Today, attorneys Toby Mathis, Esq., and Eliot Thomas, Esq., delve into listener questions including – how gains from crypto investments are classified as either ordinary income or capital gains. For property sales, we explore strategies to avoid capital gains tax, such as donating to a private foundation, and we clarify the impact of marriage timing on capital gains claims. We also cover tax implications for rental property expenses, including the timing of write-offs for losses and the criteria for short-term rental deductions. Additionally, we touch on medical reimbursements for C-corps, renovations for Airbnb setups, and backdoor Roth IRAs.
Submit your tax question to taxtuesday@andersonadvisors.com
Highlights/Topics:
- “What are the basic principles to keep in mind with gains derived from investing in crypto?” – gains from a “personal asset” need to be identified as ordinary income or capital gains
- “Is there a legal way to sell a property through a charity to avoid a capital gain and have the charity provide us with a small monthly retirement amount?” – If you already have a private foundation, you could still do this transaction as long as you gave the property to the private foundation.
- “My fiance and I purchased a property together. He is selling his property that he has owned for over 10 years. We are not married yet, but intend to get married this year. If we get married after he sells his property, can we still claim status for capital gains? He will have a significant amount of capital gains on his property. His property will sell in August, and we weren’t going to get married till October. We just want to make sure we’re okay to claim status for capital gains.” – I think what we’re getting at here is the 121 exclusion, if you meet the criteria.
- “I purchased a duplex and we’ll list it as a short-term rental in August.” I want to buy furniture and supplies and do both major and minor repairs before the listing is active. Can I write off these expenses before the Airbnb listing is active?” – Generally speaking, no, you’re not going to write it off before it’s active.
- “I bought an investment property for $260,000. It’s only worth $200,000. If I sell it, can I take a $60,000 loss?” – If we bought it as investment, maybe it was a flip or something like that, we can take it as an ordinary loss.
- “For short-term qualification, do we need to add it to Airbnb or Vrbo, or can we just rent it out to friends and family for three rentals of less than a week and still qualify for the deduction?” If yes, how do we show proof?” – there’s no requirement that you specifically set up an Airbnb or VRBO, but you can’t rent to friends and family or “related parties” – that’s personal use.
- “Can you reimburse medical costs if organized as a C-corp?” – Simple answer, yes, if you have a medical reimbursement plan.
- “Can I make renovations to my personal residence to establish an Airbnb and write off the costs?” – yes you can, depreciated over time. It must be in service to deduct.
- “What is a backdoor Roth?” – You can put it in the Roth after you pay taxes on it, if you make an income over the typical limit for Roth contributions.
- “What is a good way to plan when converting a primary residence into a rental property and have a tax-wise setup for the transition? Do we sell the property to the LLC or transfer sign the loan to the LLC? How will the capital gains be treated?” – you could do either one.
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Full Episode Transcript:
Toby: All right. Welcome to Tax Tuesday. My name is Toby Mathis.
Eliot: Eliot Thomas.
Toby: If you’re here for Tax Tuesday, you’re in the right spot. First off, if this is your first Tax Tuesday, give me a thumbs up, and I’ll see where they go. Any thumbs. There we go. For a few of you guys, this is going to be your first one. Where’s the little numbers? I’m trying to see. Maybe if I do this. There we go, now we can see some people.
All right, technology, guys. Here’s another way to ask it. If you’ve been on a Tax Tuesday before, give me a thumbs up. That way, we know. We get three thumbs no matter what. There’s a whole bunch. All right, there’s a bunch. All right, we got a bunch of old school. All right, then I’m not going to waste a whole bunch of time explaining what Tax Tuesday is, but we are bringing tax knowledge to the masses.
We answer a bunch of questions, which we’ll go over here in a second. We answer questions that somebody emailed in, then Eliot here select it, and we’ll see how you did this. We’ll see what he’s got in his gumbo of whatever it is that we’re going to be looking at. That’s fun.
You guys can always ask questions. When you ask questions, I’m going to say, please go into the Q&A and ask it. If I ask you to respond to something like, hey, is this ever happened to you, I usually tell you to give him an emoji, or you could put it in chat. But if you have a question about your tax situation, we have a bunch of accountants on and tax attorneys.
I’m just looking at it. I see Patty, Matthew, Amanda, Jeff, Troy, Rachel, Arash, Dutch, Tanya. We have a whole bunch of accountants, CPAs, attorneys, and so on. We just got a lot of folks that are there to answer your questions. You can go into Q&A and ask them.
If you get into real deep details on your situation, or you start asking us to do tax prep, we’re going to invite you to become a client. It’s not what Tax Tuesday is. We’re not going to do your stuff. Death by a thousand paper cuts, right? We will answer your generic questions.
If you have good questions like, hey, this is a scenario, what would be the outcome, you could ask that. But if you say, hey, I’m doing my 1040 and here’s this and this and this. Where would I put that? You should become a client. Don’t do your own taxes. There, I said it.
By the way, you can always send in tax questions during the two weeks when we’re in-between sessions. You just send them on into taxtuesday@andersonadvisors.com. We see it. We try to respond. We also pick questions that we will read and answer live.
Speaking of which, let’s go over reading some of these questions and answering them live. These are the ones that we are going to answer live today. I’m not going to answer them yet. Just going to read what they are and then we’ll go through them.
“What are the basic principles to keep in mind with gains derived from investing in crypto?” We’ll answer that one.
“Is there a legal way to sell a property through a charity to avoid a capital gain and have the charity provide us with a small monthly retirement amount?”
“My fiance and I purchased a property together. He is selling his property that he has owned for over 10 years. We are not married yet, but intend to get married this year. If we get married after he sells his property, can we still claim status for capital gains? He will have a significant amount of capital gains on his property. His property will sell in August, and we weren’t going to get married till October. We just want to make sure we’re okay to claim status for capital gains.” Good reason.
Hey, I don’t know if I want to get married just yet because I got the 121 exclusion to worry about. That’s a good one. Anybody who has an objection, the accountant goes up and says, well, it costs you some gain exclusion. No, that would be a weird wedding. We’ll answer that.
All right. “I purchased a duplex and we’ll list it as a short-term rental in August.” Congratulations. “I want to buy furniture and supplies and do both major and minor repairs before the listing is active. Can I write off these expenses before the Airbnb listing is active?” Yeah, good question.
“I bought an investment property for $260,000. It’s only worth $200,000. If I sell it, can I take a $60,000 loss?” Ouch. We’ll answer that one.
“For short-term qualification, do we need to add it to Airbnb or Vrbo, or can we just rent it out to friends and family for three rentals of less than a week and still qualify for the deduction?” If yes, how do we show proof?” You guys are just… Where did you go? You’re like trolling.
Eliot: They were really looking for some edge on it.
Toby: “Can you reimburse medical costs if organized as a C-corp?” That’s pretty straight forward.
“Can I make renovations to my personal residence to establish an Airbnb and write off the costs?” We have a lot of Airbnbs.
Eliot: Popular topic.
Toby: “What is a backdoor Roth?” I don’t think we can answer that on the air again.
Eliot: Right. I’m not going to touch it.
Toby: Eliot will explain that one with pictures. You could do balloon animals. I’ll show you how to do a backdoor Roth.
“What is a good way to plan when converting a primary residence into a rental property?” All the dirty minds out there. There is a backdoor Roth.
“What is a good way to plan when converting a primary residence into a rental property and have a tax-wise setup for the transition? Do we sell the property to the LLC or transfer sign the loan to the LLC? How will the capital gains be treated?” It’s just a funny one, backdoor Roth. Just sounds of the tour. Tax term, 30 accounts. My goodness. I used to have a few accounting jokes now. I think they’re done.
All right. If you guys like those types of questions, you have an inquisitive mind, and are always trying to learn more about tax and asset protection, feel free to join my YouTube channel. You could also grab Mr. Coons’. He has a great channel as well, mostly on asset protection. I tend to do more of the tax side. Together, we give you a pretty good coverage of what it means to be an investor and many things we could think about.
I’m just looking at this right now. Look at that. I see why savvy investors use land trust for real estate investments. Look at that. That’s awesome. Ms. Robbins joined me for that one. Anyway, feel free to jump onto the YouTube channel. It’s free. Subscribe and fill your brain up with as much of this stuff as you can. It does pay off as cheeky as we are and as much we seem to enjoy it, because it should be fun. Taxes should not be a horrible endeavor. It should be, hey, there are incentives, and I like taking advantage of the incentives. Yes, when I get one, woo when I don’t, but we’ll teach you both ways.
Other thing, tax and asset protection workshop. When’s the next one coming up? It looks like Tuesday, August 6th. From a week from today, you could spend a day with Clint and myself, or maybe Clint. I don’t know if I’m doing that one. You can learn all about asset protection, LLCs, series LLCs, land trust corporations, different tax treatments, real estate tax, accelerated depreciation, cost segregation, and how to plan a legacy.
There’s another one, August 17th. We have a live event in San Diego coming up, a three day workshop. If you have not done those, click on there. They’re very inexpensive. They’re a lot of fun. It’s always fun to get together with everybody, especially a bunch of investors. Not only are you guys fun to hang around, but when you’re around people that do what you do, it’s cool. You learn something just through osmosis of what these guys are doing. It’s always fun.
Somebody was talking about IRS agents when we’re talking the backdoor Roth. No, it’s not a tax treatment. It’s not a penalty for failing to pay things. The agent comes over. You might feel that way. You seem that way. You’re like, what the heck are you doing to me?
“What are the basic principles to keep in mind with gains derived from investing in crypto?”
Eliot: I think the first thing to start in basics, crypto is treated as a personal asset to sell off. We have gains. We need to know how we got the gains. If we got from staking and things like that—staking is basically where you’ve used crypto that you have to create more crypto—that is ordinary income. Not only ordinary income, but it’s subject to employment tax, depending on the type of staking and things like that. Or if you just have crypto, you went out and bought some bitcoin and you sold it, maybe a year later, it could be capital gains.
We really want to know which we have, could have, a little bit of both. We have a lot of clients who have both going on. When available, we’ll try and treat it accordingly and put it in the best structure for that. I think the basics you need to know is that there are some that’s ordinary income. You’re staking, and then the rest is in capital gains. It would probably be a good place to start with your basics on that.
Toby: I’m going to back it up even further. There are people that are out there with their computers and they’re generating crypto, and that’s mining. That’s ordinary income. You generate the ordinary income. There’s another way to generate ordinary income, and that is to do the staking, so mining and staking. Anything with an -ing on it sounds like it’s going to be ordinary income.
It’s active when you’re doing the mining. If you’re actually mining and you materially participate, then you could be looking at even employment taxes, I believe. If you spend crypto, if you invest in crypto and sell crypto, it’s capital asset, so capital gains. You sell it within a year, short-term. You hold it for over a year, long-term.
Let’s say this is a bitcoin and I trade it to Eliot for his glasses or this pen. There we go. We’ll trade it for a pen. What actually happened is for tax purposes, I sold the crypto and then I bought the pen. There’s a taxable event. I sold the crypto.
Whenever you spend crypto, you’re engaging in a taxable transaction, period. That’s what trips people up because they’ll go, hey, I made some money on my bitcoin. I went and bought a car with it, or I went and I bought something with it. That’s taxable. It’s taxable as though you sold the crypto, turned it into US dollars, and then purchased the item.
As a principle, there’s no free lunch with crypto and just knowing when is it ordinary, when is it capital, and why the heck is it so complicated because it just is. It’s an interesting phenomenon. Massive amounts of gains. I was doing a video earlier today, and I was going over US dollars versus other asset classes.
Here’s a fun one. In 1980, if I had a dollar, it’s worth 25 cents today. Purchasing power. If I had a dollar of crypto, it’s worth about $870,000 today. That was in 2010. That’s freakish, obviously. I think we’re through the crazy, hey, it’s a new technology that came in and a lot of people got their windfalls, but I don’t see continuing to do that. I would be crazy if it did. I’d be happy, I suppose, but it would also mean inflation’s gotten nuts.
When you compare those, oh, my gosh, US dollars have just been stinky. Then you look at these asset classes. I don’t care whether it’s stocks, real estate, bonds, crypto. Think of real estate. All of them just blow the heck out of those dollars. All right, the basic principles, I think we covered.
There’s also forking. You could have a soft fork, hard fork. Hard fork creates taxable income, soft fork I believe doesn’t. But if you’re a crypto person, those terms might mean something to you. If you’re not familiar, then you’re like, what the heck is that? It’s when you get extra coins. Sometimes they give you more coins, but you don’t want to be in a situation where you have a taxable event.
You’re like, gosh, darn it. I didn’t realize I was incurring a tax. Especially for those that are out there mining, they don’t realize. You’re allowed to subtract off your electricity and the costs involved in mining, but a lot of times they’re tripped up because it’s not like you got US dollars sitting in your bank account and you’re like, oh, that’s what I made. It becomes this, how the heck am I tracking it? How am I taxed? What price point do I pay? How do I track for these things? It gets complicated pretty quick.
Eliot: Just to that, the accounting for it is going to be fundamental. That’s where there are a lot of challenges in the industry, how to track your gains, what your original basis was, et cetera. Software’s catching up, but it is a different beast. There’s so much turnover. Many times people changing over their positions all the time, so it’s something that have the best software you can find for the accounting of it.
Toby: I remember when it started and we were like, we don’t know. We’re not touching it because we don’t even know how they’re going to treat it. The IRS finally gave us some guidance and then we’re like, okay. It was a bit of a mess for everybody.
“Is there a legal way to sell property through a charity to avoid a capital gain and have the charity provide us with a small monthly retirement account?”
Eliot: A loaded question. I’m assuming that we have the property in the charity already. I would not recommend selling a property necessarily to your own charity. You don’t really own a charity. It’s not really related party, but it can be collapsed by the IRS or something like that. But assuming the property is already in there, it can sell certainly, and you wouldn’t have to pay tax on it necessarily depending on how they use the funds and things like that. I guess we’d have to get a bit more into the non-prof.
Toby: Let’s say you have a house that you paid $100,000 for. Maybe it was an investment property, and 10 years later it’s worth $300,000. You’re thinking, I want to sell this, but I don’t want to pay the tax. You have a few choices. You could 1031 exchange it and trade it for more property. Maybe that’s not where your mind’s at. Maybe that’s not what you want to do.
Maybe you have losses from other properties that you could use to offset the gain, but maybe you don’t, in which case you’re like, oh, shoot, I’m going to have a big gain. How do I avoid this gain? What I really want is to have some certainty in life that I have money coming in, but I don’t need all the money from the sale.
You could donate it to a charity and take a fair market value deduction. If it’s a public charity, like you set up a public charity, it’s what we usually do you would get a 30% of your adjusted gross income tax deduction. You’d carry forward any unused amounts going into future years.
In English, I bought the house for $100,000. I could sell it for $300,000. I donate it to my charity. I get a $300,000 deduction. The charity sells the property, and now it has $300,000 and there’s no tax due on it.
Now, the next part of this is but I need money. It can’t give you an income stream where it just says, hey, here’s an income stream, because that would reduce the fair market value. I suppose you could say, hey, I’ll give you the property, but I want money back in return. That sounds like an installment sale to me, so you’d have to calculate it as such.
What you could do is say, hey, I’m giving it to my charity, I’m going to take a salary out of the charity, and I’m going to take a small amount per year, but the charity has to do something. If the charity doesn’t do something, it’s going to become a private foundation, still a charity, just not a public charity, in which case it has to give away 5% of its assets every year. You could still take a salary out of that. You could still get some benefit. Just giving you some options.
If you already have a private foundation, you could still do this transaction as long as you gave the property to the private foundation. It’s just limited to 20% under those circumstances of your adjusted gross income. Eliot here, let’s say he makes half a million dollars. He’s got this $300,000 house. He gives it to a public charity, his own that he sets up, and it’s going to do low to moderate income housing. It’s going to do teaching people accounting, fill in the blank.
He makes half a million. He would get a $150,000 deduction, 30% of his adjusted gross income. It’s $500,000, so $500,000 times 30% is $150,000. He’d use up $300,000 of the deduction this year, and then next year he’d get the other $150,000.
Flip it around and Eliot has a private foundation. All it does is give money to other charities. He donates the house, still a $300,000 house, but he’s limited to 20% of his adjusted gross income. Twenty percent of his $500,000 would be $100,000. It would take him three years to write that off, but he would still get the deduction.
You would pay tax if you took a salary out of those things, but that might be a way to get to where you’re thinking of it. Otherwise, that looks like an installment sale, which would reduce the amount of your deduction, which may or may not matter depending on your circumstances.
This is where I put the caveat. It gets complicated quick, right? You have different options, which is why you talk to somebody, which is why you reach out and you say, hey, this is my situation, what can I do? You want to have somebody who actually knows what we’re talking about so that they can actually calculate it.
Eliot: Her name is Tanya.
Toby: Her name is Tanya. Give all the really difficult ones to Tanya. Does that make sense, guys? Give me a thumbs up if that makes sense to you. See if anybody’s listening out there. There are a few. All right, good. We’re tracking.
By the way, I never talk about this, but if you ever wanted to become a client of Anderson and you just want a strategy session where you’re sitting down with somebody, just anytime during the Tax Tuesday, just write, I’d like a strategy session. Somebody will hook up and meet with an advisor.
I know that sometimes it goes without saying, but I want to make sure that you guys know that you always have that possibility that you could just say, hey, I don’t want to go through Q&A, I don’t want to go through chat, I just want to talk to somebody. Put in there, and then we’ll have them talk. Anywho, let’s keep going on. Anything else on that one? We talk all day about charities. It’s a problem.
“My fiance and I purchased a property together. He is selling his property that he has owned for over 10 years. We are not married yet, but intend to marry this year.” Congratulations. “If we get married after he sells this property, can we still claim status for capital gains? His property will sell in August, and we weren’t going to get married until October. We just want to make sure we’re okay to claim status for capital gains.” What say you?
Eliot: I think what we’re getting at here is the section 121 exclusion. We’ve talked a lot about that. That’s an exclusion on the sale of your primary residency if you meet basically three criteria. (1) You have to have lived in it for two of the last five years. (2) You have to have owned it as your personal residence for two of the last five years. (3) You can’t have taken a 121 exclusion within the last two years.
What 121 says is that if you’re single and you sell your primary residency, you met all those conditions, you can exclude up to $250,000 of your capital gains. If you’re married filing joint, though, you get $500,000. Looking back here, we really just want to go down that formula. Do we have the use, the ownership? It doesn’t look like we’ve probably done a 121 in the last 2 years.
Here, it depends whether or not are the individual asking the question was living in that house as well with the fiance? If he or she was not, then the fiance is the only one who met the ownership and used two years out of the past five years, and it was sold under these fact patterns before they got married. What’s going to happen later on, even if they marry that same year and they married filing joint, there’s a provision in the regulations that say, under this circumstance, he’d be the only one who get the $250,000. We treat it as if he was single.
You treat each of them as if they’re on status towards that test. Our questioner here wouldn’t have any status here, but if they live together, now we do have use. We probably don’t have the ownership, but the ownership is a unique one in that you just have to have one party, I believe, make it.
Toby: When you’re married filing jointly and you sell a property during a tax year, it doesn’t matter what month during a tax year, your ownership is imputed to your spouse. Under these facts, if they sell the property—I’ll just say fiancee one—and then they get married, then the ownership test (two-year period) is satisfied by the fact that during the taxable year in which they filed married filing jointly, they would impute to the other spouse, even though spouse two was never on the property.
Again, if myself and my wife, if Sandra was on our property, I was never on it, and we sold, as long as I lived in it with her for two years and we were married filing jointly, her ownership’s imputed to me. Under these facts, we don’t know whether they lived together for the two years. We don’t know. It looks like they did not because they bought a property together, probably to move in, but I don’t want to assume that.
If they did live together and they satisfy the two years, then even though they got married after the sale, it’s the tax year, the ownership requirement would be satisfied, and the use requirement of two years would be satisfied, then the only other thing that would be of issue is, did anybody sell a property and claim 121 exclusion within two years, because that would be straight up, can’t do it. Under that circumstance, you could get a $500,000 exclusion.
Eliot: We’re going to get savings on our capital gains here, it’s just a matter of how much.
Toby: Yeah, what he says.
All right. “I purchased a duplex and we’ll list it as a short-term rental in August. I want to buy furniture, supplies, and do both major and minor repairs before the listing is active. Can I write off these expenses before the listing is active?” Yes or no?
Eliot: Generally speaking, no, you’re not going to write it off before it’s active. If the furniture’s part of the whole, you can’t.
Toby: It’s no. I tried to get a tax attorney to answer something yes or no.
Eliot: That’s your real struggle in life there. We do have clients that have furniture. They keep it in a warehouse, and they may rent it to these certain. That would be a business, and now you have a whole different situation, but that’s unique. There, you would be able to deduct that because it’s a separate business. That aside, and we take the normal run of the mill, I just got a building. I want to rent out, I put the furniture in it, you’re not going to do anything until you put it into service.
Toby: Here’s the thing. You got to have the property into service before or the business started. Otherwise, you have rules, startup expenses and things like that, but this doesn’t qualify. Realistically, what this is is a five-year property furniture?
Eliot: I think, yeah.
Toby: We’re going to start writing it off. Boom. The day that that we start, you can bonus that or you can 179 it. You’re going to get to write the whole thing off in the year. But you’re not supposed to write things off until you actually start your business. This is going to play into one of the other questions because I saw, hey, what should I do first?
A lot of people put things into service early. If you’re a savvy investor, a lot of times they’re like, let’s just put it into service, then we’ll rehab. You’re like, why would you do that? Because I want to start the clock ticking for depreciation. Then the accountant might say, did you take it out of service? You’re like, no, we’re just going, and we’re going along the fly. We’re trying to start the clock.
Here, the clock doesn’t start until August. It’s not when they actually rented, it’s when it’s available to be rented. Ready and available. You’re not going to get to write off the furniture as you’re buying it. You’re going to write it off this year more than likely, but it’s probably going to be an accelerated depreciation. You’re going to be writing it off as an appreciable item. What would that be under? Would it be like other expense or where would that be hiding on the return?
Eliot: Typically if it was going to be Schedule C, normally, you just put it under depreciation.
Toby: All right. I hope that’s clear for you guys. We see this come up all the time. People are like, I’m fixing things up. Here, they have minor and major repairs. That’s depreciated as part of the structure. If you’re just fixing something, then you might be able to write it off under the $2500, the de minimis.
If you’re doing major, you’re probably amortizing it, spreading it out, but you could still do a cost seg. Especially if the major repairs are like, hey, I put in some appliances rewired them, and added new plumbing. If you do a cost seg, that appliance is a five-year item and anything attached to it is five years, so any of that work you did might be five-year, you can bonus depreciate it.
You can accelerate that depreciation, which is why accounts a lot of times when they’re looking at scenarios, they’re saying, hey, do you want to look to see if we could do that? You get a lot more deduction up front that way. Anything else on that?
Eliot: Nope.
Toby: “I bought an investment property for $260,000. It’s only worth $200,000. Now if I sell it, I can take a $60,000 loss?”
Eliot: A pretty straightforward answer, but there is a little bit of it depends. If we bought it as investment, we’re saying maybe it was a flip or something like that, and we take it as a loss, that could be an ordinary loss. Yeah, you’re going to be able to take that. Typically, an ordinary loss will go against any other income that you have on your return.
If it was maybe a long-term asset like the Bitcoin—we’re talking about crypto earlier—there is probably going to be a capital loss. In that sense, while you can take a $60,000 loss, you might be limited by the capital loss rules, which say you can deduct that loss against any other capital gains up to the $60,000. Or if you don’t have that going on, you can take $3000, the ordinary loss for the next 20 years. It would take some time to use that up.
Toby: One other thing is you got to do the adjusted basis. The things that would change this scenario is, hey, I put $20,000 in improving the roof or replacing the roof, things like that. You might have taken some losses. Some things can move the calculus, but if you just bought it and sold it, then generally, yes, depending on what your basis ends up being, because you get to add, you can subtract, especially if you depreciate it, then we might see a different number. But generally speaking, this is how it works if it’s an investment property. If it was your home, then you get nothing.
Eliot: Just so you understand, what if this had been a rental, we had some depreciation? Let’s say that the $260,000 is our adjusted basis. We sold for $200,000. Our adjusted basis is for $260,000, so we have the $60,000 loss. There’s no depreciation recapture with a loss, so you don’t have to worry about that one. You don’t have to worry about what part is ordinary, what is capital. That only comes in if we have a gain.
Toby: Yes. I’m trying to think if there’s anything I could put. No, there’s nothing I can put. Nothing on this one. I’m looking at all the cool ones. I’ve got Wilhelm Scream. I will save that one for a good time.
All right. “For short-term rental qualification, do we need to add it to an Airbnb or Vrbo, or can we just rent it out to friends and family for three rentals of less than a week and still qualify for the deduction?” I have no idea what they’re talking about here. Over what period? Can we just rent it out for three rentals?
Eliot: We get asked this thing a lot. You start to read into the question a little bit more than we should. First of all, there’s no requirement that you specifically set up an Airbnb or Vrbo. I’m not ready to get bounced by the music machine yet.
As far as running out to friends, that’s a no go. We can’t rent out to our friends, family, and things like that. If they’re unrelated friends, I should take that back. I’ve had clients come up and say, well, yeah, they’re my friends, but they’re also my business partner. That’s a related party through your business.
There’s a case out there that you might find, where they talk about the family tried to rent to the sorority of the child. That doesn’t count. That was a related party in that instance. If you do rent to a related party, what’s going to happen? That’s considered personal use. You have too much personal use. You can’t take deductions above whatever your rental income was for that year, so you don’t get that massive deduction. That’s what we’re talking about here as far as the deduction.
Toby: It’s the 14 days or 10% of the rented days. If you hit those thresholds, then you can’t take a loss. When you’re calculating your personal days, you add in related parties to you. It’s your family or anybody that’s an owner of the family. If it’s just your friends, you probably could get by.
But that’s not what this is really about. This is saying, hey, do I have to list an Airbnb and Vrbo? No. The test is, how many days did you rent this property out, and how many unique rentals were there? Different parties. It’s not like I could rent it seven days in a row, and he calls seven. Hey, each day is one day. No, I’m one person. I rented it for seven days. That’s my rental, but I could add up the days.
Let’s say I rented a property for 200 days during the year, and it was 50 different bookings. Then I would have 200 divided by 50s, and I would have four days average use. That qualifies it as a trade or business. The only question is, did I materially participate in that trade or business? If it’s making income, do I have an issue with Social Security taxes? Actually, probably not unless I was providing substantial services in addition to just being an Airbnb, like feeding them, giving them concierge service, or changing their sheets every day.
If I was acting like a hotel, then they’ll treat me like a hotel. Otherwise, no, that wouldn’t be subject to employment taxes. Like Eliot just said, if you had losses, then you could treat that as an ordinary loss and use it to offset your other income, like your W-2 income.
That’s why these Airbnbs and Vrbos are so attractive to doctors, dentists, or high income individuals, because they may have high W-2. If they can get a property, qualify it as a short-term rental, and meet the material participation tests, there are seven of them that you only have to hit one, but usually they’re managing it themselves, then boom, they get that big deduction against their W-2 income.
Sometimes it’s worth the down payment on these things. You see it, where they’ll finance and buy a really nice property. The tax savings cover the down payment, so they’re really out of pocket, zero. They’re just picking up properties and they do it every year. We have a few different doctors that buy it.
Elliot: As far as showing the proof, just keep any record like an Excel spreadsheet of your rentals, days, things like that would be fine. Some people use a calendar or anything like that.
Toby: It’s up to you. Once you meet the threshold, then they got to disprove. You just got to show that you’re doing it. Just my little thing. Trying to make this move forward. There it goes.
“Can you reimburse medical costs if organized as a C-corp?”
Eliot: Simple answer, yes. If you have a medical reimbursement plan, one of the easiest is a 105 Plan. If we set up your C-corporation, pretty much that’s mandatory that we set that up for you, so it’s available. It is a non-discriminatory plan, which means that if you use it for yourself and you have some other business, or in this particular business, you have employees, you have to extend it to them as well. That’s one thing you want to watch out for.
Toby: Hundred percent if it’s just closely held and you have no other employees in any of your other businesses, which is a big one. But you can’t just set up a C-corp and be greater than 2% shareholder. In most businesses, you and your spouse are going to have the discrimination rules attributed to you, which means, hey, I got anybody that I have in my employee. Even through other businesses, I’d have to offer them the same benefits, so I can’t write it off. It’s fun.
Somebody was asking a question on short-term rental. “Can you do repairs on your short-term rental and still have it available to rent?” Yeah, absolutely. “Can you stay in your short-term rental while doing these repairs?” Yes, and it’s not considered a personal day when you’re doing a repair.
Remember that 14-day 10%, which sometimes comes into play in Airbnbs because people like to stay in them a couple of weeks, three weeks a year? But if you’re fixing it up, then those days count not as personal days but as rental days.
All right, enough of that. Let’s go back to talking about Clint Coons and the tax and asset protection workshop. If you want to learn different tax strategies, LLCs, land trust, series, LLCs, I encourage you to attend one of our one day virtual workshops. If you want the live experience, we’re going to be in San Diego on September 26th through the 28th. September 26th through the 28th, we’ll be in Hotel Circle. I think it’s a town in county in San Diego. Feel free to join us. There are always a lot of fun.
Sometimes Eliot shows up, maybe on this one, but they’re always a hoot. There are usually several hundred of us. Somebody says, Clint is the man too. Don’t. No, he doesn’t need encouragement, Sherry. Why wasn’t Eliot in Dallas? He was in jail. No, just kidding.
Eliot: I was answering for some stuff here, all that backdoor Rothing.
Toby: Just gross. His tooth fell out.
Eliot: That’s right. Yeah, I did have a tooth explode.
Toby: All right, let’s see. “Can I make renovations to my personal residence to establish an Airbnb and write off the costs?” Look at that, we got more Airbnb.
Eliot: It was a big factor in all your questions this time. Yeah, of course you can make renovations. Whether or not they’ll be deductible would depend. Basically, does it have to do with the area that’s being rented out, or is it with your personal living space?
If you have one room and a three, maybe 30% of it’s going to be used towards Airbnb, probably 30% of those if they’re directly related to that area, you’re going to be able to deduct that in some form, be it a write off as an expense or depreciation, whichever it be.
The personal, no, we’re going to run into the stuff that built up your personal residence. Probably not. That will add to your basis for your personal home parts, but it’s not going to be a deduction at that point.
Toby: I can’t add anything to that. Renovations to my personal residence, yes, you can. You can write off the cost and depreciate it over time. What if somebody did a couple of repairs? You still have to put it into service before you write that up.
Eliot: Yeah, I think we get back to everything we talked about earlier. Yeah, it’s got to be in service.
Toby: Got to be in service. All right, enough of this. Now we’re going to your favorite. God, I don’t know why you picked this question.
Eliot: It was a retirement. Everything else was Airbnb. What is it backdoor Roth? The idea is that, generally, if you make too much money, if you have too much income, you usually can’t put it into a Roth IRA. But why do we care? A Roth IRA grows tax-free.
That’s why we like it as opposed to a traditional. It certainly grows tax-free as well, but when you take it out later on, you’re going to pay tax. Whereas in the Roth, it grows tax-free. Later on at retirement, when you take it out, you don’t have to pay any tax.
That’s why people like to put money in there, but the IRS knows that. The government knows it and says, if you make over approximately $160,000 individually, $240,000 approximately marriage filing joint, they’re not going to let you put money into a Roth, a regular Roth.
What people do is they put money into it. I’m over that limit. I got all kinds of money and it’s after tax money. I already got taxed on my W-2 income. I’m going to put that into my traditional Roth called after tax amount contribution, and then you can change it. You just convert it over into a Roth. That way, you don’t have to pay any taxes. It’s already been taxed, but it gets the money into the Roth, and now it can grow tax-free and later on, you can take it out tax-free.
Toby: Yeah, and they even have super backdoor Roth.
Eliot: Yes, they do.
Toby: Horrible. Yeah, the super backdoor is when you’re trying to put $69,000 a year into a Roth 401(k). Yes, you can actually do this. You overfund the employee portion. You write a check.
There are basically three buckets. I want you to visualize three buckets, one, two, three. One bucket is the employee deferral where I say, hey, I could put $23,000 dollars a year into this deferral bucket. The other one is where the employer can put 25% of your wage into that bucket. Those are both tax-deductible, and then I have a Roth 401(k) bucket that is not tax-deductible.
What you’re doing is you’re overfunding. I’m putting extra money up to the amount that I made this year. I need to make $69,000, I put $23,000 in there as the deferral, and then I add an additional whatever it is to make it $69,000.
Here’s the magic. I do an in service distribution from this bucket to the Roth bucket. I skipped the employer side, so I push. How much is in the bucket for the employee deferral now? Zero. How much is in for the employer contribution match? Zero. How much is in the Roth? $69,000. I am not allowed any deductions at that point because I have no contributions in those buckets that were tax-deductible. All of my money is sitting in a post tax bucket for the $69,000.
You’re allowed to do that. There’s no income limitation other than I need to have taken at least the $69,000. If I wanted to do that with $25,000, I could do it. If I wanted to do that with $15,000, I could do it. But if you want to get a larger amount, if you’re one of those people that’s like, hey. I’m okay with my tax bracket where it’s at, I’m about as low as I’m ever going to be, I want to get as much into that Roth as humanly possible so I can invest it and go nuts, and I think I’m going to be a higher tax bracket in the future, then you use the super or the mega backdoor Roth.
Otherwise, the backdoor Roth is plain vanilla. It’s just, hey, I wouldn’t have been able to contribute to a Roth, so I put it in the traditional first. Some people say, well, can’t I do that with a 401(k)? Yeah, you could put it in a 401(k). You can convert it over to the Roth bucket in the 401(k). Okay, but what if I don’t want to do that? Then you could roll it into an IRA and then convert that into a Roth IRA.
Here’s the one thing. I’m just going to give you guys this. I’m sorry it gets into the weeds sometimes. You can roll from a Roth 401(k) into a Roth IRA. You cannot roll from a Roth IRA into a Roth 401(k). Just so you know, it’s a one way street.
Eliot: Sherry liked it.
Toby: Sherry? She’s doing all sorts of innuendos in this thing. My goodness, you guys. I won’t even say what’s coming to my head because it’s not good. All right, moving on. Anything else on that?
Eliot: Nope.
Toby: Just dirty tax strategies, dirty. All right. “What is a good way to plan when converting a primary residence into a rental property and have a tax-wise set up for the transition? Do we sell the property to the LLC or transfer, assign the loan to the LLC? How will the capital gains be treated?”
Eliot: You could do either one. If we’re going to sell, we often talk about it. Clint’s got a video out there about selling your primary residency to your own S-corporation. That would be an option.
Toby: Give them the scenario so that they understand it.
Eliot: If we have a house, a primary residency, we’ve lived in it, we go back to our previous question about section 121. We’ve been there over two years of ownership, two years of living in there, and we haven’t had a 121 exclusion within the last two years, and if the house has gone up in value, let’s say Southern California, it’s gone way up in value since we first bought it, maybe you want to sell to your S-corporation because you can take advantage of the 121, $250,000 single, $500,000, half a million dollars exclusion if you’re married filing joint. You can take advantage of it because you’re selling to a different tax reporter. That’s your S-corporation.
Now, there are some caveats to that. Your corporation, if there is any additional capital gains, you got to recognize that right away in the year you sold. The S-corporation can pay you that fair market value that it bought it at on an installment over time, slow installment payments, but you got to recognize the cash right away because it’s a related party between you and your S-corp. That’s one thing.
You want to make sure your lenders are okay with it. I have never heard of a problem. We have clients who go and talk to the lenders, selling to my own S-corp. They typically don’t have a problem, but I would check, especially in this era. They’re hypersensitive to the refinancing because of the higher rates. That’s one way if you have that big gain that’s occurred with your property over time.
If there’s not much gain, and you’re not going to get a whole lot of exclusion, you can just go ahead and basically put it under the LLC, sign it, however you want to do it. A disregard LLC, that would be fine. There isn’t any tax consequence there. The only thing that could possibly come up that way would be maybe a transfer tax, but most states would not hit. Even Pennsylvania, I don’t think would hit theirs.
Toby: Capital, they do.
Eliot: They do? There you go.
Toby: Even when you put it into an LLC. They’re the only ones. Pennsylvania is horrible. They said, how are the capital gains treated? I just want to be clear that when you contribute property to an LLC, it doesn’t reset the button. It’s actually getting your holding period, one of the drawbacks or benefits. Depending on the scenario is that it’s keeping your basis. It’s keeping your holding period. That’s a big one.
Like Eliot was saying, sometimes you have somebody, primary residence, and there’s the capital gain exclusion. They don’t want to lose it. You don’t have to have lived in it the last two years before you sell it. You have to have lived in it two of the last five years before you sell it. Technically, you have a primary residence that has some gain. You have three years to sell that puppy.
Let’s say that you’ve owned it for 10 years, and you had a property that went from $200,000 and now it’s $500,000, so you have $300,000 of gain. You’re married filing jointly and you’re like, oh, man, I should sell my property, but I don’t really want to, I’d rather just make it into a rental, so you start renting it instead. You have a depreciation that you’re getting on the property, but it’s on your basis.
I remember I bought this thing years ago at $200,000 and now it’s worth $500,000. You’re depreciating it at $200,000. If you want to jump that up, that’s when you sell it. You have to sell it to another taxpayer. Another taxpayer can’t be your LLC, just you. It needs to be an S-corp for tax purposes.
You could sell it. Boom, I’m selling it now to my S-corp, just as you put it. I could carry it on an installment sale. I’m not going to get to access it as an installment sale, nor would I want to. I want to opt out, I want to grab that $300,000 of capital gain, and recognize it in the year that I sell my primary residence. The reason why is because we have a capital gain exclusion of $500,000 sitting there because we’ve lived in it for the last bunch of years.
I have no tax. It’s now in an S-corp, which some people freak out and like, oh. If you take it out to refi it, you’re going to have a bit of a tax hit, potentially, if you hold it in there for a long period of time. If you did it right away, it wouldn’t matter because it has a new basis of $500,000.
We have never going to pay tax on that capital gain. We now have $500,000 dollar tax write-off minus the land but a much larger depreciable amount, which is going to reduce our taxes. We’re still getting an income stream from the S-corp. The S-corp didn’t have to pay us. It’s going to be paying us over time under the installment sale, even though it’s not being taxed as an installment sale. You might have a little bit of interest, so you have to recognize that. Actually, would you? You probably wouldn’t have to do that.
You’re just sitting there in a much better position. That’s when you see that come up. It’s rare, but you do see it. Otherwise you’re just like, hey, I don’t want to sell. I just want to take my house and make it into a rental. Okay. Remember the most important date is the in-service date when it’s available to be rented, then we could start depreciating.
Eliot: The depreciation we said, we’ll be at a higher level because it’s stepped up. Likely, that’s going to flow through to your personal return because it’s an S-corp. I bring that up because we had a questionaire on one of the chats about why not a C-corp. You could, but it’s not going to flow through because it’s a C-corporation. All the activity is going to stay on your 1120 tax return, your C-corporation return, and you’re not going to get that benefit of it flowing that an S-corp will give you. Normally, I had that question there.
Toby: Somebody is giving a scenario and they asked me to explain it, so I’m going to go over this, Amy. You bought a property for $505,000. Right now it’s worth $1.8 million. We have $1.3 million in gain staring at us. I married and lived in it from 2019-2021, so we’re really close to the line. Converted it to a rental of last year after being empty for 21 months.
If you want the 121 exclusion, assuming that you lived in it as your primary residence, so you’re saying you lived in it for two years, you could sell this to your S-corp. You would have a tax-free portion of $500,000. There would be $700,000 some worth of gain. I don’t know if I would do that.
Eliot: Yeah. You’re going to have to pay tax on that gain that’s left.
Toby: What I would do if I was you, if I wanted to pay no tax on this and I just wanted to get rid of it is I would sell it under a 1031 exchange because you convert it into a rental, and you would get your 121 exclusion as well. As long as you did this within three years of moving out, it sounds like we’re three months away, so 21 from July, so 3 months from July, so October, Amy, what I’d be looking at is 1031 in this.
What will happen is you’ll get your $500,000 exclusion. It would add to your basis, which is $505,000, so you’d have a million dollar new basis in the new property or properties. You could buy a bunch of properties. You could split it up. You could do a Delaware statutory trust. Some of these companies do those. With that, you would be able to avoid capital gains completely. You would have a higher basis, and you’d have converted it into an income-producing property.
If you want to keep it, then you’re going to have a, you’re going to have a pretty massive tax hit. I don’t know a way around that if you’re going to keep it. Unless you sold it to a sibling or something, you could potentially do that where you wanted to keep it in the family, but pretty tough. I would actually have somebody map it out for you.
Somebody says, my interest rate is 2.5%. Yeah, you’re balancing. I have $500,000 of capital gain that I’m going to lose. That exclusion was worth what, versus him keeping the property with a really low. Amy, is the current interest rate high now? Or you’re at 2.5% now and you’re just going to stay there? Is it a fixed rate?
If your rental is under an S-corp, can you still claim losses? Yes. It flows right down on your return. It’s really no different than a partnership, except that when you take it out, it could be taxable. Now the current interest is very high. I’d get rid of that thing. I’d probably sell it and turn it into $1.8 million, I could probably buy 10 rentals with that. At least I’d go shopping in North Carolina, Kansas City, Indianapolis, Idaho, and a few other places.
I buy some income-producing properties, not pay any tax, and have a really nice new basis. I’d have the million dollar basis, but I’d never have to pay tax on that. It’s locked in. Avoid the tax. Wow, my interest rate, but the current interest rate is…
Eliot: 6.8%.
Toby: Hurting my heart. Fun stuff.
Eliot: 4.3%.
Toby: Look at that. If you like fun stuff, you can go to YouTube, you can sign up, and register. I like it, because then it looks like people follow me when you guys click and subscribe. I can tell Clint, dude, where’s yours? There are over 800 videos. You could get lost in there, but there’s a lot of good stuff.
Tax and asset protection workshop, don’t miss that. Again, I said this earlier, but Amy, this would be a good thing for you. Reach out and have somebody have a consult with you, make sure that see if there’s a way we can help you. I know she says I’m torn. I’m torn too. I feel your pain. It’s some capital gain exclusion sitting there staring you right in the face at your tax bracket. It’s probably $125,000 decision just on that, but I like cashflow. You just reach out and see if somebody can talk to you.
All right. Come to the tax and asset protection workshop. If you know anybody that could benefit from hanging out and learning about LLCs. Everybody has that friend that knows everything and they’re like, my guy said, just get some insurance, all right. Just say, hey, here’s a link. You might want to go spend some time. What’s the next one? Send Eliot here.
Eliot: Can we move more variety?
Toby: Yeah, he likes to. He’s going to pick some dirty questions next time. I already know it. I can’t believe you. I’m embarrassed. One thing we did not do today, you know what we didn’t do today? Pizza. Pizza. I got nothing. I got no pizza shop. All right, maybe next time.
Anyway, guys, thank you so much for joining us. Thank you to Patty, Matthew, Amanda. She’s a lifesaver. Some people said she belly flopped on a three-year-old in a river. Other people say she saved the three-year-old. We don’t know which one it is, whether the three-year-old might have saved Amanda. It’s possible. We don’t have video evidence.
Jeff, Troy, Arash, Dutch, Tanya, Summer. We had a bunch of people jump on. They’re answering your questions, so thank you guys for doing that. There are still eight open questions. If you have an open question, you just chillax. We will answer your question.
In the meantime, I’m going to say thank you. We will see you next time on Tax Tuesday. Send in your questions guys at taxtuesday@andersonadvisors.com so that Eliot could pick yours. No dirty stuff. No more of whatever these untoward named tax strategies, X-rated tax strategies. We’re done with it.
Eliot: Keep it classy.
Toby: Yup. From here on out, it’s only the proper names of tax strategies that we’re going to be covering. We’ll see you guys in two weeks.
