You got to be a little more deliberate than that. You got to be careful. You really want to do a calculation saying, “Here’s the trajectory I’m on. I’m in a very high earning stage of my life. Maybe I’m better off accumulating more in that corporation with the idea that it might pay me out those dividends in future years when I need them. I’m still working for the corp, it’s not a deduction to the corp. But I’m able to get the money out of the corp at my long term capital gains rate when I’m in a much lower tax bracket.”
For those of you who are not aware, your long term capital gains fluctuates depending on how much money you make. For example, a married filing jointly couple might be less than $78,000. It’s $0. “I’m in my retirement years where I have a bunch of losses that I took out of my real estate. Maybe I’m going to pay myself some profits. It’s not a bad idea. I’m not going to pay tax on it.”
Anyway, somebody said, “Can you go to the slide with the questions?” I am. The first question I answered was somebody who answered it, who asked the question via the Q&A. They said they submitted it the last time. I was trying to be kind and answer it sooner than later because it’s important.
Let’s go through these next ones. “I have a vacation rental I live in about four months per year and rent out the other eight months. What is the best tax strategy?” Well, Jeff, you probably have some opinions on this one.
Jeff: I don’t know about a tax strategy, but there are rules for handling rentals with personal use. What the rules primarily say is that you can’t deduct certain expenses for the personal use.
Toby: You can’t depreciate the house against your personal use.
Jeff: Right. Your real estate taxes, your mortgage, interest is still going to be fully deductible either on your rental property or personally. Other things like your HOA fees, your repairs, your landscapes, may only be partially deductible.
Toby: I think, here, you’re going to be getting the old ⅔ of your depreciation, ⅔ of your expenses, would be treated as an investment. You almost treat this like you have a three-plex and you live in one of them.
Toby: You’re breaking this into little pieces. That said, unless you’re in a state where we would lose the benefit, I would be more than likely be putting this rental into an LLC from an asset protection standpoint and from a state planning standpoint, assuming that this may even be a different state than where you reside the majority of the time where you could be looking at probating at two different states.
The only states where I have an issue is possibly at Texas or Florida where we don’t want to mess up the homestead, if this is considered a personal residence. I don’t necessarily think it is because you’re in it for four months and I imagine you’re staying eight months in some other location. That’s probably going to be your primary residence.
Jeff: This almost sounds like he’s staying at an off-season and maybe these are all short term rentals during that eight months.
Toby: It could be or maybe during the summer, he’s going to some place. I know people that do that. They’ll spend the summer months in places not so hot. The other eight months of the year, they were where they work. Maybe they’re a teacher, maybe they’re professors, something like that. I’ve seen that a number of times. Anyway, you just know that if you’re renting it, it’s not going to be as straightforward as we liked. It’s not one or the other. It’s both and its proportionate.
“What is the best state to form an LLC in for charging order protection?” That’s a good question. The two that we recommend—not in any particular order—is Wyoming or Nevada. Wyoming got into the habit of not putting out officers, contractors, on their secretary of state side. It’s not listed. In Nevada, you can list a nominee.
They’re pretty much identical statutes. The biggest difference is Nevada has a business court that you can apply to, pay a little higher fee, and you get a judges that are used to commercial complex litigation. If you’re an operating business, maybe that’s where you want to be, but for the most part, I’m a dollar and cents guy. It’s pretty cheap to do Wyoming right now. The statutes are identical, so it really comes down to other nuances, but I think they’re both great.
Somebody asked on that last question, by the way. On the LLC, I’m going to go back to it so I don’t confuse you, guys. Somebody said, “What if you pay rent?” You can’t really pay yourself rent.
Jeff: Yeah. You cannot rent to yourself.
Toby: You are the same taxpayer unless you put that into an S Corp or rented it, then you could, but I don’t think I’d be doing it.
Jeff: It’s primarily for that reason that they don’t want you deducting personal expenses.
Toby: Let’s see. Somebody says something about a Spendthrift Trust, IRS rules. I know what you’re talking about. Yeah, I know. There are some fun stuff out there. You know the 643(b), Common Law Trust. I always see this. Once a year, I have this stuff pop up. I would just advise you, the IRS has already ruled out most of it. It’s what I’m thinking of. “I understand in Spendthrift Trust, we have a great statute here that we like to use for Asset Protection Trust if warranted.”
Gary says, “What about New Mexico LLCs? They’re pretty strong in the last. They aren’t bad either, but I like sole remedies states. What’s the best state?” I’m just going to tell you. I’m going to use Wyoming probably 9 times out of 10. Nevada, the other one. Everything else is a distant second, third, or fourth, much way down there. That’s just from doing this for a long time.
“When you have different functions of a business under one entity, how do you write off the expenses if you have one EIN?”
Jeff: A good example of this is some of the Fortune 500 companies. They’re following one tax return. Procter & Gamble and General Electric are good examples. They have propulsion systems, they have power systems, and appliances. All of those expenses are flowing up into one tax return. Now, the difference comes when it’s different types of income. By different types, I mean, rental income versus ordinary income versus portfolio income like interest, dividends, and capital gains. Then, you have to breakout the expenses to match the income.
Toby: Let’s just say, I have one business. I have multiple DBAs or something. How do you write off the expenses? You treat it just as one business. It’s one return. You’re writing off all the expenses as one taxpayer. There’s no difference. What Jeff is saying is that if you have different types of income being generated inside that same business, that might be considered portfolio income. You might have limitations on those as to what the expenses are.
You treat it almost, from an accounting standpoint, I’m going to break off each division into a class. You’re going to break it into different classes underneath the same P&L. A lot of folks don’t realize that’s what we do.
For example, in real estate, I don’t want to have a whole bunch of different accounts that I have to open up for each property in my QuickBooks unless you really enjoy closing that set of QuickBooks and opening them up. How long does that take nowadays? It’s getting faster, but it used to be several minutes.
Jeff: Yeah. I saw somebody trying to open a set of QuickBooks this morning and waiting, and waiting, and waiting.
Toby: Yeah. It’s like, “I don’t want to have to come in and out. I’m just going to use one set. One main tax return.” That’s really what it boils down to. If you have different functions, you can label them as different classes underneath the same set of books.
Jeff: In that regard, if you have different classes or different LLCs or locations, divisions, whatever you want to call it, you want to try to apply these expenses to the income that’s being generated. Sometimes you have these overhead type expenses that you may want to allocate across all everything. You may only have one bank account and five rental properties. There are various ways of handling that, but it’s all going to end up in the same place.
Toby: Yup. So, a bunch of questions. It seems like we’re getting them from the previous question we had.
Somebody says, “It’s not a necessity to have multiple LLCs for liability purposes?” It depends on what you’re protecting. If I have a bunch of cash, I have stocks, bonds, I’m using one LLC. If I have most pieces of real estate that cause liability to each other, there’s a good chance that I’m breaking those into separate LLCs.
“Any rules against renting a home form an LLC I have an interest in?” No. If it’s a partnership, you may have a piece of it, then you’re renting it from a partnership. When you own it completely, there’s just no reason for you to do it. You can’t really rent from yourself. You’re the same individual especially if it’s personal property.
Jeff: We often hear how many properties can we put in an LLC or something like that. One of the things I often think about is how much can you afford to lose in one gulp? You need to determine your risk level when you’re making this decision.
Toby: That’s it. Do I want to lose 20%? 30%? Am I willing to lose half of my assets in one shot? Granted, chances are it’s not going to happen. It’s like a very small percentage, but it happens enough to where you have to be aware of it. It’s going to happen eventually, that you’re going to have to deal with the lawsuit. The bigger question is do you want it to be one that could take out everything? You just say, “Here’s how much I’m willing to lose.”
Somebody says, “What are the tax advantages of having rental properties in LLCs versus sole proprietor AKA 1040 rental properties going on your Schedule E, not on a Schedule C?” so, proprietorship. There is no difference depending on how you set it up, but if you have rental properties, the whole idea is we want them to flow on your personal return onto your Schedule E where rental properties go.
The question is, “Should I have them in LLCs?” Yeah. From a liability standpoint, LLCs are awesome. From a tax standpoint, we can ignore them. “Are there any tax advantages?” Yeah. We want all the advantages to flow to us. You wouldn’t use LLCs for tax reasons unless—there’s a big unless—you have a tax appetite where you have a management company like a C Corp where you’re pooling money out of your tax return. Legitimately putting it onto a separate taxpayer, being your C Corp.
“If you have a common expense for multiple properties, one tax ID, do you prorate the expenses across the properties?” We have that same question. Would you prorate them, Jeff? Internally you would. On a tax return, probably not, right?
Jeff: Yeah. On a tax return, we do it both ways. Sometimes we prorate them across rental properties if we’re talking rental properties. If we’re talking about operational type income, we’re probably not doing that. There’s no reason to break it out separately. But yeah, it’s perfectly acceptable. We prorate these overhead types of cost.
Toby: Somebody says, “Do you file multiple DBAs with the state the LLC is in?” It depends where you’re located and it depends where you’re conducting business. Your DBAs, they’re going to be city level, county level, or state level, depending on where you’re at.
Jeff: I think mostly in California, they’re in county level. I think, some city.
Toby: Like Texas is a state. Nevada, we would be looking at county. It always depends on where you’re doing business. All you’re doing is saying basically, “Hey, I’m operating under Jeff Webb Accountants.” You do not put an INC after it, you do not put an LLC after it. It is a DBA of something else. By not putting the designation after, you’re telling them to go look it up, if they got who it is that’s actually they’re operating under. It could be ABC Inc. DBA, Jeff Webb Accounting.
Jeff: It’s pretty cheap to do. Most of I’ve seen is $25 a year. It really protects you from having other people use your DBA name.
Toby: Yup. You’re basically putting the world on notice that it’s not you as a person. The default is if there’s no entity, they’re going to look at you personally.
“I am in Salt Lake City running a dealership. We should file our LLC in Wyoming?” Probably not. What we’re probably doing under that situation because we have an active business, car dealership in Utah, I would more likely have that be an entity like an LLC taxed as a corporation or a traditional corporation either S or C, depending on the ownership and what you need. What may end up doing is having the interest in that held by an LLC out of the state. The reason being is there are two types of liability: inside liability and outside liability.
The inside liability of the business is let’s pretend we have a business. An employee sues you for something. They can take what the business has. They don’t come after you personally unless you personally did something goofy. They’re limiting to the inside. In the rental world, if you have a tenant issue, it stays inside that particular entity.
Then, the opposite is—I’m giving you a real life case—a doctor, they found this the hard way. They had people over at the house. One of the individuals at the house said, “Hey, can I borrow your car? Run to the store.” They loan the car. The individual had a massive accident and cause grievous bodily harm. Of course, who they sue? The person who entrusted that individual with the vehicle, meaning the doctor. That’s outside liability. They’re coming after your stuff. The reason we use Wyoming and Nevada is because they can’t take away that stuff.
Somebody’s asking, “One of the Anderson’s YouTube videos says the IRS was specifically started looking more at real estate investors with multiple properties on their Schedule E for audits if you have a main partnership plan, have multiple LLCs.” Chris, what you’re referring to is that when you have lots and lots of properties—rental properties—I think you get three properties per Schedule E.
You’re going to have pages of your Schedule E. The complex your return, the more chances are that you might be enjoying an audit. Same thing with the more money you make on your personal return, the greater chance you’re going to be audited. What some people do is they set up a holding entity that is a partnership. That’s all. Set up an LLC taxed as a partnership, either between spouses or you have a corporation where you might have a 1% interest. All you’re trying to do is get a 1065, a partnership return, to list all the properties and they just hand you a K-1. That goes on page two of your Schedule E, and viola, you have one line item.
Some people—we’re proponents of that—quite often recommend that. Sometimes, depending on how complex you are, you’re saying, “No, I wouldn’t want to do that.” You don’t need an extra return. It always depends. I think I would probably side on the, if you have more than a few properties and I’m going to have multiple pages, I’m probably going to go to 1065 route rather than the LLC holding company. File its own tax return just because it makes my return look a lot cleaner. That’s probably because I’m going to be showing it to lenders and things like that. I might want to get a loan and I don’t want to get a whole bunch of stuff.
“Will the rental property holding company LLC need to file a 1065 or will I get a K-1?” The answer, Ron, is yes. If you have more than one owner of that LLC, again, if it’s husband and wife, we can do it or we add somebody else. Fun stuff.
Jeff: I kind of like in that case have an incorporation with the 1%. They can then be the manager.
Toby: Yup, I do too.
Jeff: It gives you a little more liability protection on top.
Toby: And I like having a C Corp or a corporation that I can split income with. Here’s the thing. I’m going to put this as a completely aside. I’m going to go back to this one.
All right, if you are doing an LLC, if you are doing real estate, which sounds like a lot of you guys do because I’m seeing the questions come in. They all seem to be real estate related with the exception of our car dealership. You can take a pretty massive tax deduction at any given time that property depending on when your purchased it. You can always take it. We just went through another course today on cost segregation. We love having those types of guys come in. We’ve talked about it in a number of times on this on Tax Tuesdays. You don’t have to take your property depreciation over 39 years or 27½ years if it’s residential investor property; 39’s for commercial.
You can accelerate and take a big chunk of those expenses. This is how it’s right now. It’s about 30% via cost segregation this year. It really comes down to what your need is, but I always look at it and say, “Hey, I want to make sure that I’m capturing all those expenses.” I’m always want to have that option. I don’t want to stand in the way of doing that on the same token. I have this big massive loss. I may still have expenses and other things that I still want to get too. Maybe I’m offsetting a lot of rents, but they’re still tax-free money that I could upstream into a corporation and still get to myself. You cannot do that if you are just a partnership. You cannot do that if you are just a sole proprietorship.
Technically, you cannot be an employee of your own partnership or sole proprietorship. If we want a bunch of the fringe benefits, if we want the tax benefits of an accountable plan, we need to have a corporation flowing out there. When you pull that money off, it’s off your personal tax even if it’s compounding and making a bigger loss. We don’t care.
Somebody asked this question earlier, “If you have losses in a corporation, who’s carrying it forward?” It’s a C Corp. If it’s an S Corp, it’s going to pass down to the shareholders. Anway, that brings us to this next question because this does have a lot to do.
Somebody says, “What type of entity should I choose for my ecommerce business?” I’m going to tell you two things. First off, the entity from a liability standpoint, I’m just going to care that you have an entity. An LLC or corporation. It doesn’t matter which to me because the inside liability, that’s what I care about. I don’t want your ecommerce business to spill over and cause you to get garnished the rest of your life because you had a business that you couldn’t pay and it just keep following you around personally because you’re personally responsible. I’m going to put an entity around that just to keep the inside liability at bay.
Then, we look at the taxes. If you have an ecommerce business, chances are you can choose what jurisdiction you’re going to be in. You get to say, “I can pick a favorable jurisdiction to operate my business.” Now, I’m looking at the questions of whether I need the money to live off of, whether I’m already independently wealthy, whether I have a tax appetite, I have a bunch of expenses that I’m not getting to write off, maybe this business could be the one that does it. I’m going to be factoring it in.
As far as entity-wise, it’s going to be an LLC or a corp. As far as a taxable entity, I’m going to probably push you towards a starting point. Most people would say an S Corp for an active business or a C Corp depending on what you have other income coming in that you want to separate out and you have a tax appetite. I’m going to be looking at either of those two.
It really comes down to are you making money? Are you creating losses? Do you want those losses? Do you want to just carry those losses forward? All that stuff comes into play when you’re choosing an entity. I’m sorry to give you a little bit of a general answer.
Somebody asked online. He says, “I want to create a consulting business with four other friends. What is the best entity to form?” When you say consulting, that’s a magic word for us. That’s a specified service business under 199A. It used to be bad tax treatment if you were a C Corp. I’ll tell you what I’ll probably do. You’re a business entity. I’m probably making that an LLC taxed as a partnership, or depending on how much money you guys are making, I might even make it a Limited Partnership with a corporate general partner. If you guys are a partnership, then you guys can each choose what entity you own your partnership interest through it.
For example, if I have four consultants, all of you guys all make pretty good money, all of you guys wanted to take salaries, all of you guys wanted to have your own retirement plan, and you don’t have a bunch of employees, I’m probably setting you guys all up as S Corps and a partnership that you’re operating your operating business through. Then, the money just flows through. You can choose how much salary you want to pay yourself. You don’t have to do the same thing your buddies are doing or your other partners are doing. You’re going to reimburse yourself to your heart’s content without affecting other people. You can do your own 401(k).
Jeff: If I may ask, four buddies get together and form an entity for consulting. On the other side of the coin, which of these entities are the easiest for either the breakup or let people leave? Sometimes these entities don’t always work out.
Toby: They’re all about the same, realistically. What I would do is, in your operating agreement have a rule, you don’t want someone to be able to sell their interest to somebody without asking you. You might want to have the ability to—
Jeff: Take a […] refusal.
Toby: Yeah. I don’t want them just to go off, hit me that way and stiff me in. I may even want to say, “Hey, even if you do sell it, they can’t become a member without my approval. They might be an assignee interest holder. They might be treated as a creditor of the organization, that’s about it.”
Jeff: Does any of these entities offer more protection from inside liability that is a partner somebody making a bad decision?
Toby: As long as you have the entity around the business, it’s not going to make that much of a difference. The only issue you have, for example, in Nevada, you have LLCs, but they have corporations. Corporations have charging other protections here, but they’re also susceptible to alter ego where you’re saying, “Hey, you and the business are one and the same.”
What would I do? If in doubt, I’ll probably, if I’m not looking at a loss, I’m going to look at the 1244 stock collection—if you know what that is—I’m probably doing an LLC. It’s like a balancing test, which I wish was an easy answer, but everybody’s scenarios a little different.
Jeff: I agree.
Toby: Somebody says, “Can I 199A as a trader?” The answer is it depends. I think you can 199A which is the qualified business income. It doesn’t work on capital gains.
Jeff: Trader in securities?
Toby: Yeah. I think they would have to qualify as a mark-to-market election as a trader.
Jeff: Otherwise, most of the income is not going to be eligible for 199A.
Toby: I can tell you unless you become a trader and make the mark-to-market, I don’t believe you get 199A. Even if you do, I’m not certain that the answer is 100% that you can. I don’t know, sitting here.
“I would like to donate one my cars to my foundation. What’s the process?” Depending on how much value it is, if it’s less than $500,000 you just […] into your foundation. If it’s more than $500,000 you got to get it on an appraisal.
Jeff: The alternative is the charity has to sell the vehicle. Then, your deduction is whatever they sold it for.
Toby: Do they always have to sell it?
Jeff: No. They can retain it. A lot of these, they’re buying them and sell them at an auction.
Toby: Let’s see. “I’m new to the real estate business under the C Corporation. I personally finance my trainings, travel, et cetera, and I have not any returns on my investment. What should we be doing now to protect the business, get a return on my tax?”
If you have a brand new business and you are doing a corporation, it sounds to me you’re probably doing training and you may not have been in the business of real estate yet, which means you’re just going to grab those expenses on that first year return and carry them forward indefinitely. It is possible to take them personally if you dissolve that corporation at some point as long as it is actually corporation and not an LLC taxed as a corporation. So long as you made it 1244 stock election which you could do anytime prior to dissolving.
Jeff: If it was a corp.
Toby: If it was a corp, yup. You’re going to capture those deductions. Chances are you would not get them if you were not in that business already. That’s always the rub. That’s why when you see people doing real estate training, our motto is always going to be to put you into a C Corp, if you’re not already in that business.
“Is it preferable, for tax purposes, to pull all of my 401(k) money at one time for real estate investing?” The answer’s going to be a resounding, it depends. It depends on a lot of different factors.
Jeff: I didn’t want to say it.
Toby: Yeah. Well, it kind of sucks. If you have losses and you’re over 55, where are we going to be to avoid the 10% penalty?
Toby: Let’s just say you have a big loss, 59½, lots of 401(k) money, no tax, […]. That’s okay. You’re 40, you’re making lots of money. Now you have a 10% penalty and it’s all taxable to you, probably not. If you really want to, you can always do real estate investing in your 401(k) and you choose to take pieces out whenever you feel like it.
Jeff: I think the only time that would be necessary, it’s not even necessary at that point, but I would say, if we’re going to get a Roth setup, the […] or business startup, you might want to jerk your whole 401(k) out and put it in your new 401(k) or Roth. Otherwise, I think I probably just pull away when I needed it.
Toby: Somebody says, “I understand the liability issues on the LLC but not the tax advantage of the LLC versus the 1040.” Okay. Here’s the deal on the LLC. LLCs do not exists for tax purposes. If we are comparing an LLC versus a 1040, you’re actually comparing a 1040 versus a 1040 in many circumstances. In other words, the LLC, if it’s just you, it’s going to go on your Schedule C. There’s no difference. There’s no tax benefit. It just gives you liability protection.
If I want a tax benefit, I am going to treat that LLC as an S Corp or a C Corp. I can just give you the numbers. You guys can prove me if you want, but go look at the 2018 data book by the IRS. If I’m making $100,000 as a sole proprietor versus an S Corp, I am 1200% more likely to be audited as the sole proprietor. When I get audited as a sole proprietor, I am 93%-95% guaranteed to lose. If I am audited as an S Corp, it’s a fraction of the time. It’s literally .02% and I’m going to lose ⅔ of the time when they audit even if it’s so much less.
Here’s the rub. On a $100,000, the average savings of being an S Corp is going to be right around $10,000 per year. If I’m just comparing one thing to the other, I do this during Tax Wise, I think I do three almost every time where I just break them down and compare two businesses side-by-side. One’s a Schedule C and the other one is an S Corp.
I never had it where that S Corp did not substantially exceed the amount of take home pay that you get to keep in your pocket. It’s because S Corps, when you take the profit off, it is not subject to self-employment tax. It is not subject to old age, death and survivors, or the medicare. It is going to mathematically save you $0.14 for the $1 that you take out as profit. Now, if you’re breaking even to $0, who cares? Be either one. Again, that’s probably the only time I’m going to say that.
Jeff: The only time I can think of where being in an LLC is going to make a difference for tax purposes is if that’s an LLC following as a corporation. It cannot make a 1244 election. It can’t take that 1244 loss because it doesn’t […].
Toby: But if it’s a sole proprietor, you’re going to take that loss.
Jeff: For all others, yeah.
Toby: Here’s the other thing. You don’t get to do an accountable plan if you’re a sole proprietor or a partnership. We don’t like those just by themselves because we lose some serious benefits. I think we delivered that one. We got a lot of questions.
Actually Colt asked a really good question. “If you have a high income W-2 job and started in LLC real estate business, we just have one rental. What is the best structure to be able to reduce taxes?” First off, I have a bunch of income. Now, I have a rental property. I’m going to tell you what my answer is. It’s going to be to qualify yourself or your spouse as real estate professional and rapidly depreciate that thing so I can offset some of my high income.
At a minimum, what I want to do is make sure that I’m depreciating my asset enough so I don’t have any more income. Even if I can’t take a loss because you and your spouse does not qualify as a real estate professional, I just want to make sure that I have a single more dollar in my highest bracket from the rental business.
I can tell you what I’d be doing at a minimum. I could say, you said you have an LLC formed as partnership is fine. It’s just going to flow onto you. Perfect. I now already know what I’m doing. I’m probably taking that property and I’m going to make sure that I’m depreciating enough so I’m not adding any taxable income.
If you don’t know what a cost segregation is, it’s really easy. A way to think of it is let’s say you bought a house and all it had was carpet in it. No light fixtures or anything. You’d be at a breakoff of what’s the value of that carpet pretty easy. The carpet’s a five year property. You would write that off over five years with bonus depreciation. You can write it off this year. I get to write that off. I don’t have to take it over 27½ years. If I have a rental property, I may want to be able to write all that off. Even if I did get audited, I want to write it off. If it’s worth $20,000, that’s a $20,000 deduction, okay. Perfect.
I thought I have one person say, “I’m always confused.” “When I started an LLC or a corporation, is the seed money considered capital stock?” Not necessarily. Depending on how that LLC taxed, the answer is it’s either paid-in capital or a shareholder loan. The reason you’re confused is because there’s plenty of options. It’s up to you, it’s how you want to treat it. It’s not always considered anything.
Jeff: Yeah. It’s not a cut-and-dried answer. You get to help determine what it actually is.
Toby: Somebody else asked a really good question. He said, “When it’s best to use a HELOC to fund my business?” If you use a HELOC, you can’t write it off on your personal tax. I’ll be looking at your standard deduction. I’ll probably be calling that a business loan and I’d be writing off the interest through my business. Let it reimburse you. See, now we’re putting it in a Schedule E.
Jeff: Yeah and sometimes we see that, where we’ll take that one property and we’ll buy another property with equity in the first property.
Toby: Somebody says, “I thought as real estate investors, you don’t want to be classified as professionals since it’ll hurt for future deals.” A real estate professional for tax purposes does not harm you in any way. Regina, no. This is from a tax standpoint. It’s not going to hurt you in the slightest. It only helps you. What it is is it’s the exception to the passive loss rule for real estate losses. When you qualify as a real estate professional, those passive losses can offset your active ordinary income.
Two for Tuesday, this is what we did last time. We’re going to keep this going because it was successful. When we’re successful at something, we keep doing it. I’ve done two Tax Wise Workshops this year. Those are two days. We go over about 30 different tax strategies. They’re two days in our Las Vegas office. What this is is you get the livestream and the recording for this year. You’re going to get the two classes we’ve already done. You’re going to get access to the livestream for the upcoming Tax Wise coming up in November.
It’s a year-end Tax Wise Workshop. We’re going to be going overall the strategies you can use to save a few dollars. Then, we’re also going to give you this Make Your Investments Bulletproof, we call it The Bulletproof Investor. It’s going to be two tickets to a three day Tax and Asset Protection Workshop Class.
You can come to Vegas. We have them around the country, we’re doing Chicago upcoming. We just did Dallas, San Francisco, in Houston. We’re always popping around. You also get Clint’s Real Estate Asset Protection book and a three part video series from Clint, Michael Bowman, and myself on making your investments Tax Wise, Bulletproof, and making sure you’re passing on creating a legacy.
As the icing on the cake, you get the strategy session to make sure you have a wealth planning blueprint. You get all of these things all together for $197. It’s a screaming deal.
Jeff: Everytime this slide comes up, maybe it’s the accountant in me, but I just shake my head. It’s like we’re giving stuff away.
Toby: It is giving stuff away. That’s what we want to do. We give, give, give. All we’re doing is we’re giving you blueprints just to give you guys an idea what’s the structure would look like and what the results would possibly look like.
“Is it okay to keep rental payments in my personal bank account or does it have to go into the property LLC’s bank account?” This is a very good question because the answer is, if you want the courts to respect your LLCs, you need to respect your LLCs. It doesn’t implode it.
Let’s just say that I have an LLC that is my holding LLC. It holds three other LLCs that have rental properties. I have three rentals and they pay a property manager. To that property manager, I say, “Skip the LLC. Just send it to me personally.” That will not implode your deal. Contrary to what anybody else would say out there, that is a factor that they look at. If you skip it and you skip other stuff, you may have an issue.
If you put it in the LLC and then just transfer it to yourself, that one little step removes that arrow. I used to have a professor. They always said, “You shoot arrows at things until you have enough of them to where it takes it down.” He used to always call it a train—try to derail a train. That’s just one of the little arrows that could hit you.
Somebody else says, “My rentals at an LLC. Should I manage the properties through my corp? Bank account in the corp?” That’s fair. It’s fine too as long as it’s not going to you personally.
“Can index universal life insurance or mutual whole life be funded with my IRA or 401(k) without tax penalties?” Deirdre, the answer is yes it can now, but there’s a tax ramification to having a bunch of cash value in your retirement plan. It has to get out someday. But yeah, you actually can. It’s something you can talk with somebody who’s going to get a calculator out and tell you the good, the bad, and the ugly.
Somebody says, “Would it better since notary fees are not subject to SC tax?” That’s weird. I didn’t know that notary fees were subject to SC tax. Did you know that? I don’t know about that. I’ll look at that, but I think that maybe your personal fees would be.
“I rehabbed a property, but my contractor is not giving me a breakdown of the stuff at cost segregation.” What you do is since they did it, you get them to give it or otherwise you just do it cost segregation study. That’s somebody who goes in your house and they’re going to tell you depending on the value the house, Christian, how much is that house worth? If you don’t mind giving me the number. $180,000. You’re probably talking about somewhere between a $30,000 and $36,000 deduction. I would get a cost seg, it’s probably on a $180,000 house. It’s going to be $1500 or less. I can send you some good folks if you want.
“For cost seg, does the asset have to be a certain amount?” No. It really depends. Rory is just asking, “Hey, why would you do a cost seg? Does it have to be a certain amount?” No. It used to be, you couldn’t do them on a residential property. Now they’re doing it below $100,000. Sometimes it works out. If I have a bunch of income and it’s going to hit me in the 50% tax bracket because I’m in California or something, I’m doing a cost seg. I’m getting a pretty good return of my money. But I want to have about a 7-10 fold return on them dollars. If I spend a thousand dollars on something, I better get a $7000-$10,000 tax benefit. That’s the way I look at it. Not a deduction, I want a tax benefit.
Jeff: The lower the cost is on that asset you’re doing cost seg on, your percentage of what you need to percentage of short term property it’s going to have to go up.
Toby: Christian, this is really interesting because you just put this property into service, you’re doing the rehab now and everything else, they could break it off pretty easy. But you get about $180,000. I’m looking at that thing at $36,000 deduction. If you’re in the highest tax bracket, if you’re a high income earner, let’s just say it’s 30%, that to me is about a $9000 win. It’s a no brainer. I’m probably doing it.
Somebody says, “There’s $197 fee applied at platinum.” Yes, Bob, but some of these stuff are already included in your platinum. I would talk to somebody here. If you’re already a platinum, you already get the blueprint and stuff.
“For the cost seg, does it have to be a certain amount?” “Is the HVAC unit eligible for cost segregation?” Absolutely, Tim. In fact, that’s one of the items that they’re looking at. The easiest way to look at it is if I have an item that is less than 20 year property. It’s 15, 7, and 5 year property, they’re breaking it out, and they’re telling you how much you could do bonus depreciation which is 100%. How much can you write-off right now? If you didn’t do cost seg, you can actually go back in recapture if you missed it for previous. It’s just that year’s loss apply.
Jeff: And you can determine where you’re going to take the loss. You can do it in 18, the current year, you may want to wait till the 19 return if you think you’re having more income. But you’re going to take the loss in the current year.
Toby: Some of you guys are asking for a cost seg person. Email in at Tax Tuesdays. “Can cost segregation be done on existing rentals?” Absolutely. There isn’t a single time when I wouldn’t possibly do a cost seg. Even if I’m about to sell a property, I made you a cost seg so I don’t have to pay recapture on stuff I’ve completely depreciated. If I can say, “Hey, my carpet is now worth zero,” or it’s considerably less, then I don’t have to do the depreciation recapture on it. I’m going to treat that as a long term capital gains.
Here’s the deal. If you guys like cost seg, it’s free to do an evaluation to a guy I know, Eric. Yeah, that’s my buddy. So, firstname.lastname@example.org. Here’s what we’ll do. Email me, they’ll do it if they get three pieces of information. We’ll gather a little bit of information that we don’t have to pay a cost, we’ll make sure that we’re getting you with the people, but it doesn’t cost anything.
They will do a free evaluation and then what they’re doing is they’re seeing how much you could actually save. You could say, “Is it worth to spend a little bit of money to save a bunch of money?” Yes. But is it worth spending a little bit of money that’s going to save you a little bit of money?” No. But wouldn’t you like to know that. Absolutely. Keep going on.
The answer to this, “Is it okay to keep rental payments in my personal bank account?” is run it through the LLC. If you really want to have it in your personal, go through the LLC first. If you don’t, then you’re just giving somebody an argument and the chances of them pushing that argument are very low.
Somebody just said this. “IRS publication, notary public. Fees you receive as services you perform as a notary public are reported on Schedule C. These payments are not subject to self-employment tax.” There you go. What Josh is doing, he was the notary who said, “I don’t think he’s going to pay self-employment tax.” Good one. You don’t pay the self employment tax, but you do not get to do an accountable plan if you are a sole proprietor and your audit rates infinitely higher.
It’s not going to save you much from a tax standpoint. Actually, so many of you guys are asking about the cost seg stuff, now I’m slightly distracted. ppiery@alglawforcostseg. Send an email to Patty and she will introduce you to Eric. He’s got a bunch of accounts, they’re all over the country. He wants to make sure you get to the right people and we want to make sure they’re getting a discount. We don’t charge for this, so we’re just going to be forwarding you to somebody else, but we want to make sure we get a really good discount and they’ll do stuff for you for free including the initial evaluation, or a lot of people charge you hourly for that.
Here’s a good one, “I’m selling a house to my brother and doing a 1031 exchange with proceeds. I heard that the IRS may disallow this transaction. Is that true?” What do you think, Jeff?
Jeff: That is true under certain conditions. What they’re mainly looking at is based with shifting. That is between related parties you’re trying to allow one person to take losses or even gains. It’s hard to describe. There is a prescribed way to do these properly.
Toby: I’m so setting you up.
Jeff: I know.
Toby: There is a way to do it properly. This was a question somebody texted me. They were freaking out, they’re about to close and they said, “Oh my God, somebody just said that they’re going to disallow it.” No, it’s not disallowed. Your brother can’t sell it for two years after you do a 1031 to him. You can 1031 exchange with related parties, but you have to hold on to it. The other thing is, you can even 1031 exchange that you buy an investment property and go live in it. People always say, “Oh, I can’t go live in it because I 1031 exchange it.”
Jeff: No, it’s not true.
Toby: You can actually live in it, you can go live in it, you just can’t do your 121 exclusion if you 1031 within the last five years. That’s the rule. But this one, I remember looking at the statute because I was, “Oh, I think it’s the other way around.” I just happen to be looking at it, now it’s here in front of us. We got a cool question.
Jeff: I’m really concerned with this, if you’re doing this as though it was an arm’s length transaction.
Toby: Look at this one, somebody says, “If one sells a 1031 exchange, buy it at $100,000 with existing mortgagees of $70,000 and inquires to be placement property, valued at $150,000 with $125,000 in new mortgages.” In this example, the taxpayer cashed out $5,000 equity potentially taxable. Does this cash boot be offset by $4000 sales commission agent? I believe so. Your cash boot, what is referring to is you had $30,000 of equity, now you have $25,000 of equity, you ended up with $5000. You have to look and say are there expenses that were associated with it because that would lower the amount that you actually have in the transaction.
Jeff: There’s two things. You don’t want to receive cash and you don’t want to be relieved at any debt. Much of those cost do.
Toby: Yeah, they increase the value of the property, and they increase the amount of debt because the difference described between them is, he went from $30,000 to a difference of $25,000. So, he was able to take $5000 of equity back out. He got some cash boot. That’s what they call it. Technically, you have expenses that offset some of that. Sitting here today, it is something I can do a 1031 exchange of primary home and get it $500,000 plus buyer rental.
The answer Sam, is I would ask your 1031 facilitators since they have to do all your forms—that’s a pun—but I believe you get to take your expenses. Your cash boot under that transaction will be about $1000, which wouldn’t be earth shattering, and chances are, no one’s going to make you report it.
“Can I do a 1031 exchange with primary home and get the $500,000 tax free?” What Sam’s referring to is can you do a 121 exclusion plus a 1031 exchange? The answer is yes. When you do it, you do get the $500,000 if you’re married, you lived in it two in the last five years. Just that rule—two of the last five years—it’s not the last two years. It’s two of the last five years. You could live in a property for two years, make it a rental for two year and sell it, and you get both the 121 exclusion, which is that $500,000 for married couples of capital gain exclusion or $250,000 if you’re single.
Somebody just said, “Just for the record, notary fees are exempt.” Yup, I already got that. You guys are absolutely right. I didn’t know that […]. We’ve been corrected, sir, now we know. That’s really cool. Probably a bunch of notaries rolling around out there. I’m sure that our guys would catch it.
This is where it’s really cool. I’m going to give you guys a real life situation. Somebody buys a house $500,000. They sell it five years later for $2,000,000. They’re down in San Francisco. This is actually […]. $1.5 million increase in value, they have a $500,000 capital gain exclusion. They paid $500,000, they’re going to get a $500,000 exclusion. They’re going to have $1,000,000 of gain on the sale of their house in California, they’re in the top bracket, they’re very successful software engineer, you’re talking about not only the top capital gains rate of 20%, but you also have the net investment income tax of 3.8% plus the […]. You’re getting that even on a personal residence. I didn’t think about that. 3.8% plus the California tax of 13%.
A lot of people say, “Oh, it’s 20%.” No, it’s actually about 36.8% for this […]. $368,000 in tax on the sale of that home. Here’s all you have to do. Instead of selling it right away, you just rent it. There’s no set time frame for renting it. In fact there’s one case where they weren’t able to rent it, but they were really tried hard. Just to be safe, rent it to somebody, maybe somebody you know for six months. Then sell and it is a 1031 exchange.
Now, here’s the rub. The 121 exclusion only covers capital gains, not depreciation and recapture, so you have your 1250 recapture. You’re going to have a tiny bit it, that’s where we tax you on your bracket capped to 25%.
What’s really cool is that entire million dollars now is non-taxable, entire million dollars is a gain now you can roll it into other properties. Then if you want to live in that property make sure it’s an investment property when you buy it, rent it again for 6 months and then go move in it. The answer is: Would you go through a headache for $300,000 or $400,000? Yeah, I would, but wouldn’t you rather know that going in saying, “Is there a way around it?” Obviously, the numbers go up, so it gets fun.
Jeff: Just keep in mind you can only rent that property that you’re selling for a couple years. You don’t want the clock to run out on you.
Toby: Yep. Somebody says, “In a 1031 exchange, when one sells one property and buys multiple, how does the deferred loss and capital gains is assigned in […] property?” It’s actually basis, it gets assigned amongst the replacement property, so you wouldn’t have loss. This is only for gain.
Let’s keep going around. “Is it true and how do we get around it?” The answer to that question is you can 1031 exchange with your brother. You just have to just sit on it, make sure your brother sits on it for 2 years. If you’re selling it to him to live in, then you want to make sure that then you’re fine.
Somebody says, “Hey, how do you get the 121 exclusion? How many years do we need to live in a property from a 1031 exchange before it’s a home and qualifies for the 121 exclusion?” Betsy, I’m paraphrasing you. It’s five years. What it really comes down to is, you cannot you use the 121 exclusion on a property that was 1031’d within 5 years, so once you’re over 5 years, you no longer have to worry about that.
Fun stuff. You guys are fun today. “Are charitable contributions deductible to a C Corp?” Jeff, you know this.
Jeff: Yes, they are deductible, but there’s a taxable income limitation.
Toby: 10% of net income.
Jeff: 10% of net income.
Toby: I kept thinking that with the 5%.
Jeff: I want to say it’s 5%, too.
Toby: Tax Cut and Jobs Act it’s somewhere, but I looked to the publication today, and it was 10%.
Jeff: The problem with this is, is the corporation running at a loss or is it making lots of money? You have to make at least $10,000 to make a $1000 contribution.
Toby: Buy you know what you can do instead?
Jeff: What can you do instead?
Toby: Through a sponsorship. Don’t you advertising because advertising is UBIT to the recipient organization. If you advertise with your church, that church is not exempted anymore. They have to pay 21% of UBIT—Unrelated Business Income Tax—but if you do sponsorship and you’re not getting anything of value other than, “Hey, ABC Inc is a proud sponsor of the pageant,” or whatever. Let’s say it’s a church, Christmas pageant. Then sponsor it. In that way you don’t have to worry about writing an office a charitable donation, it’s now sponsorship and it’s expensed. You can write all the expenses you want.
Jeff: I agree.
Toby: Fun stuff. Learn something new every day. All right. I like to talk about charities. You skip right past that one pretty quick. ppiery@alglaw came back as non-deliverable. Patty, can you reach out to Shawna and make sure she gets your correct email address? What I’ll probably do is include Eric’s information when we send out an email as a follow up. We’ll get all that.
“I provide gas, food, and lodging for an unrelated person. Is any of that deductible on my personal return?”
Jeff: Actually what you’ve done is you’re giving this unrelated person a gift.
Toby: The good news is, if it’s less than $15,000 a year, you don’t have to pay tax on you being nice.
Jeff: If you’re extremely nice, you may have to file a return and later pay taxes upon it.
Toby: Yes. This is just bizarre. I provide guest food and lodging and the IRS wants to punish you for it.
Jeff: But no, it’s not deductible. It’s not a recognized charity or anything.
Toby: In certain circumstances, I run across this a lot with people helping their parents out. They have ageing parents, they want to give money and they give them a gift, and they can’t write it off. Instead I say, if you’re going to go to their house, rent the house and have a business meeting at the house. If it’s less than 14 days, you can write it off through your company and they don’t have to recognize that income.
I’m a twit on these things. I look at it and say, “You know what? Decide you guys you’re going to have a family meeting. Invite your parents then to participate.” I’m a big advocate of having a family corporation where you actually bring everybody in and you sit down and have an actual meeting. I would do that. In that way you can get some money to them, otherwise if you’re providing guest food and lodging to an unrelated person, immediately, start taking it’s a girlfriend or a boyfriend or something. I usually put them on my couch. It’s hard to get a tax benefit if you’re just a giving person. Otherwise you got to have a business reason.
Somebody asked a really good question here. “What if that person becomes a dependent on your tax return?” That’s cool except your exemptions are gone, so you get a standard deduction. You really get nothing for dependency.
Jeff: And it’s no longer a gift. It’s now you’re providing for their support as a dependent. No deduction.
Toby: Yeah, don’t do it. Don’t be nice to people. You know what you can do is set up your own charity and you help people. Then you don’t have to worry about deducting any of it because every time you get money to your charity, you’re writing that off or you give assets to it, if you’ve been listening to us.
“Should I be making investments as a limited partner in hedge funds in real estate syndications through my Wyoming company? Or is it better to set up a separate entity that the holding company is manager of?” I’m not sure I follow that one completely. “I have a limited partner in hedge funds in real estate syndication.” Here’s what I’m doing. Again, you have inside and outside liability. It doesn’t matter if from an inside liability standpoint of how you own your investment in a syndication. What it matters is whether somebody can take that ownership away from you in that syndication. If somebody were to sue you and want to go after your assets, can they take away your syndication? The answer is generally yes. Unless you place it in a virtual safe, it’s like an LLC in Wyoming. Nobody can take your assets out of it.
If it’s me, I’m putting it into an LLC, in a state that nobody can touch. Just because I never know when something’s going to pop up plus I’m orderly. I like having all my stuff in one or two places, and I know where everything is, and I made it really easy so that if I get hit by a Mack Truck tomorrow, my estate’s actually really easy to identify. They’re like, “All right here’s where everything goes.” Not everybody is like that. Some people like having lots of different interest in lots of different things, and it’s all over the place. It becomes a puzzle.
Jeff: There’s very, very little inside liability with securities or those types of things. It’s like having a lot of money in your wallet. Nobody’s going to sue you because you have money in your wallet, but they will sue you to get the money in your wallet.
Toby: There’s two letters in the English language that makes somebody really sue the heck out of you. That’s MD. If you know any of those chaps and wonderful women that are medical doctors, and they get into a car accident, don’t admit that you’re a doctor. Is there anything else?
“Hey, I’m in NorCal and want to Airbnb my home. How do I do this without the LLC in California or paying tax on the full rental Airbnb earnings?” This is an odd question. I don’t know why I just grabbed this because it’s not related to the other ones, but what the heck. Airbnb, if it’s seven days or less, it’s an active trade or business. If you’re in California and you’re making money as an Airbnb and it’s your house, the big issue is, is it worth it? If you’re doing it for your personal house, then if you can keep it to 14 days or less then you don’t pay any tax.
Somebody says, “The house is on sale, so I’m trying to make some cash.” Do it 14 days or less, Alicia, otherwise you’re going to have self-employment earnings on that and tax. If you’re going to go bump 14 days, then here’s how I do it. I would have an LLC hold your home. This is really frustrating for me.
Jeff: I wouldn’t do that. We’re just […] with you.
Toby: No, because you’re worried about the $800.
Jeff: A year.
Toby: Yup. You get it. If you’re Airbnbing in Northern Cal and you’re going over 14 days, you’re going to have to do the math on it. Number one, contact you insurance and let them know you’re doing short term rentals so they’ll add a rider on that will cover the people and cover your house in the event they steal everything. What I would probably do is have it in a trust and I would make the beneficiary that trust outside the state, probably an LLC in Wyoming just to keep that house, so that it doesn’t follow you around if somebody does a header in your house, and there have been death claims on Airbnbs.
Make sure the insurance is good, make sure that you’re putting a land trust that holds the property, have it assigned to an out of state. This is what I would do. If you’re going to make $30,000 or more, I’m going to rent that house to a C Corp or an S Corp and have it be the host. That’s only if my rentals are seven days or less. The reason you do that is because you want to be able to get your $28,000 monthly earnings—she’s got a badass house. I want to run the numbers, Alicia.
This is a prime example of when you take your home, you break it in doing an LLC and you rent it to your corporation, and your corporation then turns around as the host. The reason you do that is you want your home, the rents, fair market values to still be subject to depreciation. You still want to be able to get all the benefits of passive income, and then your host is the one who’s getting the short-term and is being sheltered from you so it’s subject to the self-employment tax. If you do that, there’s a good chance you’ll get the most money back in your pocket. We’d have to do a little calculation and make sure the complexity is worth it.
Alicia, just email in, we’ll get somebody to walk you through it. Our guys are good. They’ll be able to break it down for you. “What are the advantages of switching from an S Corp to Multi-member LLC Partnership?” An S Corp could be an LLC. It can be an LLC taxed as an S Corp. If I’m going to become a partnership, the biggest advantage is you don’t have to take a salary, but the disadvantage is, then it’s then all earnings are subject to self-employment tax if it’s active income. This is real estate, I would rarely have you in an S Corp. More than likely if it’s real estate, especially commercial property, we’re going to have a multi-member LLC taxed as a partnership. If it’s a business where it’s generating profits, then I’m probably going to have you an S Corp. You could still be an LLC taxed as either.
Jeff: But would you switch from an S Corp to a partnership? The only thing I can think of is if you have more than a hundred investors or something like that. You have to switch to a partnership.
Toby: You could always layer it, but yeah, you’re going to have the other partnership under either those circumstances. I stand corrected, you’re right. If you’re going to have more than 100 especially if you’re doing—
Jeff: Or foreign and more stuff like that.
Toby: Foreign, yeah, unless if they’re a resident alien, they cannot be an […] S Corp, you violate the status. Plus if you have a bunch of people or investors, you don’t put the kibosh on them being able to transfer the ownership. You could unintentionally undo your S status pretty easy.
“Is a Florida single member LLC have any personal protection from creditors?” Some, but the jurisdiction that had the homestead where they pierced this single owner LLC, so you’re running a risk. If I have an LLC in the State of Florida, that’s good inside liability and I’m going to have it held by my Wyoming LLC which is great outside liability. We’re just going to do it that way. If I don’t want your name to show up in the public records in Florida, I can actually do that. I can have the Wyoming entity be the member manager of the Florida, can keep your name out name out of it completely, which has that funny way of keeping lawsuits away, if nobody can tell what you own.
Somebody says, “If I join Anderson can I get you to do my taxes?” Yes. We can always get you handled there. We love doing tax. How many returns a year we’re doing now.
Toby: 6000. We’d do two or three. We get a little busy.
Jeff: I think we won’t have time for two more returns
Toby: The good, the bad, and the ugly of Anderson is really smart people. There’s about 250 of us here. Great. The bad is that we’re really, really busy and the ugly is that when you have 500 people to site, they want your return to get done, and you have 30 preparers, you just get killed because then everybody’s mad at you. They write you hate mails saying, “Why didn’t you do my return? I gave you my stuff?” That’s just the nature of the beast. It’s either drive your prices up, which we don’t want to do. We try to keep our business model, we believe in doing stuff like this and giving back, so we’re altruistic, but it’s not without its downsides.
The downside is that you have a lot of people trying to come in. But absolutely, we’ll talk to you and absolutely we love working with entrepreneurs. What tax software do you use? Jeff.
Jeff: CCH Axcess.
Toby: Yeah. Which is the ProSystem fx top of class.
“My partner and I own a lodging business that is broken even over the last few years. There are seven cabins, none of which have ever depreciated. Next year, the mortgage will be paid off,” they had to own this for a while, “and our K-1s will begin to show income. Will we still be able to take depreciation?” Do you want to hit this? I don’t like giving bad news.
Jeff: What’s your bad news?
Toby: Bad news is if you missed the depreciation in the past, I don’t think you can take it.
Jeff: Actually, you can.
Toby: I think you have to go and you can amend returns.
Jeff: You’re going to actually do a change of account method like we do for the cost segs, and go back and recapture all of that depreciation recognizing the current year.
Toby: You can do a 3115?
Jeff: You can do a 3115.
Toby: And allow […]
Toby: I remember […] your toast. You’re sure of that?
Toby: Thank God you’re here because I would have told them that they’re hosed.
Jeff: If you haven’t had the property for a long time—
Toby: Talk to Jeff, I’m just going to give you bad news. Jeff’s like Santa Claus.
Jeff: I’m usually the bad news guy.
Toby: I always think of that. Here’s what it is. So depreciation, you don’t have to take it. It may take, but you have to recapture.
Jeff: You’re going to act like you did take it whether you’ve […] it or not.
Toby: I’m reading that, that you couldn’t go back in, that you’d have to go back in and amend.
Jeff: You can actually do that change of accounting method where you’re saying, “Oh, I did this wrong. I want to change to this.”
Toby: And you recapture all the previous. I’m going to hold you to that.
Jeff: You can even do that and you’re selling a property, which is just crazy talk.
Toby: The answer is will we still be able to take depreciation? I know the answer is yeah, you can still take depreciation. It’s going back and capturing. Jeff and I have a split decision. I’m going to say Jeff is probably right on this, because I haven’t looked at it.
Jeff: I bet you, though.
Toby: You don’t want to be me […] because then I’ll be right. I’m always taking dollars from you, I don’t want to do that today. For a penny.
Jeff: I just want to add in. The mortgage being paid off really doesn’t have anything to do, but I see what you’re saying is that, now you’re going to have more income such enough making those mortgage payments. I don’t know how long you’ve had this, but like Toby says, it sounds like you had it for quite a while. If you haven’t had it for real long, this is a perfect case of where a cost seg would work really well in your favor because this is the kind of property that sounds like a lot of it could be land improvements and such, that you’re not going to have a whole lot of 27½ year property on this.
Toby: The idea, again, is that if you have a property that’s depreciated in 15 years or less—especially if you’ve owned it for 15 years—you’re not selling that. Your gain gets spread out as though everything that’s in it appreciated which is just not the case. You have stuff that’s not worth anything anymore. You should not be paying gain on that.
It says, “No amendments on depreciation. May take in the year you realize the depreciation is not deducted in the past.” See? I love having an accountant. It says you’re right.
Jeff: Thank you.
Toby: “What is a cost segregation?” Bill, a cost segregation, is when you take a piece of property that would ordinarily, under the Modified Cost Recovery System (MACRS) and normally, let’s say, you have a building. It’s 39-year property. The IRS would say, “Oh, it’s all 1250 property. It’s all the structure. You’re going to write it off over 39 years.” But a lot of that stuff is not 39 year property. A lot of it is 5 year property, 7 year property and 15 year property. For example, my electric system, what would that be, 15?
Jeff: No. Electrical system is usually whatever the building is. It’s considered a structural component.
Toby: What if it goes to a circuit breaker, it has its own box, it’s all the wiring and all that stuff. I know that can break that out.
Jeff: Maybe for certain machinery or stuff like that. For specific use, then that is not 39-year property.
Toby: Then that would what? 15?
Jeff: It would be 15 year property.
Toby: All right, then you can write it all off in one year.
Jeff: Actually, I think it’s even shorter than that.
Toby: Seven year property?
Jeff: Whatever it’s hooked up to as.
Toby: What you’re doing is you’re taking all those shorter periods of time and you’re writing them all off. The good news is that if it’s less than 20 years, you can write it all off this year, whether it was put into service this year or past, it could be used, it could be new.
Jeff: The thing with the cost seg is whenever was placed in service, that’s the one which you have to use. The 100% bonus didn’t exist before 2018.
Toby: Yup. So now I have to look at this. Somebody said, “I like having accountants out there that help.” Thank you. Robert I owe you one. Got to get through this, actually.
Jeff: We got more to go.
Toby: Still be able to take depreciation. “I have an HSA with my W-2 job where I contribute the max annually. My wife and I have a separate C Corp. Can I create another HSA through our C Corp and contribute to two?”
Jeff: No, the next wife. No, I’m sorry.
Toby: Yeah, you can. You just have one limit.
Jeff: He’s saying they already contribute in the max annually.
Toby: The question is whether you contribute the max as a single or whether you contributed the max as a family.
Jeff: Those maxes are determined no matter how many HSAs you have.
Toby: Here’s the deal is, if you have separate C Corp, why you’re doing an HSA? Why don’t just do a medical reimbursement? Because you’re going to write off 100% of all your stuff. You don’t have to put in a separate account. You’re not getting a write off for the HSA.
Jeff: Well I guess there’s a way.
Toby: I guess yeah.
Jeff: That’s reducing your taxable income.
Toby: It’s sitting in there and then it’s just growing, and as long as used for medical. I’m just going to use the C Corp. I would just write it off as we have any income to the C Corp unless you have employees of that.
Jeff: No. What you said, though, is a good example. You have an HSA, you max it out. It says, it’s over the top of the HSA that aren’t reimbursed got for the C Corp.
Toby: See, you’re just tapping out to the medical reimbursement. We got good accountants out there, which is rare, Robert. I usually don’t like accountants.
“Can I qualify as a real estate professional even though I have an unrelated W-2 job if I can prove I work 750 hours in my real estate business?” What do you say Jeff?
Jeff: I’m going to say it’s difficult because doesn’t that need to be your primary use of your time?
Toby: Yes. Here’s the rule: 750 hours plus 50% or more of all your personal service time. If you’re working a W-2 job, you better be a part time employee. Because if work 750 hours in your W-2 job, then you have to exceed 750 hours. Now, that’s step number one.
Step number two is you have to materially participate in your real estate activities, usually we’re making aggregation election and treat all of your real estate activates as one activity. But if you have a spouse that can make the 750 hours test, then your point return would be real estate professional. Let’s say that I work too much as a lawyer and I have a spouse who does real estate, and she does 751 hours every year as a real estate agent and she doesn’t even help on our real estate. Let’s just say that she’s a real estate agent, she does buying and selling or broker—doesn’t matter as long as you’re involved in those fields or construction or any of those—and she meets that requirements. It can be your spouse, he meets that requirement.
I don’t want to be sexist, but let’s just say my spouse is a she. But let’s just say that we meet that test. Now, the second test is both spouses together. Now, do we materially participate? There’s three levels of test: 500 hours, 100 hours or all we met we self-manage. In our case, we’d be doing the 100 hours and between the two of us, do we exceed 100 hours? If the answer is yes, then we are a real estate professional. You just pass, go, and voila! But if you are a W-2 worker doing full time W-2 job, and it’s just you, it’s going to be really tough time. There’s no physical way you’re going to exceed 2000 hours.
Jeff: You’re going to have to come up with at least 2100 hours to make it work.
Toby: Yup. And then courts have looked at that. The courts don’t believe it. Somebody has said, “I’m doing 2000 hours.” They’re going to say, “There’s not enough hours. You’re not working 16 hours a day.” They’re just going to scoff at it.
Jeff: Usually, as soon as they find out you’re a full-time employee, we’re done.
Toby: Yup, so let’s not to that. “We have our personal residence paid out this year and we’ve only owned it for four years. Shall we do a cost seg on our personal residence?” You can’t. Cost seg is only on investment property. You have to be able to depreciated it. You can’t depreciate your personal residence.
I think we’re getting towards the end. There’s a Two for Tuesday offer. I’m not going to go labor you guys. You can email on in if you like to take advantage of that. Maybe Patty has a link. Patty, do you have a link? Maybe she does. twoforandersonadvisers.com/two.
“How do I track hours of work?” Any reasonable means. When you’re tracking your 750 hours, it’s any reasonable means. If can be your phone, it could be writing it up.
Let’s see fun stuff that’s free iTunes. Come to our podcast, we do make these Tax Tuesdays into podcast. If you miss one you can always listen to it while you’re running around the gym, you don’t have to watch it as a video. You can listen to it as a podcast. We are on iTunes, Anderson Business Advisors, or you can go to andersonadvisors.com/podcast or you can email us to say, “What’s your podcast?” I run Google Play as well. Your replays are always in the platinum portal plus we will email it out to you. You can always go in and watch what you missed. The other fun one is go back, join us on social media, Facebook or YouTube. You get the gist. We like to record ourselves. We can’t stop listening to ourselves for some reason.
Jeff: I don’t. I’m just like him.
Toby: All right. Then questions email@example.com. Actually somebody was really mean. They wrote and they said, “This is what happens when you have too many lawyers because you have these types of things.”
Jeff: What a terrible thing to say no matter how correct it is.
Toby: “You have to opt for a change of accounting method to do cost segregation?” Yeah. You’re actually making a 3115, but you can classify different entities, and also, you don’t have to take bonus depreciation on all of it. You could choose to take only bonus depreciation on certain portions of it.
Jeff: It’s either you take bonus on all your five-year property or none of your five-year property.
Toby: Or you just take five years. Once you know, now you’re not doing 27½-year or 39-year, you’re doing 5, 7, 15. You’re just going to run the numbers. This is the beautiful part, the three rules of tax are always calculate, calculate, calculate. This is where you get to do those calculations. This is so much fun to sit there, look at your numbers, and say, “What do I want to pay? I choose zero.” Or, “I choose a little bit. I’m okay,” but you get to decide.
All right guys, we’re way over. First time that’s ever happened. All right guys, until next time. We’ll see in two weeks. Great having you on. This is an hour Tax Tuesday. Until the next hour long Tax Tuesday, we will see you.
Jeff: See you next time.