Afraid of taxes? Spooked about getting audited? Halloween isn’t the only day of the year that most of us fear. So, Toby Mathis and Jeff Webb of Anderson Advisors provide fast, fun, and educational answers to your tax questions. Do you have a tax question? Submit it to taxtuesday@andersonadvisors.
- How can I minimize taxes for someone with no children and no longer able to itemize miscellaneous deductions under new tax laws? Depends on where income comes from
- Can you get lender financing for a property deposit from a self-directed IRA? Not likely because IRA can’t be collateral, but a 401(k) can be used
- Are horses and their expenses tax deductible? Yes; some are also depreciable
- What do you need to do to use the Medical 105 Plan and reimburse your medical expenses? Corporation with plan document is required; show receipts for reimbursement
- What does DBA mean? Doing business as (a.k.a., Fictitious Name)
- Should I form an LLC or Corporation for rental properties? Corporation should be your last choice; LLC is not a tax designation; put rental properties on your personal return
- If I purchase one or more vehicles, with the intent of renting them out, should I title them in an LLC? Yes, due to liability; also have immaculate maintenance records, commercial insurance, and titled to renter’s LLC
- Can I offset gains from rents with depreciation? Yes; rental income is offset by all your rental property expenses, including depreciation
- Can a small, newly set up LLC buy a property? Yes, seasoning requirement isn’t required
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Real Estate Professional Requirements
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Modified Accelerated Cost Recovery System (MACRS)
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Full Episode Transcript
Welcome to the Anderson Business Advisor podcast. The nationally recognized preferred provider for asset protection and tax planning in the nation. This show is for investors and business owners looking to save on taxes and build long-term wealth with Toby Mathis, an attorney, author, business owner, and a featured instructor at Anderson’s tax and asset protection event held throughout the country. Enjoy the show.... Read Full Transcript
Toby: Hey, guys. This is Toby Mathis.
Jeff: And Jeff Webb.
Toby: We’re going to jump in. We’ve got a lot to go and I decided to bite off a big chunk because we have a lot of questions to go through. All right, let’s get into it. First off, we’re going discuss a couple of reminders. We have, obviously, Youtube channel and a Facebook. Feel free to join whenever you feel like it. We have a book coming out. The Tax Wise book is going to be coming out and I’m also going to be coming out with an Infinity Investing next, probably by June. One thing at a time because I have to finish up all the changes in the tax code with Tax Wise.
I try to use things that are easy to follow, that don’t change because congress loves to change some of the rulings here are in there, some of the rules, so I try to stick with things that are going to be consistent like you’re not going to have to relearn over and over again. Obviously, Congress is congress. They do some weird stuff sometimes.
Let’s go over rules and I’m going to change things up a little bit tonight. You can always send in your questions via Tax Tuesdays to Anderson Advisors. We are through, I think it’s the 15th. We have most the questions that you guys asked, that we’re grabbing the longer ones. We’re about a two week lag. Some people come up and say, “Hey, I emailed you a question. I didn’t hear it last time.”
We’re going to reach out to you no matter what, but when we’re selecting questions to be answered, we have quite literally hundreds and we’re going through them in the order received. We select which ones will be the best for the group, meaning that they’re general, they’re not, “Hey, here’s my scenario. I make this much and this much. Can I write this off?” We try to use things that are more general.
That being said, if you do submit something that is a very specific question for you, you’re going to have to be a Platinum client or a tax client. Otherwise, we’re not going to go through and answer two hours of questions for you just because.
This is fast, fun, and educational. We want to make sure that you guys start getting the gist. I meet people all over the country; truly fun this. This week, we were in California, in Nevada. We do the nice class in Nevada with a bunch of real estate investors, which is really fun, and I met a bunch of doctors down in Los Angeles, some investor group. Believe it or not, these doctors are actually really cool. It’s a bunch of doctors who figured out the real estate investing is very lucrative and you don’t have to work 80 hours a week to do it. It comes attractive for a lot of those folks.
But everytime I go out and do these, you get people that have been listening to these for a while, and they’ve gone through a number of the Tax Tuesdays and they’re saying, “Hey, I can start answering the questions.” That’s the whole point. It’s that you’re able to start answering these things once you get the gist. That gist just comes with time. That’s why we do it. It’s a lot of fun.
Let’s go with the questions we’re going to answer tonight. Speaking of so much fun, here’s some opening questions. “We’re purchasing our first buy and hold property through an LLC. All the loan documents request a personal name and following signatures. I thought an LLC was to help with protection via anonymity of personal information. How does one sign an LLC purchase?” We’ll answer that.
“How can I minimize taxes for someone with no kids, who, under the new tax law, can no longer itemize?” That’s somebody who had their miscellaneous itemized deductions, go to the wayside. They don’t have kids so they don’t qualify for a child credit, earn income tax credit, some of those things. They’re like, “Hey, what do I do?” We’re going to get into that.
“Can you get lender financing for a property deposit from a self-directed IRA?” There’s a couple ways to read that one, like three or four times trying to figure out what exactly the same, but I think I got it.
“Our horses and their expenses tax deductible? Can a revocable living trust be the managing member of an LLC flowing through […] a couple of tax return when there are two trustees?”
“What do you need to do to use the medical 105 plan and reimburse your medical expenses?”
“What is the meaning of DBA and what are the implications of setting up business structures using DBA?” We’ll go over that.
“I recently sold a home and purchased another in the same year. I did not fill out any special tax paperwork. Will this qualify as a 1031 exchange?” This one came in a few different pieces and I actually put it together trying to bring the tea leaves to what they’re asking. They said they didn’t do any special paperwork and what would this be treated out as everything else. We’ll go over that, what that means when you don’t go through an intermediary.
“Is it better to form an LLC or corporation on rental properties?” That’s interesting. Some of you guys are already laughing because you know where I’m going to go with this immediately.
“If I planned to purchase one or more vehicles with the intent of renting them out, should I title the vehicles in an LLC?” Somebody’s going to go out there and probably lease to the Uber drivers.
“Should I turn my residence into a rental property sold after two years and 1031 it to delay paying property gain, $1 million tax?” We will definitely go over that, that’s interesting, too.
“Can I offset gains from rents with depreciation?” We will answer that. These last ones are short. There’s a large number but they’re not as big as some of the questions we sometimes get.
“Can I expense travel to a real estate investment owned by my qualified plan in order to supervise renovation?”
“Can a small newly set up LLC buy a property?” We’ll go through all those. Even when you think you guys know the answer, sometimes it’s fun because it’s so interesting. There’s different ways to read these and depending on how you read it, you can have pretty different results. We’re going to go through these.
Jeff, this is going to be fun.
Jeff: And scary since it’s halloween.
Toby: Scary. All right. “We are purchasing our first buy and hold property through an LLC,” congratulations, “all the loan documents request our personal name and following signatures. I thought an LLC was to help with protection via anonymity of personal information. How does one sign for an LLC purchase?”
Jeff, this isn’t really a tax question, but it’s a very interesting question.
Jeff: When you go to the bank, somebody has to sign for the LLC, one of the members, preferably the manager can deal with it if you have a separate manager. One thing I was a little concerned with, though, was making sure that they’re not getting personal guarantees.
Toby: They probably are. Anytime you have a business, there’s three Cs. You can actually write this down, this can be helpful to anybody doing this because you can explain this to your kids. You have cash, collateral or credibility. You’re going to need one of those three Cs—cash, collateral, or credibility.
The reason people don’t like to give young people loans is because they usually don’t have any of those three, they don’t have a history yet. They certainly don’t have enough cash and I’ve done this with businesses by the way. I’ll actually go get a CD and you pledge it as security on a line of credit on business. The business starts to get credibility, not just me, otherwise they’re always going to look at the owner. The collateral is the real estate. That LLC has no credibility, so it’s going to have to borrow somebody else’s, that’s where the owner comes in.
Almost always when you’re financing property, your first bunch, probably your first 10 at a minimum, they’re doing direct financing with you. Once you have enough credibility and collateral—there has to be equity in those properties—then you’ll start giving loans that do not have personal guarantees.
Frankly, you’ll learn that you don’t really care whether you have personal guarantee or not on the property. That, in and of itself, is not an asset protection issue. Maybe there’s something going to happen on that piece of property and they’re going to pull the loan to see who’s signed on it.
That loan document and that mortgage or the security against that property is going to say that you guaranteed it. That doesn’t put you in a firing line. Being a guarantor on a loan does not make you liable to tenants on that property. That would still be the LLC.
Jeff: Sometimes we see a lot of refinancing of these rental properties. The bank wants you to pull the property out of the LLC.
Toby: Give them to the individual.
Jeff: Give them to the individual, refinance it, and then you end up dumping it right back into the LLC.
Toby: Somebody just said this, “I got my first property under my personal name. How can I change the title now from mortgage company to LLC name?” We don’t change it to mortgage company, you’re still on the hook. You’re just transferring it into the LLC or more likely than not, if you have a loan and you’re worried about that loan, you’re going to use a land trust. There’s somebody else who asked the exact the same question.
“If you convert around a home from a personal ownership to own by your single member LLC, where had you make this change on the tax forms?” You don’t. This is the thing. An LLC is a creature of state law. You always have to look at things instead back and pack them. From a tax standpoint, this is more than likely 99.9% of the time completely neutral. That’s because you own the LLC and it’s going to go on your Schedule E. The only question is whether or not you own that LLC straight up or it’s a disregarded LLC, meaning, it exist for state law, it gives you asset protection. For the federal government and the state, they look at it and say, “Ignore that LLC, we’ll look at the owner.” That’s option number one.
Option number two is if you have a spouse on it or you’re in another third party, you might say, “Hey, you know what? Make it a partnership.” In which case, all you’re doing is saying you file an information return called a 1065 with the IRS that says, “Here’s how much money it made, here’s the owners.” You get a K-1 on your same Schedule E, just goes on page two instead of page one. The properties are not all listed on your 1040. There’s a summary line, it’s just the summary from that LLC.
At the end of the day, it will make zero difference. The only difference between those two things is I have a somewhat cleaner 1040 if I do that partnership return. If it’s no partnership return, then it’s the same as me owning it personally.
Now, somebody’s going to say, “Wait a second, I want anonymous ownership.” Well, the anonymous ownership is going to be completed either using a land trust or you use somebody else or whatever, a company, better yet as the trustee. From a personal title standpoint, somebody goes and searches who owns that property, they will not see your name. If they pull up that LLC, you can have anonymous ownership in LLC, they don’t see your name. If you have it in the land trust and they say, “Who’s the beneficiary?” Other than in Arizona—there’s just a work-around even there—you do not list beneficiaries in land trust.
You’re just saying, “Hey, the bank knows that I am on the hook and I am on the hook for that loan to that bank but not in any other third parties.” In other words, somebody trips and falls, they do not get to sue you simply because you guaranteed a loan or that you helped that company get a loan. I hope that makes sense.
Jeff: In this particular case, if there was a land trust involved, would the trustee of the land trust actually be the person signing for the purchase?
Toby: Yeah. The trustee would be signing.
Jeff: The buyer would be the land trust itself?
Toby: If you’re buying directly through the land trust. Most people buy and they close in the land trust or the LLC or they buy and they have financing like in this case. There’s no way the lender is going to let you close in the name of the LLC. It’s not going to happen. First time you do it, they’re going to say, “You need to close on this individually.” The reason being is they want to make sure that they have you on the hook. They want to make sure that you’re going to be responsible. They’re going to make you close in your name. If you transfer it afterwards, they really don’t care because your still on the hook.
“Do all states recognize land trust?” Yes. There’s about 15 states with actual statues. The rest of them are common law.
“How do you become an anonymous owner of an LLC in California?” I’ll give you a way to do it, it’s two steps. Number one, LLCs in California incur $800 a year franchise tax. I probably would use a land trust and have it held, have the beneficial entries held outside the state. If I want to have an anonymous relationship directly in the state, I would create a Wyoming or Nevada entity that’s anonymous. I would have it be a member-managed LLC in the state of California which means the member is whose listed and that member is the out-of-state LLC. That’s how you create anonymous ownership there.
Somebody says,”My wife and I are starting a new single member LLC taxed as disregarded entity. In the formation documents, isn’t necessary to list her as a member? If we do, have we move away from a single member LLC and are now a partnership?” Kevin, the answer to that question is are you in a community property state? Because if you’re in a community property state, you both can be listed. If you’re not, then technically you’re a partnership and you’re both listed. You would then file a partnership.
If you want to avoid filing as a partnership, and you’re in a separate property state, and you set up a living trust with the two of you guys as trustees, and you guys are both beneficiaries but then you have only one trustee own the LLC. That’s a little tricky way to do it and the IRS is already cool with it. That’s usually the way to do it.
Somebody says, “What’s the workaround on an AC trust?” In AC trust, the beneficiaries going to be listed such going to have to be an LLC, already there that’s anonymous. There you go, Jeff. There’s always a way to get around it.
“For a brokerage account with the single member LLC as the beneficiary, is a guarantor who can best be the trustee?” I saw you’re saying, Maria. This is a question. It’s a little bit different, it’s not right on real estate, but quite often when you are having a brokerage account in an LLC, the brokerage company start to wanting to charge LLC as professional traders. They start trying to charge them a couple of hundred bucks a month. Do you see more in that? Or you saw some of those, right?
Jeff: Yes, we ran into some with that exact thing.
Toby: Yup. What you do is you set-up a personal property trust—we do this as a courtesy for our clients, by the way—where the beneficiary is the LLC. It’s the same as holding the account in the LLC and you as an individual or the trustee. Then, they’re happy as a clam. In that particular case, you should be the trustee because you want to be in control of the account.
“Can I change the name of my Florida LLC?” Of course. you can always amend the name, you can amend your own personal name, too.
Somebody says, “With an LLC, isn’t it different state to state?” Yeah, all states have different statutes. A lot of them have the Uniform Limited Liability Company Act, but there’s differences. For example, there’s differences in Nevada and Wyoming. You cannot foreclose on an interest in real estate. That’s going to be very different in a state like Washington or California.
Somebody says, “Is it true at tax lien purchases you buy tax lien?” If you’re not financing, you don’t have to worry about it. You can buy it directly. It’s only when you have financing.
Somebody says, “I’m transferring a rental property from my name to an LLC. Can I record all income and expenses for the year to the LLC? Or do I need to have a partial year on a personal return and partial year on a 1065?” You do the latter if that LLC is actually a partnership. You record the partnership income. Here’s the funny part, Jason. It’s all going to end up on your 1040 anyway.
Jeff: It’s going to make no difference in the end.
Toby: Yup. Somebody says, “As a real estate agent, is there a benefit to getting paid through my entity as opposed to myself, personally? If yes, which would one use? An LLC or my C Corp?” Chris, as a real estate agent, your state is going to have restrictions on what kind of entity you can be as a professional and having a license. Your real estate board and your state are going to have little restrictions. Usually, it’s an S Corp or an LLC taxed as an S Corp or disregarded.
Remember that LLCs are creatures of state laws. They’re not a tax type. You can have an LLC that’s taxed as a C Corp. You can have an LLC that is taxed as an S Corp. You can have an LLC taxed as a partnership. We could tell the IRS to ignore the LLC. You can do it.
Jeff: The other thing we see what the real estate agents, even at the state law allows them to put the income on a certain thing, the broker won’t always allow it.
Toby: You got it. What Jeff is saying is critical. For example, I have my company. I set up an S Corp. I am the real estate agent and you’re in the state of, let’s say, Texas. Texas has some inconsistent rules. Some say you can do it, some say you can’t. Brokers are going to take the more […] route and say, “I can’t pay your S Corp.”
All you have to do in order to comply—there’s actually a tax ruling on this, the Friedman case—where it says, “You need to have an employment agreement between you, the agent, and the S Corp showing that it has dominion and control over you. You have to make your broker aware. It doesn’t matter whether it pays it to you or not. You’re going to list it on that S Corp. You will win under those circumstances.”
Some people just put it on a Schedule C and zero it out. They say, “I made $100,000 and then we have $100,000 expense going on to an S Corp.” You could try that, too, but I prefer to follow what the IRS says.
Let’s go to question number two. I do see that you guys are asking a lot of questions and we will get them. We will go through a bunch those. “How can I minimize taxes for someone with no kids, who under the new tax law, can no longer itemize?” Jeff, what do you feel about this?
Jeff: This has a big it depends answer to it because it depends on where your income is coming from, whether you’re just a W-2 employee, or whether you have rental incomes, or some kind of outside company that you may own, a corporation or a partnership. There’s various things you can do whether it’s retirement, contributions will lower your income. If it’s money coming from other entities, there are other ways to minimize some of that income. What say you?
Toby: Me, I’m kind of like this process person, I always trust the process. If I have somebody—I don’t care who you are, this happens to be if you’re single, no kids, maybe you’re married with no kids—you don’t have miscellaneous itemized deductions. You have your standard deductions. That standard deduction is step number three in my world.
Step number one is calculating all your different income types and how do you minimize your taxes is you keep that income from hitting your turn. If I have income coming from a business, I’m going to try to keep that from just jumping onto my return. If I have income coming from rental properties, then there’s a way to start pushing that up into a management entity to keep it from hitting my return. If I have income from a business and it’s all going on my Schedule C, then there’s a way to keep that. I could put that in a C Corp, I could put that in an S Corp, and there’s things I could do to keep that from hitting my return.
Step number two is, when you were looking at adjusted gross income, what are the areas of adjustment? Like Jeff is saying, you’re going to be looking at IRAs, you’re going to be looking at HSAs, you’re going to be looking at anything that’s going to adjust your income.
Last but not least, we’re going to get where we have deductions and you guys all have a standard deduction. Problem that is those standard deductions are really big now. We have these huge standard deductions. Now, a lot of you guys aren’t getting the benefit of your charitable giving, you’re not getting the benefit of your mortgage interest, you’re not getting the benefit of your state and local taxes. You have a $10,000 limit. We saw a lot of people just getting hammered on that. That’s really bad. We’re talking about people with $60,000–$80,000 of state local taxes that they couldn’t write off.
You’re going to say, “All right. How can I minimize taxes?” I’m going to get the money out some other way. For example, and I’m sorry to give you guys a long answer, but let’s say that somebody has a home. I want the home office deduction and I don’t want a home office deduction as sole proprietor. I want an administrative office in the home with the employers reimbursing them.
The employer gets deduction and then I’ll have to report the income. I’m going to write off somewhere around 15%-25% of all of my expenses associated with my home, including my utilities and everything else. I’m not going to have to report it, but I had to make sure that that never hit my return as income. So, I need to have a business. I have to have an accountable plan to do that.
That’s why you hear me sometimes going off on accountable plans. You have to have an S or a C Corp from a tax standpoint. So yes, it’s going to be an LLC taxed as an S, LLC taxed as a C Corp. You got to have one. Otherwise, you can’t do that.
Last but not least, there are things that, when we look at the deduction side, now I’m looking at things and I’m like, “Maybe I can deduct this. Maybe I can. Maybe I can get some real estate professional status and make a big deduction of the depreciation. Maybe I’m going to work my Schedule A and I’m going to give a whole bunch of money to a charity. Maybe it’s my own charity. Maybe I should set up my own operating profit that I can toss a bunch of money into. That all will reduce my taxes for sure. Maybe I’m not going to credits, maybe I’m looking at solar credits. Maybe I put a, ‘Hey, I get a 30% solar credit, maybe I’ll buy an electric car so I can get credit.’” I’m looking at all these things and I’m going to a mental checklist to figure out what is available to me and whether any of it follows into category that I may want to take advantage. If I do that then I don’t care if you have kids, I don’t care if you’re married, I don’t care. We’re going to get your taxes lower. It’s just how much of an appetite you have and how much of a benefit.
For a doctor in California, which I got to meet a whole bunch—they’re pretty funny—they have a tax appetite. Some of those guys are paying 53% tax. Before you say, “That’s impossible.” No, it’s not. You add up the payroll taxes, you add up a net investment income tax, the state income tax, and the federal tax. They get up over there and it stinks. It’s just not right. So, they have a tax appetite. If I can get a $20,000 dollar deduction that they wouldn’t otherwise get, that’s a $10,000 savings, too. It’s really strong.
If it’s a 24 year old who’s making $40,000 a year, they don’t have much for tax appetite. They’re not going to want to do that. They’re going to say, “Wait a second. Why would I spend $2000 to save myself $1000?” It’s always going to be a value proposition.
Somebody says, “How can I minimize taxes for someone with family gross income on a W-2 around $300,000.” VJ, you reduce that tax by again, credits, deductions. It is an old adage that if you pay taxes—it’s voluntary—but you pay taxes because you don’t have enough real estate. That’s the old joke. The reason being is because I can take real estate and I can overcome the implication that is passive by either myself or a spouse being involved in real estate to […] real estate professional status. It doesn’t actually exist under that name, under the code, it’s actually just an exception for real estate, for real estate investments, […] participate, just great. If you like code provision as 26 USC 469(c)(7). If you’re nerdy, go there, read it, it gives the exact rules.
All of you real estate deductions including depreciation, you can offset your $300,000 in income. VJ, we can eliminate your tax if you want to. Just buy enough real estate and make sure you qualify or your spouse qualifies in a real estate profession. If that’s not your flavor, set up a charity and do your real estate investing through a charity. You’re allowed to do that. Actually, low- to moderate-income housing or Section 8 qualifies as a non profit activity. Then, if I give my charity a $100,000 to buy a property, I get a $100,000 deduction right now. Just going to lower my $300,000 to $200,000. I’m going to save—depending on your tax bracket—probably between $22,000 and $37,000 for doing that, and I still own the property and everything else.
Jeff: A lot of how you’re going to minimize taxes is going to depend on what type of income you have and what type of income you can commit to in the future. Capital gains, we have opportunity zones, we have contributing appreciated assets to charities, we have selling of your losers to minimize your gains on capital gains. Every item seems to have a number of ways to do this.
Toby: There are so many cool questions right now. We’re going to go one. “Based off to what you just said there,” really quick, “how do you keep your rental income going onto your income on your tax return?” […] you get a star because you’re thinking right. “Hey, this income is going to hit me. How do I keep it?” We offset it, there’s a deduction called depreciation. If you follow the IRS guide and changes like a rental property—I’m going to assume it residential—that’s 27½ years.
That’s the MACRS—Modified Accelerated Cost Recovery System—that’s the default. Default isn’t what you’re required to do. You can change that. You can say, “Hey, wait a second. Parts of this house aren’t going to last 27½ years, it’s going to last 5 years. Carpet’s going to last 5 years, paint’s going to go away, the doors going are going to last 27½ years, the appliances aren’t going to last, the electrical system is going to last 15 years. If it’s less than a 20 year time period, you can write it all off in your one.
That’s how you keep that income from hitting you is you accelerate the depreciation that negates the income, you still have the money but you don’t have to pay tax on it. That’s how you do it and it keeps it from ever from hitting your tax return.
Rori says, “How does this accountable plan work?” Same situation. Let’s say that I have rental properties and I have rental incomes being made. What I would do is pay a corporation to be the manager, my own corporation and it will set up an accountable plan. It would reimburse me for things that benefit it as the management company, my family management company. Now, I’m going to get my cell phone, my equipment, my computer, a chunk of my house, I’m going to get all these things. Miles, medical, dental, vision, and all these things, I’m going to write them off. But I’m not going to have to report this income, it doesn’t go in my 1040. We just eliminated a big chunk of text.
“Does deduction applied to both free and clear as well as properties with leverage?” Yes it does, Kevin.
“I have W-2 rental properties. Is it recommended to open a property management from under my wife and contribute to retirement for her?” You get to star, too. Mina and the sum of both gets stars because they’re starting to think tax wise.
“Hey, if I can get the money into a corporation, how many they’re going to get it out to myself tax-free, or I’m going to let the corporation pay tax, or I’m going to pay it to somebody for services rendered, and I’m going to defer it into a retirement plan, and I’m not going to pay any taxes?” How about them apples? I’ll take that action all day long. Absolutely. You guys are nailing this.
Somebody says, “I lost my job midyear and I went to rental real estate because rental real estate pays you whether you want to work or not. What is the best approach to prep for taxes? I have three units.” What I want to do, Kevin, on that is you’re going to want to calculate how much the improvement is on that property, how much income is coming in, and we’re going to determine how much tax you want to pay and you have a choice. I could choose to just write-off 5 year property, 7 year property, just 15 year property, take bonus depreciation and not take bonus depreciation. I have so much control in the accountant. For whatever reason, they always say 27½ years. That’s kind of lazy, that’s all it is.
“What if I’m already enrolled in a 401(k) from a job? Can I do beyond that amount?” Well, your your deferral is for you only, but you can contribute to multiple 401(k)s and you can go up to the $56,000 this year?
Jeff: Yeah. You can contribute to this if you’re under the age of 50.
Jeff: $19,500 total but that $56,000 limit is per employer.
Toby: Per employer, per 401(k), right?
Jeff: Per 401(k).
Toby: And that’s based on 25% of your salary. You can actually contribute $100,000+ in your 401(k) if your employers can’t do it for you. You can do your own. That’s so cool.
“When do you need to create a resolution for an LLC and what types of situations?” Any major decision you want to back up with writing. The way I tell people is if you fell off the face of the earth, and somebody’s tried to figure out what you were doing, they would need to have a paper trail. You should be able to tell what that company was doing based on that paper trail
If you went there to explain it, you just want to have a rhythmic explanation, that’s all. The way I would look at it is the amount of respect you show your business is the amount of respect banks, judges, and other third party will show your business. Just keeping a paper trail keeps you out of trouble.
“I do cost seg, then sell one- or two-year items. We don’t have to recapture so there’s very little benefit.” All right, here’s how it works. I actually had cases. It was in the webinar we did about two months ago with Eric Oliver. There was a great example where we did a cost segregation right before selling a multi unit and it saved the taxpayer $70,000.
The reason being is this, when you depreciate under straight line, you have to recapture that at your ordinary income tax bracket capped to 25%. If you are in the highest tax bracket, the more you are going to pay is 25%. When you do accelerated depreciation, then you are either paying ordinary income on the fair market value of that piece of property when you sell or it’s long-term capital gains. Long-term capital gain being capped to 20%, also being taxed commensurate. It could be either 0%, 15%, or 20%.
When somebody is doing this and you are just going to hold it for two years, it really depends on how old that property is so if I have a five year property, I’ve had the unit for three years, I do a cost segregation on a five year property, it has no value. It’s going to be taxed as long-term capital gains and I’m going to get an accelerated depreciation for that extra year right now. That’s an interest-free loan.
It’s really hard for those things to not pencil out to be beneficial unless it’s under $250,000. But everything else I’ve yet to see situations where it’s wasn’t a tax benefit then it just becomes, is the tax benefit worth the cost of doing the cost segregation? If you are doing the cost segregation is $2000 and it saves me $6000, some of you guys are going to say it’s not worth it. If it’s $2000 and it saves me $60,000, then you are crazy not to do it.
“Can you get lender financing for a property deposit from a self-directed IRA?”
Jeff: I read this as they were wanting to get the downpayment from the lender and if you are talking from a bank, I would find that highly doubtful. Ergo was the money from you, or the entity, or something.
Toby: I can’t see how you’d ever get your deposit out of an IRA. I don’t think you can. I think you can get a distribution for a new first homes and things like that for a set amount, but otherwise, the lender can’t use your IRA as collateral.
Jeff: Yeah. You can’t secure a […] loan with an IRA.
Toby: Here’s the trick. You can’t borrow from an IRA, but you can borrow from a 401(k). You can borrow up to $50,000 over five years from a 401(k) and you can do that per participant. Husband and wife can borrow up to $100,000 from a self-directed 401(k). If I see a self-directed IRA, I’m probably rolling that into a self-directed 401(k) or better yet, Anderson, we do one where you’re the trustee. You don’t even have to be a custodian, you are in complete control. Just want to make sure that you’re doing proper loan docs in case you’re ever audited, but you don’t see that often either then you can borrow.
Jeff: Otherwise, if it’s a rental property I can see the IRA contributing to that for share.
Toby: Someone just said something really good. “What about using a self-directed IRA or solo 401(k) to contribute to a syndication as a limited partner?” You can absolutely do that, but here’s the difference. If I have a self-directed IRA, if it uses leverage, you have to pay tax. It’s called Unrelated Debt-Financed Income. You have to pay tax on the income derived into the IRA from the leverage. If I buy into a syndication, chances are they’ll going to lever my money. They are going to take a $2 million investment and turn it into $10 million by borrowing, which means if that’s the ratio, then for every dollar I put in, 80% is going to be taxable because I’m levering 80%. But that is not true for the 401(k). A 401(k) doesn’t have the same thing. Somebody else has to pay.
“If I want to invest in real estate, I believe possible, can I use an IRA?” I don’t think I’ll be using an IRA. I think I’d be investing directly through a 401(k). As I need money, I will take it out and I would pay the penalty and the tax on it. I’ll be on the lower tax bracket if I don’t have a job. That’s this case, so I’m just paying 10%. I’m doing that. I’m taking that action. I’m going to leave it in my plan because you could really get those things cooking. I’d rather not have the penalty and everything else and then invest. I’d rather invest and then have the money I actually need to pay a little bit of penalty. Isn’t that fun? You can’t borrow from your own self-directed IRA, but you can borrow from someone else’s and then you can loan their IRA from your self-directed IRA.
Susan, no. That is a…
Jeff: Step transaction?
Toby: Yeah. That’s like textbook. You’re learning quid pro quo in the news. You can’t do that. You’re benefiting from your plan document. The IRS is going to tax you. Don’t do that. That’s really bad.
Jeff: What IRS looks at when they look at these step transactions and quid pro quo is, they disregard all the different steps and say, “What actually happened?”
Toby: Yeah. You both took money out of your accounts. That’s really, really bad. This is why we do not show your names when you’re asking questions, in case you do it.
“What about a 401(k) that is rolled over to an IRA upon leaving an employer?” You could still roll that into another 401(k), but that 401(k), you roll it into an IRA and if it’s self-directed, you could do it.
“What if a self-directed IRA holds a trust that holds a property, can you get lender financing that way through the trust?” Well, it’s to be subjected to the special self-directed IRA text. The answer is yes because it’s all going to go on to that self-directed IRA and it would have the Unrelated Debt-Financed Income. Hey, it’s Amanda. Amanda, you would roll that into a 401(k) and you would do the financing. Instead of doing a self-directed IRA, you’re just doing a solo 401(k). You don’t even have to contribute to the 401(k). That’s what a lot of people think. You just roll your IRA directly into it and I don’t have to worry. You can get all of the financing you want. There are companies that specialize in finance.
“I can be the trustee of a self-directed 401(k) and can set one up myself because it’s correct.” Katrina, you could set one up or you have to use a prototype plan. We have people doing it all the time. Last check, I think we have 5500 exempt organizations. A lot of them are doing real estate. Don’t let somebody tell you you can’t.
In fact, there was this weekend, again it was the same fun group of doctors and one of them was up on a panel. He was talking about when he first got into real estate, he got one of those books off of late night TV that said how to buy real estate, no money down. He said, “I did this thing where I got the no money down.” And then about a month later, he bought a book that said it’s impossible to do no money down. He had bought an apartment complex in the meantime for no money down and he goes, “It’s a good thing I didn’t order the second book.” It told me I couldn’t do it. I just did. Don’t do it.
“Can you roll a 403(b) from a former employer to a self-directed 401(k)?” Yes. Again, you could do a self-directed IRA. Me personally, 401(k)s are the way to go. You have so much more control. You can actually invest in many different things. You don’t have Unrelated Debt-Financed Income. It’s just way better.
Let’s see the next one. We’ve got some more questions but they’re not necessarily related so we’re going to keep jumping through. Here we go. “Are horses and their expenses tax deductible?”
Jeff: Yes, they are. As a matter of fact, some horses are even depreciable. You can depreciate breeding horse. You can depreciate racehorses. For race horses, it’s once they reach two years of age.
Toby: There are some really cool cases on horses, by the way.
Jeff: Yeah, we see a lot of those in Kentucky.
Toby: That’s where Jeff is from. There are some great tax court cases. There was one dentist who is making on average about $100,000 a year and her expenses on her horse is about $50,000. There were three audits. She won audit number one as to whether it was active or passive because she merely participated. They audited her again saying it was a hobby about five years later. By this time, she was just racking up massive losses. She lost money every year. At Section 183, they applied this nine-part test. Number one is do you have a true and real profit motive? They went through this big analysis. The gal’s daughter was a CPA and they tried to run through this. She did everything herself. She had a one-page business plan that was a form that was halfway written out. They looked at all the expenses and realized that about 1% of it, total, was for generating revenue. The rest, it was just caring for the horses.
And then there are other cases where, of course, they write off everything. What was the funny one? The guy from Peaches and Herbs, “Reunited and it feels so good.” What’s that guy’s name? Barker? Cecile Barker. Beverly will love this because she loves that stuff. They also did Georgia. There was something Georgia, Gladys Knight & the Pips, won a Grammy with Cecile Barker, so completely out there. But anyway, he lost $38 million over a period of 11 years trying to get his son into entertainment. He would try to start a label and he won. He won because he showed he had a profit motive.
Jeff: That’s the most important thing. We say, “Yes, you can deduct these expenses.” That’s what we talk about race horses and breeding horses. That is the profit motive.
Toby: Yeah. You just got to show you’re trying to make money. You got to always show that you’re trying to make money.
Jeff: We’ve also seen in some other fields like physical therapy where they’re buying horses and actually help with some of their patient’s muscleology needs.
Toby: They’re doing it with people that are alcoholics, in drugs, and all this stuff. When you have an addiction, they use equine. There are all sorts of good stuff. This is so interesting because there are so many funky cases. The poor gal that got out of it three times, she was going to tax court when they did the third audit.
Jumping through. “Can a revocable living trust be the managing member of an LLC flowing through to a couple’s tax return when there are two trustees? It seems like I’m having déjà vu. Did we have any answer this?
Jeff: No, but this answer to this one is yes, you can always do this. I think every state would allow this.
Toby: Every state allows this but even more importantly, when it flows through the couple’s tax return, when there are two trustees, if you’re in a community property state, you don’t even have to do a separate tax return for that LLC.
Jeff: Here’s my question for you. If a revocable living trust is the manager and member of an LLC and that living trust has a lot of other assets, does it deserve an asset protection issue?
Toby: Would you repeat the question, Jeff?
Jeff: Okay. It’s a managing partner of this LLC.
Toby: There’s a managing member. Usually, we don’t like to see managing members, by the way. 98% of them or so are going to be manager managed.
Jeff: If it’s a managing member and the LLC is served for something in particular and this revocable living trust has a lot of assets.
Toby: Yup. You’re going to say, “Should you have a holding company between it?”
Toby: The answer is there is always good, better, best. Good is at least to have an LLC, better is to have a holding entity that holds the LLC so it’s keeping you twice removed, and best is have that holding LLC in a state that you can’t take away and has anonymous ownership. If you’re going to do this with a living trust and it’s just holding cash, a non-risk asset, something that’s not going to get you sued, then go ahead and have that LLC right there. We don’t really care. Personally, I would rather have that LLC in a state where nobody can see it, nobody could take it as cash, but that’s not going to be a huge liability.
If it’s a property, the last thing I want is to have to defend myself for outside liability and defend the LLC for inside liability in the same state, in front of the same court. I actually want to make that extraordinarily complicated and involve two jurisdictions to make it cost-prohibitive for anybody to really try to do it. The old adage is for $250,000, you could breakthrough most plans. For the most part, I could make your life miserable if I decide to spend $250,000 and sue you to pieces. The trick is never putting yourself where that’s ever worthwhile and making it so nobody ever really sees that you have anything to justify the $250,000. It doesn’t mean you’re going to lose, by the way. It just means that somebody can make your life pretty miserable if they decide that they’re just going to target you.
Jeff: Right. You don’t have to lose a lawsuit to be defensive.
Toby: No. You can win. We just had a client. Client had a tenant destroy the downstairs of what was going to be his dream house. They flooded it out. In exchange for flooding it out, they sued him for mold and tore up his house. He sued them because it was them that caused the problem. They flooded the downstairs. Their kids did or somebody did. We don’t know to this day. He won the two-year trial, $200,000 and some. and they went bankrupt the following month to not pay the judgement. What he got out of it was he spent about $200,000 and some, plus all the time and everything else to get nothing. It’s not worth it. It was just somebody just trying to shake him down. Kudos for fighting it. No kudos for the fact that you can’t get it. You’re better off just having an LLC where you’re like, “This is the max that I’m ever going to lose.”
“I’m going to answer a couple of questions. Thinking about liquidating a previous rollover traditional IRA to fund a short-term rent in Orlando. I’m under 59½. Is there a strategy to avoid recognizing the amount as income? I already I am out 10%.” You’re going to have income if you take that out unless you fall under the category of the hardship. Even with the hardship, I think that’s just going to get rid of the penalty. You can avoid the penalty if you do a 72(t) election, which is taking out equal distributions, I think, that would be 55.
Jeff: Even the hardships are very specific as to what is allowable. Although I think it’s changing in 2020. They’re changing some of the hardships.
Toby: Yeah, there are some other ways to do it, but the better thing is just to roll it into a 401(k) and then invest through the 401(k). And then if you need money, borrow it. If you need money and you can’t afford to pay it back, then pay the tax only on that portion of the money. You can do that through a 401(k). You cannot do that through an IRA. IRA, it’s either good or bad. When you take a distribution out of the 401(k), if you choose not to pay it back, there are portions that you could have as tax.
Jeff: Here’s one of my issues. I’ve seen this often with people in financial straits. […] money the lenders, creditors, and so forth. Most of the time, retirement money is protected from those lenders. They can’t touch it.
Toby: Yeah, we call it OJ money. OJ has, I think, over $60 million right now that he owes the Goldmans and they still can’t touch his pension or the distributions therefrom.
Jeff: […] you pull it out, that’s free money.
Toby: Only the IRA, you pull it out, then it’s free money. But even in a pension, the distributions are protected. That’s why OJ has to stay in Clark County right now. He lives in Summerlin because he’s on parole, he has to live out here. He still has his unlimited homestead in Florida, he’s still getting his distributions out of the NFL players. Even with that huge judgement, they can’t do anything. There’s just nothing to get.
Somebody says, “Hey, a husband and his two sisters are doing an investment in LLC. Husband has a Wyoming LLC but the sisters don’t. How do we complete the anonymity?” You don’t have to worry about it, Lisa, because the anonymity is through the Wyoming. The one with the sister, that LLC, chances are the sisters are going to be listed. There’s no anonymity. If you want anonymity for the whole thing, you would have to put it in a state where there’s anonymity, which is really going to be Nevada and Wyoming.
Keep in mind that right now, we have the house that passed a resolution for transparency. They’re trying to get to all the owners of all the companies. They don’t like not knowing who owns what. I think the senate will knock it down, but just know every year, we go through the same thing where we’re always trying to figure out who are the owners of things. They’ll always going to come up with some cockamamie idea that it’s a bunch of terrorist laundering money, which is absolutely not the case. If you guys knew how money laundering goes, I hate to even say that I know how some of this stuff works. They’re not using that. There are lots of other ways to launder money without doing anything.
If you need a 401(k), Anderson does it. If you need help on taxes, you could certainly contact us as well. That’s not the reason I do these webinars though. Just know that we’re just trying to get the information to a bunch of people who keep asking. I think tonight has been a little more active than normal. Usually, I don’t get to go off this much. I think we’re three questions in.
“Do the horse question pertain to livestock, dogs, et cetera?” Yes. The horses are special under the hobby loss rules. They have to make money five out of seven years. In fact, they look at horses because they’re so expensive and they think you’re going to try to make horses into your hobby and to a deductible event, but it’s much easier with other livestock.
If a friend contribute to your investment with a percentage, how can I set this up properly for the tax? Kevin, that’s a good question. What you want to do is figure out what type of entity it’s going to be and usually, it’s going to be a partnership, and then the question is who wants the short-term losses and things like that?
“What do you need to do to use the medical 105 plan and reimburse your medical expenses?” You can hit this one.
Jeff: First off, you need a corporation. That’s the only place a 105 plan actually works. You need a plan document that’s usually about a one-page document that says I’m an establishment 105 medical or health reimbursement account and then you have to show your receipts to the 105 plan, the sponsor of that client, and they reimburse you.
Toby: 105 plans really are just a fancy way of saying a medical reimbursement plan. We’ll start with the 2% or greater shareholder of an S corp. You have to recognize anything that gives you as taxable income and then you would write off the insurance premium only on your 1040. There is a self-employed reimbursement form. You’re not going to get a benefit under a 105 plan if you are a sole proprietorship or a partnership as the proprietor or as the partner. If your spouse is an employee of the organization, then they could be covered under it.
It’s so much easier, the last entity, which we didn’t talk about was the C Corp. It’s so much easier to use a C Corp for this. Then, you don’t have to recognize any of it. If it’s a C Corp and it’s just you, husband and wife, small company, then it’s so much easier.
Jeff: Keep in mind that if you have full time employees, they are also part of this 105 plan.
Toby: Yup. Somebody says, “Can you do a 105 plan with an LLC taxed as a corp?” Absolutely. It’s treated as a corporation for the IRS so the 105 plan is no different than having the 105 through a regular C Corp.
“Can I reimburse medical expenses from my LLC taxed as a C Corp, which go above the income earned for the year?” Yeah. Absolutely. There is nothing that even says that you have to take a salary or anything. That’s actually part of the compensation. In fact, you can look at 26 USC 61. You’re going to see all the different types of income. They have everything listed there. If you get a fringe benefit, it’s compensation. So if I hire you and I pay you in Ferraris, I have to a withholding on the value of the Ferrari. If I give you fringe benefits, so all I give you are, let’s say, vouchers for eating and maybe playing vouchers, whatever, that’s compensation or if I give you car allowances, compensation. If I reimburse your car, not compensation if it’s business use. If I reimburse you for medical, dental, and vision, not compensation if it’s a C Corp and you follow the rules.
Jeff: Allowance is kind of a dirty word. It’s going to cost somebody money.
Toby: Somebody says, “Is a 105 plan vouchers for Krispy Kreme?” You are right on. You must have been doing events. Love them Krispy Kremes. 105 plan is only for C Corp, S corp it’s not allowed. No, you can have a 105 plan in an S corp, but when it pays you as a greater than 2% shareholder or your spouse, who is imputed because they’re married to you as a 2%, that is wages. It’s not subject to employment taxes, right?
Toby: It’s not subject to old age, death, survivors, and medicare.
Jeff: Right. The only time I’ve seen the 105 plans and the S corporations is if they did have unrelated employees and those 105 plans usually have limits set upon how much they were willing to reimburse.
Toby: “Can I do a partial in-kind distribution of a rental property that’s held in an IRA LLC without getting into a privative transaction? Because now, the IRA and I own the property assuming that I’m over 60 years old.”
Jeff: I want to say no.
Toby: Actually, you can.
Jeff: Can you?
Toby: Yeah, you just can’t enter into a repeated transaction. It’s weird, but you can do it. I believe I’ve never seen anybody actually want to do it. Usually, they’re going to try to find a taxable amount and they’re going to come up with cash, so it gets funky.
“What about reimbursements from medical problems from the Krispy Kreme?” You can write those off too.
Jeff: And it’s usually the same expenses that can be deducted for medical on your Schedule A, like over-the-counter drugs or not.
Toby: “That was such a good question, by the way. Is there an advantage having a corporation as opposed to an LLC taxed as a C Corp?” Mina, there is one advantage. There is only one difference that I’m aware of. I could tell you that the LLC usually gives you better protection than the corporation shares. The only state that has statutory protections for shareholders is Nevada. There is no other state that does it. Normally, what you’re going to do is have an LLC taxed as a C Corp.
The biggest difference between an LLC taxed as a C Corp and an LLC corp is what’s called a 1244 stock loss. When it says stock loss, that means membership interest in an LLC. All that is, is if I have loses in a C Corp up to, let’s say, I lose $30,000, I have lots of expenses and I don’t make any money, and I get tired of running that C Corp, I can dissolve it and I can take that $30,000 loss in the C Corp and write it off against my active ordinary income, my W-2 income. You can do that up to $50,000 per shareholder. Husband and wife could write off $100,000. I can’t do that with an LLC taxed as a C Corp.
If you did this LLC taxed as a C Corp and you did that same transaction, you’d have a capital loss of $30,000, which could or could not be offset to capital gains. You’ll be able to write off $3000 per year against your W-2. You just carry it forward. That’s the difference.
It is possible for you to just sell the property inside the LLC so hooray, when you’re asking about the in-kind distribution, it is possible. In fact, you can actually partner with your IRA and buy property. That’s not a prohibited transaction. It’s the continued transactions between you and that property that become the issue.
Jeff: What if I already own the property?
Toby: Then I don’t see how it’s a privative transaction.
Jeff: Can I sell part of my interest to my IRA?
Toby: I’ve seen people do that. I’m not sitting here today. I don’t know if I could answer that question.
Jeff: I’m just trying to put you on the spot.
Toby: I’m sitting here thinking about it because if I am buying that interest from my IRA, I don’t believe that I can just enter into a transaction where I’d buy it. I think that I am going to have to use it. Some third party is going to have to acquire it. But I think I can turn it into cash or I think I could possibly swap it up for something of equal value. You’re an owner, usually, what you’re going to do is set up an LLC and you’re going to distribute and you’re going to pay tax on a portion of it on those distributions. Being a partner with your own IRA or 401(k) is not a prohibited transaction. In fact, there’s whole thing called ROBS transaction that you do where you can actually partner and use the money from your 401(k) or IRA to buy a business. A lot of people use it for franchises.
Buying and holding a tenplex with a non spouse partner in Ohio, both residents of California, best way to structure, where to form the entities. Chris, what I’d probably do is have a Wyoming entity just to keep you from having California seeing you. You’re still going to see your K-1. You’re still going to pay tax. And then, any of the properties that it owns, I would have an in-state entity like I would have an Ohio entity own the tenplex and the owner of that Ohio entity will be the Wyoming entity owned between you and your partner and then you could do that over and over again.
“What is the meaning of DBA and what are the implications of setting up a business structure using a DBA?”
Jeff: DBA means Doing Business As. In some places, I know Los Angeles county, they call it fictitious name. I like the idea of DBAs. They’re not foolproof, but I feel like they add a little more anonymity, too. If I go Chuck E. Cheese, that’s not who actually owns that place.
Toby: Right. Chuck E. Cheese would be…
Jeff: Jeff Webb franchise or Jeff Webb LLC.
Toby: How about Anderson Business Advisors? I don’t know if anybody ever noticed there’s nothing behind that name. Anderson Business Advisors is a DBA of Anderson Law Group, PLLC. All a DBA is it’s a registration, usually in the county, or city, or state. Everybody is different. Like Wyoming, it’s a state and it calls it fictitious name. I think you have a fictitious name statement in Texas. You could do the Clark County, for example. In Nevada, we don’t have a state registration. You have it per county. In Washington state, it’s a state wide. But you just say I’m doing business as Jeff’s Doughnuts and it’s ABC Inc. doing business as Jeff Webb’s Doughnuts.
The DBA is just a database saying, “Hey, here is a business name. You cannot put LLC after it. You cannot put Inc. after it. You cannot put anything else.” No w, you’re just saying, “Hey, I need to look to see who the actual owner is.” It’s not uncommon for a corporation to have multiple DBAs and be doing business as different organizations.
Toby: The implications, it’s nothing more than a name. It’s just pointing to some other entity. It has no tax ramifications. A lot of people will use a DBA for sole proprietorship like Jeff Webb doing business as Jeff Webb’s Doughnuts. There is no asset protection under that. There is no tax. You’re going to be a sole proprietor. You’re going to be a Schedule C.
Jeff: For example, I have a company that has a really boring name and it doesn’t explain what I do, then I could call it DBA Taxes Are Us.
Toby: Yeah. So you could have a really boring anonymous name the company, hint, hint and then if you’re going to do business in a state, you say, “I’m doing business as Jeff Webb’s Tax-o-rama. If I’m going to go into Texas, I’m going to be Redneck Taxes.” This is because I go to the Redneck Country Club. That sounds horrible to me. […] anonymous, somebody said. No, I used to go to Redneck Country Club so I’m not calling people in Texas rednecks before I get hate mail. But you know, something cool, Longhorn Taxes. And then if you’re from Philly, Flying High Taxes.
“I recently sold a home and purchased another in the same year. I did not fill out any special tax paperwork. Will this qualify as a 1031 Exchange?”
Jeff: I’m thinking this is going to be a fail from the start. You probably sold the home, received the cash, and then purchased another home. The problem with that is you can’t touch the cash. The qualified intermediary has to touch it.
Toby: Yes. It’s going to be a fail.
Jeff: The other problem is you have to act within 45 days of selling the first home. You have to identify what you may be buying. This is not going to work. You can’t do a 1031 as an afterthought.
Toby: But here’s the thing, if you sold a home and it was your personal residence, we could still 121 it. There’s another way where it’s going to be fun, too. I love when they do the 121 and the 1031 Exchange together. This house, so I purchased another in the same year, sold it, purchased another, you may be able to qualify to opportunity zone that if you did it this year. You may still be able to do it but the 1031 Exchange, you can’t touch the money. You have to have an intermediary in there. Somebody is asking that. 121 is the home exclusion for capital gains on your property that you lived in the last five years.
Redneck Country Club in Houston, you know what it’s called now? They changed the name. I think it’s Republic I think it’s something republic. Anyway, the Redneck Country Club is really cool. Who is it? Jeff Lunding. They do free beer every month. Good group, by the way. Love these guys. Eddie Gant over there and Jeff Lunding’s a good dude.
“Is it better to form an LLC or a corporation on rental properties?” Now, you know what I’m going to do, right?
Jeff: Yeah, go ahead and say it.
Toby: An LLC can be taxed as a corporation. An LLC is not actually a tax designation. An LLC can be partnership, a disregarded entity, S corp, C Corp, trust, whatever you want it to be.
“So, is it better to form an LLC or a corporation?” You don’t really want to have a corporation for rental properties.
Jeff: Yeah. I was going to say that would be my last choice.
Toby: I’m going to make it real simple. You want rental properties to flow onto your personal return. You do not want them going into corporation. The reason being the corporations just have income but they have a little problem. That is if they give a shareholder an appreciated asset like a rental property and you take it out to refinance or to do anything else, all the appreciation, whether you sell it or not, is taxed as wages, the day that it gives you that property. Republic Country Club & BBQ. There you go. You guys rock. Texans are pretty darn cool.
Toby: “If I plan to purchase one or more vehicles, with the intent of renting them out, should I title the vehicles in an LLC?” You’re probably renting them to like Uber drivers or things like that.
Jeff: Two things I’ll note is yeah, I think they definitely should be put in an LLC because there is a lot of liability without renting out vehicles. The other thing is they need to be titled to the entity or person who is actually doing the renting.
Toby: Are you saying that, let’s say I put them in ABC LLC and I rent them to drivers, It needs to be titled in ABC LLC?
Toby: It’s not going to be titled in the driver’s name?
Jeff: No. Correct.
Toby: 100% agree with you. The way that they do these, I’ve had clients do this, they buy a bunch of Prii or Corollas, there are a few different vehicles that are in the $13,000, $14,000, $15,000 range that don’t cost much to operate that they like to rent to the Uber drivers on a weekly basis, Lyft drivers and things like that. You put them in an LLC to keep them from flowing over to you because as Jeff said, when you are the lessor, usually, you’re not going to get too drawn up in the drama, you’re just exposed to the loss of the vehicle. The driver is who’s going to be responsible but they could try to say that you were negligent in leasing the vehicle to a driver.
The other thing you do is you make sure that you have commercial insurance. A lot of folks just go get regular insurance on a car then they use it in commerce. They’ll put it in a company name or something and they don’t realize that that’s a different type of insurance policy. That’s a commercial policy.
Jeff: Another thing I would suggest is immaculate maintenance records on your vehicle.
Toby: Yeah, absolutely. This is lucrative though. This is something I did in college. I used to work for Alamo Rent-A-Car when they first got going, where they took off a ton of money because they weren’t tied to any car places. Some people would just give them cars and say, “Hey, we’ll pay you to put 10,000 miles on this so that the new market wasn’t as saturated.” It’s pretty interesting.
“Management company is protected better as a C, or as a corporation, or LLC?” Protection wise, you’re almost always going to be better as an LLC but it can be taxed as a corporation.
“Should I turn my residence into a rental property, sell it after two years, and 1031 it to delay paying property gain, $1 million in tax?” They have $1 million. The answer is yes and that is a great strategy.
Jeff: That’s what I thought.
Toby: Jeff, you want to lay it out for him?
Jeff: To get that Section 121 exclusion that $250,000 or $500,000, you have to have lived in it for at least two of the last five years. It doesn’t mean you couldn’t have rented out for the last 35 months and move somewhere else. So then after that time passes, it looks like maybe three years, they lived in it and rented it out for two years and then they decided to sell it, they’ll first going to take that 121 exclusion of say $500,000 of gain.
Toby: Yup. That’s the capital gains exclusion. Guys, this is not depreciation recapture exclusion, this is just capital gains on the sale of a personal residence, property that was used as your personal residence two of the last five years.
Jeff: Right. It’s got to be your main home. If you have a second home, it does not qualify.
Toby: You could actually two homes and then you qualify two. Run one for two years, another for two years. You got to specify which one is your primary.
Jeff: But with the remainder of the gain, that remaining gain, say it’s another $500,000 in gain, can be deferred by selling this house through a 1031 Exchange.
Toby: Yup. The IRS is the one who actually spells this out. It jumps your basis in the property because if you guys know 1031 Exchanges, you know I’m just swapping my property A for property or properties B, C, D, E, F. You can just have a ton of properties. The new properties inherit your basis. Everything about property one is transplanted into property two.
When you do this and you have both a 121 and a 1031, your 121 jumps up the basis to. If it’s a married couple, it’s $500,000 and the new 1031, the remaining portion. When you do the rental property, you just have to be very careful because you want to make sure that you’re just specifying that the depreciation recaptures all going to the 1031.
If you have $1 million in gain, then we look at it and say, alright, whatever that property let’s say it’s $500,000 and you’re selling it for $1.5 million, the way it would look was you would have a sale of $1.5 million, you have the basis step up for the $500,000 121. So your new basis in the property would actually be $1 million and you’re deferring $500,000 of gain.
Jeff: I’ve forgotten that the 121 does step up your basis.
Toby: Again, when we do these things, you’re following, here’s the IRS guide and it’s pretty straight forward. Just knowing it exists, most accountants don’t. Most people don’t. It’s not a slight on them. They just don’t. If you don’t know, you don’t know. If you’ve never heard of this, you’re never going to know.
Jeff: I knew it. I just didn’t remember it.
Toby: Yeah. That’s it. There’s always a little specific.
“Does the house require two steps to the sale?” No, John. You could actually do this. This is what’s funny. Guess what? You could make that 1031 into an investment property. Rent it for a few months and then go move into it.
Jeff: I was […].
Toby: I think that the rule is that you can’t do another 121 on that property for 5 years if it was part of the 1031 Exchange. You can actually go read 26 USC 121. You’re going to see it has a specific language saying, “Was the property used part of a 1031 Exchange in the last five years?” They’re letting you know right there, “Hey, it’s okay. We know that you’re going to do this.” If you live in Manhattan, San Francisco, certain really expensive places, Hawaii, yeah, it’s gets really annoying. It was fun.
Jeff: And you know, while we call it like-kind exchange, it doesn’t mean you have to sell a rental property for another rental property. You could buy a land. You could a commercial property. Almost any king of real estate.
Toby: A lot of people, what’s funny, they’re selling all their single families and putting them into a storage units […] tenants. That’s why property managers exist. But yeah, that’s actually not too bad either. Some people are just getting annoyed because the millennials—love the millenials—sometimes can be frustrating when they’re your tenants.
“Can I offset gains from rents with depreciation?” The answer is… You go for it.
Jeff: You can’t. Your rental income is to be offset by all of your expenses from your rental property including depreciation.
Toby: A lot of people don’t realize depreciation is a deduction. It’s a tax deduction. If you start looking at everything and you say, “Alright, income, adjustments, deductions, credits.” And you start looking and you say, “Income, there can be exclusions from income. If I get reimbursed by an employer, I exclude that. I don’t have to report it. Now, I have income, are there adjustments that I can take against that income? Are there deductions that I can take? Are there credits that I can apply towards my taxes?”
Jeff: The only issue with this is if you’re not a real estate professional, how much you can actually deduct on the return may be limited.
Toby: Here’s an easy rule. There’s active income, there’s capital, there is portfolio, there is all this fun stuff. What we look at is what type of losses do we have? Do we have ordinary losses? Active losses? Do we have capital losses from a sale of capital assets? Do we have passive losses from things you don’t maturely participate in? Real estate is considered passive, per se, so if it’s investment property.
If you have depreciation, it can’t offset your other types of income unless you fall underneath one of the exclusions. We’re talking about one of the exclusions earlier, which is again, 26 USC 469(c)(7). You go there and you look at it and you’re just going to say, “Here’s the exclusion.” You have to jump through the hoops. It’s 750 hours for one spouse with it being more than 50% of your personal services and you have to maturely participate. You hit those, if you have depreciation that creates $100,000 loss, you get to offset your W-2 income with it.
Somebody says, “Can depreciation offset W-2 income for an Airbnb business on a Schedule C?” That’s great, great question. The answer would be pretty much kind of a yes because you get your depreciation and you’re an active participant, but I believe your real estate is going to be sitting on your Schedule E under those circumstances. You’re going to grab the depreciation and you’re going to use it on Schedule C. I could see somebody putting it on there. I’m just not sure whether you get to put it on your Schedule C or whether it’s sitting on your Schedule E.
Jeff: Yup. Even with the short-term rentals, I’m not sure that you’re providing substantial services.
Toby: Oh yeah, that’s right. You have to do the substantial services and then you get ordinary loss, which means you got to do a lot more than just be an Airbnb.
Jeff: You got to start looking more like a hotel.
Toby: Yup. Otherwise, you’re not getting it. The Airbnb, the way we suggest people do it is they have a corporation that is the host and you rent your property to the host so that you’re getting rental income, passive income. With the depreciation, you’re trying to get that thing as close to zero as possible and then you’re trying to offset and write off everything else on your corporation. I would not put it on a Schedule C simply because as of 2018, $100,000 a year business, the audit rate was 1200% higher for Schedule C versus an S Corp and about 800% higher for the Schedule C versus a C Corp.
“Can I expense travel to a remote real estate investment owned by my qualified plan in order to supervise renovation?” The answer is kind of weird. Realistically, if you’re the trustee, so your company is a sponsor of the 401(k), and it has an investment, then technically, that could possibly fall underneath an administrative expense but you got to be careful that you’re not getting any personal benefit out of that thing.
I believe there’s an argument that you could but I ran this by a few other people that were in that industry—nobody knew the rule, by the way, it was funny—they said, “Hey, this is like when you have soft cost in a mutual fund, you have expenses that you’re personally benefiting, you want to make sure that you’re not possibly walking into that grey area.” That being said, exempt organizations have about 800 agents nationwide and there are quite literally billions of exempt organizations, so the chances of you getting a really thorough review are slim
I would just say, “Hey, what you can always do is expense something through your company if there’s a profit motive,” and I would just say, “Hey, as a trustee, I’m going to kill two birds with one stone. I’m looking at an area, but I’m also looking at the plan” I don’t think I would use plan assets to reimburse that company. Frankly, I wouldn’t want to. I want to get more money into my plan than anything else so I think I would just expense it through my company and I wouldn’t tie it to the plan.
Jeff: The whole problem with this is that there are really two different issues here. One is as Toby said, you cannot benefit from plain […] assets. You cannot personally benefit. The other issue is that the client cannot benefit from your work if you’re a participant within that 401(k), or IRA, or so forth. Again, I was not sure which way to go with this one.
Toby: I’d just be careful. I would just run up to the company. I wouldn’t specify it as having anything to do with the plan. Make it easy.
Jeff: I would make sure that if I did this, that all my travel was only for…
Toby: Yeah, if you’re going out to a property and the plan is paying for it, that’s the big thing. The answer is can I expense travel? Yes. But do I want my qualified plan to reimburse me for it? Probably not.
“Can you have one corporation flip active and comeback into passive for multiple properties?” Not quite following that. Yes.
Jeff: […] one again?
Toby: There is one that says, “Can you have one corporation to flip active income back into passive for multiple properties?” I’m not really following that one. You’re flipping your active.
Jeff: Generally, the character of the income doesn’t change just because you changed entity types.
Toby: “Can I create an S Corp late in the year run all of my income, expenses from an Airbnb business through it for the year?”
Toby: No. You start once it’s incorporated, once you get that business going. You can grab some of the expenses sometimes, startup expenses. Like if you were doing this and you’re out to money, you could lump it under the corp if you wanted to.
“Can a small newly set up LLC buy a property?” Yes.
Toby: Yeah, absolutely. That’s because it’s new, there is no seasoning requirement.
Jeff: When I first looked at this question, I was going to say, “Well, you have to have money.” But no, actually, you don’t.
Toby: Yeah, you don’t need to have that money. Hey, next week, I think it is. Is it next week or the week after? Maybe the week after. We’re doing the Tax Wise Workshop starting to blend. It’s getting towards the end of the year where it’s getting really, really active. It’s not too late. We got a full house, in-house. We’re still bringing people in on the livestream but I think we’re sold out internally, but you still get to do the livestream because we can do that for infinity. You get a Two for Tuesday. It’s $197. You get the Tax Wise Workshop plus access to all three we did. The one I’m doing in two weeks is going to be a year end. We’re really focusing in on doing year end planning.
Also, it includes the Bulletproof investor, which is two tickets to a three-day tax and asset protection workshop here in Vegas or anywhere in the country where we hold them. Early next year, we’re doing San Diego, San Francisco, Los Angeles, Houston, Dallas. I think we did Chicago recently, Boston recently. We’re going to continue to do them throughout the United States. You get Clint’s book on tax and asset protection for real estate, you get immediately a three-part video series, and you get a strategy session.
“Can somebody contact me about the Two for Tuesday?” Yeah. Let’s see. We’ll have to have Patty or somebody reach out. We’ll get it. How about Minnesota? Yeah, it will be fun to go out to Minneapolis. Beautiful city. I worked at some place there. My mom is actually from St. Cloud. We used to fish on […] lake and eat bugs, which I didn’t mean to do that. I still remember vividly, as a kid, and running out in the backyard after one of my brothers is yelling at him and getting a mouthful of whatever just hatched. It was pretty cool. Florida, we’ll probably do something down there. Florida, where they have mosquitoes as large as bats. Happy holidays.
Actually, I love Orlando. We’ll probably do something there. Actually, with all seriousness, I know that we are working with a big real estate group with Miami that we’re going to be going down. I think it’s in December that we’re doing an event there. I’m not hating. What else do we have? You can go listen to our podcast. There are a lot of cool stuff. My partners are really awesome on this. Carl is really awesome on this. Clint has fantastic interviews. Michael does. Please listen to our podcast Coffee with Carl, he’s one of our attorneys. He’s pretty funny. Look at that big waves. Lots of big waves.
I’m going to be back in Hawaii in December working with a buddy of mine on the real estate board over there in Alaska. We’re doing continuing education for a whole bunch of realtors. All the Alaskans coming to Maui. There are probably 150 of them. That will be at the Sheraton Black Rock in early December to watch the beautiful whales and do all that, if you ever feel like doing that and get some continuing education. You should reach out. Just Google it. You’ll find it. Jerry Royce is the guy’s name. He’s a fantastic dude. You guys rock and visit us at Anderson Advisors. Do the free stuff.
Somebody says, “Come to the North Shore of Oahu.” I love the North Shore of Oahu. It’s one of the few places where they don’t have so much build out and that’s my buddy Lane is out there. Oh, you’re in Turtle Bay? You rock. You guys have some big waves out there right now. Oh my God. I imagine you guys have some pretty big surf. Love you guys. Hope you guys are doing great and we’ll see you in a couple of weeks. Thanks guys.
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