In this episode of Tax Tuesday, Eliot Thomas, Esq. is joined by Anderson CPA Barley Bowler. They explain how transfer-on-death titles still provide beneficiaries with stepped-up basis advantages and clarify that short-term rentals don’t qualify for real estate professional status. You’ll hear proper entity structures for rental properties, recommending against holding appreciating real estate in C corporations. They thoroughly explain the 280A “Augusta Rule” that allows tax-free rental income from personal residences to your business for up to 14 days annually. With input from bookkeeping expert Troy Butler, they recommend QuickBooks Online for tracking rental property finances. Additionally, they cover Roth IRA conversions, tax withholding strategies, and 1031 exchange rules for deferring capital gains.

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Highlights/Topics:

• “When a house is under a transfer on death title, does the beneficiary still get a step-up in basis?” – Yes, they still get a stepped-up basis.
• “If I already qualify as a real estate professional rep status via short-term rentals and add long-term rentals to the mix. Can I lump the two kinds together? And does having an S corporation that manages everything affect my rep status?” – Short-term rentals don’t qualify for REP status. S-corps generally don’t affect REP status.
• “Where real estate properties are in individual LLCs, disregarded and owned by my C corporation, does the C corporation maintain one bank account and collect rent for all individual properties?” – Not recommended. Use a management company instead.
• “If you get started in wholesaling, should you file as an S corporation?” – Yes, use S or C corp.
• “What kind of bookkeeping is needed for rental real estate? Do you have any bookkeeping software to suggest?” – QuickBooks Online is recommended. Track properties separately.
• “When doing an IRA to Roth conversion, are there any limits? Are pre-tax conversions always treated as ordinary income? Is it true that the IRS does not know or care when the conversions were done during the year?” – No limits. Yes, ordinary income. IRS treats as earned throughout year.
• “How does tax work if a business owner is paying himself as an employee, do we have to tax twice? Once for the business income and once as an employee?” – No, payroll is deductible business expense.
• “How do I do a 1031 exchange? And how do I maximize real estate property depreciation after I do a 1031 exchange? Am I stuck with the previous depreciation rate and amount of the previous property?” – Use a qualified intermediary. Trade up for more depreciation.

Resources:

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Full Episode Transcript:

Barley: Hey everybody. Welcome to Anderson Business Advisors. Welcome back to Tax Tuesdays. My name is Barley Bowler. I’m one of the CPAs here at Anderson, joined by Mr. Eliot Thomas, the manager of our tax advising department. Tell the people who we are, Eliot.

Eliot: We are bringing tax knowledge to the masses. That’s pretty much what we do, live from the 500 North Rainbow, beautiful Las Vegas, Nevada.

Barley: Live from Las Vegas Studios, that’s right. Tax Tuesdays. You guys know the drill. We’re going over your questions. We ask you to submit your questions. We go through and we try to look for ones that maybe have some crossover. You guys have a lot of the same issues we’re facing, so try and pull some of those questions together.

As usual, you guys know the drill. Let us know where you’re tuning in from. Let us know if you have any questions. Shout out any questions here in the Q&A.

Eliot: And on that, just a reminder, we got the webinar chat. Put in there where you’re watching or hearing us from. If you have specific questions tax related, put it in the Q&A. We got a whole staff there. We got Troy, we got Rush, we got Jared, Jeffrey, Marie, Rachel, Ross. I’m probably missing some, but that’s as far as my list will go.

Barley: Holy cow, that’s great. We got a whole team. In case get them pick up the theme, we really like bringing this open format to you, so you can just ask your questions, get this knowledge built up. We’ve got the Platinum Knowledge Room, kind of a similar Zoom meeting format with a bunch of tax advisors in there. You can submit questions to the Platinum portal.

Today, we’d like to really specifically go over your questions that you have submitted. Let’s go ahead and touch base. Hop in.

Eliot: Had some Hong Kong, Long Beach, San Diego.

Barley: Excellent. Nice international clients. Love that.

Eliot: All right. The questions, we are getting them from you. Please by all means, send in your questions. I go through them every show, I go through every one of the questions, try and get the ones where I’m seeing the same type of question coming up. Of course, if we have some really unique ones, I try and throw those on as well. We can get those in. Email us at [email protected].

We simulate them all. Then the ones that we don’t get to on the show, we send to actually our team. In tax advisors, we handle quite a bit of those in our platinum questions. If your questions today are a little bit more detailed that you’re asking our panel, we might have to have you become a Platinum client before we can answer those. And if it’s even really more detailed, going to be some calculations and things like that, you might need to be a tax client.

Barley: Yeah. Fun, fast, educational. We want to give you all the tools we have. If you need specific guidance or calculations, we want to set up a tax call just so we can make sure we’re crossing the T’s, dotting and the I’s. It’s not like we have the answer, we’re just not giving it to you. We just got to make sure we get all those pieces. Until then, we can cover a lot of ground just by going over these same questions.

Let’s hop right in. We’re going to run through the questions real quick, guys, just give you an idea of what we’re looking at. Then we’re going to go through, pick these apart, go into a lot more detail.

“When a house is under a transfer on death title,” that sounds like something to do with taxes, doesn’t it?

Eliot: Exactly.

Barley: It sounds very tax related. “When a house is under a transfer on death title, do the beneficiaries still get a step up in basis?” Ooh, that’s a big word isn’t it? Step up basis. That can be a huge deal, so we’re definitely going to be addressing that.

Eliot: “If I already qualify as a real estate professional,” REP status, “via short-term rentals and add long-term rentals to the mix, can I lump the two kinds together? And does having an S-Corporation that manages everything affect my REP status?”

Barley: We talk about that a lot. Certainly, we’re going to be going over that. “We’re real estate properties are in individual LLCs, disregarded, and owned by my C-Corporation, does the C-Corporation maintain one bank account and collect rent for all individual properties?” So using a C-Corporation for management to preserve the limited liability in the LLCs. How do we use a management company without losing liability protection?

Eliot: That’s why we set it up in the first place. We definitely want to have that clear.

Barley: Definitely want to have that.

Eliot: But it all comes down to tax in the end. Why don’t we shake it out? If you get started in wholesaling, should you file as an S-Corporation?

Barley: You’ll hear that a lot. We suggest setting up a corporation. We’ll go over that. “Explain thoroughly 280A.” This is a low-hanging fruit. This is an easy way we can pull cash out of the corporation. We’re going to just do a full deep dive on that. You’re going to know every single step you have to know. It’s really not that much.

Eliot: Not a whole lot.

Barley: It’s not a lot.

Eliot: But all those steps, you’re going to know them.

Barley: Yup, you got to know. You got to follow each detailed step if you want. That last step is that big fat check in your pocket tax-free that you don’t even have to report. We love that.

Eliot: That’s the win.

Barley: Bookkeeping?

Eliot: Yeah. “What kind of bookkeeping is needed for rental real estate? Do you have any bookkeeping softwares to suggest?” We might need some help on that one. We’ll see.

Barley: We might need to call in the pros on that one. But it does all start with bookkeeping. Great question because that is what starts our fundamental knowledge of this whole journey into tax and—

Eliot: Otherwise your taxes could be off when you’re not paying enough if your bookkeeping wasn’t good.

Barley: Got to be more patriotic than that. Let’s operate in guys. Any comments or questions you want to address before we…?

Eliot: Not yet. I think the team’s getting them so far.

Barley: Excellent. All right. “When doing an IRA to Roth conversion,” what are we talking about there? Traditional IRA versus Roth IRA. We can convert a traditional to a Roth. That’s a taxable event, though.

“When doing an IRA to Roth conversion, are there any limits?” I’m assuming we’re talking about dollar limits here. “Are there any dollar limits? How much can we convert? Are pre-tax conversions always treated as ordinary income?” We have various forms of income. Part C is, “Is it true that the IRS does not know or care when the conversions were done during the year?”

Great question. A couple of moving pieces to that. “Is it true that a withholding payment to the IRS will trump all other forms of payment? For example, quarterly estimated payments?” Another great question. “If so, as a small business owner, can I just issue it myself, a payroll check at the end of the year that withholds enough to cover all conversions for the whole year without penalty for not doing quarterly estimated payments.” A bunch of great questions there. Let’s hop in.

Eliot: Then “How does tax work if a business owner is paying himself as an employee? Do we have to tax twice, once for the business income and once as an employee?” Payroll taxes.

Barley: Definitely want to look that. “How do I do a 1031 exchange?” You’re in the right place here.

Eliot: “And how do I maximize real estate property depreciation after I do a 1031 exchange? Am I stuck with the previous depreciation rate and amount of the previous property?”

Barley: Very powerful tax tool. Certainly going to be going over that.

Guys, make sure you subscribe. We mention this a lot. So much good content. Oh, we’ve hit a thousand videos. Woo. We, sorry.

Eliot: Well done.

Barley: Good work, Mr. Mathis. Stay up to date here, guys. Obviously, tons of good tax and asset protection, tax planning. Tax planning more on Toby’s side. Also. many good industry interviews, captains of industry being interviewed there. Just a bunch of great material on there. Clint, obviously focusing more on the asset protection side. Bunch of good information there. Make sure you tune in. What do we got here?

Eliot: We have our event coming up in Las Vegas, June 26th through 28th, $99. Hit the little code thing there and join us live. This is our regular TAP event. Well, not regular in that it’s in Vegas, that’s pretty cool, but a great time to come and meet everybody. Meet some of our staff, meet other clients, meet new clients, clients who have a lot of experience all across the board. Great networking, great ideas. Just flowing back and forth.

Everyone who goes there, I’ve never heard anybody say, wow, I didn’t enjoy it. They just sit there and really have a good time. We’re looking forward to it. Again, 26th through 28th, and I think it’s at the new Durango.

Barley: Oh, nice. Come see all the new development in Las Vegas while the city’s really taking off. And Tax and Asset Protection workshop, of course, going over the basics here, May 10th is our next…?

Eliot: We’re going to have the May 10th event, and the May 17th. Those are typically online events. Rhen of course the big one, live here in Vegas, 26th through the 28th.

Barley: All right guys. Ready to talk tax?

Eliot: Let’s do questions.

Barley: All right. Death and taxes, the inevitable subjects. Let’s go ahead and just breach these two subjects here. “When a house is under transfer on death title, do the beneficiaries still get a step up in basis?” That’s a pretty big deal. We want to know if our beneficiaries are going to step up in basis, right?

Eliot: Yeah. We probably want to know what transfer on death is.

Barley: I have no idea.

Eliot: That is something unique to certain states. About half our states have it. It’s a certain mechanism by which you can just have your property go straight to the beneficiaries and avoid probate.

You often hear Toby talk about it. Clint, Michael Bowman, all of our partners talk about how expensive probate can be. When passes away, it goes to probate. The attorneys are taking a big chunk out of that.

Maybe something like transfer on death is a way you could get a property, a house to move without having to go through probate. Better than all that, why don’t you use a living trust or something like that and avoid all that probate? But transfer on death is a specific thing. Approximately, again, 27 of the states I believe have adopted it, and it’s a unique provision in that it wasn’t done.

For instance, we have community property states or non-community property states. Those go by regions, west coast on down through the south. This is something that’s dotted across the whole US. Some states have this transfer on death, some don’t. You got to know your state that you’re in, or better yet just get the living trust and avoid it all.

The big question here from a tax perspective, are they going to get the stepped up basis? Yes, they generally will. In other words, I pass away, I leave my house to Barley, he’s going to get stepped up basis immediately when I die. Nevada is, by chance, is just so happens a transfer on death title state, it has it available, but if I made that provision, then it would go straight to him. It avoids probate, saves the money, keeps the attorneys out.

Barley: Excellent. Now, like Elliot mentioned, you’ll obviously want a living trust. We’re a more debits and credits tax, CPA side. Talk to your attorney about a living trust. That’s more of the legacy planning tools.

Eliot: It definitely encompasses a lot more. A lot more moved over for that probate.

Barley: Let us know if you have any follow-up questions on that step up in basis. That’s crucial. We wouldn’t want to do it if we didn’t get a step up in basis.

Eliot: Well, let’s go with it. What is the step up in basis? How’s that help us?

Barley: When we typically up upon passing, we see this a lot with an inheritance. When we pass away, we pass on assets to our heirs. When we pass and our heirs inherit our assets, they get a step up in basis. That’s where we’ll most commonly see it.

Why is that such a big deal if your parents bought a property way back in the 80s or 90s or something for really cheap, and instead of giving it to you at their historical basis, what they paid for it, you can inherit it at the stepped up basis, which is what fair market value. Meaning you could turn around and sell the property for probably no taxable gain. That’s the real big deal here.

Eliot: Absolutely. Just a real quick example, Barley buys a house 10 years ago for (let’s say) $100,000. Now, if nothing else happened and (let’s say) before he passes he gives it away to someone else as a gift, they’re going to get his original basis—

Barley: Even to my heirs or kids.

Eliot: Correct. As long as you’re alive still, when you gave that gift, they’re just going to take that same basis, so they have very little to depreciate if they’re going to (let’s say) turn it into a rental or something of that nature.

But if we wait until Barley passes and then they inherit, they’re going to get the stepped up basis to whatever the fair market value is at the time of death. Maybe it’s worth $500,000 now, they’ll take it on at $500,000.

That basis is so critical because if you ever sell it, we subtract the basis from the selling price that determines your capital gain, how much tax you’re going to pay. Or if you turn into a rental, how much you have to depreciate. Boy do we talk about depreciation a couple of times, huh?

Barley: Yeah. I was just going to make that, that’s going to calculate your depreciation expense off that larger number. It’ll give a much larger depreciation expense, lower taxable income. We just follow the tax chain.

Eliot: Right. Only we could take that question and turn into 14 minutes.

Barley: Talking about death and taxes, we can really go deep—

Eliot: All day long.

Barley: Yeah. Let’s see. “If I already qualify as a real estate professional,” REP status, we talk about this a lot, real estate professional status, “via short-term rentals,” what’s wrong with that sense? It’s a short-term rental; we’re going to have to dig into that one, “and add long-term rentals to the mix, can I lump or all pepper it together? Can I lump these two kinds together?” Kind of, maybe. “And does having an S-Corp that manages everything affect my REP status?” Not in the vast majority of cases. Let’s pick this apart.

Okay. First of all, REP status. What are we talking about? We’re only talking about long-term rentals when we talk about real estate professional status. This short-term rental, that term is a misnomer. It’s really a short-term business that we actually just happen to be renting out to people on a nightly basis or whatever the case may be, like a hotel. We don’t call a hotel a rental. It’s a business that’s seen in the same light.

REP status is going to be achieved by working on real estate activities in general. But because of this little classification, short-term rentals aren’t technically considered real estate, more of a business, so we can’t get REP status working on short-term rentals.

I’m probably not explaining it as articulately as I could be, but just want to clarify because right off the bat we said can I qualify as REP status via a short-term rental? The short answer is no, we can’t.

Eliot: Right. Short-term rental, again, average seven days or less is that. That’s our quick litmus test. Anything else would be long-term. Just as you said, short-term rental is going to be like a hotel. It’s going to be an actual business is how the code looks at it. Whereas that rental activity, long-term rentals, the key here is that that’s usually what we call passive state.

If you have real estate professional status, that’s going to change it to active income. We might have some tax benefits down the line from that. But quickly here, again, short-term rentals, you’re not going to get short-term rental activity. It’s going to allow you to have real estate professional.

What you can get is what we call material participation with a short-term rental. And that just means that you’re putting more time in than everybody else, typically. That’s the quick answer. But a couple of tests out there, one is over 100 hours more than anybody else. You’re directly managing it yourself. Or over 500 hours. Those are the two most common tests we use.

When we get that, then it’s no longer a passive activity. It becomes active and we can do some things with depreciation, create some losses, perhaps. Those losses are now ordinary and we’ll offset any income that we have on our return. But we’re not going to get there through real estate professional status because they’re short-term. But we do have maybe a little fix that we could do and maybe denature that short-term rental. We’re that going on there.

Barley: Yeah, kind of a unique exception. Let’s say you’re managing several long-term rentals. You have real estate professional status. I’m going to throw in a tax term here. You’ve aggregated those rentals together. Now let’s say you want to add another short-term rental that’s not part of that mix. But I have real estate professional status. I might want to do a cost seg study, take some depreciation from there, and offset my W-2 income. How can I pull that into the rest of this pool?

We can do what we call a master lease or a long-term lease through a corporation. Won’t go too far into the weeds on this today, guys. But essentially if that’s you, if you have this pool of long-term rentals and you’re adding a couple of short-term, you want to pull those benefits into your real estate port portfolio, There is a way we can do that. We call it a long lease through a corporation.

Eliot: Basically, the corporation rents it long-term from us. It’s our house. short-term rental, but it just takes a year-long lease, and then it subleases it out to the general public for the short-term rental activity. That way, because we talked about the aggregation that could pull that property all the way back in to the REP status, and we can get what you want as far as your tax status.

So can it be mixed together? Not without some help. We got to add some other ingredient in there. C-Corporation, master release, some of those terms, and then maybe we can get to the spot where we have them all in there with the real estate professional, get all those great benefits we always talk about.

Does having an S-Corporation management, is that going to mess with the REP status at all you think?

Barley: Not necessarily. We want to be careful here. We’re assuming that this is an S- or C-Corporation that you own and control. You’re greater than 5% owner. That’s going to be the vast majority of our clients. If you’re a fractional owner in Coldwell Banker or something through through a separate corporation, those hours would not count towards your REP status.

I’m almost certain what you’re talking about. I have my own S-corp managing the rentals. I’m likely the 100% owner. Those hours will count towards your real estate professional status. Not the material participation. But we get those real estate professional hours through our corporation, absolutely.

Eliot: And if a spousal situation where you’re both shareholders of that S- or C-Corp, then you consider your time and your ownership together to get that 5%, at least for the material participation. A REP status though, we would have just one that we’d be wanting to get all those hours, just one of the spouses.

Does having an S-Corporation as a management corp necessarily hurt anything? No, but we just want to be careful. You would want to sit down and map this out with one of us, a tax advisor or something like that, some professional who understands some of this. But the quick is that on its own, no. You wouldn’t mix the short-term and long-term rentals unless you take some of those strategies that we talked about, then we could put them together and the management corporation. As long as applied properly, you could still use that too and it should not negatively impact REP status.

Barley: Using a corporation, that could likely be very much to your benefit. Likely would be recommended if you have some investments to manage there. Let us know if you have any follow-up questions on that. Great question.

What do we got going on here?

Eliot: “We’re real estate properties are in individual LLCs that is disregarded and owned by my C-Corporation, does the C-Corporation maintain one bank account and collect rent for all individual properties and pay expenses to preserve limited liabilities in the LLCs?” So we got a bunch of LLCs. We’re saying they’re owned by our C-Corp. We say they’re collecting rent from those properties that are in those LLCs. Any thoughts on that?

Barley: The first thing we got to throw out (obviously) is the holding real estate in a corporation. Appreciating real estate, we generally recommend not holding in a corporation. Not to say that there aren’t times you do it. Flipping, wholesaling real estate, that would be. We would generally see that through an S- or C-Corporation.

I just want to throw that out there right off the bat. We want to distinguish, are we using the C-Corp to manage or is the C-Corp the owner? That’s going to be a different thing. Very big distinction we want to make here. You stated it as they’re owned by my C-Corporation.

A couple of ways we could look at this. Let’s assume these are flip properties held in disregarded LLCs. That sounds good to me. Got flip properties down to the C-Corporation. The C-Corporation can have its bank account. You’d likely want to do a bank account for each LLC, even if these were flips.

Eliot: You could get away with the one, though.

Barley: You could get away with the all-in-one account there. And then you mentioned collecting rent. Now I’m thinking these probably aren’t flips. But just for illustration purposes, we can hold real estate. It’s called inventory really when we’re talking about flip and wholesaling properties in LLCs disregarded to a C-Corporation.

But I have a feeling we’re talking about rent here. We want to first look at that. First, talk to your advisor or talk to one of the attorneys about your structural setup. Make sure we’re on the right page there. But as far as one bank account collecting rent for all individual properties, the main thing I think, at least the thing that first pops out to me, is maintaining our liability protection. We got to maintain our asset protection. We need to treat these as separate, individual projects so that the courts also do. The potential creditors also do. The bankers also do.

Eliot: And one of the ways we do that?

Barley: Is through the bookkeeping.

Eliot: Exactly. And bank accounts and things like that. To sum this up, we would not recommend a C-Corporation owning a bunch of rentals and LLCs that it owns. We probably have a situation where a C-Corp should be managing those LLCs. It can collect the rents. That’s part of its management function.

It pays out some of the bills, releases the rest of the funds, because rumor doesn’t own the properties. That rental income doesn’t belong to the C-Corp but it sends it back. That’s part of its job. It can earn a management fee. Very common structure we work with all the time.

We recommend in that case that each LLC have its own bank account. There’s good, better, best. That would be best. But as long as we have good bookkeeping that independently breaks out those LLCs and tracks what’s going on in each and one of those rental properties, and of course the C-Corp too that would need its own books, as long as we have that all going on, then you could probably get away with maybe one bank account at the holding company.

All these LLCs have them owned by one holding company in Wyoming is often what we’ll do. Then offset over here, we’d have our C-Corporation unrelated to any of these rental properties, but managing them. And there, we would have a bank account in our C-Corporation, one bank account in our Wyoming holding, we probably get there, that’d be good, but best would be have a bank account in each entity.

Barley: I say this a lot, guys. Think of this as just a traditional property management relationship. If I buy a rental and go hire a third-party property manager to manage that rental for me, just think of it in that exact same way. They’re just going to manage the property, collect rent, send you the balance. Most of that paying the bills, that’s going to be all out of that LLC account.

Typically, your property manager’s not paying your property taxes, mortgage interest and things like that for you in most cases. If that helps, think of it as help delineate some of those functions. Traditional property manager, your personal investment is the rental LLC. The property manager is the business managing the asset.

All right. “If you get started in wholesaling,” it started down this road a little bit, “flipping,” roughly synonymous terms here, wholesaling, flipping, “should you file as an S-Corporation?” What’s a user?

Eliot: First of all, wholesaling, what is it? It’s basically where I go out, I look for a property, maybe it’s a distressed property, have a seller who’s really excited, really wants to unload this thing, I can get it under contract and then immediately sign the contract over or we can do a double closing all at once, but really I don’t ever own it for too long or just a brief period of time.

I sign the contract over, I take part of the profits for doing that from the ultimate buyer. That’s wholesaling where again, I’m not really flipping, I’m selling, not holding it to rent or anything.

Barley: A middleman of sort.

Eliot: Exactly. They’re in the middle trying to meet between a seller and a buyer, be that bridge between them, and take a cut of the action for it. That’s an active endeavor. When it’s active in the case of taxes here, that means that it’s not just going to be subject to ordinary tax rates, meaning we don’t get capital gains treatment, but it’s also going to get hit with employment taxes.

We’re really throwing the taxes on here, so we do really recommend that you do it in an S- or C-Corporation because there are a lot of goodies there. Some benefits that we can do, some reimbursements, accountable plan, corporate meetings. We might even be able to change how much we pay as a reasonable wage of our S-Corporation so we have less employment tax. There are a lot of good benefits. So yes, we certainly recommend doing it in a corporation, S or C.

Also, if you have a repetitive activity or something like that, wholesaling being akin to flipping, you might get something like dealer status or perhaps, which can have a negative impact down the line in your investments. Should you file an S-Corporation? Well, I’d say S or C, I think you’re good. Again, these always include LLCs taxed as S- or C-Corporations. I think we’d be good with that.

Barley: Yup, good work. All right, let’s go through thoroughly explaining the 280A process.

Eliot: Never talked about that before.

Barley: This one comes up a lot, doesn’t it? First of all, what is it? You hear it called the Augusta Rule, the 280A rule. You hear it called the Augusta Rule for Augusta, Georgia, the Masters Golf Tournament. That’s the origin story for this piece of legislation, this piece of code.

The deal is the Masters Golf Tournament, this big golf tournament that happens every year, the poor little town of Augusta, Georgia gets descended upon by hundreds of thousands of golf fanatics. The people that live there are like, we got to get the heck out of here. They’re not forced out of their homes, but they kind of are. Their town gets invaded for a week and they have to get the heck out of there. You can’t blame them.

So the IRS gave them a break. If you live in Augusta, Georgia, […] rights if you live in paradise, you get a break if you rent out your house for less than two weeks. This could apply to a bunch of different situations, as long as it’s less than two weeks total.

What we’re talking about here are types of income we need to exclude or include when we’re talking about rental activities here. 280A rule essentially says if we rent out our home for less than 14 days, we don’t have to include the income. That’s the background. Give us a little more on that.

Eliot: 280A is just a code section. It really is meant to prevent you from taking deductions on your personal residence, or what we call a dwelling if you stay too long in a house. The government doesn’t want you deducting your personal expenses on your living condition. 280A is really a restrictive provision.

There are two commonly used areas where you exceptions to it. One is if you have the home office or administrative offices as we often use it. Well then we might be able to take some deduction there, given that all the boxes are checked and things like that. Then we have the 280A(g), which is the idea that you can rent out your home for 14 days a year, no more, and the income that you receive is tax-free.

A long time ago, Toby wrote a white paper about this, about how we can use it maybe for a corporation. Corporations often required to have meetings, C-Corp or S-Corporations. Why not it be the one doing the renting?

It has a meeting in Barley’s house, pays Barley $1000 for each meeting. It does it 14 times a year. As long as he doesn’t rent out his house again, that’s tax-free. He pockets $14,000 tax-free, and the corporation gets to take it as a deduction because it’s a reasonable meeting expense, ordinary business expense. We got a deduction at the C-Corp level. We got free cash to Barley to the tune of $14,000. It’s a win-win.

Now, there are a lot of little things there behind that $1000 that I just throw out there. How are we going to determine that $1000? Where are we getting that number from?

Barley: Great place to start. Again, like I started off saying, this is an easy one guys. If you have an S-Corp, you set up in 2025, you’ve already made a good profit, you don’t have an accountable plan in place yet, and you’re not renting out another room in your house, you can sign this template. Go set up these 14 meetings for the rest of the year. This is an easy one.

The only thing we really need to do, well, the first step to really substantiate the deduction, get three quotes. Call up the local hotel. Just like Eliot said. Why pay the Hilton $1000 to rent their conference room? Write that check to yourself. You don’t have to report it. You don’t have to pay taxes on it. And you can do it again next year, the year after that, and the year after that. This is a great way to pull cash out of your corporation.

The three quotes, make them official. If you can, make it look like an invoice. Tell them, hey, I want to rent a conference room. Can you send me a sample invoice? Or at least in an email or something. The more official you can make it, the better. Three of those, take the average. That’s our annual expense right there. That’s the end of the road for the calculation as far as that’s concerned, how much we’re going to charge.

Then we just write up a simple invoice from you to the corporation. Corporation deducts a meeting expense, deduction on its profit and loss. What agreement do we want to see there?

Eliot: Well, we have a 280A kit in the back of the form, just an agreement that it will be $500 or whatever amount you determine for however many meetings you do. Just a very basic, simple invoice saying, hey, today’s May 6th. ABC Co had a meeting in my home. We agreed it to be $500. Here’s an invoice. Put that in the bookkeeping—always got to use that bookkeeping—for your S- or C-Corporation—LLC taxed as an S or C, can all take advantage of this—and then that’s going to get your amount.

Also, the corporation must—this is critical—cut you a check or transfer online the cash. It has to pay it if it’s going to get the deduction. You certainly want to receive it if you have the free cash. We got to have that transfer, ideally before the end of the year.

There are a lot of different rules we won’t get in today. If it’s something that happened on the 31st or whatever, cash basis rules. The bottom line, get the quotes. You only have to get three. We’ll use those for the whole year. You don’t have to get three quotes for every meeting, and then the next year go out and get three more.

Barley: Explaining thoroughly. We’re going to apply this to S- or C-Corporations, generally not to sole proprietors of partnerships. It’s not you can’t do it there, but that the guidance we offer is generally for S or C-Corporations. Make sure you’re not renting another room in your house. Get your three quotes and take your average.

When we say upload a copy or keep the invoice, all we’re talking about is Box. Upload it to Box. That’s your permanent digital storage. That’s where you’re going to put your invoices, your quotes, your invoice to the corporation, et cetera. What else?

Eliot: You got the amount and make sure it pays it.

Barley: Yup, write the check. From the very last step, we get a check for ACH (or whatever) in our pocket that’s tax-free that we don’t have to report. How do we substantiate that? We have to have the corporation actually write a check or make the transfer. That justifies the corporation taking the deduction on its books.

Remember, this is a double benefit. The corporation’s going to write us a check for $12,000 or $14,000. That’s a legitimate business expense to the corporation. Lowering the taxable income, lowering the amount of tax we have to pay at the corporation. Benefit one. Then we get a check in our pocket that’s tax-free that we don’t have to report.

The last step to that, you have an S- or C-Corporation. You’re going to sign an accountable plan template. We have that available for you. The IRS just simply says, you need a reasonable plan for reimbursements in place. Put a signature on that accountable plan template, upload it to Box, then you’re good to go.

You got your accountable plan signed, you got your quotes, you got your invoice to your corporation, your corporation writes you the checks, and you don’t do anything. You just take the money.

Eliot: Yeah, and that’s 280A.

Barley: That’s 280A. I can’t think of anything else to add there.

Eliot: That’s as thorough as we can get.

Barley: You can still do it with a home office. Technically speaking, you aren’t including the exclusive use portion of the home for the home office in the 280A. You’re renting out the rest of your home for the 280A. That’s not even a concern. You can still get the home office deduction and 280A.

Eliot: The accountable plan really goes more to the office because there, it’s a reimbursement. 280A’s really not a reimbursement. It’s actually rent.

Barley: We just don’t have to declare it, exactly.

Eliot: It’s a good deal. All right, I think we beat that one up.

Barley: All right. We got that one. Let us know. I hope there are no questions on there. Hopefully, we got that thoroughly.

Eliot: Uh-oh. Speaking of bookkeeping.

Barley: Ooh. I think we might need to throw in a lifeline for this one.

Eliot: “What bookkeeping is needed for rental real estate? Do you have any bookkeeping software to suggest?”

Barley: No, but I have a bookkeeping professional.

Eliot: We know a guy who knows a guy.

Barley: I know a guy that knows a guy.

Eliot: Troy, are you there?

Troy: Hello. Can you guys hear me?

Eliot: Now we can.

Barley: Oh man. I have a feeling a lot of the people in the crowd are familiar with Mr. Troy Butler.

Eliot: Yeah.

Barley: Hi Troy. Thanks for hopping in today. How are you, sir?

Troy: Of course, good. You guys are doing great so far.

Barley: Very much appreciate your help.

Troy: No complaints in the Q&A, so that’s good.

Eliot: That’s a first. It’s good to have a victory. So, Troy, bookkeeping.

Barley: I just want to throw this out before we hop in. We do have a bookkeeping open office hour in the Platinum Knowledge Room every, is it Thursday from 1:00 PM to 2:00 PM Pacific?

Troy: That sounds correct.

Barley: So you may have seen Troy in there. Where do we want to start on this? I got some rental properties. I know I have to do bookkeeping because that’s the foundation of all my efforts. Where do we even start with this? Do we look for software? Do we call Anderson? Do we talk to Troy? What should we do first?

Troy: There is an IRS requirement that you do have some form of bookkeeping, but what the IRS tells us isn’t very clear as to what that bookkeeping needs to entail. So do you have to have software? Can you just have a box of receipts? Whatever. They don’t really specify.

At Anderson, we use Quickbooks Online as our bookkeeping software. But there are thousands and thousands of other softwares out there. Tessa has some bookkeeping functions built-in. Tessa—fun fact—is asset spelled backwards. that blew my mind the first time I’ve learned about that.

Barley: Is it rental-specific kind of…?

Troy: Rental specific, yeah. That’s for property management companies, landlords.

Barley: There you go.

Troy: Zipbooks is another one. Xero, that’s another good accounting software. Fun fact is they all do the same thing, They all have different looks, but they all end up creating the same thing. It’s really just user preference.

The reason I like QuickBooks the best is because if you ever run into a problem, you’re not the first person to run into a problem using QuickBooks. There are thousands of forum posts, YouTubes, goes on and on for the support for QuickBooks. That’s what we usually recommend. But then, yeah, actually taking care of your books, just buying QuickBooks isn’t going to be enough. You’re going to actually have to use that QuickBooks and input the income and the expenses.

If you just want to keep track of your income and expenses, you can always use something like Excel. It’s not going to be pretty, it’s going to be a lot more work, but you could use Excel. QuickBooks and all the other softwares that I mentioned, have some sort of function. In QuickBooks, it’s called classes and locations. You can set up a class for each and every rental property you have. You’re keeping track of each rental separately.

That becomes very important when you’re trying to do your taxes because we have to report it by rental. It helps for planning because If it’s all jumbled together, it doesn’t mean a whole lot. You don’t know how each property is doing.

Three, that makes sure that you’re not co-mingling funds. If you have an LLC that owns one property, and LLC that owns another, the two aren’t co-mingling. Any other questions on that?

Barley: Price is always an issue. I know that’s not really the topic today, but QuickBooks is just so expensive. Is there any competing with them that offers a similar service? I know it’s off-topic, but…

Troy: The ones I mentioned, they’re a little cheaper than QuickBooks. Quickbooks is kind of—

Barley: And Xero, did we say right?

Troy: Yeah, it’s all kind of pricey. The crappy part is QuickBooks used to offer a desktop version, which you could buy it once and have it forever. They don’t do that anymore. It’s all subscription-based now. That’s the way the world’s going.

The one other thing that I would mention is we do have a bookkeeping department here at Anderson that can help you with all of that. Reach out to your advisor if you’d like to hear more about that. We have a bookkeeping essentials product, which is very good. Highly recommended.

Barley: One last question for you, sir. As far as you mentioned the desktop version, and probably for most people this is what they’re using, with QuickBooks online, that allows you and your bookkeeper to collaborate virtually. I like that feature. That’s probably one of the benefits of not having the desktop.

Troy: That’s a really good point, Barley. Back in the olden days when we had desktop, we had to send files back and forth. We don’t have to do that anymore, which is a big benefit.

Barley: So you can go in and see the adjusting entries your bookkeeping team is making. Awesome. Well, thank you so much Troy. And again, Thursday from 1:00 PM to 2:00 PM Pacific, open bookkeeping office hour, plus Platinum questions, right? We get our own bookkeeping Platinum question?

Troy: Absolutely. Lots of different ways we can help you guys.

Barley: All right.

Eliot: Sounds good. Thank you.

Barley: Thanks Troy. Appreciate the time very much, sir. Thank you. So there it is guys, the bookkeeping. That’s the scaffolding of our operations. It really is.

For example, we take our profit loss statement, a line item like dues and subscriptions or something. We want to be able to look at that line and just have an idea of where that number came from. So dues and subscriptions, $1000. We’re like, oh, that’s going to include my monthly Platinum thing, maybe some trade publications that I subscribe to, or my QuickBooks online or something like that. We just want to have the bookkeeping, understanding the bookkeeping will give you a much clearer idea of how all that stuff is constructed.

Eliot: The bookkeeping is the foundation to everything. If you don’t have good numbers, your tax plan’s out the window. Just as importantly, your management’s out the window because you don’t have any idea if that rental is making you money or if it’s costing too much. Or why is water so expensive on this unit versus the other unit. Good bookkeeping keeps it all organized, helps you make better decisions, and certainly helps you from a tax aspect.

Barley: Sounds nerdy, but a well-prepared set of financials is a very empowering thing.

Eliot: Oh yeah, absolutely.

Barley: A profit and loss statement, balance sheet, general ledger for each of your investments, because we can really zero in on profitability, just like Eliot mentioned there. Profitability, cash flow. These are things that are crucial to maintaining an ongoing enterprise. We’re maintaining an ongoing business, even if it’s just a collection of rentals. That’s our business that we have to keep going. And cash flow is king.

Eliot: Absolutely.

Barley: All right, what else we got here?

Eliot: We got a reminder. Something’s going on in June 26th through 28th.

Barley: Sounds like a nice time to be in Vegas.

Eliot: Only $100. Can’t beat it. Our TAP event live here. Please by all means, join us again in great event.

Barley: No, 26th to 28th, that sounds like a weekend.

Eliot: It usually is. I would think so. That wasn’t for somebody.

Barley: You know what that means, guys. We went over this last week. Book your travel Monday, Wednesday, and you got those business days. That’s a business trip. We can write that off.

Eliot: There are some deductions to be had.

Barley: There are deductions to be had, there you go. And of course, the tax and asset protection. Just reminding anyone that came in late. We got these great workshops coming up.

Eliot: May this Saturday the 10th, next Saturday May 17th. It’s going to be our online version of it. Again, as we just saw, 26th through 28th, the live down here in Vegas.

Barley: And just as a reminder, if you want to scan this code and set up a session right now, you can. We love this format where we get to go over all of your general questions.

I like to remind you, guys. If any of this is obviously specific to what you’re doing, please submit a Platinum portal question, set up a tax call, take the next steps to really drill down on this because we could go into way more detail on all these subjects.

It gets pretty heady, so we want to just give you the tools that we hope will add the most value as we can here and now, and you can let us know what guidance you’re looking for there. Meet with the tax team, schedule a strategy session. It’s a great way to get started.

Eliot: Pull it all together.

Barley: That’s right. All right, you ready to dig? Here we go. We got some…

Eliot: We got about four parts here. Just so you know, normally I won’t pick ones that have multiple parts like this, but it was really a nice way it flowed through.

Barley: It’s four parts, but it’s really six or eight issues that are crucially important, so let’s hop right in.

Eliot: You want to read it?

Barley: Sure. “When doing an IRA to Roth conversion,” so a traditional IRA to a Roth IRA, Senator Roth who named this for, “are there any dollar limits? How much can we convert?” is basically the question there. “Are pre-tax conversions always treated as ordinary income? Is it true that the IRS does not know or care when the conversion was done during the year? Is it true that withholding payment to the IRS will trump all other forms of payment?” We’re going to talk about estimated and quarterly payments.

“As a small business owner, can I just issue a payroll check at the end of the year that withholds enough to cover? I’ll just issue myself a bonus and withhold a bunch at the end of the year. Will that avoid all penalties?” Maybe, maybe not. We’ll talk about that without penalty for doing quarterly estimated payments.

All right, let’s hop right in. First of all, are there any limits when we’re converting a traditional IRA to a Roth IRA? What are we talking about here? If you’re AGI (adjusted gross income) is too high to make a Roth IRA contribution, you may have the option of doing an after-tax contribution to a traditional IRA, then converting that to a Roth. That’s a taxable event. But then we can start building the Roth, can then grow tax-free.

A couple of considerations we want to look at here, but that’s the background. That said, are there any limits?

Eliot: Yeah. Again, IRA you’ve put funds in, you got to deduction for it, typically. But it’s going to grow, and when you finally take it out, you get taxed. People want it in a Roth because you don’t get a tax benefit for. It grows tax-free, and at retirement you take it out without paying taxes. That’s why people like to get in there if they can.

Are there any limits? Now, we’re not talking about a backdoor here, but an IRA to Roth conversion, there are not any limits because the government’s going to get its money. It’s going to be able to tax you on this. It’s a taxable event. So $10, $10 million. They get a big chunk of change coming into them, so they’re happy with that. They’re not going to place limits on that.

There might be limits to what you want to do from a tax planning perspective, but from the government standpoint, no. Bring it all in. We’ll take that money. So no limit there.

Part B, are pre-tax conversions always treated as ordinary income? Yeah. There are no capital gains going on here. That’s one of the things, well, hold on. I’m invested in Bitcoin inside my plan, or in stock. It’s growing. If I sold that personally, I’d get capital gains. But you don’t in a retirement plan. It’s all ordinary. We don’t have that distinction between ordinary or capital gains. It’s all ordinary.

Part C, is it true the IRS does not know or care, IRS always cares. I’ll tell you that right now.

Barley: They’re just a caring bunch.

Eliot: Exactly, a lot of care. Do they care when the conversion was done during the year? In other words, if I do the conversion in December, will I be treated as if I just had received that income in December as opposed to January? And why do we care? Because the government looks at when you earn dollar through quarters.

If you’ve done it in the first quarter, you might have to make estimated payments during the first quarter for income earned during that quarter. Whereas, if you did it in the fourth quarter, maybe you only have to make contributions for the taxes for anything earned in the fourth quarter.

The problem here is that the IRS does care. Let’s say you have a conversion. Let’s say you have $100,000 that you converted of taxable income. They’re going to look at it as if it was done evenly throughout the year. That means some first quarter, second, third, and fourth.

If you wait all the way to the fourth and don’t make estimates, you’re going to get hit with some penalty. Now, even in the fourth, if you made enough to cover the damage, so to speak of all quarters, it’s going to be limited, but there are going to be some, especially if you do a really heavy amount of income coming in that fourth quarter.

In this particular time, this particular event where we’re doing a conversion, it does matter. At least it’s going to be treated as having been done throughout the year, so you’d like to make some first, second, third, fourth quarter estimated payments, et cetera.

However, is it true that a withholding payment to the IRS will trump all other forms of payments? In other words, quarterly estimated payments. The idea of what’s going on here is what if I paid myself in a business as an employee?

Let’s say I make $500,000 and I pay myself a really large wage in the fourth quarter. And I do a lot of withholding, maybe $300,000 worth of withholding tax on that. Will that go all the way back to January and cover that conversion I did in December for that time period that’s being held over the whole year? Treat it as having been done over the whole year? It actually probably will. It’s not a strategy. It’s not something that you can rely on.

Barley: Thank you. That’s a good point.

Eliot: Yeah, it’s not in the code. You know that you can do this and don’t worry about it. So if the IRS ever did, let’s say they finally got their computers updated, it’s something a little bit more timely or whatever, they may be able to track that and they would see that you didn’t make that payment or that that was for a different type of income, et cetera. It could be.

It’s not foolproof, but it is. Well I just said it’s not a strategy, but it is a technique that people haven’t been using. But we can’t guarantee that’ll always work. A lot of times people do this when in a jam. They do that to try and cover that payment from back before. It typically does work, but I can’t promise you.

Barley: The IRS has their magic wand thing with it. We’re going to annualize the income, we’re going to look at the quarterly income. We’re going to go look at this year, we’re going to look at last year, and then poof, here’s how much more money we want. You’re asking the right questions.

Eliot: Absolutely. That’s what towards the end here, they’re just saying, yeah, I could just cut myself a check. We’re talking employment check, a W-2 wage where you have to pull out. For those purposes, for those funds, that will be treated as having been paid over all year a little bit.

It’s one of those weird situations where the IRS is very generous on that particular instance where you’re taking the paycheck, to allow it to go all the way back because you probably earned that paycheck throughout the year.

However here with the conversion, we don’t get that treatment. It is typically treated as if it was earned throughout the year, so we’d like to get that first quarter payment in there. Or do something like the technique mentioned here, doing that payroll the end of the year. But again, it’s not a guarantee. Can’t promise you.

Barley: Do we want to talk about…

Eliot: We can talk about the quarterly. We didn’t talk too much about it. Quarterly is just that. It’s an estimated payment you make each quarter.

If you knew that this was going to happen, you know that later on at the end of the year you’re going to do this, make some larger payment each quarter for that additional amount that you think you’re going to convert—you know, Eliot, I don’t know 365 days ahead of time how much I want to convert in December—at least we can do tax planning and get an idea.

We can create a glide path for you, landing pattern for you, to determine, well we don’t maybe know exactly, but maybe we have a rough idea. You can at least make some estimated payments that are a little more accurate, knowing that this is going to go on. That’s what we do in tax planning, is to try and make it a little bit easier for you.

Barley: And I hate saying this. It sounds demeaning almost, but I feel like they almost do that for your own benefit. Make estimated payments please, because if you get to the end of the year and you got this massive tax bill, how much more stress can you get? You got to figure out where to come up with the funds, make the estimated payments is usually going to be just in your benefit.

Use the vouchers. If we’re preparing your taxes, they’re going to come with a voucher. You don’t have to clip them and mail them in or anything, but it’s going to tell you how much to pay, by when, all the information, all that stuff.

Pay through the IRS. You get confirmation. They have a nice little readout of everything you’ve paid. Make sure you select the right date of year.

Eliot: Right year.

Barley: It gets a little tricky.

Eliot: We see that all the time. Someone goes in, they pick the wrong year, and the IRS applies it. Now sometimes, the IRS won’t even listen to you and they’ll apply it to a back year if you owe back taxes. Be aware of that. If they know, but they won’t. You just want to be very careful to make sure you’re getting the right year on there.

Barley: Then similarly, on this guy’s a lot more information here. When do we do a conversion? What about earnings capacity? How close we are to retirement? A lot of different factors here. How much we want to do, this all comes down to tax planning. That’s where we really want to detail it out. Calculate, calculate, calculate. Give you guidance that you can rely on with some accurate numbers as we can come up with. Great question. We could go into a lot more on that one.

Eliot: But they did a nice job of summing up.

Barley: Yeah, breaking down all the parts. Great work. Let us know if you have any follow-up on that, guys.

Eliot: They already got 89 questions answered. Good job guys.

Barley: Oh wow. Nice.

Eliot: We’re moving through it.

Barley: Good job on theming these together. I like that. Congruency here. “How does tax work if a business owner is paying himself as an employee? Do we have to tax twice? Once for business income and once for employee payroll taxes?”

Great question. The first thing we want to talk about here is payroll is a tax deductible expense. When your business pays payroll, that’s a tax deduction. It’s going to lower the taxable income.

Unlike maybe a dividend. The C-Corporation’s going to earn income, then pay tax, then it will issue a dividend that you have to pay tax on a second time. Double taxation there. Not quite the same with payroll. That’s a deduction to the company. You have to pay your payroll taxes, your employer or you paying your payroll taxes as well.

Eliot: I think something that gets confused here a lot is I’m an employee of my business. Well, many would think that, okay, what I’m a sole proprietorship. I just do schedule C. Am I an employee? No. You’re not considered an employee. All your income is considered, your earnings, but we don’t call you employees. We don’t set up payroll for that. 100% of it’s subject to employment tax, income taxes, et cetera. We have no payroll there in the sole proprietorship, so we don’t have to worry about being an employee there.

Partnership, really partners are not considered employees unless it’s favorable to the US government. There are certain types and times where they actually consider partners employees, but for our purposes of being considered an actual employee, you are not an employee of your partnership either. The money flows through you via K-1.

S-Corporation, now all of a sudden we got something different. It’s a corp. It’s a separate reporting instrument, has a little bit of a corporation aspect to it, thus the name S-Corp. It does require reasonable wage. That’s going to be an employee. You’re paying yourself that reasonable wage. How do we calculate that reasonable wage?

Barley: Reasonable wage, kind of a three-prong approach. One is this very wide range, 30% to 50% or 60% of net income. That’s not going to help you too much. That’s a very, very wide range, gives you a place to start.

Second part of that, and two and three are very closely related, if I went on Glassdoor or indeed.com or something like that and found XYZ description of a property manager, how much are they getting paid? That’d be my replacement salary.

Again, closely related, pretty much the same thing. How much would I have to pay to have somebody just replace me to do my job? Maybe the distinction would be one’s an industry average and one’s more based on the particular job functions that I’m doing, how much it would cost to replace me.

So that’s our reasonable wage. Now we have this range. Very generally speaking, the less we pay ourselves, the less payroll taxes we’re going to owe. The more we pay ourselves, the more could be eligible to contribute to a qualified retirement plan if that’s our goal.

Of course, this has to be in a reasonable range based on services provided, all that good stuff. But then we want to look at our planning aspect as well. Where are we headed? Are we trying to just lower taxes, cut taxes down to nothing? Are we trying to pat out $70,000-plus a year over to a Solo 401(k)? Those are very different goals. It depends on where we’re headed.

Eliot: And then of course, outside the S-Corporation we have a C-Corporation. What if I have my own C-Corporation? Yeah, you’re an employee there as well. You’re just going to do straight payroll like you’re working for anybody else.

How does this all come down to how it’s taxed? Well, again, if you’re a sole proprietor, all that just flows through to you. There’s no payroll. We only get taxed once on our 1040 return, our individual return for those funds.

Partnership, very similar. It does file its own return, and each partner gets a K-1 that represents their portion of the earnings. But it only gets taxed once when that K-1 hits their personal return. So therefore, again, only one time we’re being taxed there, and that money just flows through just like the sole proprietorship.

S-Corporation is a hybrid as you so well put. You’re going to get the income there, the reasonable wage. That’s going to be payroll. You’re going to pay payroll taxes and everything on that. It hits your 1040. You’ll pay income taxes, but it’s payroll. The S-Corporation gets a deduction.

If we have an S-Corporation, we pay Barley $100,000 or something like that, the company gets a deduction for that amount. That amount only gets taxed on his personal return. The rest of it is flow-through. It’ll only be taxed on the 1040. Everything that’s not W-2 income on an S-Corporation will just flow through to the K-1.

Barley: Distribution.

Eliot: Distribution, that’s the word. Thank you.

Barley: Kind of misleading. Whether you take it or not, it’s called a distribution.

Eliot: Exactly, whether you distribute or not. Then the C-Corporation, again is completely a separate taxpayer. Again, it pays a salary to Barley. That’s a deduction. You’re going to get a tax only once again on Barley’s 1040 when he puts his W-2 income. There’s no double taxation going on, any of that. The business does get a deduction in those cases, and no case that I can think of would it be double taxed.

Barley: Now remember, one of the powerful aspects of this is that you’re both the employer and employee. We can max out both sides of that calculation. Knowing it all figuratively ends up in your pocket at the end of the year, so to speak.

Eliot: That’s tax planning right there.

Barley: Yup, that’s tax planning. All right, this is a fun little change. “How do I do a 1031 exchange?” A 1031 exchange, like-kind exchange. We used to be able to do that with business assets maybe way back in the day. But this is only related to real estate now.

So 1031 exchange, like-kind exchange that used to be a much more general term. You’ll see this Form 8284 or something like that for your like-kind exchanges. Used to be a very general term. I could exchange this type of asset for that type of asset. Now it’s just related to real estate. Was this a Tax Cuts and Jobs Act thing?

Eliot: It was, yes.

Barley: So how do I do a 1031 exchange? Let’s start with what is a 1031 exchange. This is, I have a piece of real estate used in business. It’s not for personal property or personal use real estate. A piece of real estate used in business, and I want to exchange it for another piece of real estate also used in business. That’s a 1031 exchange.

Essentially, what we’re trying to do is defer the gain and then get an adjusted basis in the new asset. Has Ross in the chat today? Ross is in here. I love using Ross’s phrase. What’s he say? Till death. I like to say 1031 for life, but Ross—

Ross: 1031 until you die.

Barley: That’s right. Ross says it a little more morbid. It’s 1031 until you die. That’s the Donald Trump strategy if you will. You’re going to keep increasing your assets and then, what was that term? Stepped up basis. When you pass, your living trust assumes ownership of everything and your heirs. Get it stepped up to today’s fair market value.

A little off-topic there, but these are closely-related strategies. You don’t ever have to sell real estate. You can just use it for its advantages and keep building the asset value of your overall portfolio. So let’s hop right in. How do I do a 1031 exchange? Where do we start?

Eliot: First of all, again you’re trying to defer tax. Let’s say we have a rental. We’ve had it for 27½ years. We’ve fully depreciated the thing or something like that. I don’t want to sell it because I would have to pay 100% tax on everything, every dollar that came in. There’d be no basis to take against it.

I want to maybe get another bigger piece of property. I’ve made so much cash on this one. That’s called the relinquished property. I have to go out and I have to buy another property called the replacement property. Now I need to do this within some timeframes. Within 45 days, I have to determine what property I’m going to pick up, the replacement property. I have to list it out. I have to let the government know.

If I go literally one minute over, was it midnight in that particular time zone, it’ll be too late after 45 days. They’re very, very tight on these rules. Then I have the remainder up to 180 days—

Barley: To actually close.

Eliot: Yeah, another 135 days to actually get all the closing done.

So I sell a property, all this has to be done through a qualified intermediary. You cannot touch the cash. You’re going to go to a third-party that’s just sitting there as a banker, if you will. They’re going to take the cash from the sale of your property. They’re going to send it out, buy that replacement property all within the timeframe. They’ll try and keep you on track, make sure everything’s moving forward, and so and so forth.

Now you get that replacement property as long as the property you bought costs more than the value of what you sold. Let’s say you sold it for $100. You have to buy that new property, the replacement property for $100 or more. Let’s say there is some debt left on that property, $20 of debt. You have to pick up at least $20 or more of debt.

As long as you do those two things, you’ll typically defer all the taxes, and you’re not going to have to pay any at that point. That’s a big goal to be aware of, how much are you going to defer. You want to make sure you can defer all of it.

Some people say, no, Eliot. I only want to defer 90% of the tax liability. That’s where you get into tax planning and things like that. But in this case, that will give you a full deferment.

Now the big question is, once you do all that and you do the 1031, you pick up the replacement property, that is now yours. The QI signs off on everything, you take over the property and continue renting it out. That’s a 1031. It’s a like-kind exchange.

There are more significant rules. It’s how many properties you pick up and everything like that. You can pick up to three properties in exchange, or you can pick up an unlimited amount of properties as long as it doesn’t go over 200% of the value of the property you got rid of. Those are some of the rules on how many properties.

Barley: You can have a couple of extra. You don’t have to jeopardize your whole exchange if one of the transactions falls through.

Eliot: Our next question actually goes in far more detail, so we’ll hit that here. Just coupling off what we just answered. “How do I maximize the property depreciation after I do a 1031? Am I stuck with the previous depreciation rate and amount on the previous property?”

Barley: Good question.

Eliot: Let’s change it up and let’s say we didn’t fully depreciate at all. There’s still a little bit of depreciation in our property we gave up. It’s called carry over. That basis is going to carry over. You take that same amount.

Let’s say there was $10,000 that we had not depreciated. That becomes the basis in our new property. Wait, I just bought a new one for $200. I didn’t get $200. No, because remember you had to defer the taxes. What’s really going to happen, the calculation for the basis is going to be…

Barley: A lot of fun.

Eliot: Right. It’s going to be the sales price of the property you purchased, the replacement property, minus the deferred gain.

Barley: That’s it?

Eliot: That’s it right there. You take the amount you paid for the new property, subtract out your gain that got deferred. That’s going to be your basis in the new property.

Now determine that deferred gain, all of a sudden now we’re getting to what we’ve been hitting all day, the basis and things like that. To determine our deferred gain, you take the sales price of the property you gave up, let’s say we sold it for $100, we had $10 of basis left. That leads us with $90 of adjusted basis. If we didn’t do anything, that’s our gain.

Again, if we meet those two criteria, if we bought more expensive and we picked up more debt, we fully deferred then. In our case, all $90 got deferred. That will be part of our basis, to help determine sales price minus our $90 deferred. That becomes our basis in the new property.

How do we depreciate that $90? You got some options. You can continue doing the same thing you did on that first property. In other words, we’ve depreciated down to $10. We’ve had it maybe 20 years. That’s 27½ year property. You can continue just taking that amount and doing it over the rest of the 7.5 years at $10. And then the new stuff, anything additional that you picked up, you can start over at 27½. Or you can elect to call all of it brand new, and let’s do at 27½. So you have some options there.

One might have a better play for you in a particular year than another. It’s one of those things. Again, you want to calculate, come and have some tax planning. But how do we maximize? Well, the way you maximize is just buy more.

Barley: Trade up.

Eliot: Exactly, trade up. The more you trade up, the more depreciation you’re going to have to work with. Are you stuck with the previous depreciation rate? In a sense, yes. It’s either that or you start over at 27 if you decide to combine all the assets. Those are your two options there.

Barley: Boy.

Eliot: There’s a lot to it.

Barley: Proud of you guys. That’s a big one. That 1031 exchange worksheet can’t be super complicated. But yeah, I’ve realized that that sales price might as well be deferred. You’re going to be your adjusted price going forward.

Eliot: Yeah, but that’s how you do it.

Barley: That’s how you do it. Well let us know if you have any questions on that, guys.

Eliot: Again, speaking of questions, we now got 124. As we’re tying it up here, thanks to Troy, Ross, Dutch, Jared, Jeffrey, Marie, Rachel, Ross. Thanks to the guys in the back making everything happen. Got Amanda on YouTube. I think she’s out there too, I believe.

Barley: Nice. Was that our last one?

Eliot: That was our last one.

Barley: What? Good work guys. I guess that wasn’t too bad, was it? Just a reminder, guys. We are here every other week. Let’s do a quick. We got the YouTube channels, we got some announcements to make. Let’s go over the services real quick. Just to reiterate here again, guys.

Tax Tuesdays, every other Tuesday going over your questions that you submit. Platinum portal questions, please submit written questions. Usually, can get back to you within 2–3 days.

The Platinum Knowledge Room, five days a week, five hours a day. Please consider this like you have a professional services team on call, at your beck and call, on demand five hours a day, five days a week, staffed by CPAs, attorneys, the tax preparers, bookkeepers, the nonprofit team is in there. Again, five days a week, five hours a day. Guys, please take advantage of that service.

So many ways to get your questions answered. Just to reiterate, if you do want calculations, specific guidance, we’ll push you to become a tax client. Set up a tax call. We can go into a lot more detail as we mentioned.

Eliot: A reminder. Next week, next Thursday and Friday, we have something called TaxWise, that Barley and I will be—

Barley: Oh, the TaxWise Workshop. I haven’t heard of that for a while.

Eliot: Those of you remember, we used to do it every two weeks I think it was. We’ve condensed it down into quarters. We’re going to do it every quarter. We’ll be starting it up next Thursday. It’s going to be all day Thursday, all day Friday. We’re going to go through all those strategies that you know and love, except for the strategy of paying payroll at the end of the year to cover your Roth IRA conversion.

Barley: We’ll just cover that as an option.

Eliot: That’s a technique, not a strategy.

Barley: Two-day, full live virtual event, guys, TaxWise Workshop. We are going to just hit the main strategies that we recommend, that you’ve definitely heard of here at Anderson. We’re just going to drill down on every single one of those. Two-day, live virtual event. Please join us for that.

Eliot: We’re going to have some people in the background answering questions again, just like we do today. We’re excited to take it on the road and do that again. We’ve been waiting.

Barley: And of course, make sure you come to the live events, guys. Text Tuesday Tax and Asset Protection Workshop.

Eliot: Make sure you get those questions in. Email [email protected]. I read through every one. Every one of those questions I go through. Pick out the ones that are, oh wow. We got like five questions about this topic. I’m going to pick one out there that broadly hits all the aspects of it as much as I can. Or come to our website, andersonadvisors.com, check us out.

Thank you so much for joining us and bringing those questions in. We greatly appreciate it.

Barley: Yup. Good work today, guys. We’ll give you the clap track.

Eliot: All you.

Barley: All right guys, submit your questions. We’ll see you next time. Thank you so much for tuning in. We really appreciate your business and look forward to seeing you again soon.