Did you miss the April 15 tax deadline? Are you safe from significant penalties? What’s the best way to legally, morally, and ethically not pay taxes? It depends. Jeff Webb, Tax Director, and Eliot Thomas, Senior Tax Advisor, of Anderson Advisors answer your tax questions. Submit your tax question to taxtuesday@andersonadvisors.
Highlights/Topics:
- If you experience a one-time large capital gain from exercising stock options, is it absolutely imperative that you figure out quarterly payments to avoid penalty, and if so, what if you missed April? There’s a safe harbor for calculating tax estimates and it requires paying in 90% of the current year tax or 110% of the prior year tax; and estimated tax penalties are typical not significant, but handle missed payment soon
- What is the best way to take advantage of Section 179 for new vehicles over 6,000 pounds? Typically, most people do not use Section 179 because of bonus depreciation, restrictions, and limitations
- How are crypto currencies taxed, and what’s the best way to legally, morally, and ethically not pay taxes? Depends on how you are getting the crypto currency; if you are buying and selling, it is treated as a security and other rules apply; if you are mining crypto currency, find out the value of that crypto bitcoin the day it is created
- What will happen if you open an LLC with Corp status but you missed the deadline? What should you do? If you missed the tax deadline and have a loss on your Corp, it typically doesn’t affect you; if you have a lot of startup costs, you need to file your initial tax return on time
- Does tax on depreciation recapture, like capital gains, go away when property is inherited? When you inherit property, everything resets and goes away, like capital gains
- Do I have to report a home I lived in and sold even though I purchased a new home? Previous Section 121 states as long as you buy a more expensive home than the one you sold, you can defer any gain until the age of 55; Section 121 now states if you lived in the home for two of last five years, you can defer a large part or all the gain
For all questions/answers discussed, sign up to be a Platinum member to view the replay!
Go to iTunes to leave a review of the Tax Tuesday podcast.
Resources:
Infinity Investing Workshop on June 5
Infinity Investing: How The Rich Get Richer And How You Can Do The Same by Toby Mathis
Real Estate Professional Requirements
Section 121 – Capital Gains Exclusion
Employee Retirement Income Security Act (ERISA)
U.S. Department of Labor (DOL)
Anderson Advisors Tax and Asset Protection Workshop
Anderson Advisors Tax-Wise Workshop
Anderson Advisors Infinity Investing Workshop
Full Episode Transcript:
Jeff: Hi, welcome to Tax Tuesday. I am not Toby Mathis; he’s not here today. Instead, we have Eliot Thomas with us. He is our Senior Tax Advisor right now. I’m Jeff Webb, I am a CPA here at Anderson. This is Tax Tuesday, bringing in tax knowledge to the masses.
You can ask live questions and we will answer them as we go. We have onboard Tavia answering your bookkeeping questions, Dana, Christos, Piao answering questions, and Patty helping out with chat and questions. You can send your questions to taxtuesday@andersonadvisors.com and we will get to them as we can. We get a lot of questions in. We pick ones that we do live and try to answer the others as we go.
If you do need a detailed response, you need to become a Platinum or a tax client with Anderson. By detailed response, I mean we talk about where it’s a lot of detail particular to your situation that may not apply to people who are in this group.
This is fast, fun, and educational. We love to do the education and give back to everybody. Personally, a smarter client is a better client. I know Toby likes to ask where you all are from. I’m not going to ask because then our chats spin for the next five minutes while everybody answers. But we do appreciate you all joining us. I know you’re from all over the place and that’s great.
We’re starting to get questions come in on the question side. If you do have a question, make sure you’re asking it in the question side and not the chat side. If you ask a tax question on the chat side, it’s likely not to get an answer, but it will get an answer on the question side.
Let’s get into our questions. Our opening questions, “If you experience a one-time large capital gain from exercising stock options, is it absolutely imperative that you figure out quarterly payments to avoid penalties, and if so, what happens if you’ve missed by April?” We’ll talk about that.
“What is the best way to take advantage of Section 179 on new vehicles over 6000 pounds?” We’ll talk about that.
“How are cryptocurrencies taxed? And what’s the best way to legally, morally, and ethically not pay taxes?” We’ll try to fit in all three.
“I have two LLCs right now—one holding real estate, and the other a farming business. As a single member LLC that seemed to have some tax benefits, my question is, could I move the equipment from one LLC to the other entity, and then lease it back to the custom operating company, thus creating some additional deductions?” We’ll talk a little bit about that and what benefits are maybe. My vision is not the greatest, so I’m a little slow to read the questions. I apologize. Read this next one.
Eliot: “I am rolling out an employer DB (Defined Benefit) plan where I had employees in the past, and want to set up a Solo 401(k), is there a restriction, three-year waiting period to do this? My administrator says there is.”
Next, “If I currently have a 12-unit apartment building with a mortgage, and I sell a single family house rental property, can I use the proceeds from the sale of the single family rental property to pay off the mortgage of the 12 unit building to avoid capital gains tax?”
Next, we have, “What will happen if you open an LLC with a corp status but you missed the deadline? What should you do?”
And then, number six, “How do you depreciate rental property after one of the owners dies?”
Number seven, “How do I set up my company in Nevada when I will be conducting business in Texas?”
“Does tax on depreciation recapture, like capital gains, go away when the property is inherited?”
Number nine, “Do I have to report a home I lived in and sold even though I purchased a new home?”
Jeff: And we’ll get into the questions now. Thanks, Eliot, for doing that. “If you experience a one-time large capital gain from exercising stock options, is it absolutely imperative that you figure out quarterly payments to avoid penalty, and what happens if you’ve missed April?” meaning they […].
What happens there is, there is a safe harbor for estimated taxes. That’s primarily what we’re talking about, calculating the estimates. The safe harbor says that you have to pay in at least 90% of the current year tax. If these were actualized in 2021, they would have to put in 90% of the current year tax or 110% of the prior year tax.
Let’s say that your normal income is $100,000 but you have an additional $100,000 of capital gains from exercising these stock options. What you could do then is based your tax on the prior year, based your estimates on the prior year, pay them, and when April 15th comes in 2022, you would need to make sure that all your tax was paid in.
Eliot: It’s not necessarily imperative, but it might be a good idea. If you had a bump quarter—I think we had a whole lot—you might want to pay some of the tax there. Just so you don’t have to worry about later on, but you don’t necessarily have to as long as it’s done by the end of the year.
Jeff: You make a good point that you need to, even if you don’t have to make the payments now, like I talked about my mother in her farm. She’s selling the farm, she’s going to have a huge tax bill, but she’s not going to have to make any estimated payments in the year of sale because in 2020 her net income was maybe $30,000.
Eliot: She just has to make the liability from the previous year.
Jeff: Correct. Now, come April 15th, she’s going to have a huge tax bill. I’m going to give the poor woman a stroke. I’m going to have her write down the check and that will be all. That’s kind of the way it’s working.
Eliot: But not having to pay a lot of tax right now, isn’t because you’re her son, right?
Jeff: That’s true. You may owe a lot of money on those capital gains but you may not have to pay for them right now. And we’re usually of a position that it’s better for you to hold your money than loan it to the government sooner that you have to.
Eliot: We have a lot of investors who do a lot better, pay a little bit of penalty or something like that because they’re good at what they do, and they will make more money. Caveat to that, the opposite side of that, some aren’t.
Jeff: Yeah. and sometimes the estimated tax penalties are not that significant, depending on how much you owe. If you miss a payment, it’s not a big deal. Make that payment as soon as you can. They’re actually counting days when they’re figuring the penalties. If you miss the April 15th payment, if you make a buy May 15 for now, the end of May, you’re gonna have a little penalty on that but it’s not going to be huge.
Eliot: That’s basically, based on ½ of 1%?
Jeff: Yes. Next question. “What is the best way to take advantage of Section 179 for new vehicles over 6000 pounds?” You go ahead and give your first reaction to this.
Eliot: Whenever I see 179 here in the last year or two, I can’t even remember 179 for a second because nobody uses it. The reason why is because right now we have bonus depreciation. There’s no sense in using 179. 179 actually has restrictions to it. You can only use your depreciation or your 179 expense up to the amount of profit that you have. There’s other limitations as well.
We really deal with most depreciation which says, if I get that vehicle that makes that 6000 lbs and it qualifies as SUV or what have you, then you can take that immediate 100%, and you don’t have to worry about it. You can create a loss from that, and that can offset other ordinary income on your return.
Jeff: Let’s talk a little bit about how this 6000-pound rule applies to bonus depreciation. The rules for 179 and bonus are pretty much the same as far as whether a vehicle qualifies or not. Both for passenger vehicles like sedans, coupes, your basic passenger vehicle and other vehicles, the rule says if it exceeds 6000 lbs, you can take bonus depreciation on it.
However, sedans and coupes have a different rule from the SUVs, trucks, and vans. When we’re talking SUVs, trucks, and vans, we’re talking Gross Vehicle Weight Rating—GVWR—which means the loaded capacity of that vehicle, typically.
I’ll give you an example. Let me tell you the other side. Sedans and coupes are what’s called unloaded weight, or what you may hear as curbside or curb weight. It does include fuel but it doesn’t include passengers, or cargo, or anything like that. You take something, we’ll take like a Bentley Continental which costs well over, it’s a six-figure vehicle. If it could use that GVWR, it is over 6000 lbs. But since it’s a sedan, it has to use the curb weight, which is more like under 5000 lbs. By having this little rule, they tend to rule out sedans and passenger vehicles, what we call cars.
You see a lot of the SUVs, if they have any size to them at all—I think mom, I have a Hyundai Santa Fe, I think that qualifies—all of the domestic full-size pickup trucks qualify. It’s pretty easy to look up to see if a vehicle qualifies or not. You just have to differentiate between the car or what type of vehicle it is. Once it gets over 14,000 lbs—there’s some other specific rules and there’s different rules—now it’s a heavy vehicle, it no longer qualifies this way but it could still qualify other ways. All that being said, is once again, a bonus depreciation could be taken against, you can take a loss with bonus depreciation.
Eliot: Exactly.
Jeff: Section 179 you take that and let’s say, your income is about $1000.
Eliot: We just wasted 179. We could just the bonus depreciation, got a heavy loss and offset other income on your return.
Jeff: That’s really important, especially in these passthrough entities or Schedule Cs. You want that loss to pass through. You don’t want it suspended until you someday make a profit and can take that.
Eliot: Yeah, because you never know if that’s coming, that profit.
Jeff: One other quick thing you need to remember is both 179 and bonus, we’re mainly talking about 100% business use. Once you start using it for less than 100% business, you get less and less of a deduction out of it.
Eliot: You might have some ordinary income depending if it’s titled in the name of the business, what it should might be.
Jeff: This is a link to IIW. This is our Infinity Investing Workshop. It’s aba.link/iiw. I believe it’s this Saturday.
Elliot: I know we have a lot of them.
Patty: June 5th.
Jeff: Thanks, Patty. Please feel free to attend this. I think the registration is at this link.
We have to skip the questions and answers, and keep moving on. “How are crypto currencies taxed, and what’s the best way to legally, morally, and ethically not pay taxes?” We’ve talked about this in the past. It really depends on how you’re getting the cryptocurrency. If you’re buying and selling, it’s treated like a security. If I buy for $100 and sell it for $150, then I have a $50 capital gain.
Short-term and long-term rules apply. If I hold it, if I buy crypto today at $100, sell it a year from now at $150, I have a long-term capital gain of $50. Most people don’t hold crypto that long, they go in and out. It’s mostly short-term.
If you are mining it, then the day it’s created, you need to find out what the value of that current coin is, that crypto is. If I had mined it a month ago, it was worth approximately $60,000 a Bitcoin, I would have ordinary income of the price of that coin when it was created.
Let’s say I created the $60,000 Bitcoin. I turn around and sell it when it’s at $65,000, I now have $60,000 of ordinary income and $5,000 of capital gain.
Now, here’s the problem with the recent market. If I created that coin at $60,000, Bitcoin selling for about $35,000, I now have a $25,000 capital loss. I still get taxed on that original $60,000 for creating the coin, but now I have a capital loss. If that’s the only capital gain or loss I have, that’s limited to $3000 of loss each year. That’s something you have to consider.
Now, what is the best way to legally, morally, and ethically not pay taxes? Well, we go back to our normal tools of offsetting capital gains. When you’re mining coins, you can offset it with the cost of producing the coin. You’re going to have substantial electric bills. You’re going to have other ordinary costs incurred from producing that coin that you can use to offset the income from that coin. But when we’re talking about the capital gains side of it, then you’re starting to look at, do I have any losses? Unrecognized losses that I can go ahead and recognize? That I can sell something and create a loss to offset my gain?
Eliot: The earning of it and the mining of it, which is going to be ordinary income if we start there, if you knew you’re going to start this project, you might want to do it in a corporation. Maybe an S-Corporation where you can get some tax advantage through reimbursements and things like that, corporate meetings, so on and so forth. Get a little break there, then you’ll be able to get your capital gains.
Later on, you can trade in. That’ll be like our trading structure, perhaps, for capital gains and still offset some income. Set it up as a partnership. Put your interest, your capital gain, crypto, in there. Maybe push off a certain percentage or something like that to a C-Corporation where the rest would go to you individually, and get more corporate deductions there, perhaps.
Jeff: Most of these are going to be short-term capital gains when we haven’t held up the crypto for a year. It’s going to be taxed at our normal rate, whatever our ordinary rate is. Then, we really have to work on what our plan is to reduce our tax load. Sometimes, when the people I work with bought a lot of stock at the beginning of the COVID downturn and he’s been sweating it, trying to hold it for a year.
Eliot: Yeah, well, what more now?
Jeff: It’s partially a timing issue. Congress has taken away a lot of our tools—investment deductions, things like that—within the individual return on the 1040. Then, we have to do what you are talking about, maybe we need to look at a trading partnership that has a corporation involved. Then the corporation can deduct certain things that the individual couldn’t do.
Eliot: Correct, and you’re getting a portion of your income off your 1040 that way a little bit. Like Jeff points out, it’s ordinary short-term capital gains rates. Well, that’s ordinary rates. Effectively, you’re at the highest tax bracket you’re going to get taxed at. Taking a little bit off and getting that into a corporation might cut you some slack. Even if you didn’t sell it or later then sell, right now that’s 21% on the C-Corp level, so you’re getting a little bit of a break there. There are things that can be done and we don’t have to worry about morals here or ethics, but it is legal.
Jeff: Some people out in the internet world are still talking about, well, I can exchange my Bitcoin for ZCash or one of the other cryptocurrencies. No, you can’t do that. That is not a like-kind exchange. There is no such thing. It would be like trying to exchange your P&G stock for Kroger stock and not recognizing gain. It doesn’t work.
Eliot: “I have two LLCs right now—one holding real estate, the other being a farming business—as single member LLCs that seem to have some tax benefits. My question is, could I move the equipment into another entity and lease it to the custom operating company, thus creating some additional deductions?” Good question.
Jeff: Go ahead and give me your thoughts on that.
Eliot: I guess he’s saying they’re a single member LLC. I’m going to assume that means they’re disregarded. That may not be the case, but we’ll go with that. If we take some equipment out and try to lease it around, you just incurred additional income within what I call your macroeconomy. You didn’t earn more money from leasing it to me or Jeff; it’s within your own business. You just create more taxable income. I don’t like that. Maybe even if you get an offset deduction against it, perhaps, at the federal level and you’re not going to at the state level, typically they’ll tax you that. I don’t think the leasing is something that you want to do with the equipment.
Jeff: I’ll give you a couple of scenarios why this doesn’t work. Let’s say you have a tractor in your farming business. Let’s say that the tractor is fully depreciated. You’re still using the tractor. If you move that into another entity and then lease it back to the farming business, you’re actually not accomplishing anything. You’re creating a deduction on the farm side, but you’re also creating income on the other side. They’re offsetting each other.
This would also not be considered a passive business. You couldn’t generate passive income in this leasing entity because you’re leasing to your own business. You couldn’t use that to offset other losses.
The other problem is if it’s fully depreciated in the farming business and you transfer it to the other entity, there’s nothing to depreciate. You can’t start depreciating all over again unless you sell it to another business.
Eliot: You just recognize gain.
Jeff: That’s exactly right. The farming business now has a gain on the sale, which is going to take at least five years. It will be less than that with bonus depreciation.
Eliot: What if you sell it again afterwards? You have to worry about depreciation recapture, too, later on.
Jeff: Now, let’s go a different route. I have a farming business. I need a new corn planter. I may want to purchase that in the other LLC, and then lease it to the farm. The entity that purchases it gets to take the depreciation, gets rent from the farming business.
One thing this does—you’ll see it not only in the farming but in other businesses—if I have my equipment, especially my expensive equipment in a separate LLC, I am now protecting my equipment and my business from each other. That’s something I often see.
I see it in residential assisted living, that the property and even some of the equipment may be on this entity, but the operations are actually in this entity. That’s basically to make sure you don’t lose your shirt on everything should something go wrong.
Eliot: Yeah. Clint has some really good examples of that when he’s talking about business. I believe his brother’s keeping equipment out and I think he does road repair or something like that. I don’t remember what it is exactly, but Clint often talks about that, and it’s something that we’re used to.
Like Jeff points out, that’s if we have brand new equipment. Maybe we don’t want to do that if we’ve had equipment for a bit. Also, Jeff was talking about how this is going to be ordinary income. You might have employment taxes if it’s disregarded or Schedule C. Ultimately, you probably want to sit down, have a consultation, and review everything.
Jeff: Ask your tax professional. Moving on.
“I’m rolling out of an employer DB plan where I had employees in the past, and I want to set up a Solo 401(k). Is there a restriction three year waiting period to do this? My administrator says so.”
I know if you terminate a 401(k) plan, which is not a DB plan, then for at least 12 months after that, you cannot form another 401(k) plan. It’s all about discrimination rules. These are mainly ERISA rules. I’m not sure about the DB plan, but I see something similar applying there. It’s mainly to keep you from cutting people out of your plan.
Eliot: Yeah. Even when employees are gone. We researched this quite a bit to try and get more information about it. It’s not a lot out there. It is not uncommon that DB plans do get turned over. You’re going to have to abide by all the rules and there probably is some restriction there.
It seems very reasonable. I don’t know if it’s been three years. I can’t tell you that. I would think there would be some kind of holding there because you did have employees in the past. They want to make sure that those employees, their rights are represented.
Jeff: When you terminate a defined contribution plan, which is a 401(k), 43B, or 457, certain things happen. If you have a vesting schedule, that vesting schedule goes away and everybody is immediately invested in that plan for any profit-sharing contributions you put in.
There are a few other things that happen when you terminate a plan. It’s still usually fairly easy to do to terminate that plan. Pay it out and move on. Not so easy with the DB plan. You have to be really cautious about terminating a defined benefit plan. The way the defined benefit plan works is you’re setting up a retirement plan that is guaranteeing that you will pay out benefits at a certain time. Now, you’ve seen where they could possibly, what’s the word? It’s not converted.
Eliot: It is a conversion. I’ve seen some things where they talk about the conversion of it but I can’t give you too much detail into it. Really, it’s going to be dependent not only by the rules of ERISA but by the administrator of the plan. They have very detailed rules in there. Even though the law says you can, the original agreed upon agreement may not.
Jeff: Now, here’s the problem with that as far as this question goes. You cannot do that conversion and make it a Solo 401(k). Your employees would automatically be brought into that also.
Part of the problem with terminating that DB plan—I’m assuming that’s what you mean by rolling out of it—is that you’re terminating the plan is settling up with the employees. ERISA could get involved and the Department of Labor.
Eliot: Yeah, and there will be actuarial calculations because on that conversion, you have a set amount that past employees are entitled to. Now, if they’re going to have rights in this new 401(k), that has to be accounted for. That’s a complex calculation. Not saying you shouldn’t do it, but there probably are some waiting periods in there, I would imagine. That wouldn’t surprise me.
Jeff: If this was a solo defined benefit plan or just maybe you and your spouse were participating in it, it would be a lot less tedious to shut down. But since you have outside employees, unrelated employees in the DB plan, you have certain obligations you have to meet to them.
I would probably listen pretty closely to your administrator. It doesn’t hurt to check around. I will say we could not find anything definitive on this, but it kind of makes sense. We’ll leave it at that.
Eliot: “If I currently have a 12-unit apartment building with a mortgage and I sell a single family home rental property, can I use the proceeds from the sale of the single family home rental property to pay off the mortgage on the 12-unit apartment building to avoid capital gains tax?”
Jeff: See, when I read this the first time, I got down to almost the last line and I thought I knew the direction this was going. Then, it kind of made a turn on me.
You absolutely, first off, can use your proceeds from the sale of your 12-unit building for anything you want. I think paying down your mortgage is a great idea. However, it doesn’t avoid capital gains tax.
In the old days when you sold your home, as long as you bought something more expensive then you could defer that. I think that might be one of the later questions. We’ll skip that. But yeah, if you have capital gains tax and possibly recaptured the depreciation, then you’re going to have to pay the tax on that.
The upside of this is you may also have suspended losses in this apartment building. I guess, technically, they don’t offset each other if you have losses that you’ve built up over the years. You’re losing $1000, $2000, $3000 a year. Those losses are being suspended every year. As soon as you sell this building, any suspended losses are going to get released.
Eliot: Yeah, passive losses.
Jeff: They can, more or less, offset that capital gain. The other thing that happens is when you sell something like an apartment building that you’ve been depreciating, any capital gain you have is considered passive capital gain. If you have suspended passive losses and other things—for example, you sold your single family home rental property—if you have losses that were in the apartment building—I kind of got this backwards before—any gain that you have in that single family home can offset losses that are suspended in that apartment building. You must straighten out what I said?
Eliot: No, that’s exactly right. Yeah. If you have built up PALs—Passive Activity Losses—over the years and you sell one unit, we call it releasing the PALs. They come running out and you can use those to offset a lot of your capital gains.
That’s not going to get rid of our depreciation recapture. If we still have remaining capital gains, that’s still going to pile on top first but it will reduce a lot of it potentially. If you got rid of all the capital gains, well, then you wouldn’t have any capital depreciation recapture as most capital gains.
Jeff: Sometimes, Toby has to translate for me.
Eliot: Yeah. This is something if we could sit down, look at all the numbers and all that, we could give you an idea, really dial in how much you’d be looking at and saving all over.
Jeff: You may not have as much capital gain as you think you have, especially if you have those passive losses that are just sitting there waiting to be released into the wild. But yeah, that is something to look at.
One other quick thing is if I take my proceeds from my sale, my single family home, and pay down my mortgage, that’s also going to make your income higher simply because you’re going to have less interest coming from the mortgage. You’re going to have less interest expense.
Eliot: That’s true. Less deduction there.
Jeff: They’re usually not a big deal, but I would rather have less mortgage now and not worry about the interest deduction.
All right, moving on. You can follow Anderson on social media. You can see all the different kinds. We have Facebook, YouTube, LinkedIn, Instagram, and Twitter. Please follow us. There’s a lot of good info out there. Not only the Tax Tuesday stuff, but Clint and Toby both put out a ton of content that is helpful. Please follow us. It’s aba.link/ whatever one you choose.
Eliot: Yeah, a lot of options.
Jeff: “What will happen if you opened an LLC with corp status but you missed the deadline? What should you do?” I’m guessing you’re talking about the deadline for filing your tax return.
Eliot: I wasn’t sure about this one, if it is either that or the deadline for declaring it as a corp status, but probably the tax deadline.
Jeff: If you miss the tax deadline, if you have a loss on your corp, it typically doesn’t hurt you. If you have a lot of startup costs, we need to talk because we need to look at whether or not you’ve started a business. The reason I say this, there’s an election to make of how you’re going to report the startup costs. It has to be made on a timely file, first year of business return. We can work with that in certain cases but we do want to get that file on time if it’s an initial return.
If you don’t owe any money on tax, you’re not going to have any penalties for late filed return. Let’s say you do […] and you missed the deadline, you want to get that filed as soon as possible even if you can’t pay it right this minute. You’ve got to get that return filed. The penalties for late filed returns are substantial. They’re roughly 5% a month up to 25% of what you owe with that return.
Eliot: I’d be more worried. […] C-Corp, but if it’s an S-Corporation, we have a whole another round of problems for being late. There’s going to be a penalty per shareholder or LLC unit member per month. Was it $200?
Jeff: $205, I believe.
Eliot: $205 a month for each of them per month that you’re late. It adds up fast. The IRS likes to see your pass through entities as your partnerships, your S-Corporations. They want to get those out because they have to have those key ones out to do 1040s. They really punish you for being late on that. What do we do? Get it in as fast as you can, number one. Number two, maybe an abatement letter.
Jeff: If this is your first time misbehaving, they usually give you a pass. We just have to call the IRS or somebody else calls the IRS and beg for forgiveness. It usually goes away if it’s your first time with this particular entity doing something like that.
Eliot: Especially if Jeff signs the letter.
Jeff: I don’t think that’s part of the question but I’m going to bring it up. What if you’re late filing with the Secretary of State or something like that like your annual registration? You want to make sure you get that taken care of because a lot of the states, the Secretary of State can disband your entity. You really don’t want that happening. It can be cured, but it’s kind of a pain. They make you jump through a lot of hoops and it could be costly. They’re like a little flush with that late filing.
Next question. “How do you depreciate a rental property after one of the owners dies?” Eliot and I talked about this for a little bit and there’s different scenarios. We’ll start with the simplest one. I have a rental property, only my name is on it. I die and leave it to my wife. She gets the property at the current fair market value on my date of death. If she continues to rent that property, she gets to depreciate it all over again. Anything that happened before I died no longer exists. Once it is in her hands, she can continue to rent it. She depreciates the fair market value rather than what it was in my hands. Kind of like she just bought the property.
Eliot: You could have done while you both had it. You could’ve done a cost segregation if it was a newer property and got all that benefit. Then, you passed, gave it to her, and she get to do another one.
Jeff: We do like cost segregation. I hadn’t thought about that one.
Eliot: I used to die, right? Occasionally, you’re the one left.
Jeff: Now, let’s say the property was in a partnership. Eliot and I are in a partnership. Again, I die. I seem to be doing that a lot. My wife once again inherits it, my interest in the partnership.
Elliot is still a partner, but now my wife has replaced me as a partner. She gets what is called a 754 or 704. I think they kind of work the other 743. Anyway, what you need to know is if she gets a stepped up basis on her share of the property, let’s say we have a $400,000 property between the two of us and that was our cost. I suddenly died and it’s now worth $500,000. There’s $100,000 of additional fair market value in that property. If I own half of it and now my wife owns half of it, she gets a step up in half of that increase in basis.
We said from $400,000 what we paid for it, it’s now worth $500,000. The difference, the $100,000 half of that, she gets a step up of $50,000. Then, she gets to start depreciating that inside the partnership and only she participates in that depreciation. Eliot would continue to depreciate his share of the $400,000. She’d get her share for a depreciating $400,000 plus that little extra $50,000 piece.
There are other situations. If it’s an S-Corporation or a C-Corporation, those entities actually own the property. If we’re in an S-Corporation together and I die, nothing really changes just because we bring a new owner in. The rule about the step up in the 754, that is particular to partnerships. If every time somebody died, would Amazon get somebody as a step up on Amazon? It doesn’t work like that. We have rules for partnerships, we have rules for individually held properties, and then we have everything else.
All right. Infinity Investing: How The Rich Get Richer And How You Can Do The Same. This is a great book. I’ll be frank. It’s not about getting rich quick. It’s about investing properly to the point where you can’t spend your money fast enough from what you’re bringing in. It’s talking about doing it the smart way, not the get-rich-quick way.
Toby, if you’re listening to this and I’m misrepresenting your book, I’m sorry, but this is the way I see it. They really preach about dividend, earning, stocks, and things like that, investing in real estate. Basically, the things that we see other people do and do well. We’re trying to present it to you. Toby said Infinity Investing is still doing really great on Amazon. Patty, how do they get this book?
Patty: I just posted the link, actually, in chat.
Jeff: She just posted the link, I see it. It’s a good read. It’s not a hard and long read. This is also in conjunction with our Infinity Investing Workshop. We talk about a lot of this. I encourage you, if you have not already ordered, to please do so. Toby would like you—if you bought the book—to leave a review, good or bad. He just wants people’s thoughts on the books.
Next question. “How do I set up my company in Nevada when I will be conducting business in Texas?” What do you say?
Eliot: Well, it’s going to depend on some facts here. What kind of business? How is it going to be taxed and things like that? Nature of the business being conducted in it? But if we’re just talking in general, any kind of ordinary business, and you really wanted to have it somehow set up in Nevada, you would probably have a Texas entity. If you disregarded LLC, that is disregard to Nevada. Perhaps a holding company or something of that nature.
Perhaps, what you’re looking for is like charging order protection or something like that. Very popular in Nevada. Might want to think about Wyoming if we have no other reason to be in Nevada just because it’s a little bit cheaper. Both states are incredibly good at asset protection for small businesses.
More likely that would be it. Work with a disregarded entity in Texas and then have it owned up. Or, it could be an S-Corporation or C-Corporation. Just have the shares owned by the Nevada holding as well. Maybe that would probably be the best route, I guess, taking back on my first comment there.
Probably have a C-Corporation or S-Corporation in Texas, have the units or the shares, depending if it’s a corporation or an LLC owned by a Nevada holding, and then you just run your business.
Jeff: We know that Texas does not have an individual income tax. They do have a franchise tax which kicks in at, what, $4 million or am I right?
Eliot: Last time it was $1 million, but it’s up there.
Jeff: It’s pretty high. If I’m only conducting business in Texas, that’s all I’m doing, let’s say I live in Texas anyway, am I making a mistake by forming an entity in Texas and not running it through Nevada?
Eliot: Well, you’re going to get taxed in Texas because your business is operating. You’re conducting only here in Texas. That’s Texas income more likely. Then, we get back to the original, what kind of businesses are we operating? Is it operating directly in Texas? Then, you have Texas income. Either way, you’re going to have to pay some kind of fee to Texas and you’re going to need to be set up in Texas for asset protection purposes, I would think.
Jeff: Let me ask a different question then. Let’s say I’m operating a business in Texas, but I’m also operating in Oklahoma, Arkansas, and maybe Louisiana. Does that make even more sense to do the Nevada parent?
Eliot: It can, if we can kind of maybe argue that our operations are out in Nevada and then we are present in these other states, then we can set up entities in there. We have a presence there if we feel we need to. Just get on the type of business that’s being operated, et cetera.
No matter what here, you’re going to want to talk to one of our business advisers or one of our platinum attorneys to see what exactly your fact pattern is. There is some flexibility here, different ways we could do it. Those are just some examples.
Jeff: Great.
Eliot: “Does tax on depreciation recapture, like capital gains, go away when the property is inherited?” like we were just talking about.
Jeff: No. That sounds familiar. Yes, when you inherit a property, everything goes away. Everything resets. We’ll start with a basic. I inherit my mother’s Norfolk Southern stock. She may have paid $100 for it, but it’s now worth close to $300 a share. All that capital gain goes away.
Now, let’s move on to something like a rental property. She owns a house that she’s been renting out for 30 years, so it has fully depreciated. She has no basis in that home, but the fair market value is $200,000.
I inherit that property. Nobody pays the depreciation recapture. Not her, not her estate, not me. I now have a house that’s worth $200,000. It doesn’t matter that she’s fully depreciated it. Remember, we’re only talking about inheritances. If we ever talk about gifts in the same fashion, all of that goes away.
Let’s say I have a rental property that’s partially depreciated. I gift it to Eliot. He takes over that property. He doesn’t pay any tax on it. If anybody’s going to pay tax on it, it may be me, but I will have to have gone through my $11 million of excluded gifts first.
Elliot takes over the property. He steps into my shoes. Meaning, my basis is now his basis. My depreciation that I’ve already taken is his depreciation. He takes the property and a gift exactly the way I held it at the time I gifted it to him.
Eliot: That’s a lot of taxes if I ever sell, and I will have depreciation recapture then if I ever sold. Unless it depreciates.
Jeff: “Do I have to report a home I lived in and sold even though I purchased a new home?” We hear this question more often than you think we would. Up until 1995 or 1996, the old Section 121 rule said that as long as I buy a home that’s more expensive than the one I sold, I can defer any gain until I believe I was 55. I think when I was 55, all that gain would go away.
They replaced that rule in the mid-1990s with a new Section 121 rule that says, if you’ve lived in that home for two of the last five years, you can defer up to either $250,000 or $500,000 in gain, depending on your marital status.
To answer your question, no. Just because you purchased a new home, that doesn’t qualify you to defer that gain or to avoid that gain. You’re still going to have gain. Now, if you’ve lived there in two of the last five years, you may be able to defer a large part, if not all of your gain, depending on how much gain you have. Of course, the longer we’ve lived in that home, the more gain we’re likely going to have. A house that you may have paid $30,000 four years ago may be worth 10 times that amount.
Eliot: You’re certainly not have to report it no matter what. You’re not going to have any taxable gain perhaps, like Jeff’s talking about. One thing that we do run into a lot with the nature of a lot of our clients being real estate investors, maybe you rented it out first for some period of time, then you moved into it, made it your personal residence. You qualify for 121 but because you have that nonconforming use—it is the term they use of where you rent it out prior—you may lose a fraction of your exclusion on the $250,000 or $500,000 exclusion.
We have to break out the calculator and do some calculations, see exactly what happens on that. Oddly enough, they don’t punish you or take away that. If you lived in it and made your home for two years, then you rent it out for a year or two, and then sell it, you don’t have to consider that nonconforming use. I still have not been able to understand their logic for that, but it’s good for the taxpayer. You’d be able to do the $500,000 or $250,000, whatever you’re entitled to.
Jeff: Sometimes try not to understand the why.
Eliot: Yeah, just live with it. That’s what it says.
Jeff: Yeah. A lot of people can exclude most, if not all, of their gain through the newer Section 121 Exclusion. Whether or not you buy a new property or decide to rent it, has no bearing anymore on the gain or loss.
Eliot: We do have another technique. If you want to keep that home, of if you’ve seen this is worth a lot, if you had a lot of appreciation value in it, Clint has a video on this where maybe you sell it to your own S-Corporation. The purpose of that, you can go ahead as long as you’ve had it as your personal residence and then you sold your S-Corp. You can go ahead and rent it out. You can still use the deferral for $250,000 or $500,000.
If you take all that you choose, you elect to take the capital gains right away, and then your S-Corporation can make payments over time to pay back an installment. You’ve paid your taxes on it. And the S-Corporation’s now renting it out at the stepped up basis that we keep talking about. Now, you’ve got a much larger amount to depreciate, maybe hit up a cost segregation of some losses come through. It might help you out later on in your return.
Jeff: I really like that idea. If you have a house that you’ve lived in and been qualified for the two out of five years deduction, then you want to keep it and rent it out, you need to clarify something here. When we say rent out the property, we mean to somebody that’s not you. You cannot sell your house to your S-Corporation, rent it back, and still live there. That doesn’t work.
Eliot: Keep it to non-related parties.
Jeff: Non-related parties, yes. You can even do kind of like an exchange.
Eliot: Yeah, you can do the1031 as well. If you’ve made that time to live in it under 121, then you have a business use of it. But the business use in this case would have to have come out at the end. You have to be currently using it for a business purpose, meaning renting it in order to do the 1031 in combination with 121.
Jeff: This is a really nice strategy. It does work. The IRS has approved this. Make sure you’re talking to somebody before you just do it. It’s fairly easy to do it wrong if you don’t take the right steps. It’s kind of like the 1031 Exchange, the like-kind exchange. Sounds easy but it’s really easy to screw up.
You just want to have a little guidance. It’s worth paying for that guidance, whether it’s us, your local CPA, or somebody who is aware of the strategy to save you quite a bit of money and taxes. And my mother asks the same question, I bring her up a lot. She thought she could still do this. No, Mom, sorry.
Eliot: I think that was our last one. We have had a lot of questions answered. It looks like we got Christos, Piao, Dana’s on there, and […].
Jeff: Yeah, it looks like they’ve been flying through those.
Eliot: We have 78 questions. Just a few still open.
Jeff: Subscribe to Anderson Advisors on YouTube for the newest updates at aba.link/youtube. You can see some of our podcasts at andersonadvisors.com/podcast.
Here are some of our podcasts. You’ll see the Tax Tuesday with me and Toby, Michael’s content, Clint and Toby each put out a lot of content. We got Coffee with Carl. We have a lot of Toni Talks out there. All good stuff. We’re really putting the stuff out for everybody’s benefit, and the guys love […], I’ll be frank.
Replays. Replays will be in your platinum portal if you are a platinum member. They usually come out the following week after Tax Tuesday, about a week from now. If you have any questions, send them to taxtuesday@adersonadvisors.com or visit andersonadvisors.com. We thank you for watching and being part of Tax Tuesday.
