In this episode of Tax Tuesday, Anderson Advisors attorneys Eliot Thomas, Esq., and Amanda Wynalda, Esq., dive into various tax strategies. You’ll hear about renting property to your business, self-rental rules, and IRS grouping options. Then, we address the sale of a California primary residence, including the $500,000 capital gains exclusion for married couples. We’ll explore cost segregation for landlords and the 1244 stock loss provision for individuals. We also have answers about tax implications for C Corps, including reimbursement rules for accountability plans and transitioning from LLCs. Lastly, we touch on Opportunity Zones, rental property sales strategies like 1031 exchanges, and the tax impact of converting a rental to a primary residence.

Submit your tax question to taxtuesday@andersonadvisors.com

Highlights/Topics:

• So can I rent real property to my business? – Check self-rental rules, and the ‘grouping’ option from the IRS
• Just sold our primary California residents in July for a million and ninety thousand dollars. We purchased it five years ago for six hundred and fifty thousand, with three hundred thousand down and a three hundred fifty-thousand-dollar mortgage. Any taxes due considering the 121 married filing joint exclusion of five hundred000 capital gains. – We’re going to look at the sales price, less our ‘adjusted basis.’
• Could you give an example about cost segregation? Have you heard? I have heard you talk a lot about it and they’re kind of confused. I’m thinking about becoming a landlord. How can I do a cost segregation on, for example, the appliances that come with a purchased property? – The building itself has straight-line depreciation over many years. Contents of the building are depreciated at different rates.
• Is the 1244 stock loss provision, a $50,000 tax credit, that is dollar for dollar, against your 2024 interest, social security and passive incomes on your 1040 for 2024. – 1244 is only applicable to individuals, as a deduction/loss. It reduces your taxable income.
• When using the accountability plan for a C Corp, do the charges have to be made from the employee’s personal account to qualify, and what happens if those charges are made on the company credit card? – The individual needs to pay for them first personally of their own pocket for a reasonable business expense, then submit for reimbursement.
• We purchased our first commercial building this year. Even though I knew in the back of my mind the property was in an opportunity zone, it did not hit me until a couple days ago. Is there still an advantage for us to go into the opportunity zone route? I believe the only benefit at this point is a 10-year mark and step-up in basis. Is this correct? I believe there would be some elections we would have to make in a fund. Can you explain how it all gets set up and what we would need to do? – Once you obtain that property, a stopwatch starts, and you have 30 months to substantially improve it. You had to put the funds into the Opportunity Zone fund, which is the business entity, and then purchase the property there, not going to be able to back into it.
• We are changing our LLC from being disregarded to being a C corporation. Over the year we have moved substantial money from our LLC to our personal accounts as distributions. Do we need to relabel those as dividends and would we be able to transfer the funds back, or does the C Corp election only affect forms from the date of transition, meaning we’ll file a split return 1040 for a disregarded entity, 1120 for the C Corp? Thank you for all the great media you guys put out. – Nothing happens with the previous activity, but going forward you can’t take money out in the same way.
• We have rental property bought originally in 1991 as our residence. The current tenants want to purchase the property. What is the best way to approach this? To lower capital gains, we are considering using the funds either to purchase another property or invest in tax liens and deeds. – You have a lot of options. Installment payments, interest from seller financing, or 1031 exchange
• What are the tax implications of moving into a house that has been held as a rental for 12 years? They’ve never lived in it themselves. – What is your value/investment in the house? That becomes your adjusted basis when you move in, for future tax purposes. Many items are no longer deductible if they become your personal residence.
  
  

Resources:

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Toby Mathis YouTube
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Clint Coons YouTube

Full Episode Transcript:

This is the Anderson Business Advisors podcast, the show for real estate investors, stock traders, and business owners. We help you keep more of what you earn and protect what you’ve built. Let’s get started.

Amanda: Welcome into Tax Tuesday. I’m your host today, Amanda Wynalda, and I’m joined by…

Eliot: Eliot Thomas, manager of tax advisors here at Anderson.

Amanda: Nice. Toby is out.

Eliot: Yes.

Amanda: Probably doing something fun.

Eliot: Nothing more fun than taxes.

Amanda: That’s true. Not going to be having as much fun as we are today. It’s Tax Tuesday. What we do is we go over your tax questions. You can send those questions into us at taxtuesday@andersonadvisors.com.

Eliot: Correct.

Amanda: Correct. Eliot will then comb through them, so send a lot in. He needs to stay busy. He picks out a handful and we go over them, so let’s go over the rules. This is live Q&A via Zoom. If you have any technical issues, you could put that into chat. We have an events team. We have some people in the background that can help with that.

If you have a question, a tax question, maybe related to what we’re talking about, maybe not related to what we’re talking about, you can go ahead and throw that into the Q&A. We have a lot of people here helping us today. We’ve got Arash, Dutch, Jeff, Jennifer, Rachel, Tanya, Troy. All of them are CPAs, bookkeepers, really professionals that are going to be able to help you untangle whatever tax questions you have. If you need a detailed response, you can always email in. If you’re an Anderson Platinum client, you can also send in a Platinum question or come into our Platinum Knowledge Room. Same type of setup and get individualized help.

Eliot: We got the YouTube going too. 

Aman: Yeah, that’s right. We’re live on YouTube. I believe Troy is helping out in the chat there, so send him in your questions. It is a little bit challenging answering questions.

Eliot: That’s why we have her do it. This is why we have the champ.

Amanda: Yeah. There’s a character limit. How do I answer this complex tax question in less than 250 characters?

Eliot: Not easy to do sometimes.

Amanda: That’s why Troy’s doing it today. Okay. Let’s just go over. We’re going to quickly go over the questions that we’re going to be hitting on today. “Can I rent real property to own my business?”

Eliot: Do we want to go through the questions?

Amanda: We’re going to go through the questions first. You read the next one.

Eliot: Okay. Just sold our primary California residence in July for $1,090,000. We purchased it five years ago for $650,000 with $300,000 down and a $350,000 mortgage. Any taxes due considering the 121 married filing joint exclusion of $500,000 capital gains?

Amanda: That’s a lot of numbers. They tell you when you go to law school, you’re not going to have to do math. And that is a lie. That is a lie. “Could you give an example about cost segregation? I have heard you talk a lot about it and they’re confused, so I’m thinking about becoming a landlord. How can I do a cost segregation on, for example, the appliances that come with a purchased property?” That’s a good one. Cost seg is always a popular one. 

Eliot: Yes, a lot of things to that. “Is the 1244 stock loss provision a $50,000 tax credit that is dollar for dollar against your 2024 interest, social security, and passive incomes on your 1040 for 2024?”

Amanda: Lots of things to dig into in that one. All right. The next one will be, “When using the accountability plan for a C-corp, do the charges have to be made from the employee’s personal account to qualify, and what happens if those charges are made on the company credit card for medical expenses, prescriptions, et cetera, if they were charged to the corporation credit card?” We’re going to go over that as well.

Eliot: We’ll mark that one up in red.

Amanda: This is a long one. 

Eliot: “We purchased our first commercial billing this year. Even though I knew in the back of my mind, the property was in an opportunity zone, it did not hit me until a couple of days ago. Is there still an advantage for us to go into the opportunity zone route? I believe the only benefit at this point is a 10-year mark and step up in basis. Is this correct? I believe there would be some elections we would have to make in a fund. Can you explain how it all gets set up, and what we would need to do?”

Amanda: Opportunity zones have some great tax benefits but can be complicated.

Eliot: Yes.

Amanda: All right. “We are changing our LLC from being disregarded to being a C-corporation. Over the year, we have moved substantial money from our LLC to our personal accounts as distributions. Do we need to relabel those as dividends, and would we be able to transfer the funds back? Or does the C-corp election only affect froms from the date of transition, meaning we’ll file a split return 1040 for disregarded entity, 1120 for the C-corp. Thank you for all the great media you guys put out. Thanks.” You’re welcome. I like how you left that part in. These are your exact questions. No editing done.

Eliot: There’s a little dumb, but not that part. All right. “We have a rental property bought originally in 1991 as our residence. The current tenants want to purchase the property. What is the best way to approach this to lower capital gains, where you’re considering using the funds either to purchase another property or invest in tax liens and deeds?

Amanda: Gosh, 1991 doesn’t seem like that long ago, but it’s the late 1900s. “What are the tax implications of moving into a house that has been held as a rental for 12 years?” They’ve never lived in it themselves. All right. We’ve got a lot of good stuff coming up, but you’re on Toby Mathis’ YouTube channel. He is tax wise Toby. Please click subscribe. You’ll get notifications when he comes out with a new video. Lots and lots of good stuff there.

Eliot: He’s got a few of those.

Amanda: A few videos. Yeah. Him and Clint get those YouTube awards because they’re so influential. Clint Coons is our other founding partner. He focuses a lot on asset protection, although tax and asset protection, as we know, because we’re Anderson, they hold hands in a lot of ways. Subscribe to him as well.

We’ve also got our Tax and Asset Protection workshops. We call them the TAP workshops. The next one is going to be Saturday, November 23rd. You can register via these links. They’re free virtual events. It is a little bit of a commitment all day, but I’m there all day Saturday and a lot of times, and we’d love to have you.

We also have our live event coming up. We only do this four times a year. This is the last one for this year, December 5th through 7th in lovely Las Vegas.

Eliot: Actually, Henderson, I think we have it going.

Amanda: Henderson’s part of Las Vegas.

Eliot: Yes, it is.

Amanda: It’s actually still very close to the Strip.

Eliot: It is.

Amanda: Yeah. If you want a tax deductible business meeting to Las Vegas, come and visit us. We like to have fun. Although, the attendees have much more fun than we do at those things when they’re in Vegas. Yeah. They show up a little bit later every morning, but then our last tax and asset protection workshop of the year is Saturday, December 14th. Actually, I think we have one more before the end of the year. Come and join us.

All right. “Can I rent real property that I own to my business?” This is one of those lawyer answers where it depends. You can, but is it going to actually be tax wise, Eliot?

Eliot: Yes, that’s the thing. The first thing we want to look at is what we call the self rental rules. That’s just a provision that says, if you are renting to your own business, the general format there is that if you have overall gain, it’s going to be ordinary. It’s going to be taxed at ordinary rates. But if it’s losses, it’s going to be automatically passive. That’s not fun. That doesn’t usually work into our game plan as far as tax planning and things like that, but we want to be aware of that.

There is something else we can do called grouping. Grouping is a special election that you make. Let’s just say you had a popular example that I actually think is in the IRS publication. Let’s say you had a grocery store and you also own the land that the store is on. If you ever watched this one, Clint talking about the asset protection, we’re going to separate those. We’re going to put the land one LLC and then we’ll have the operations, the store in this case, and it may be an S-corporation or a C-corp.

Amanda: That’s one of the key tenants of asset protection. You don’t want to run your business out of the same entity that you’re holding your assets. That works across all kinds of industries, not just grocery stores, but residential assisted living. You hold the real estate in one entity. You run the business out of another. I have a lot of clients who are doctors, dentists. They actually run their practice through typically an S-corp, but then they also own the real estate underneath. That applies to all of them.

Eliot: Yeah. If we group, then what that will allow us to do is to take the depreciation on that building against our ordinary income on our business. It can be a really great tax event if we can make that happen. There are some rules about grouping, it has to be an appropriate economic unit. Basically, that just comes down to it makes sense. All right. It’s reasonable that we put the two together.

Also, you can’t have an overabundance of impact from the rental against the business or vice versa or the thing that really allows most people walk in the door. You have about equal proportional ownership for both the operational business and the land. If we got that, then we can group. We can take advantage and we can get around that self-rental rule, where we’re limited to just passive losses or active ordinary income.

Amanda: Okay. When you read this question, you were thinking of doctor, dentist situation. I actually read this question as can my business rent, maybe an ADU at my personal residence. Or I have a rental property that’s just a single family rental or an apartment, can my business actually rent it from myself? Does it work the same way?

Eliot: It really would. I don’t know why it wouldn’t. I can’t think of because you are doing effectively the same thing. You’re renting something to your business. I believe, yes. Yeah, you could.

Amanda: You really got to run the numbers.

Eliot: Yes, always. Always calculate, calculate, calculate, the big mantra of Toby. Absolutely.

Amanda: Yup, calculate, calculate, calculate again. All right. “We just sold our primary residence, it’s in California, in July for $1.09 million. That’s actually not that much for a California property. The average property value in California in 2023 was $850,000, almost $860,000. Pretty good. They purchased it five years ago for $650,000. That is a lot of gain over just five years.

Eliot: That is very California.

Amanda: The down payment was $300,000 and it had a $350,000 mortgage. Are there any taxes? Let’s first backup and what would you normally pay capital gains on in this situation?

Eliot: We’re going to look at the sales price, less our adjusted basis. Our adjusted basis in this case was the $650,000 we bought for.  If we had any improvements that we made over the year, we’d increase that if we put $50,000 into a new edition or something like that, but here we just were given the $650,000, so that’d be our adjusted basis. We subtract that from our $1,090,000 and we get $440,000. Is that right? 

We got our $440,000. However, they talk about this 121 exclusion, and that’s unique to our personal residence when we’re selling that. That says that if you have a personal residence, you’ve used it as a personal residence for two of the last five years, owned it for two of the last five years, and then you sell, you can go ahead and exclude up to half a million married filing joint. That’s what we’re referring to here. If you’re single, $250,000. We could take that.

We could take the basis first. In this case, as long as we met those conditions, ownership and use two of the last five years, then they’re going to be able to tack on another $500,000 deduction or exclusion here, which is going to put their gain at zero gain. We will have no capital gain.

Amanda: It is an exclusion, it’s not a deduction. Explain how that  makes a difference in this scenario.

Eliot: Yeah. Effectively, you get to the same place, but you just ignore $500,000.

Amanda: You can’t go into the negative though.

Eliot: Yes. Good point, yeah. A loss expenditure deduction would create a negative amount here. Here, the exclusion just says you just forget about it, but it’s not going to create any kind of loss carry over or anything like that. Very good point.

Amanda: Yup. The 121, the requirements are lived in it as your primary residence, so live own as your primary residence two of the last five years. Those two years don’t need to be consecutive though.

Eliot: No, they don’t. That’s correct.

Amanda: It’s 24 months. You can move in, you can move out, you can move back in just two of the last five years, and then it’s half of that. It’s $250,000 if you’re single, single filer. 

Eliot: Exactly right.

Amanda: In this case, the answer is zero tax.

Eliot: Absolutely.

Amanda: All right. “Can you give an example on cost segregation? I’ve heard you talk about it a lot and you’re confused. You are not the only one, so don’t feel bad. I’m thinking about becoming a landlord. How can I do a cost segregation on, for example, the appliances that come with the property I purchased?” First, we need to start this conversation by talking about depreciation and what depreciation is.

Eliot: Exactly. In this case, we’re talking about landlords. I’m going to go with a rental building, and then we’ll talk about the contents later on here in a second. The building, the normal aspect of it for depreciation is going to be what we call straight line depreciation. 

Your purchase ability for X amount of dollars, let’s say we’ll go $500,000. We know that maybe $100,000 was the land. We got to subtract that out, that leaves us $400,000 for what we call the improvement or the building. We’re going to depreciate that over 27 1⁄2 years as Amanda is showing here, if it’s a residential rental or 39, if it’s commercial. That would be your short term rental type arrangement.

We look at that. We’re going to take either those 25½ or 39. We’re going to divide that into our $400,000 basis, and then we take that amount each year. We call it straight line depreciation each year for 27½ or 39 years. The situation here is that most will look at that building and I’ll say, now, hold on. What’s wrong here, Amanda? You got carpet? That’s a five-year property.

Amanda: That does not last  27½ years.

Eliot: No, it doesn’t. It got lights. We certainly have them here. We got wires, everything, and then you have a foundation. Those all have their own depreciation life. What a cost segregation study does is they come in and they basically break it apart into the 5, 7, 15-year properties. There will be some that’s 27 or 39, and they just determine all that and break it into those pieces. Right there, we’ve had a benefit because now that carpet’s no longer deducted over 27½ years, but five, so we’re speeding it up.

We can often latch on something called bonus depreciation and speed up even more, but that’s our cost segregation, how we break it into our pieces, 5, 10, 15, 27 1⁄2 year property or 39. What about appliances? 

Amanda: Yeah. To me, you don’t even need cost segregation in this situation. Cost segregation study, you are hiring a specialized accounting firm. They’ll come out. They’ll do a lot of research based on what’s on the public record, but then you can have them come out to the house. They literally go through and they count the number of shrubs. They measure everything. You could do it virtually via a Zoom call, the same thing.

If you’re just coming in, you’re the landlord, and you just say replacing the refrigerator or replacing the stove, you don’t need a full cost segregation study to accelerate the depreciation or take the full deduction for that in the first year.

Eliot: That’s right. Those appliances really aren’t part of the house, so you’re buying those independent as personal property. You can go ahead and deduct those typically over five years. A microwave might be five years, a stove, refrigerator, or what have you. We don’t have to worry about cost segregation in that situation. In fact, if you buy one separately, it’s under $2500, and you make what’s called the $2500 de minima selection, then you can go ahead and expense that right away. You don’t have to worry about any depreciation. 

Amanda: If you’re doing a full remodel, you can do a cost segregation light is what I call it. If you’re keeping track of everything that you’re replacing and purchasing, you have the amounts there, and you already know. You don’t need the cost segregation company to come in and pick everything apart into the individual property. You already know because you’ve put it in. You’ve got a lot of options in terms of depreciating different appliances, different things, or in lieu of doing a full cost segregation study.

Eliot: Exactly. Appliances were probably okay. The building itself, we may want to do a cost segregation. Of course, you always want to know what’s the effect. Either way you’re deducting, you create a lot of losses. That doesn’t necessarily mean you can take them. You always got to watch out for what your status is if it’s real estate professional, passive, et cetera.

Amanda: Yeah. If you’re just regular W-2 active income and you’re generating all of these losses on your rental property, rental properties per se passive, those two buckets don’t cross over unless you meet some certain other specific conditions. Real estate professional status is one of them. I would caution against doing a bunch of extra work if it’s not actually going to benefit you on the tax side.

Eliot: Very good.

Amanda: All right. Next up. “Is the 1244 stock loss provision of $50,000 tax credit that is dollar for dollar against your 2024 interest social security and passive incomes on your 1040 for 2024?” First, let’s talk about the distinction between a tax credit and a deduction.

Eliot: Exactly. A tax credit is what we’re asked about here. Is a dollar for dollar deduction against your tax liability? That’s really nice. A tax deduction is just a reduction against your income. It’s an expense. You just take it as a deduction, but it doesn’t go against your tax liability directly. Given the same amount, do I want a $10,000 tax credit or a $10,000 tax deduction? It’s always you’re going to take the tax credit.

Amanda: You don’t usually get to choose though.

Eliot: No. Yeah, it’s not a choice. Unfortunately here, the 1244 is not a tax credit, it’s a tax deduction. Stepping back to what exactly is 1244, that’s a special provision, and it only works with C-corporations that have stock. We’re not talking about our friends, the LLC taxed a C. Those have units, they don’t have stock. We’re talking about what I call true C-corporations with stock here, Boeing or whatever. That’s always in the press now, so I will use that one. 1244 stock loss, we have some criteria maybe.

Amanda: Yeah, there’s lots of criteria. It actually probably wouldn’t apply to Boeing.

Eliot: No, you’re right. First of all, we got to be tiny, less than a million dollars.

Amanda: Yeah, it’s typically going to apply to your own corp that you started as a small business, maybe a management company. It’s not going to be any stock that you’re out buying on the stock market, the Tesla, the Amazon, the Apple. It’s not going to qualify there. It needs to be a smaller company.

Eliot: We’ve got to receive it directly from the company. If Amanda started a C-corporation, she’s doing really well with it, and I said, I’m going to buy her shares, I don’t get the 1244 stock treatment. She would because she got it directly from her business.

Amanda: You have to be one of the original shareholders. It has to be a US corporation, so you can’t take your foreign corporation just because it’s doing business here. If it’s ending up with a loss, you’re not going to be able to deduct that from your US income tax either. US corp can’t exceed one million dollars when the stock was issued.

Eliot: That’s right, the capitalization, the value of the company. Yeah, it’s only individuals typically that can get this. You can be a partnership, and that can flow down to the partners if they’re individuals. Typically, we only see it as individuals. There’ll be people, not corporations or things like that that can take advantage of this.

That’s what qualifies for 1244. What it is, is a loss. You get to take it as a deduction not tax credit, a deduction of $50,000. It becomes ordinary if you’re single or $100,000 if you’re married filing joint. If we didn’t have this provision, let’s say you had a $75,000 loss, you’re married filing joint, that would be a capital loss. You’d be stuck at $3000 each year for 25 years before you deducted all that. Unless you had other capital gains, you could offset it against it.

This was a provision to encourage investors in a small business and not to be lured away from it because of that limitation. They say, we’ll give you a little bit that you can deduct. That’s an ordinary deduction as opposed to those capital loss limits.

Amanda: Yeah, that’s going to offset any ordinary income you have, 1099 contractor income, W-2 income. It reduces your total taxable income, which in effect reduces your taxes.

Eliot: Yup. The interest, social security, passive incomes, it’s going to reduce any of those. 

Amanda: All right. But again, not an LLC taxed as a C-corp.

Eliot: No, correct.

Amanda: It’s called the 1244 stock loss. What do you need? You need stock.

Eliot: Yes.

Amanda: All right. “When using the accountability plan for a C-corporation, do the charges have to be made from the employee’s personal account to qualify? And what happens if those charges are made on the company credit card for medical expenses, prescriptions, et cetera, if they were charged to the C-corporation credit card?”

First, let’s make a distinction between the accountable plan, which it sounds, and the medical 105-B plan. They’re technically not the same type of plan, even though mechanically speaking, in terms of the reimbursements not being taxable income to you, they work the same. They are technically two different types of plans under two different portions of the IRS code.

The accountable plan covers things like phone, internet, home office, administrative office, mileage, or things like that. Whereas the medical 105-B  plan covered out of pocket medical expenses that by nature, obviously, are personal that your corporation can reimburse you for. What happens if we use the company credit card for that?

Eliot: Then we got problems. These things, these accountable plan reimbursements are just that. They’re a reimbursement, which means the individual needs to pay for them first personally of their own pocket for a reasonable business expense, and then they can turn it in to be reimbursed from the corporation, get their money back, and corporation takes a deduction.

Here, we’ve tried to cut corners and go straight to it. Let’s just use the company card for these expenses that we know would have otherwise been available under our accountable plan, and that’s a no, no because now we use that term earlier. I think it was commingling. What’s going on there?

Amanda: You don’t want to do that.

Eliot: No, we don’t.

Amanda: You don’t want to commingle. Not only is this bad from a tax deduction standpoint, but the reason we run our businesses through separate legal entities is to limit our liability and talk about piercing the corporate veil. In order for the courts to maintain your company as a separate and distinct entity from you, you have to also treat it as separate and distinct.

One of the main things you want to avoid doing is commingling your personal and your business expenses. Using the business card to pay for personal expenses, we don’t want to do that directly. Even though the company can reimburse us for some of our personal expenses, our phones, our internet, our medical expenses, those are personal to us. We need to use our personal funds first. We need to do expense reports. I know that sounds time-consuming. You don’t have to do it every time you have an expense. I personally just do them at the end of the year when it’s time to go through taxes. You can do it all in a couple of hours, and then your company can reimburse you.

For medical specifically, you also don’t want to use any HSA plan because the IRS is really not going to let you double dip. The HSA is already a tax deferred or tax preferred account that you’re saving funds in to pay for medical expenses, so you can’t double dip that then reimbursing yourself also from the C-corp.

Eliot: Very good point. We just happen to have a question here about using the business card for qualifying meals. That’s something else. Yeah, your business can pay directly for those meals and that’s fine. It gets 50% of that, or you personally could pay for it and then turn it in for reimbursement. Either way, we get to the same spot. 

Amanda: What’s the distinction when we’re thinking should I use my personal card first versus the company card? Because a meal seems personal.

Eliot: Yes. I think when in doubt, pay for it personally and then try and reimburse it. It’s got to begin. It’s got to be something out of your own pocket for a reasonable business expense that you paid and then you turn it in for the reimbursement. Your operational expenses, generally your C-corporation would pay for that itself.

In a while, I think after doing this, it will become second nature. You know which one you should pay by the business card, but you can always reimburse as long as it’s a for a good business expense. You can reimburse that. It doesn’t matter what it’s for. You’re always safer there. You will gradually used to knowing, for 280A corporate meetings or something like that, you can get that paid for directly by the C-corp.

Amanda: “We purchased our first commercial building this year. Even though I knew in the back of my mind the property was in an opportunity zone, it did not hit me until a couple of days ago. Is there still an advantage for us to go the opportunity zone route? I believe the only benefit at this point is the 10-year mark and the step up in basis. Is that correct? I believe there would be some elections we would have to make and a fund, capital F. Can you explain how it all gets set up and what we would need to do?”

Let’s talk about what opportunity zones actually are because they haven’t been really popular for a few years. Opportunity zones were created as part of the Tax Cuts and Jobs Act. Each state was responsible for designating certain areas. These were usually dilapidated areas. They could be rural, they could be in the city. Each state was able to choose. Even in Vegas, we have some spots just north of here in downtown Las Vegas.

The idea was to generate investment in those places, bring business, bring jobs, bring renovations, and things like that. It’s very similar to what they did with the golf zones, which were part of the rehabilitation of after Hurricane Katrina down in New Orleans. What you’re able to do in those zones is you can take gains from something else, from selling stock, from selling real estate. Similar to a 1031, roll those into an opportunity zone. What were the tax benefits of using these opportunity zones?

Eliot: Yeah. When this originally started, it comes from your capital gains. You’re going to put those into the fund. We’ll talk a little bit more about that. Then you would get a stepped up basis, an artificial basis of a total of 15%. It was 10% if you started seven years out before 2026, then it became 5% I believe two years later. A total of 15%, you get this artificial basis. If you sold or incurred anything in between, then you’d only pay tax on 85% as opposed to 100%. 

As our questioner, Mark, points out here, if we hold on to the whole thing for 10 years, then we get a massive step up. If you sell, then there’s no capital gains on it. One important point I’m missing here, remember you had capital gains, you put them, you invested them, and they’re deferring this. It’s a deferral only up to the end of 2026. At that point, then you will have to pay the tax on that capital gains. It’s a temporary deferment on those capital gains. The rest of the project, if it goes up in value  after 10 years, you won’t pay any tax on that increased value. That’s how the tax part of it works.

Amanda: At the most, you’re deferring some of the taxes a couple of years?

Eliot: That’s correct.

Amanda: Maybe one year?

Eliot: As we get closer to the end of 2026, it really lost its luster. We’ll past that 15% basis break that we got, the 10% and the 5%. That’s gone and now really it is only that stepped up. You’re going to have to pay the tax at the end of 2026 anyway on the capital gains you deferred. Really it is, as you point out here, only the 10-year mark that you get to step up basis, that’s really all that’s left. 

Amanda: Other than whether or not from a tax perspective, this would actually give them any benefits. I am concerned about the timing because if you purchase the property, the commercial building earlier this year, an opportunity zone has to actually be set up in a specific way.

Eliot: Yes. You got to put those funds into an opportunity zone fund, which has to be a partnership or corporation, S or C. We put the funds in there, and then you can go out and get the property, what we call the opportunity zone property, so you get the house, let’s say. Once you do obtain that property, then a stopwatch starts. You have 30 months to substantially improve it, they call.

An example, let’s say that it’s a $10,000 house that you bought in some area, you’d have to at least double that up to $20,000 of value. You have to substantially improve it. If it was barren land, then you’ve got to put a certain amount into a house on there. It can’t just be a shack. The reg’s go into a lot of detail on some of those things.

Again, we set up the fund. It’s a partnership, a C-corporation, or an S corporation. You put your capital gains or at least the dollar amount. It doesn’t have to be the same from your exact transaction when you sold your capital asset, but you put that dollar amount in there. It goes out, buys the property, and then we can start that deferral, but again, it ends at the end of 2026.

Amanda: Yeah. I don’t think you would necessarily be able to back into it this way. Purchase a property with capital gains funds, and then realize it’s in an opportunity zone, and then be like, oh, I’m going to claim these tax benefits. You had to put the funds into the opportunity zone fund, which is the business entity, and then purchase the property. They’re not going to be able to back into it. 

Eliot: When we get there to the time to do the tax return, every year you have to self-certify, the business does, that it qualifies. It’s called Form 8998. You fill it out every year and that’s just self-certifying that, hey, yeah, we qualify as an opportunity zone fund. You’ll be doing that for a while. It goes on the tax return including extensions. That’s the background ways of doing it.

Amanda: Yeah. It doesn’t sound like it’s going to work for this day.

Eliot: Yeah.

Amanda: All right. “We’re changing our LLC from being disregarded to us to being a C-corp. Over the year, we have moved substantial money from our LLC to our personal accounts as distributions. Do we need to relabel those distributions as dividends? And would we be able to transfer the funds back? Or does the C Corp election only affect funds from the date of transition, meaning we’ll file a split return? Thank you for all the great media you guys put out.”

All right. An LLC for just basic background, an LLC can be taxed as disregarded, which means for tax purposes, the government, the IRS doesn’t see it. All of that income expense shows up on your personal 1040, either Schedule C or Schedule E. It can also elect to be taxed as a C-corporation or an S-corporation by filing an 8832 entity classification election. It’s pretty big change though, disregarded to a C-corporation.

Looking backwards, they’re asking about all of the funds that their company, their LLC has earned in the past that they then took as a distribution. That wasn’t necessarily a tax. That actual transfer of funds from the LLC to them wasn’t a taxable transaction. Does that change now that they’re becoming a C-corp? 

Eliot: Nothing happens with the previous activity, but as our questioner asks or points out here, there’s a transition point where we became a C-corp. Going forward, we can’t just take money out. Then we do have taxable events going on there, be it wages or dividends. Prior to that, the fact that they took money out, that’s what they’re supposed to do in a sole proprietorship. That’s fine. It’s going to show up on the Schedule C, Schedule E, as Amanda pointed out, and they pay the taxes there on the 1040. No worries there. You’re good.

No, you do not have to put the money back in when you turn it into a C-corp. That would be awful. No, you do not. We’re very good there. But once you’re a C-corporation, it’s not your money anymore. It belongs to the C-corporation. It’s a separate person. We can’t be taking that out. That gets into something called fraud if we try and steal them or theft when we try and take money out.

Unless it’s taxable via dividend or W-2 wages, there can be reimbursements for things like an accountable plan for administrative office, the medical reimbursement plan, or even corporate meetings, you can be paid. That would be ways to get cash out, but that’s a little bit different. Certainly, they’re not dividends.

Amanda: Yeah. I think that this question asker hit it on the head with the split return. When you fill out the form to elect to be taxed as a C-corp, there’s going to be an effective start date you’ll list on that form. Everything prior to that, all the taxation, all the distributions, all the contributions will be on your disregarded LLC, and then everything moving forward will be on your C-corporation. What about any initial capital contribution they put into the LLC that is still in the company? What does that turn into?

Eliot: When we do the C election effectively, you’re taking all the assets, putting them into the C-corp, whatever’s in the disregarded LLC, in exchange for stock. It now owns it. That value becomes the value of your stock. It becomes your basis in your stock going forward. We take everything and rip it out of the sole proprietorship. I understand it’s the same LLC, but we are changing it from a different type of LLC into something that’s very unique, a corporation. You put in, you get your stock back, and that all becomes your basis in your stock. 

Amanda: I hope so.

Eliot: There you go. I guess that was it.

Amanda: All right.  We’re going to plug our tax and asset protection event.  If the taxes and the legal really get you going, come out to our day long tax and asset protection workshop. That’s a virtual webinar. We have attorneys, we have CPAs on there. You can listen, you can ask your own questions. That’s going to be November 23rd and another one, December 14th.

We hold them about twice a month. We have people who come for the first half one weekend and then come for the second half the next weekend. It’s usually asset protection in the morning, tax in the afternoon. Whatever gets you going, you can come in.

We also have our live tax and asset protection event this December 5th through 7th in Las Vegas. Technically Henderson, but it’s the same. We’re in Las Vegas. It’s about 10 minutes from the airport, so it’s super convenient if you’re coming in plus totally tax deductible as a business expense. Come and see us.

All right. “We have a rental property originally bought in 1991 or the late 1900s as the kids say. The current tenants want to purchase the property. What is the best way to approach this to lower capital gains? We are considering using the funds to either purchase another property or invest in tax liens and deeds.” Got a lot of if you’re seller financing, depends on how the tenants want to purchase the property, but you got a lot of options here.

Eliot: Yeah. To lower our overall tax, you certainly could do something on an installment where you just receive a little payment over time, and there you would only recognize a little bit of tax just on that payment and interest.

Amanda: That’s what you think of as a seller financing. Think of downpayment, and then you’re just recognizing you’re spreading the total gain across however many years you want to sell or finance that for.

Eliot: Exactly right. That’d be a nice option, just a little bit of tax each time. Alternatively, probably the bigger would be a 1031 exchange. You get an immediate deferral, indefinite, unless they change the rules, but right now it’s indefinite. Often what will happen long term thinking long term, a parent may do a 1031, leave that to their heirs later on when they pass, and they get that stepped up basis. Very nice option there.

I think the installment, I think the 1031, probably is your best. As far as tax liens and deeds, if we did something like that, we’re going to incur that tax immediately this year. That would probably be your worst option because you’re not going to defer on a lien or a deed on all that.

Amanda: Yeah. When you’re doing a 1031, you need to reinvest in like-kind properties, so tax liens and deeds aren’t necessarily going. They’re not going to fit into that category. You can’t 1031 from a rental property to tax liens. Can you do the DST?

Eliot: You could. Delaware Statutory Trust, that’s a popular option. A little more complicated, but yes, it could be done. Even the UPREIT.  I oh, always forget the, yes, the upright uniform.

What is it? Umbrella Partnership Real Estate Investment Trust, that’s something we’re going to do. DST, the UPREIT, 1031, those are the things that could, theoretically, depending on the math, works out permanently defer that for a long time. Whereas the tax liens and deeds, again, you’re going to have to recognize that income immediately. That would probably be your least tax friendly option. Installment sale as Amanda pointed out, very good option there, too.

Amanda: This analysis is just solely based on this. You could have other capital gains activity, losses gains going on, and other places on your tax return. That would offset the gain, so you really need to look at your situation holistically.

Eliot: Just one more point here, you mentioned that you originally purchased it in 1991 as your residence. Let’s say we didn’t start renting until very recently, then we get into that 121 exclusion. That could be a play. I jumped to that. Maybe we haven’t had a residence for a long time, but that might not be the case.

What if we bought this and just turn it into a rental in 2022? As long as you meet the two years of ownership, two years of using as your personal residence within the last five years, you would have probably a really good exclusion there of up to half a million married filing joint, $250,000 single. That could be in play here too.

Amanda: Yeah, that’s true. 121. “What are the tax implications of moving into a house that has been held as a rental for 12 years?” People are holding their property a long time. Held as a rental for 12 years. They’ve never lived in it themselves, so 121 is off the table because that’s only for your primary residence. Moving into a house that’s been held as a rental for 12 years.

Eliot: Here, really the only tax consideration is now it’s your personal residence, but we want to know what the basis is. What’s your value in it? When you originally purchased this house, let’s say it was $100,000 and you made some improvements for $50,000, so it was $150,000, but you took depreciation for maybe $100,000 over these years, so it leaves you with an adjusted basis of $50,000. That becomes your basis now that it’s your personal residence.

We want to know that. You want to have that calculated out. If you ever sold this property or did something else with it, usually you’re very busy with that transaction. You want to know what your adjusted basis is or at least have a rough idea of it right away. You want to calculate that kind of known in the back of your mind, what’s your adjusted basis is because that will carry over to you in your not new house, but your new residence.

Amanda: Yeah. Now that it’s your residence, quite a few things are no longer going to be deductible. It’s not business, use properties. You’re not going to be able to deduct at least against the property taxes, the mortgage interest, utilities, all the things that you normally deduct, repairs. If something breaks, you just got to pay for it. No deduction available.

For property taxes, if you’re itemizing on your schedule, then you do still have the state and local tax deduction. It’s limited to $10,000. If you’re in an area where our property taxes are quite high like California and New York, you may bump up against that limitation. You do get some deduction there, but most people are itemizing these days. The standard deduction is pretty high. It’s going up to $15,000 per person next year. You probably aren’t going to be getting a deduction for those property taxes there.

Is there a way  just to get creative? It’s a rental now. Could they make all kinds of repairs that individually fall into this 2500 safe harbor, maybe they need to redo the bathroom or replace some appliances? It’s been 12 years, but they still leave it as rentable. They still leave it as listed. Could they make those, deduct them, not get another tenant, and then move in after the fact and still be able to deduct those costs, or is that pushing the line a little too much?

Eliot: I think that’s pushing. Yeah, he wants to run it. The thing that always scares me about rehabbing and doing a lot of repairs, if you do have a tenant in there, it’s a liability. Thus, that’s why you keep it separated. You keep it in a box, an LLC, to keep it protected because now you got nails, boards, saws, and things like that going on. You have tenants living there. It’s a good mixture for a lawsuit.

Amanda: Not as many deductions if you’re it. If they need to say replace the HVAC or repair the roof, should they do that now while it’s still a rental property, and then you still get to deduct it or at least add it to your basis?

Eliot: Yeah. You still get to do the calculations, but I’d probably want to do it before while it’s still a business so I get a little benefit there. While it’s going to increase your basis, once it becomes your personal residence, who knows when you’re ever able to take advantage of that? If you’re going to hold on to this a long time as your personal residence, then you may never see that benefit. I would try and get it done first.

Amanda: What happens to all of the depreciation they’ve taken over the last 12 years? Do they have to recapture that right away?

Eliot: No recapture on that.

Amanda: It gets still hold off on that recapture until you sell the property.

Eliot: Exactly. 

Amanda: Nicely done. All right. This is Toby Mathis’ YouTube channel. Please like, subscribe. Smash that subscribe button as the kids say. Tax wise Toby, it’s all tax asset protection. Our other founding partner here at Anderson Advisors, Clint Coons, they throw up a couple of new videos a week.

Eliot: A ton and it’s all good. It’s all good content.

Amanda: It is. We sometimes can’t even keep up with it.

Eliot: We got a heck of a sense of humor.

Amanda: Final plug because we really just want you to come see us out here in Vegas for our live event, December 5th or 7th, totally tax deductible trip. It’s Thursday, Friday, and Saturday.

Eliot: Then they have the mixer.

Amanda: Yeah. We’re doing a new client networking event, so you can network with other clients. We have a lot of clients who do all different types of investing, so you get with them. People put deals together. I met at our last event in San Diego a group of four individuals who are Anderson clients that come from all over the country, and they come to our events is their girls trip. They all come in from different places. They hang out for the weekend. It’s usually a pretty nice hotel, and then they just get going on different deals and stuff.

We also have our one day live webinars. It will start at about 9:00 AM Pacific and go to about 3:30 PM Pacific. The next one’s on November 23rd the next one on December 14th. Those are about twice a month. Those are great because we have really good deals at those.

Eliot: Yes.

Amanda: We have really good deals. If you’re a seasoned investor and you need to get an entire asset protection structure set up, if you’re just looking for tax help, or if you’re just even brand new, we’ve got something for everyone.

Eliot: Go value shopping.

Amanda: If you have a question and you can’t make it to Tax Tuesday, just email us, taxtuesday@andersonadvisors.com or visit us at andersonadvisors.com. Again, we’re going to stay on until all of the last eight questions are finished up. Come see us here. We do this every other week, right?

Eliot: Yes.

Amanda: I don’t do this every other week. Eliot is the star.

Eliot: No, she’s the one rocking it behind the scenes and the YouTube. Yeah, that’s hard to handle. You get all those coming in.

Amanda: We fix it in post, as they say.

Eliot: We got our other teammates here. Who do we got here? We got Matthew, Jason, Jennifer, Kate, Arash, Dutch, Jared, Jeffrey, Jennifer, Rachel. Any more? It goes on.

Amanda: Yeah. Tonya and Troy. Thank you so much for joining us. Let us know if you have any more tax questions. We’ll see you next time. Take care. 

Thank you for listening to today’s podcast. Show notes for links to everything mentioned in this episode can be found on our website at andersonadvisors.com/podcast. Be sure you subscribe to our podcast. If you are already a subscriber, please provide us a review of what you thought of this episode.