Ever wonder how cryptocurrencies and real estate investments play together in the sandbox of taxation? Or how to pay your family members through your business in a way that could benefit everyone’s wallet? We’ve got answers to these questions and more. Welcome to another episode of Tax Tuesday, where tax experts Toby Mathis, Esq., and returning guest Jeff Webb, CPA, and CFO of Anderson Business Advisors share their expert advice. This episode delves into the nuances of crypto transactions and the impact on your tax bill, along with a deep dive into payroll complexities that could save you a headache—or better yet, a hefty fine. Plus, we discuss why paying children through your business isn’t just a clever maneuver; it’s a strategic move that could pave the way to a tax-free goldmine.
Submit your tax question to taxtuesday@andersonadvisors, and check out our new “knowledge room” available to Platinum members, from 9a-2p daily.
- I owned a condo for the last 28 years and depreciated it down to zero. In January this year I sold the condo to the renter and installment sale. For the next 10 years, I’ll receive monthly payments, with a balloon payment at the end of 10 years. My question is as follows Do I have to recapture the depreciation and pay tax on it? Am I too late to do a 1031 exchange at this time? – If you’ve already sold it, it’s too late. 1031s do not work well with installment plans.
- What would be the best way to sell a small business and limit as much as possible the tax implications? – a stock sale is best, but almost no one will go for that….
- When are crypto earnings taxed?- When you sell it, you pay capital gains tax on the difference between your buy and sell.
- What activities classify for the 750 hours? Does training, traveling, searching for properties? – It’s going to be real estate activities in your real estate business. Training, traveling, and searching for properties is “investor” activity
- I self-manage a single short-term rental that I own. I want to pay my kid, who is 16 years old, for doing legit work for the Airbnb at a reasonable rate. Do I just write them a check every month based on the hours they log, or do I have to hire a payroll company to issue them a check? I do not have any other employees. If I don’t hire a payroll company, how do I issue them a W2 form? – you really should hire a payroll company, if you 1099 them, they will have to pay tax.
- I’m planning to start lending money to real estate investors. Other private money lenders I know do their lending businesses through an S-Corp. I currently don’t have an LLC or an S-Corp for lending. I have a Wyoming Hold LLC that I opened to use for real estate investing. Which would you advise is best for private money lender an LLC, an S-Corp, any other, and why? – Do not do it through your Wyoming LLC. I like the S corporation rather than the LLC…
- I have a 50-50 partnership with a friend and we own two short-term rentals together. Each of us is maturely participating in one short-term rental each. Is there a way to take full cost-seg advantage against our respective W-2s or can we only take 50% of one property against your W-2 and the other person? It will go to the passive bucket and vice versa for the other property. – Couldn’t we both get that deduction? Yeah, you probably could if we go back to the aspect that it’s a trade or business
- I am a W-2 earner. Can I save taxes if I buy a long-term rental? – Probably not. Probably not at this time. Unless you’re a real estate agent.
- I’m getting a lot of pushback against cost segregation from my accountants. They say that it could trigger personal property issues in Maryland and that the cost of the study is prohibitive. – So what? The personal property taxes and most states is based on The Advalorium they call it. It’s based on the current value. They usually have depreciation schedules of their own and it’s not that much property tax.
Full Episode Transcript:
Toby: All right. Welcome to Tax Tuesday. If you’re looking for Tax Tuesday, you’re in the right spot. If you’re looking for something else like Barney, I think it’s on another station. First off, happy 2024.... Read Full Transcript
Barney’s not so bad. I used to watch VHS tapes of Barney, if you guys remember that, and you get that anxiety when you hear it spinning and rewinding when your kid’s watching it repeatedly. You just start to sweat a little. Barney’s giving you chills.
All right, 2024. Welcome to this first edition of the new year. If you’re looking to get some tax knowledge to the masses, you’re in the right place. Jeff, welcome.
Jeff: Thank you.
Toby: We all survived another year, so we all get a star. Sherry, happy new year to you out there. You guys can always chat. I’m Toby Mathis, and this is…
Jeff: Jeff Webb.
Toby: We’re going to be your guides today. What we’re going to do today is answer a bunch of questions. You guys submit questions throughout the weeks, and we grab them. Eliot goes through them, so we can blame him if they’re crappy questions. If they’re good, then it was Jeff.
We’ll go through those questions, and then you can always email in questions at taxtuesday@andersonadvisors. That’s where we grab the questions that we go over usually about 10-15 every session. If you need a real detailed response, please become a client. It’s not that expensive. I think it’s whatever it is per month. It’s not that much, less than a hundred bucks. You could ask away all the questions you want. Plus we actually have a live knowledge room every day now. I think it’s every day. Is there a day that they don’t do it?
Jeff: Every day, our door’s open. I am in there along with a bunch of attorneys and CPAs
Toby: Attorneys and CPAs every day. If you’re a platinum client, you could use this every single day. I think it’s 9:00-2:00 Pacific Standard Time. You can pop in there and ask a question. You could always email, you could always do that too if you’re a client.
Just so you know, we really do enjoy having an open format, where we’re teaching and we’re answering questions. If you have something that’s an emergency, pop on and the attorney will grab you, put you in another room, and answer your questions individually. Or if they need to get on a call with you, they’ll do that too. Easy way to make it work. Some people are like, I like phones, ready to sit there. I don’t like that. Pop in, enjoy it. Join us in the knowledge room.
Jeff: Yeah. One of the nice things about that knowledge room, we are 9:00-2:00 on there, and there’s always somebody from various departments. I saw James Morris from entity processing in there this morning. When you ask a question, it can be a multifaceted question. We’ll discuss it between attorneys, accountants, and so forth.
Toby: That’s the fun, and that’s it. Here’s a question that just came in. Quentin, you don’t have to retype it. By the way, you guys can do Q&A for a detailed question. If you have a tax question that’s been eaten at you, ask it in the Q&A. Otherwise you can make comments in chat, but somebody was just chatting there. I read the chats as we go along, because I like to see what you guys have to say.
He said, hey, my C-corp has the year end. He says it’s fiscal year end is September 30th, does that mean my year end is September 30th? Interestingly enough, yes, that’s exactly what it means. It means that your corporation’s December 31st is September 30th.
A lot of governments or entities, for example, use that year end, but you can pick a different year end for your C-corp. Your LLC taxed as a C-corp, but not much else. I think the rest of us are stuck with that 12/31, which is always fun. We love the 12/31.
Real quick, before we get into all the questions, let me know where you’re sitting, what city and state. Intoxicated is not a state. You already know I’m going to get a few of those. But there we got Orlando, we got Nevada, Phoenix, Arizona, Anchorage, Dallas, Denver, Albany. Now they’re flying by too fast.
Kapolei, I saw that. I saw Costa Rica, I saw Hawaii, I saw Arkansas. I see Maine, Tennessee, Colorado, San Antonio, Texas, Pensacola, Florida, Pura Vida. You’re sitting in Pura Vida. If you’re in Miami, you’re on my poop list right now. I’m going to give you the stink eye, I guess, where she wants to be right now.
Marksville. Somebody said they’re in Miami. Palm Beach. Everybody’s having a good old time today, so I’m just glad. We have people from all over the place. There’s Destin, Florida. Parents used to live in Santa Rosa Beach right down there. Here from PA. Grew up in Wallingford Elementary School. What was it? Media. There we go. I grew up in Media, Pennsylvania outside of Philly.
Michigan, California. We got people in Michigan. You guys are going to be playing the Huskies for the national championship. Anyway, this will be a whole bunch of fun. Get to taxes. Enough of this nonsense. Let’s get in. Some of you guys are already antsy. You’re ready.
All right. Here’s the questions we will be answering today. “I owned a condo for the last 28 years and depreciated it down to zero. In January this year, I sold the condo to the renter in an installment sale. For the next 10 years, I’ll receive monthly payments with a balloon payment at the end of 10 years. My question is as follows. Do I have to recapture the depreciation and pay tax on it? Am I too late to do a 1031 exchange at this time?” Good questions. We will answer that.
“What would be the best way to sell a small business and limit as much as possible the tax implications?” Good question there too.
“When are crypto earnings taxed?”
Jeff: It depends, but we’ll get to that.
Toby: I think we’re going to be talking about soft forks, hard forks, staking, all that fun stuff. All right. “For real estate professional status, what activities classify for the 750 hours? Does training, traveling, searching for properties?” Good questions, and we’ll answer them.
“I self-manage a single short term rental that I own. I want to pay my kid who is 16 years old for doing legit work for the Airbnb at a reasonable rate. Do I just write them a check every month based on the hours they log, or do I have to hire a payroll company to issue them a check? I do not have any other employees. If I don’t hire a payroll company, how do I issue them a W-2 form?” Thank God I have Jeff sitting next to me for this one. I’m a bit of an idiot on those things.
“Hi. I’m planning to start lending money to real estate investors. Other private money lenders I know do their lending businesses through an S-corp. I currently don’t have an LLC or an S-corp for lending. I have a Wyoming holding LLC that I opened to use for real estate investing. Which would you advise is best for a private money lender, an LLC, an S Corp, any other, and why?” Great questions.
“I turned a home into a rental in the middle of the year. Can I take a whole year of depreciation? Can I utilize cost segregation? And what value do I have to use when starting out since I own the home for several years? Do I use the current value of my home, or do I have to use the actual cost basis when I purchased it?”
“I have a 50/50 partnership with a friend and we own two short term rentals together. Each of us is materially participating in one short term rental each. Is there a way to take full cost seg advantage against our respective W-2s? Or can we only take 50% of one property against their W-2 and the other person, it will go to the passive bucket and vice versa for the other property?” Really good question.
Jeff: That was a really interesting question.
Toby: Yeah. I’m going to say, Eliot, where do I do this stuff? That is really loud and really long. I see somebody else clapped too for Eliot. You picked a good question, my friend.
All right, “I am a W-2 earner. Can I save taxes if I buy a long term rental?” We’ll answer that.
“I’m getting a lot of pushback against cost segregation from my accountants. They say that it could trigger personal property issues in Maryland and that the cost of the study is prohibitive. What say you?” It’ll be interesting when we get there. That’ll be towards the end.
All right, first off, guys, I have Eliot, Troy, Yulia, Ross, Tanya, Jared, Amanda, Elisa, Matthew, and Patty, all sitting around waiting to answer your questions. If you go into Q&A, you could pick the brains of some really great CPAs, tax attorneys, EAs, and other folks. So it’s fun. We’re going to have some fun today.
If you have a question, throw it in there because they love to answer questions, especially Amanda. Amanda, I heard that you like to answer questions. I’m just going to say, Amanda loves to answer questions, probably Tanya too, maybe Jared, definitely Eliot, maybe Troy, Yulia, Elisa, Ross, up in the air, but we’ll see. I have a feeling that they like to answer questions, so make sure you ask them a lot of questions.
Speaking of questions, there’s my YouTube page. Go on. If you’ve never subscribed to my YouTube page, this would be a good day to do it, because we are just under 300,000. If you just give us that little shove, I think we’re probably within 10 or 20 people away from hitting over that 300,000. Not that we’re vanity metrics, but we’re vanity metrics, so it would help. Plus mine’s more than Clint, and I can make fun of him that way. I’d say, dude, why are you so far behind?
Jeff: I was listening to one of your videos this morning talking about 70/30.
Toby: That’s this one. That’s build endless passive income. Let’s see if I can actually circle it. That one right there.
Jeff: It was actually one that I’ve listened to a couple of times, because I think it’s one of those that you have to listen to more than once for it to actually take when you’re breaking down.
Toby: It took me 20 years to figure it out.
Jeff: All that to say, watch these videos. There’s a lot of good information in both Clint and Toby’s videos.
Toby: Clint has a page too. You guys go to my page, go to Clint’s page. He tends to focus more on the…
Jeff: On the structures, yeah.
Toby: Yeah, he does more on the land trust, LLCs, corps, CTA, and all that. Whereas I probably spend more time on the tax and a little bit more of the wealth building side. We’re the yin and yang, but yeah, absolutely.
Jeff: Both sides of it.
Toby: We try. We’ve been doing this a long time, and it’s whatever floats your boat at this point. It’s like, what brings you joy? You know what brings me joy? It’s helping people keep more of their money. Helping people make money is really cool too. But at the end of the day, this last month, it’s just been like drinking from a fire hose of different scenarios.
You have so much thrown at you. You’re trying to do your best. In some cases, you do some amazing things, or you’re able to save people just a truckload of money. Sometimes you’re able to bury it down. But whatever, it’s always a little puzzle and it’s a lot of fun.
If you like that thing, by the way, we’re doing the tax and asset protection workshop. I know I’m teaching it this weekend on Saturday, so feel free to come on. That’s definitely a live one. I’m not sure if it’s Clint or Brent. I think it’s Clint coming on to do this one on January 6th, so it’s coming right on up. Just feel free to join us. We have a lot of fun on those, which is always cool.
You can ignore this button. There we go. Let’s jump into some actual content. I got to get some content. Let’s get this done.
“I owned a condo for the last 28 years and depreciated it down to zero.” Which happens if you own property for 27½ years and you don’t replace major components, I suppose. I have a feeling that you have some more depreciation there, we got to get out of that. “I sold the condo to the renter in installment sale. For the next 10 years, I’ll receive monthly payments with a balloon payment at the end of 10 years. My question is as follows. Do I have to recapture all the depreciation and pay tax on it? Am I too late to do a 1031 exchange?” What do you say?
Jeff: I’ll answer the second question first. If you’ve already sold it, it is too late to do a 1031 exchange. Also, 1031 exchanges do not work well with installment sales.
Toby: It’s possible to do them, but they’re a pain. You actually have to have the QI to receive all the money, right?
Jeff: Correct. You cannot have the note in your name.
Toby: Somebody says, what is a 1031 exchange? It’s a tax free exchange of real estate. I sell one property, and I buy another property for equal or greater value, or it could be multiple properties. It could be I sell one property, buy 10, it could be I sell 10 and buy one. But what I’m doing is I’m exchanging property. Usually within 180 days, there’s a reverse exchange that does it differently or a swap that does it slightly differently.
In a traditional 1031 exchange, a starker exchange is what they call it, you have 180 days. You have 45 days to identify replacement property or properties, depending on which method you’re using, which is far beyond what we’re discussing today. And then you swap it into another property, but you can’t touch the money.
Toby: You have to go through what’s called a QI, a qualified intermediary. You have to do it when you sell, you can’t touch the money. They don’t work well with installment sales, like almost impossible to paint in the [inaudible 00:12:53].
Jeff: Unfortunately, if you receive a dollar from your sale, it turns into a dollar of gain, so this can go south. But the other question about depreciation recapture, yes, to my knowledge, even though it’s fully depreciated.
Toby: You recapture all in the year of the sale, I think.
Jeff: Correct, and that’s the downside. Is that broken up between the installments?
Toby: I think you have installment sale, Eliot or any of the accountants, please correct us if we’re wrong, but I’m pretty darn certain that when you do an installment sale, the recapture is in year one, the gain and if you have interest, and the return of basis is spread out over 10 years plus the final bonus. Let me know, Eliot.
Eliot: Typically, your recapture is handled right away off the top game. You have to handle that first, I would think, like you’re saying, Toby.
Toby: Yeah, I think that’s the case.
Jeff: If I have $500,000 to depreciation, but my gain is only $250,000, my recaptures could be limited to that gain. It’s only going to be on that $250,000. You don’t recapture everything. You only recapture up to the amount of your capital gain. It’s at most 25%.
Toby: It’s your ordinary bracket up to 25%. Everybody just says 25%. The only issue here is you have some depreciation that you didn’t take too. You have some adjustment of basis. I don’t know if that’s going to change things for the depreciated. Now you have some non depreciated. I guess it wouldn’t really matter. Maybe it’ll adjust your basis. If I did a new roof and stuff, would that impact my recapture?
Jeff: Possibly. This drives people crazy, but you probably got some land included in that. I know your condo is not sitting on any land, you don’t own the land, but the IRS considers part of it to be land.
Toby: Yeah, so it is 25% of what? You pay recapture. If I took depreciation while I owned a piece of rental property, which just means I’m taking a deduction against the rents or creating passive loss, whatever the case, I am taking a deduction against whatever income is coming in off that property. When I sell that property, I actually have to recapture that at my ordinary tax bracket capped at 25%.
Like Jeff said, your recapture is part of the gain. It’s limited to the gain. What you usually do is you break it down and say, here’s the the gain, here’s the recapture. That will give you your net capital gain that you have to pay tax on.
In this case, your accountant is going to be spreading that 10 years out. You’re going to have a big recapture, and then you’re going to be spreading out the capital gain over 10 years. Depending on what you actually made on this, it depends on the recapture. It could be a really small amount because if you bought this 28 years ago, chances are it’s a smaller amount compared to the gain. I imagine you’ve had some great appreciation.
What’s weird on condos is you can actually have a zero land value. I learned this the hard way. It depends on what the assessment is. If your building is assessed at zero land, you may have depreciated the whole dang thing. In which case, you’re going to have an ouch. You’re going to have some recapture.
Somebody says, what do you mean by the recapture of capital gains? You have recapture and you have capital gains. Recapture is the depreciated amount you pay tax, 0%-25% on it, depending on what your tax bracket is. On capital gains, depending on how long you held it, this was more than a year. So their capital gains would be long term capital gains, which will be at 0%, 15%, or 20%, depending on their tax bracket.
When you do an installment sale, the reason people like installment sales is because I’m spreading out the recognition. I may be able to put it into the 0% or 15%, much more so than getting hit at that 20%, which really isn’t 20%, it’s 23.8%, because we have a net investment income tax. We’re spreading it out over years.
The other thing you have to be aware of is you’re going to have interest no matter what. You’re going to be imputed, or you’re going to have to pay tax on whatever a portion is attributable to the interest that’s being paid. You’re actually going to have long term capital gains, you’re going to have recapture, you’re going to have interest income, you’re going to have return of basis, which is zero. And you’re basically going to have to track those over that stretch.
First year, you’ll knock out the recapture, but the rest of the time you’re stretching it out, those three things over a period of 10 years. Then your balloon, it’s when you receive the money. It’s when it’s taxable. In that 10th year, you’re going to get […]. Anyway, isn’t that fun?
Somebody says, if you depreciate the house down to zero and then give it to a nonprofit, can you take a deduction again? Yes. That’s why we love doing that. When you depreciate a house, and Dion just nails it out of the park on that one, if you have your own 501(c)(3) and you’re interested in doing work, maybe it’s veterans, single moms, maybe it’s transitional housing, whatever the case, or maybe you just want to do section eight housing, you can give it to your own charity.
You could set up a charity. You don’t own it, but you control it, and you get a fair market value deduction. I can actually donate my condo or whatever. I shouldn’t be saying this, because this guy’s listening. He’s going to cry a little bit now. But you actually take a nice, big tax deduction when you do that, and now you don’t have any gain recognition.
There’s no tax to the exempt entity. The money is now in a charity. A lot of you guys are givers anyway. You’re like, hey, I can give a lot more if I don’t have to pay tax and recapture on this thing.
Jeff: No depreciation recapture.
Toby: No recapture, no gain, no nothing. Plus if you buy more property with it, you usually can escape county real estate taxes too. Actually, we like that. Anything else on this one?
Toby: All right. Let’s move on. “What would be the best way to sell a small business and limit as much as possible the tax implications?”
Jeff: In my opinion, the best way to sell a small business is a stock sale. Unfortunately, almost nobody will go for that. Are you going to pull that tax cut out?
Toby: There’s a couple of ways to go about it. Most buyers, to Jeff’s point, want to buy assets. (1) They want to buy assets, because the liability stays with the company. They may not want the liability of buying that business and having some lawsuit from something that occurred three or four years ago, pop up, or five years ago, six years ago. They want to know, hey, I’m buying this and I don’t need to deal with that nonsense.
(2) They want to be able to write off and take a deduction for whatever they buy, which means I can’t deduct the stock I buy. For example, if I buy shares of Microsoft, I get no deduction for that. But if I buy computers from Microsoft as a business, I could depreciate the computers, and I could get a write off.
If I’m buying Jeff’s business, and let’s say it’s a pizza shop with a big oven, bunch of stuff, I can depreciate that. Even the goodwill, I can depreciate. It’s over 15 years, but it’s an intangible asset that I can depreciate and write off. Whereas if I bought Jeff’s stock, I don’t get to write anything off. Jeff, on the other hand, as the seller, gets capital gain treatment. It gets better.
If you sell your business and its capital gains, you could do things like qualified opportunities. Actually, you could do that on that previous question too on the real estate. Not so, I didn’t talk about it. Technically, if somebody sells that property, they could go back and do a qualified opportunity zone, which is a little bit complicated. For me, a red herring, but you could do that.
There’s another one, which is the 1202, which is if you are a small C-corporation or taxed as a C-corporation, you’ve had the business for five years, your tax is zero up to10 times your basis, minimum. If I sell a small business, I sell it for $3 million, that’s a C-corp or LLC taxed as a C-corp, I’ve had it for five years, I made the requirements of 1202, I’m the original stockholder, and it’s a small business, good idea is that I’m not going to have to pay any tax on it.
The other route is if you are an S-corp, there’s something called a 336H10 or 336H8, which is, I get to treat it as the seller, as a stock sale. The buyer gets to treat it as an asset purchase, but not for tax reasons, just in general. I get to sell it. I could sell them the stock. I’m still treating it as an asset sale, which may or may not be okay, depending on what type of goodwill it is. That could still be a capital asset, so I might still get preferential long term capital gain treatment, but then they get to write it off. That might be something that you get to explore, but that’s only for S-corps.
Jeff: This is the tax code I was hinting at.
Toby: It gets complicated.
Jeff: You’re the seller. The buyer only wants to do an asset sale, basically taking everything off your hand. You want as much of that value, because you’re going to have to break down what they’re buying and how much you’re applying to each piece. You want as much as possible against capital assets.
Toby: And then the IRS doesn’t have to listen to whatever you guys say. They can go and put whatever the substance of the transaction is. You guys could all agree, hey, this is all goodwill. But there’s a whole bunch of equipment and they say, no.
Toby: They might want that to be ordinary tax treatment to you.
Jeff: It might be as little as limiting your sales price to the basis, your basis, different equipment, and all. Saying it’s goodwill that you produce is a great one, because that gets capital gains treatment. I never really understood that, but yeah.
Toby: Here’s another one is depending on the type of business, you could always contribute that business partially to an exempt entity, or you could do an installment sale. There are different ways to approach this. It can get very complicated very quickly.
Let’s say that I have a business that I’ve owned for a number of years, and I know it’s valuable, and I sell it to a trust that’s for my kids, maybe on an installment sale, and then they sell it. But they step up the basis to its fair market value on the date that I sell it. It means I could avoid a big chunk of capital gains on that if I do that proactively. I can’t do it with a transaction that’s eminent, I could do that ahead of time. I could donate some of this to charity. If it’s a C-corp, I could potentially do that. Even in S-corp, I could potentially do that.
During the transaction, I could do an installment sale where I say, hey, I don’t want to get hit with all this tax, why don’t we do it over five years? I’m more interested in the revenue. If you’re going to roll up your business, for example, you have somebody who’s buying you, but they want to merge you into private equity, and they want to put you in a parent company, you may be able to roll tax free some of your company shares into the new company shares.
For example, if they come in and they say, we’re going to pay you out on 50%, we want you to roll 50% of the purchase price up into the new entity, and they’re basically partnering with you on a new one, you could avoid tax on it. You could stretch it out over many years with an installment sale and stretch out the tax that way. There’s a lot of different complexity here.
Jeff: Normally, if I exchange this stock for this stock, it’s a taxable event if I sell this, take that money, and buy this. But with a merger, that works differently that I’m getting stock for my stock.
Toby: Usually, it’s a contribution into a partnership, right?
Toby: You’re doing it that way, but that’s perfect. That actually works really well.
Jeff: Where it gets a little more expensive is if you’re putting a lot of the sale towards non compete agreements, things where you have to work in the business for a couple of years. Those are all going to be taxed at your ordinary rates. It can get a little more expensive that way, because you have higher tax rates.
Toby: Perfection. Somebody says, “Question number one, if the seller took straight line depreciation on that condo, they can realize the depreciation recapture pro rata based on the profit percentage.” All right, we’ll take a look at that. We might be wrong. If they took bonus or appreciated, then all that recapture is due in the sale.
Jeff: If it’s real estate, you can’t take bonus depreciation or accelerated depreciation. It’s always straight line.
Toby: If it’s real estate?
Jeff: If it’s real estate. The 1250 property is 27½ years straight line and commercial, 39 years straight line.
Toby: Yeah, the real estate component. You’re breaking off the personal property when you’re doing a cost seg and writing that up faster. All right, we’ll take a look at that one. Eliot.
Jeff: One thing we do in that case is I’m selling my rental, and I’ve done a cost segregation or something that’s why I have all this 1245 property. When I sell my property, I am putting all the proceeds towards the real estate, not the personal property part. I’m basically abandoning the personal property.
Toby: That’s usually how people write it up, because it makes sense if I’m selling a building and I have a bunch of land improvement, or let’s just say carpeting. The last thing they’re buying is the carpeting, you say it’s zero value.
Jeff: What that does is keep me from having to recapture that 1245 depreciation at ordinary rates.
Toby: Probably just lost 99% of the people there. All right, that question was a little bit complicated. Let’s dive into one that’s a little more straightforward. “When are crypto earnings taxed?”
Jeff: It depends.
Toby: Gosh, bless it.
Jeff: Let’s do what most people are doing. I’m buying and selling crypto. Let’s treat it like a security. When you buy it, it’s not a taxable transaction. When you sell it, you pay capital gains tax on the difference between your buy and sell. That’s scenario number one.
Toby: What if I trade a bitcoin for some dogecoin?
Jeff: It is a taxable event. It’s considered a sale, the bitcoin and a separate purchase of the dogecoin.
Toby: What if I trade my bitcoin for a Lamborghini?
Jeff: You’re going to have to recognize any capital gain you have on that bitcoin. But that also gets in the scenario three for the person you sold or bought the Lamborghini from.
Toby: It comes down to that crypto is not currency, it’s considered property. Imagine that you’re just dealing with shares. We like crypto, because they’re not subject to the wash sale loss rule, because they’re considered property. They’re not considered a security, but it’s best to think of. I have Microsoft shares, and I want to buy a computer. I have to sell those shares and then buy the computer. In crypto, that’s what’s going on.
Crypto earnings are taxed when you trade the crypto for another crypto, or you trade it for other property, or you sell it. What if I sell crypto and buy silver? Then the crypto is, I sold the property, I recognize the gain, and then I buy silver. There’s no tax free way to do it unless you put it in an IRA, Roth, a 401(k), or another exempt entity, even using a charity works.
Jeff: What if I mine or stake, I create this crypto?
Toby: All right, staking is ordinary income when you get paid. Hard fork, that bonus, those airdropped tokens are taxed when they’re received. When you mine, you’re taxed at the value on that day of the value that is mined. If I create a bitcoin at $40,000, my income is $40,000 minus my expenses, my electricity, and things like that.
Once I’ve mined it, now my basis is that’s my basis. If it’s $40, 000, it’s $40, 000. Anything above that is then capital gain. If I hold it for more than a year, it’s long term capital gain, less than a year, it’s short term. Staking and mining are ordinary income activities. Trading, selling the crypto, that’s capital gain, because it’s the sale of property.
Jeff: If you’re accepting cryptocurrency for people to buy stuff from you, it’s treated pretty much whatever the value was as ordinary income to you. It’s treated as though you received that.
Toby: If somebody’s paying you?
Toby: Yes. The value on that date, I never could figure out. It doesn’t close. That market doesn’t close, so you pick a value to that date. When you donate crypto, you actually have to get an appraisal. Kind of weird, but there are companies that do it for $300, but the value of your crypto on that day can be a little letter so you can donate it.
Crypto is one of those interesting areas, where I’ve gotten more people get incensed at the idea that they get taxed on mining it. I’m like, you’re mining something. You’re mining something of value. It wasn’t there, and now it’s there. Yes, you’re solving equations and you’re spending a bunch of energy on it, but the IRS treats that as no different than if you made anything else. Here’s its value in your hand, and then they’re going to let you treat it as a capital asset beyond that.
Jeff: It’s one of the few pieces of inventory that is taxed when created, which is weird.
Toby: Is gold taxed that way?
Jeff: Only when I change it from lead to gold.
Toby: You’re the alchemist. Crypto earnings, I guess, is the easiest way to look at it. Let’s put it this way, your earnings’ taxed upon the sale or trading it for something else. It’s the easiest way to look at it. Fun stuff. A soft fork is not taxable, hard fork is taxable. Hard fork, ordinary income. Every other sale, like when you sell crypto generally is treated as capital. Fun stuff.
“For real estate professional status, which activities classify for the 750 hours? Does training, traveling, search for property?”
Jeff: It’s going to be real estate activities in your real estate business. It does not include real estate financing. Traveling generally does not get included in that 750 hours, and I wouldn’t think training would either.
Toby: There are two tests. Whenever we deal with passive activity loss rules, and we’re trying to take the real estate profession. Test number one is one spouse if it’s a married filing jointly or just the taxpayer if it’s single, has to meet the 750 hours in a real estate trade or business.
It could be multiple real estate trades or business. I could be in construction, I could be a real estate agent, but I have to hit 750 hours, and it has to be more than half of my personal services for that year. That’s test number one, it has nothing to do with my properties.
Test number two is, did I materially participate on my properties? Again, if it’s married filing jointly, you add them up. If it’s one person, it’s just them. There are seven tests to meet material participation. The problem is, is that training, traveling, and searching for properties, investor activity? It doesn’t follow into either bucket except in extraordinary circumstances.
Generally speaking, if Jeff is driving around looking for properties, he’s scouring the internet looking for deals, he can’t add that to his real estate trade or business. Let’s say Jeff is in construction. What does searching for investment properties have to do with his construction business?
If what he’s doing is he’s flipping, and it’s part of his business, you may be able to put it under there. Or if it’s part of Jeff’s licensing, where he has to get continuing education to keep his construction license, then that’s going to be included. But the IRS likes to say, oh, you’re acting as an investor, doesn’t count towards anything, or you’re in your trade or business.
We’ve seen folks that track their time, and they tracked a whole bunch of education, looking around for properties, and they said, that’s my trade or business. And you’re like, that’s not. It would have to fall in. If you’re a realtor and you have to do continuing education, then that would work. If you have to go to a conference as part of your organization, that would be part of your 750 hours.
It is not part of your material participation on your properties. The material participation on your properties is the management, negotiating leases, fixing things, overseeing construction on your property or repair, and the hours are much, much less. It could be literally a hundred hours or less, depending on the level of your activity compared to other people’s. The get out of jail free card between a husband and wife is 500 hours.
As long as you hit 500 hours of material participation on your properties, and you could group all your properties is one, as long as you do that, you’ve hit the material participation level, but they’re two very, very different things. I always like looking at those. I know it gets complicated, guys. Just to be annoying, 469(c)(7) is the code provision that covers passive activities and specifies this exclusion.
There’s one other, by the way. There’s active participation, which doesn’t require much of anything other than managing the manager, but it phases out. If you’re adjusted gross income, it goes over a hundred thousand bucks, then it starts to phase out. That’s for $425,000 a year. There are some little things that you could use in the code. You just have to be aware, and then you have to make a good narrative.
If you’re doing training, traveling, and searching for properties, it better be part of your real estate trader business. Otherwise, upon examination, the IRS is going to say, no. Especially if you’re right at 750 hours, they have a catch, which says if you just did the time to meet 750 hours, they can ignore it. You got to make sure you’re tracking this stuff, and it’s really legitimately part of your business. Anything else on that one?
Jeff: No, sir.
Toby: I could blabble about that stuff all day long. All right, let’s talk about short term rentals. In this case, let’s see what it says. “I self-manage a single short term rental that I own. I want to pay my kid who is 16 years old for doing legit work for the Airbnb at a reasonable rate. Do I just write them a check every month based on the hours they log? Or do I have to hire a payroll company to issue them a check? I do not have any other employees. If I don’t hire a payroll company, how do I issue them a W-2 form?”
Jeff: You hire a payroll company, or hire somebody to do your payroll for you. It may not be Paychex, ADP, or some of the others. Here’s why you want to do payroll in this case. It’s probably through your Schedule C, or I guess it could be through your S-corporation. But if you just write them a check every month and then 1099 at the end of the year, they’re going to have to pay self-employment tax. No ifs, ands, or buts. If you W-2 them, and you pay them with paychecks through your Schedule C, your sole proprietorship, or your partnership, you don’t have to withhold payroll taxes on them.
Toby: It really comes down to, what is the short term rental and how is it taxed? If this is a short term rental that’s in an LLC that’s disregarded or an LLC that’s taxed as a partnership, then you don’t have to do any payroll or anything. You can literally just pay them, and you don’t have to worry about withholding.
Jeff: I think you still have to do payroll, but you just don’t report any of the tax.
Toby: You don’t have to report any of the tax. In other words, you’re just running it through. Would they have to go through a payroll company to do that, or could they do that with an accountant?
Jeff: They could do it themselves or with Quickbooks, I think you can do it. Troy is all over this subject.
Toby: You can just call us. If you’re working with our tax department, then you could just have them do it. If somebody says it’s $600 or less, I don’t think you have to file it as payroll. There is a de minimis amount. I forget what that is too.
Jeff: No de minimis for payroll, only for 1099s.
Toby: I thought there was 1500 or something like that. Is there some weird one? Maybe Troy knows. Troy, you’re smart.
Troy: Hello, it’s me, Troy. Jeff is correct. The $600 is for 1099s, not for payroll. That’s the case. You could do quarterly payroll or annual payroll rather than doing weekly or biweekly. However, you still are required to fill out the quarterly payroll forms. Even if they’re zeros, you still have to file them.
Toby: Could you do that at the end of the year?
Troy: You can’t do the quarterly filings at the end of the year, because you’ll accrue penalties if you’re late filing. You want to stay on top of those.
Toby: Even if there’s nothing owed. Do they penalize you a dollar amount?
Troy: You’re asking me hard questions on the spot here, Toby, but there is a penalty for not filing timely with those quarterly reports.
Toby: So your best bet is just to put it through payroll then?
Troy: Yeah, correct.
Toby: Can somebody do that individually, because there are zeros? What do they have to do, the electronic payment thing? What do they do?
Troy: Honestly, for the zero reports, those are really easy. It’s knowing what your EIN number is and filling out your basic information, putting zeros on the dollar amounts. That part’s easy, and then you can work with ADP, Anderson, Intuit, or whoever, to do the big payroll at the end of the year.
Toby: Yeah, but what if you have no actual payroll? What if it’s just the husband and wife? They own the partnership. They want to pay the kid. Is that a big deal? You just do it once a year?
Troy: Yeah, you could do that. The problem is if you’re doing it by yourself, figuring out those calculations can be a little difficult, especially if there are states involved.
Toby: What if there’s zero? They’re all zeros? You’re not paying anything, right?
Troy: If they’re all zeros, then correct. But that one at the end of the year is not going to be zeros, right?
Toby: Because you have to put the amount that you actually paid your…
Troy: Correct. Right.
Toby: The child probably won’t pay tax on it. There’s no withholding, there’s no nothing. There’s a lot of zeros, plus the one amount that you paid. What would you say, Troy? Just have them reach out if they need that.
Troy: Yeah. You reach out, or we can get you set up with ADP. We have a partnership with them as well. We can definitely help out.
Jeff: That’s relatively inexpensive, the program we have with ADP, isn’t it?
Troy: Yeah. I want to say it’s $600 a year or something like that. It’s not a huge, huge number. It might be worth it for the tax benefit to do it and make sure you have that peace of mind.
Toby: Yeah, because you pay the 16-year-old. Let’s say you pay them $10,000 a year, they’re going to have zero federal income taxes. They could throw $7,000 into the Roth IRA and literally never pay tax on any of that money or the growth ever again. Seems like it might be worth it. There, fun stuff.
Jeff: Thanks, Troy.
Troy: No problem. One thing I did want to clarify real quick is on that zero withholding, zero taxes, that is only if it’s a partnership or an entity that’s disregarded to your 1040, not a corporation.
Toby: Correct. Right. Yeah, but we’ll make it clear. If they’re doing a C-corp or an S-corp, you’re paying into social security, which isn’t bad. We have 40 quarters in order to qualify, so it’s going to be a really small amount, but then they could also jam that.
Now you have up to $23,000 this year, 401(k), where you could jam that much into a Roth. If you’re paying your child even a little bit more, you might be able to get all that into a Roth. It’s fun. Anyway, thank you, Troy, for jumping on. That’s why I like having accountants around here. Thank God. I’m surrounded by them.
Jeff: You can’t swing a cat without hitting one.
Toby: That’s about right. I don’t want to swing my kitties, they’re good kitties. All right. Do I have to write a check every month based on the hours they log? Not necessarily. You could pay probably quarterly.
Jeff: That’s actually another reason to talk to somebody beforehand. You don’t want to be writing a check and calling those checks payroll, because then that gets into the whole situation where Roy was talking about, if I pay Toby today and say it’s payroll, then I have to file that first quarter report with numbers on it.
Toby: Somebody says, don’t I just need to file the W-2, W-3 and skip the 940, 941s?
Toby: We could do the 940s?
Jeff: Yes. They have to match your W-3, and you will get notified if they don’t.
Toby: All right, let’s move on. “Hi, I’m planning to start lending money to real estate investors. Other private money lenders I know of do their lending business through an S-corp. I currently don’t have an LLC or an S-Corp for lending. I only have a Wyoming holding LLC that I opened to use for real estate investing. Which would you advise is best for private money lender, an LLC, an S-Corp, or other? And why? Thanks in advance.”
Jeff: Do not do it through your Wyoming LLC. That’s a start. I like the S-corporation rather than the disregard LLC if all you’re doing is lending through this, because everything you make an interest is considered ordinary income in that business. Whereas if I have this business, then I also lend Toby some money, that interest is just interest income to me. There is a difference there.
You want that status in case something goes south that you can write off that bad debt, whereas you’re unable to do that otherwise. I like the S-corporation, because there’s no self-employment tax on your earnings.
Toby: I will say that I like to keep things once removed from my pot of money. If I have cash in a Wyoming holding entity, or if I have other business interests, maybe it’s holding some real estate LLCs, the last thing I want to do is have Dodd-Frank claim or something else bring somebody right into where I have all my assets. Once removed, I want to have that.
It could be an S-corp. Somebody says, could it be a C-corp? It could absolutely be a C-corp. What I would do is I would loan the money to the C-corp. Let’s say I loaned the money to the C-corp at AFR rates, which right around 5%, and it turns around and lends it for 10%, and there’s that little 5% that it’s making, and it’s paying my expenses, it’s reimbursing and everything else, and it gets it down to zero, that’s a big win for me.
I still have interest income, but what I’ve done is I’ve created a buffer between me and the individuals to whom I’m lending. And I do have other deductions that I might be entitled to. If it’s going to be pure profit, like you’re just doing gravy here and you don’t have a lot of expenses, or you have another business where you write off a lot of your expenses, then I’m with Jeff. You’re probably doing it as an S-corp and just letting it hit your return, but you don’t want to have to be forced to take a salary out of it. The good part about using an S-corp is that the nature of the income is maintained when you do that.
Toby: Pretend that I’m the pot of gold and Jeff is the S-corp. I’m loaning money to Jeff. Jeff is loaning it out to other people. If somebody sues, they’re coming after Jeff. Jeff doesn’t have a lot, because he owes me all the money. I loaned it to him, he loaned it to you. It takes it out of the firing line of that individual if there’s anything that goes wrong. Asset protection side.
All right, “I turned a home into a rental in the middle of the year. Can I take a whole year of depreciation? Can I utilize cost segregation? And what value do I have to use when starting out since I owned the home for several years? Do I use the current value of my home, or do I have to use the cost basis of the home when I purchased it?”
Jeff: Good questions. The answer to the depreciation question is no. You start your depreciation in the middle of the month that you converted it to the rental property. You can do cost segregation, but I’m going to talk about the basis, which is the second half of this question. Your basis is going to be your cost in the home and not just your purchase price. Any improvements you made, my house, I built a pool, I put solar panels on, I did this and that.
Toby: Solar panels. It doesn’t help you if you’re doing it for the pool.
Jeff: No, these are real solar panels, not the pool heating.
Toby: You got a 30% extra.
Jeff: I do. All of that, and if we put solar panels on, that confuses things, but we’ll get into that at another time. Your basis in the property is not only what you purchase it for plus your closing costs, but everything else that, improvement wise, put into the house.
There is one specific rule, I turn my principal residence into a rental property. If the value of the property has increased, I use that higher fair market value. If the fair market value has gone down below my basis, then we use my basis and not my fair market value. Not likely to happen in this recent market.
Toby: Again, let’s break these things into their little pieces. We have the depreciation. Let’s say I bought a house. Let’s say it was a $400,000 house, land was $100,000, the improvement was $300,000. I put about $30,000 into it, so now my improvement value is $330,000. And I put it into service in the middle of the year. Let’s say that that’s what I’m into. My basis is higher than the fair market value. I’m taking that, right?
Toby: The fair market value has to be equal or greater than basis, right?
Toby: All right, let’s say they’re roughly equivalent. You’re going to start writing off the 27½-year property mid year. Is it mid year right in the middle?
Jeff: Mid month.
Toby: If they put it in in June, it would be the middle of June?
Toby: All right. You get that portion 27½ years, let’s start it. You’re going to get half of the year. But let’s say we cost seg. Cost segregation just means we’re breaking out the personal property from the real estate improvements, the structural components.
My driveway, that’s 15-year property, shrubs and everything I put in there in the trees, fences, all that stuff is 15-year property, carpet is five-year property, the appliances, the counters, window, treatments, all that stuff might be five-year property. I have a whole bunch of five, seven, and 15-year property, boom. Those, I can accelerate the depreciation. If it’s this year in 2024, it’s 60%.
If I put the property into service in 2023, it sounds like last year, it’s 80% of that. You can write off in year one, period. It’s not partial, it’s not half the year. If you put it into service in December, you could still get the 80% deduction. It’s just like buying a pizza oven for your pizza business. You’re writing that puppy off at the end of the year.
Everybody runs out and buys a vehicle with a gross vehicle weight of over $6000. That’s what they’re doing, even though they have no idea what they’re going to do themselves the next five years by doing that, but we love our accountants that like to do that. If it’s truly equipment, if you are doing that, then you get to write that puppy off in that year.
The answer to your question is, can I take the whole year of depreciation? No. Can I utilize cost segregation? Yes. What value do I use for starting the home, the basis plus any improvements, so the adjusted basis? Then I’m going to put a caveat that if you cost seg the property that is five, seven, and 15-year, you can write off and bonus that depreciation and write it all off in year one to the extent that you can to 60%.
Jeff: In your scenario, and I’m bringing this up because it comes up in a later question, if I just don’t cost seg, I’m probably gonna get about $5500, $5000 of depreciation in year one. If I do cost seg, that number can arise somewhere between $40,000 and $50,000.
Toby: Yeah, and the number I gave when I said it was 100 and 400, it’s actually a little bit higher. You’re going to see, on average, probably about 30% of the basis. You’re probably talking about $120,000, 60% of that is $72,000, and then you’re still writing off the rest.
Somebody says, would it have been better to sell the home to an LLC before renting it out? It would have to be another taxpayer. Unfortunately, it probably have to be an S-corp. You could do that. We do that. I’ll tell you when we do that. It’s very seldom you want to see a piece of property in a corp, but when you see it, it’s almost always, because you wanted to take advantage of the 121 exclusion that you were going to lose if you just sat on the house. You’re not paying any tax, you’re adjusting your basis up, and then you’re depreciating it faster.
Jeff: I see you read questions. Something just made me think of is, it was my personal residence, I turn it into rental, I’ll take this bonus depreciation on the cost segregation, and I rent it out between two and two and a half years, then I can turn around, take that $500,000 exclusion on my gain, plus I can 1031 that exchange up.
Toby: That’s a really good point. Here, we have a home that we turned into a rental. It was at a personal residence that was used as your primary residence two of the last five years. You have three years to do this. Then you could take the 121 exclusion, which if you don’t know what that is, it’s a $500,000 exclusion if you’re married filing jointly on your primary residence, so long as you lived in it two of the last five years as your primary residence, not as just a typical, not a second home, but your primary residence. You could do that, and then you have a 1031 for the rest of it. You could literally double up. That’s really smart.
Jeff: I like it that way sometimes.
Toby: I hope you guys are starting to realize that there are lots of different ways to get where you want to go. There are some complexities here, but it’s not rocket science. You’re just sitting here bantering this stuff back and forth, looking for the best way to do this for you. And that’s the fun of it.
Speaking of fun, again, we have the tax and asset protection workshop coming up this weekend. I think we have another one on the 11th and another one on January 20th. But if you want to learn about LLCs, land trusts, corporations, dealer status, 1031s, how depreciation works, that thing called cost segregation, common errors that accountants make, and then even learning about estate planning and how to use a living trust, and the three options you have when you’re looking at estate planning and the four ways to distribute estate, we go over all that on Saturday at the tax and asset protection event and also on the Saturday the 20th.
They’re a little bit of fun. You can always come and you always learn something new. I’ve been doing them for 25 years, and I still pick stuff up or my, gosh, I forgot about that. That’s pretty cool. Or you see somebody’s scenario, and you have to work through it. Even now, Jeff, you’ve been doing this for how long?
Jeff: Thirty-three years.
Toby: Thirty-three years and I’m 25 years. You still see stuff where it’s like, it could be this, this, or this. You’re just trying to find the best way to navigate your way. It’s a little bit of a game. If you look at it that way, you’re a lot happier. If you just get mad at the tax code, then you’re pretty miserable.
Somebody says, can we get a recording of this? Let’s see. For the tax and AP, we don’t do recordings. For this, we do. I think we break them down and put them on YouTube. If you’re platinum, I think you automatically get it. But I think we send everybody the link to the copy. You don’t have to go through the pieces, you can just go through the whole thing.
All right, this is a fun one. “I have a 50/50 partnership with a friend. We own two short term rentals together. Each of us is materially participating in one short term rental. Is there a way to take full cost seg advantage against our respective W-2s, or can we only take 50% of one property against their W-2 and for the other person, it will go to the passive bucket and vice versa for the other property?”
Jeff: I had to stretch my brain for this one. We got a partnership with two properties in it. Toby does all the work on one, I do all the work on the other. The partnership is materially participating, which is important. But once it’s reported to my 1040 and your 1040, I’m only material participating in one of the entities.
Toby: What if it’s one entity, and we elect a group, all the activities is one activity?
Jeff: It’s not going to matter here, because it’s a short term rental.
Toby: Even with short terms, we can’t match them up?
Toby: I think you can group.
Jeff: So you’re electing the group?
Toby: I take two rentals, and I treat them as one activity. The only question is, did I materially participate so that when I get the depreciation or the loss, because this is going to be a trade or business? If it’s seven days or less, this is not a rental activity. When people hear short term rental, you should think we’re running a pizza shop.
Let’s say we have two pizza shops. Jeff has one on the south end of town, I got one on the north end of town, and we treat them as one activity, it’s really one restaurant. We are both materially participating in that. Couldn’t we both get that deduction?
Jeff: Yeah, you probably could. If we go back to the aspect that it’s a trade or business, it only matters that I’m materially participating in the partnership, not the activities within the partnership.
Toby: Exactly. It’s like having five restaurants. Did I materially participate? Do I have to do each restaurant? Or if I lumped them as one activities, one economic unit, I can do that.
Toby: Any of the accountants out there, Ross, Tanya, Jared, Eliot, Troy.
Jeff: I know Eliot has looked at it.
Toby: Any of you guys, anybody who wants to chime in, can we group our friends the two Vrbos? Let’s say we have an Airbnb and Vrbo, Jeff works one, I work the other, but we’re a partnership.
Eliot: Jeff was right, you do the material participation at the partnership level, so then both activities will be split out amongst the two K-1s, I think is how it happened. I don’t know that we would group here, because grouping is a taxpayer thing that happens on the 1040, not at the partnership level. It’s my understanding.
Toby: We’re just using the partnership. As long as they have one partnership, let’s say they had a single LLC on these two.
Eliot: I think this is that classic situation, where each partner has over 500 hours. One can’t have less, because otherwise we’re looking at 100 or more than anybody else test. As long as they both have 500 hours, material participation within the partnership activity, I think then you just split up the activity. I don’t think you would send necessarily one short term to one partner and the other to the other.
Jeff: Eliot, you wouldn’t split out the activities, because you don’t do that with short term rentals. You only do that with long term rentals.
Eliot: Yeah, I wouldn’t. I would put it all under the partnership level and see if they materially participate.
Jeff: Yeah, it will just be ordinary income of the partnership.
Toby: Yeah. It’s no different than if they ran [inaudible 00:55:46]. Let’s say they didn’t do that. They each had a short term rental, and each had a passive interest in each other’s short term rentals, then you could do it that way too and say, hey, this is mine. This is what I materially participated in. The other one on passive, in which case, I think what they said here is 50% flows to the one individual as a material participant, 50% flows to the second individual as a passive activity, and vice versa on the other property.
Jeff: Keep in mind, they have to be under the same entity umbrella for this to work. If you have them in two different entities, this is probably going to fail.
Toby: I would think that it would work. The 50% passive would work if they’re in two different LLCs. If I have property A, and I’m running it, and you’re just a passive owner, in property B, you’re running it, and I’m just a passive owner, then I get the K-1 off of this one. It’s passive. I get the K-1 off of this one, it’s active. Vice versa for you, you’re getting the active over here and the passive over here.
If we want to treat them all as one big old active activity, which would be ideal, obviously that’s best for everybody. If they want to have ordinary loss, and they materially participate, which for the test, I think Eliot’s right, I think it’s the 500 hour test, because how could you meet that 100 hour if you’re not married, it’d be more than anybody else. You both have to hit that.
Jeff: If I want to have these two properties in their own LLCs disregarded to the partnership, that doesn’t change anything, right?
Toby: No, that would be fine too. Yeah, you can do that. Again, different routes to go. There are some questions here. You say short term rental, are you really hitting seven days or less? Who’s doing what on which property? What’s the basis of these? Does one look really good and very attractive from a depreciation, and one’s not so great? All those get factored in.
All right. “As a W-2 earner, can I save taxes if I buy a long term rental?”
Jeff: Probably not at this time. The problem of long term rentals is unless you’re a real estate professional or active participant, any losses you have are probably going to be suspended. They will be suspended, there’s no probably about it.
Toby: Let’s break this down, because you’ve given the right answer.
Jeff: What did the accountants say?
Toby: I’m looking at it. There’s a W-2 earner, and they obviously want to offset the W-2 income. But they asked, can I save taxes if I buy a long term rental? If that long term rental is kicking you $20,000 a year and because of depreciation, you don’t have to pay tax on it, then I say, yeah, you’re saving taxes.
If you want to offset your W-2 income, you have to fall into one of two categories. It’s going to either be active participant, which means you have to be making less than $100,000 of adjusted gross income up to $150,000, phases out, and you could write off up to $25,000. There’s no real special bells and whistles, you just have to be managing the manager.
The other side is being a real estate professional, which is the two-part test we discussed earlier, 750 hours more than 50% of your time, personal service time, in a real estate trader business, or real estate trades or businesses, you could have multiple, and you have to materially participate on your long term rental. It’s going to be really tough to do, unless you’re managing that long term rental, and you better be in a real estate business.
If you’re a W-2 earner, unless you’re a real estate agent, a construction, or something, and you own more than 5% of that business as well, it’s going to be really a tough road for you. It’s probably going to be that active participation, that might be the case. We’d have to see what your income is.
You can save on long term rentals, but there are hoops you’d have to jump through. It might be impractical, which is why Jeff is very hesitant to say. We deal with this all the time. Somebody comes and says, I want to write this off. Okay, 750 hours. One spouse has to qualify, it has to be real estate trades or businesses, here’s the list the IRS gives us, and you have to materially participate in all your properties.
We’re probably going to group them all together and aggregate them all as one activity. There are some hoops you have to jump through. If you do hit it, it’s great. It’s like a grand slam. If you don’t, it’s a big whiff. You get no benefit. You either strikeout or you hit a grand slam on that.
Here’s an interesting one. “I’m getting a lot of pushback against cost segregation from my accountants. They say it could trigger personal property issues in Maryland and that the cost of the study is prohibitive.” What do you say?
Jeff: When they say it could cause property issues in Maryland, I think they’re talking about personal property taxes. Here’s my honest answer. So what? The personal property taxes in most states are based on the ad valorem they call it. It’s based on the current value. They usually have depreciation schedules of their own. It’s not that much property tax.
Toby: When you do a cost segregation, I think that the personal property is still treated as real estate for state tax purposes.
Jeff: I don’t know. I have not dealt with cost segregation with personal property type.
Toby: I’ve done them. I think we’ve done them in Maryland, and we’ve never had an issue. All I can say is, if your accountants are pushing back, it’s probably because they haven’t done it. We have a great relationship with the Cost Seg Authority. They do them all over the country. We never had an issue. We never had an issue in Maryland that I’m aware of, that I know of. I don’t think so. The other question that Patty says, no, we never had an issue.
But the other issue is the cost of the study being prohibitive, and it used to be. It depends on who you’re working with. I use a simple rule. If the juice is worth the squeeze, I want to 7x time return on whatever the amount is. If it’s $2000, I want to save $14,000. If it’s $3000, I want to save $21,000. The idea is that a dollar today is worth more than a dollar tomorrow. A dollar today is worth more than a dollar in five years. A dollar today is worth more than a dollar in 15 years.
I want to accelerate that depreciation now. If I can get at least a seven to one, I’m taking it. I’m taking it all day long, and I’m going to reinvest that money. It’s going to save me money, put it in my pocket. Those types of studies to get to your number to see whether it’s worth it is free.
We have great relationships, you can reach out to us. It’s the Cost Seg Authority. It’s Erik Oliver that we’ve worked with for years. We’ve done hundreds of studies with them, probably more than that. I don’t know how many studies we’ve done over the years, but it’s a lot. They do a great job, and we’ve just had great results. We’ve never had an issue.
Jeff: I’m not sure if you heard what Toby said about Cost Seg Authority. I know we’ll give you an estimate of how much your depreciation or how much you’re going to save before they actually do the study.
Toby: Yeah, they won’t charge you in that time. They’ll say, give me your numbers, give me your tax, give me this, and we’ll lay it down. They’ll send you a link. Patty probably has it. I think it’s aba.link/csa. They’ll ask you a few questions about the address, type of building. They’ve done them all over the place. They use engineers. They’re super great. It’s andersonadvisors.com/csa. They’ll do that all for free just because they like our clients.
Jeff: I’m not going to say they’re wrong, but I think their concerns are a little dramatic.
Toby: I have a simple rule. If they’re not up on it, they’re down on it. If they don’t want to be involved, then they’ll find a way not to be involved, even if it’s in your best interest. Again, there are three rules I use whenever it’s financer tax. Are you ready? It’s real simple, three rules, super, super simple. Calculate, calculate, calculate.
You got to give somebody options, and they should give you the option to say whether it’s cost prohibitive. If somebody comes to you and says, hey, I would have done that for $1500 and would have saved you $50,000, you’re going to want to punch your accountant. I don’t want you to punch your accountant. Accountants work hard, but sometimes they need to learn a few new tricks.
Let’s get the numbers, then they’ll probably be so happy. They’ll say, it was never like that before. Or they’ll say, I did not know that I’m so happy. Maybe I’ll give you a big discount on your return, said no accountant ever.
Jeff: There’s my buddy Toby.
Toby: There’s me. We are only at what is it? 739 videos today. We’re very modest in the amount that we publish. We try to put some stuff out there, including you’ll see some of these questions pop up. If we think they’re good, we’ll share them out there. But you could absolutely go on to the YouTube channel and register. Hopefully, we get over the hump of 300,000, because that would be cool. I don’t know what that does. I think it means that my cats might sit on my lap a little bit longer and purr just a little bit louder.
The tax and AP event with Clint, we got one coming up on Saturday, so please join us for that. There are some other events coming up as well in January, but the fun one will be this weekend, because we haven’t done one for several weeks, where we’re chomping at the bit. We really like to do one.
If you have questions in the meantime, we don’t charge you for this. Just reach out to us at firstname.lastname@example.org. We’ll answer your questions to the best of our ability, and we may pick one and throw it up on the screen during one of these events. Keep it generic. Don’t put all your name. We’ll take your name out of it anyway. We will always take a look at it.
A big thank you to Patty, Matthew, Eliot, Troy, Yulia, Ross, Tanya, Jarred, Amanda, and Elisa. They’ve been answering questions. They still have a few questions to get to. They’re getting through as fast as they can, so do not worry. Even though we may go away now and say, sayonara, if you are waiting on a question, just hang out. They will answer your questions. They get through them quick.
I’d imagine within five minutes at the end, you will have an answer, so stay on if you have an unanswered question. If you leave, you’re not going to get your answer, so just stick tight. If you have a pending question, we will get to it. We’ll see you in two weeks on another Tax Tuesday.
People always say, why do we do this? Because it’s fun, it’s interesting, and it keeps us always engaged in what’s going on out there. There’s all sorts of stuff changing all the time, and it’s pretty tough to keep up on. At least this way, every two weeks we can get together and say, hey, has anything changed? We’ll just keep you posted.
Believe it or not, if you just listen to the anxiety level of being around taxes and doing taxes, you’re going to hear something that’s going to prompt savings at some point. You’re also going to hear something that makes you go, oh, good, I did that right, maybe give you a bit of peace of mind. If you hear something that you’ve just never heard of before that might be ethical to you, it’s really fun to find that money. Sometimes it’s just like, yay, me. You get to keep some more dollars in your pocket.
I have a real simple philosophy. You’re probably a better steward of your money than the government. Nothing against the government, but they don’t spend the money that well. I’d rather you keep the money, and you decide what you want to do with it. You have to pay the government your fair share, but you don’t have to leave them tips. We’re going to do our best to keep some of that tip money in your pocket. Anything else, Jeff?
Toby: All right. Happy 2024. We’ll see you in two weeks.
Thanks for watching. Click the link so you can join us live and get your question answered by myself and my tax team.