Are you going to inherit a house from your parents? Also, how will the new IRS rule on third-party payer apps, such as Venmo and Zelle, affect a landlord to collect rental payments? Beware of gift taxes from real estate, 1099-K and 709 forms, and other tax implications.
In this episode of Tax Tuesday, Toby Mathis and Jeff Webb of Anderson Advisors discuss gift taxes from real estate and new IRS rules on CashApp as well as answer additional tax-related questions. Submit your tax question to taxtuesday@andersonadvisors.
Highlights/Topics:
- I am from Dallas, Texas. My parents have a primary home and rental house. They want to give me their rental house, but they owe $42,000 to the mortgage company. What’s the best way to inherit the house, how do I deal with the gift tax, what tax implications do I need to be aware of, and how can I avoid the taxes if possible? If you are gifted an encumbered property, it decreases the gift amount. Take over the loan, or if you are not able to pay off the loan and the parents continue to pay it, then that would be considered a gift. Otherwise, do nothing.
- Can one circumvent the $16,000 maximum yearly gift tax exclusion by giving $16,000 to multiple persons who in turn also give $16,000 to the same single final recipient? No, you can’t do this step transaction, a collapsible transaction. The IRS looks at what happened from the beginning to the end and will find that you actually made that gift yourself to that single recipient.
- How will the new IRS rule on third-party payer apps, such as Venmo, Zelle, etc., affect a landlord to collect rental payments via a phone number or email linked to one bank account. The landlord will get a 1099-K for payments received, which is personal income, but taxable revenues are split amongst rental entities. What’s the best way to handle this? If all the properties are in your name, it will not make any difference. If you have one party collecting for yourself, partnership, or S Corp, then it can create an issue.
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Resources:
Unrelated Business Income Tax (UBIT)
Unrelated Debt Financing Income (UDFI)
Full Episode Transcript:
Toby: Hey, guys. Toby Mathis here with…
Jeff: Jeff Webb.
Toby: And you’re watching Tax Tuesday. Not only are Jeff and I looking at you here, but we have Eliot, Dana, Dutch, Troy, Piao, and Ian. All of whom are tax professionals or legal professionals here to answer your questions. Why do we do this? I don’t know. Let’s jump on it. We do it because it’s fun. We always say we’re bringing in tax education to the masses. It’s supposed to be fun, fast, and educational so we want to make sure we’re getting something back.
You guys can always email in questions at taxtuesday@andersonadvisors.com. If you ever say, hey, where do I email in those questions? Patty or somebody will jump on and tell you exactly where. We’ll also put it up on another screen. If you need a detailed response to something, sometimes you’re going to be a Platinum client like if you’re being technical, otherwise, we just answer your basic questions. We don’t charge for it. It’s hard enough to get answers these days and it’s hard enough to get tax professionals to give you an answer these days.
They always like to say, well it depends, let me research it, and how much is the retainer? We try to get rid of that stuff. You can give immediate feedback on a question like you said, hey, I need clarification in the chat. If you have a question that you want answered, go into the question and answer. It says Q&A on your screen. There are two buttons there, chat and Q&A. Q&A will not disappear, for example, if I say, where are you sitting right now? What city and state? We’re going to get hundreds of answers like shotgunned at us. Hey, where are you sitting right now? What city and state? Let’s see how good you guys are. Jeff is looking relaxed and well-rested.
We have Dodge, Iowa, Round Rock, Texas, Washington, Rockport, Georgetown, Texas—just outside of Austin, right? Redwood City, Southeast Florida, Nashville, Queens, New York, cold San Diego, Wears Valley, Baltimore County, St. Louis, Los Angeles, Boston, Beaverton, Anacortes, Concord, Diamond Ohio, Dallas, Tampa, Ventura, stuff flying by really, really fast. Michigan, Iowa, McKinney, Texas. People from all over the country always come on to these and it’s always fun.
All right. Let’s dive into what are the questions we’re going to ask today because we’ll be here all night otherwise. There’s Hope Mills, North Carolina in the house.
“If you have a solo 401(k), can you lend money to a friend or third party as they are not disqualified person with no limitation like $50,000 limit if you’re loaning to yourself and what does the interest rate have to be? Can you make it a 1% interest rate or it has to at least be LIBOR? Or can it be whatever you want?” So we’ll go through that.
“I’m in Dallas, Texas. My parents have a primary home and a rental house. My parents want to give me their rental house. They still owe $42,000 to the mortgage company. I just want to know what the best way to inherit the house is? How to deal with the gift tax or if there is anything I need to be aware of? What tax implications do I need to be aware of? How can I avoid the taxes if possible?” Good question. We got a lot today.
“Can one ‘circumvent’ the $16,000 maximum yearly gift tax exclusion by giving $16,000 to multiple persons who in turn also give $16,000 to the same single final recipient?” I’ll give you the look. That’s the look. We’ll answer that one.
“When a beneficiary of a Roth who is not a spouse receives the Roth, is there a way for them to continue to receive tax-free income that is generated from those Roth investments? What happens when the investments are sold? Is it different for a spouse?” It gets complicated, but we’ll answer that.
“I have invested in a multifamily apartment using my self-directed IRA. Will UBIT taxes be applicable when the sale happens? I am a passive investor and the sponsors have taken a debt of 75%. If UBIT is applicable, is there a way for me to avoid the UBIT by moving assets to a QRP?” Really good questions. That’s a really good one, by the way, because it’s not a straightforward answer.
“My wife has a dental practice that is a C Corp. She wants to sell within the next four years and retire. Will she save money by changing from a C Corp to an S Corp?”
“If I have a manager managing two STR,” short term rentals, Airbnbs, “and my wife and I are managing two long term rentals (LTRs) and we are materially involved at greater than 100 hours, can we still depreciate the short term rental assets rapidly as one would a long term rental? Thank you.” I like the thank you at the end, you’re welcome.
“If I have a Charitable Remainder Unitrust, which owns a foreign corporation, which is the managing member of a US-based LLC, which uses debt financing to flip bank paper for a profit with the profits paid to the foreign corporation, which in turn are distributed to the CRT as dividends be considered unrelated business taxable income?” Nothing like a little UBIT in the afternoon, right? I need some coffee for that one.
“How will the new IRS rule on third-party payer apps such as Venmo, Zelle, et cetera affect a landlord to collect rental payments via a phone number or email that’s linked to one bank account. The landlord presumably will receive a 1099-K for home payments received, which will count as personal income, but the tax revenue split amongst multiple rental entities and not really personal income. What is the best way to handle this?” Oh, boy. Good question. Actually, a lot of people didn’t even realize that they were about to get 1099 from Venmo, Zelle, PayPal, and even GoFundMe.
“My daughter is a US citizen living abroad. She was planning to come back to live in the USA. If she will rent an apartment in her name, can I still pay her rent from my checking account? If yes, any tax obligations? What about buying an apartment condo for her? I think there are three options. One, she put it in her name and I’ll pay for it. Two, I will buy it in my name and later transfer it to her. Three, I will give her a cash gift of the amount necessary and she will buy it. I have to mention no loan mortgages are involved. What is the best option or any other option available?” Great question. Glad you’re asking ahead of time rather than just doing something and then saying, what’s the result? All right, so really good questions, which we’re going to answer.
In the meantime, if you would be so kind, jump onto our YouTube channel. If you’re already on YouTube, thank you. Just make sure you’re subscribing, but if you want to go to aba.link/youtube, you can absolutely subscribe and then you’ll get our replays. We break these down into bite-sized pieces and you could go listen to some of the other ones that have already been posted. You can always run around and say, I like Tax Tuesday. I want to hear what questions they did. You can fast forward if you want. Usually, we go over all the questions at the very beginning and then you’ll see them. On YouTube, usually, we’re putting the questions in the title.
“If you have a solo 401(k), can you lend money to a friend or third party as they are not a disqualified person?” We’ll go over a disqualified person here in a second, “like the $50,000 limit if you’re loaning to yourself, and what does the interest rate have to be? You can’t make it a 1% interest rate or does it have to be LIBOR? Or can it be whatever you want?”
Jeff: Yes, you can lend to third parties. We’re assuming that they’re not going to turn around and lend it back to you, personally, but just to get around the $50,000 rule. Let’s assume this is an arm’s length loan. You can do that. The interest rates are going to be based on the current AFR rates, the applicable federal rates. Right now, they’re running between 1.5% and 2%.
Toby: AFR, the applicable federal rate, they’re published monthly. I always just go and say what’s the applicable AFR rate and it will tell you short-term, mid-level, and long-term mid-level. They will say, basically, based on the length of your loan, what’s the minimum amount that you could charge friends, family, business partners, and things like that? That’s what you would look at.
I think they were below 2% for sure, and that’s what you’d want to do if it’s a related party. If it’s, hey, I’m just loaning it out. Please don’t do 2% because inflation is growing faster. If you’re giving it to a friend, you might want to look at adjusting that interest rate since you’re really losing money. The way that inflation is going right now, what is it? 6% something silly? You probably want to charge something commensurate with what’s going on in the world as […].
Jeff: Here’s another thing, if you’re blending out $50,000 or $100,000, it may be to a friend, but I want to secure that debt.
Toby: Yeah, make sure you have a deed of trust or a UCC if you’re putting it against property, but we always have a joke, right? Lawyer joke, there’s no such thing as a loan between family members and friends. They’re all gifts. You’re never going to get paid back unless you want to treat it like they’re not your friend, actually document it, and make sure it’s secured as Jeff says.
Jeff: Yeah, we don’t want a situation where finances cause barriers between friends.
Toby: Somebody said this, I gave $10,000 to their brother-in-law or loaned $10,000 to the brother-in-law. It was the best $10,000 I’ve ever spent. He’s never talked to me since. Every time I go to a party he disappears. He hides from me.
Anyway, follow up, “Can you loan to a family member?” Richard, that’d be a disqualified party, for the most part, unless it’s like a sibling—this is what’s weird. It’s lineal descendants. Your parents, your grandparents can’t loan too, your kids, your kid’s spouses, or your grandkids, you can’t loan to. You can loan to your siblings, cousins, and things like that, I believe. You could probably get two, but otherwise, they’ve disqualified parties. It’d be deemed a distribution if you did it. There we go. That’s how you do it. You asked the question, “Are depreciation rules changing?”
Jeff: No.
Toby: No, the bonus depreciation is still there. It’s going to change in two years?
Jeff: 2023, I believe.
Toby: Yeah, we’re going to start to go down to 80%, 60%, 40% on down.
Jeff: When it first came out, it was 50% anyway.
Toby: They jumped to 100%, which they do periodically. They also played around with that 179 deduction, which is on equipment, and used to always be at $25,000 until the end of the year. It was always December, it was always the last week, and they would say let’s make it a million, and then they just ruin every accountant’s Christmas. Everybody’s like, oh, we need to close on this.
All the accountants out there, you can feel the pain, right? Does Congress love to do it right before they leave for the year? They like to pass just a little low blow, sucker year just at the very end of the year. Let me just pass this little tax thing just to annoy all the accountants. It’s like coal in your stocking.
“I’m from Dallas, Texas. My parents have a primary home and a rental house. My parents want to gift me their rental house. They still owe $42,000 to the mortgage company. I just want to know what is the best way to inherit the house and how to deal with gift tax? Or if there’s anything I need to be aware of what tax implications do I need to be aware of? How can I avoid the taxes if possible?”
Jeff: I believe if you are gifted an encumber property, that is a property that has a loan on it, I believe it decreases the amount of the gift.
Toby: Yeah, if they are still obligated.
Jeff: Right. I think first off, I would see if I could just take over the loan if I was not able to pay off the loan.
Toby: If the parents continue to pay it, I believe, then that would be considered a gift.
Jeff: Yes.
Toby: The part that bugs me here is, let’s go over what happens if you do nothing. Mom and dad have a rental house. Let’s say they pay $200,000 for it and let’s say it’s worth $300,000. When mom and dad pass away, the basis of that house steps up to $300,000. If you inherited it, you would get an asset with no tax liability whatsoever, assuming there’s no inheritance taxes or estate taxes triggered. If it’s in Texas, I believe that you’re looking at it, but you’d have to be well over, I think it’s $12 million per spouse. You’d have to be over $24 million of the estate before you’re looking at estate taxes. There’s no inheritance tax.
You’d be getting a stepped-up basis on that asset for $300,000. You could sell it the next day and you’d pay no tax. If mom and dad gift it to you, then let’s say that it’s a $300,000 property and they gift you, you get their basis. You now have a $200,000 property. I’m not even dealing with the mortgage on this, but you’d have the base of $200,000. If the same scenario, they passed away and you sold it, you would have $100,000 of capital gain.
In addition, if it was a rental house, you’d also have depreciation recapture depending on how long they held it. If this is me, I’m not gifting it or anything. I am saying, hey, mom and dad. If you want to give me money, that’s great. If you want to give me the property, maybe I buy it from you and maybe we work on something, but I do want to make sure that even there, the other parents have recapture and capital gains. Maybe buy it on an installment note and spread it out. The only way to really win this is literally to do nothing. My opinion. What do you think?
Jeff: I’m just thinking of if the parents just really want to get rid of the property, they’re tired of renting. I think I may choose to ship sell it on the open market instead.
Toby: They’re still recapturing capital gains. If they want to give it to you, I would probably do a long term purchase to spread out the capital gains and everything over a longer period of time and have them give you the money. Or if you’re going to make it into a rental, they could gift you money and you could be paying it out of the rental income too.
Again, the only way to make it as painless as possible is really just to let life do its course and for them to keep it when they pass. The risk is obviously if something happens to mom and dad and they have liabilities, let’s say they have a whole bunch of medical bills or 10 years from now they have catastrophic financial or something and that house or rental is part of their state, they take it.
Jeff: What if we go with your scenario? What about having the adult child as a property manager kind of taking the load off of the parents making some money on it?
Toby: Still available to the parent’s creditors, still not yours. Still, if they sell it, there’s a taxable event. In the event that they pass, you still get the step up. What about transferring the property to an LLC? That’s a good idea if it’s a rental property, it should be in an LLC already. If it’s not, you’d put it in the LLC, but it wouldn’t make a difference for the tax considerations.
Other considerations to think about. If I’m going to make it my primary residence and what they do is they gift to me the home, I may not be worried about the tax because I’m not going to sell it. If mom and dad die, I lose the step-up in basis. I’ll just walk through this in Los Angeles County. A step-up basis worked for a sale in 2021, but the time from the death of the owner and the actual sale, there was a huge increase in the parent’s tax value versus what the step-up basis was. I had to pay three months’ difference in taxes. Thanks, Los Angeles County. But you got a nice property with the step-up in basis.
“I am able to pay off the house for my parents. Should I do that?” That’s actually a really good question. If you wanted to do that, I would buy it from them. Maybe go to the lowest end of the purchase spectrum like what’s the range of value and buy it as low as possible so there’s this little taxable event to them as humanly possible. Just know you’re giving up the step-up in basis. Mom and dad die, whatever that step up is is what you’re giving up. Any taxes that are paid in the meantime, even if it’s spread out over a period of time, are sunk money.
Somebody says, “What is step-up in basis?” Step-up in basis is if I paid $200,000 for the house and it’s worth $300,000 when parents die, the new basis—what you paid for the house—is now $300,000. It steps up to the fair market value. If it’s sold for 300,000, there’s zero gain. If mom and dad had sold it the day before they passed away, they would have had a gain of at least $100,000, the difference between $200,000 and the $100,000 plus depreciation recapture because it was a rental property.
The only way I would look at this is if you’re going to live in it and it’s going to be your primary residence or something, are you just going to keep it forever? Have them gift it to you if they don’t want the money. Hey, I want to give this to you. You got to deal with the $42,000. Maybe you’re going to pay off the $42,000 yourself. They have a ton of gifts that they can give you. They have $24 million that they can gift you during their lifetime.
I think that you’re going to be just fine. You’d have to fill out a gift tax return, which would probably require an appraisal of the property. Then it’s your property, you don’t have to worry about anymore. If you’re not going to sell it, who cares? Then you just make sure you don’t sell it at some point in the future. Maybe you give it to your children or you pass away and the basis steps up, it still works that way. When you gift, you get the basis of the giftor.
Jeff: Correct. There’s no step-up on gifts.
Toby: “Yeah, they just want to gift it to me, but it’s the mortgage. Should I pay off the mortgage first?” I would pay it off in conjunction with the gift. Unless you want to make a gift for them.
Jeff: Right, otherwise, it’s a separate gift to them.
Toby: Then they’re going to be annoyed because I have to do a gift of $42,000. Just do it all at one time. We’re going to transfer and at the time, put $42,000 in escrow, pay it off. You get the house on their basis, make sure you’re tracking that. No taxes will be due except the transfer tax. You’re a winner. All you do is you fill out your gift tax return, which one was that?
Jeff: 709.
Toby: A 709 and as long as you’re not selling it, you’re going to keep it? Yes, that’s what I would do. Free advice on the internet, what could go wrong? That’s actually pretty solid. You might want to bounce it off somebody else, but I think that’s very, very solid advice.
Jeff: There’s a caveat at the bottom of that screen that is so tiny, you can’t read it.
Toby: Obviously, those guys that are giving out financial advice are […] you must get sued. “Should I have a CPA help me do the gift?”
Jeff: Yeah, because one of the things you may want to consider is if you’re going to pay off the $42,000, you may want to loan your parents money long enough for them to pay it off and then just get it back from them.
Toby: Yeah, you can do that too on them. Just document it and you can reach out to us. “Can one ‘circumvent’ the $16,000 maximum yearly gift tax exclusion by gifting $16,000 to multiple persons who in turn also give $16,000 to the same final recipient?” I think I gave you the eye earlier, Jeff, if you want to answer that, well, I give them the eye.
Jeff: No, you can’t do this.
Toby: The second you said can I circumvent, then I’m like, no.
Jeff: This is what you call a step transaction, a collapsible transaction, meaning the IRS looks at what happened between the beginning and the end, and they’re going to say no, you actually made that gift yourself to that single recipient. This has actually already come up in court cases. You’re not the first to try this.
Toby: Here’s the other one, so what? You have $24 million. If you’re single, you got $12 million. File the flipping tax return. Hey, I’m using up my lifetime exclusion of $12 million. I’m going to give multiple $16,000. $16,000 by the way is the amount you can give somebody without having to file the tax return that’s in 2022. It was $15,000 last year.
Jeff: Correct. It was $15,000 last year and we were talking about this earlier, but a lot of people get hung up on this annual gift exclusion. It is only what you can give, like you said, without filing a gift tax return to report it. Just because you file a gift tax return doesn’t mean you’re going to be paying any tax.
Toby: Yep. You’re not going to be paying anything. It’s an exclusion. You’re just keeping track like, hey, I can give away $12 million to people tax-free during my lifetime or I can give away a whole bunch of $16,000 to all sorts of different people as well. But if I’m giving big chunks, they don’t want you to give a million dollars away every year for 20 years and not have to pay tax on it. They’re just saying like, hey $12 million, we’ll let you.
Somebody says, “Do I need to document a $16,000 gift my dad gave me in cash this year? No. Last year, you went over the, $15,000 unless it was dad and another party.
Jeff: You don’t have to document it. Your dad has to document it. It’s the person giving the gift that’s responsible for everything, not the person receiving the gift. No matter how much you gift me, Toby, I’ll never have a tax on that.
Toby: I can give Jeff a lot of cash. What’s the most cash you’ve ever seen in place.
Jeff: Cash, probably about $2 million, and that was payroll for a NetCruise when I was in the Marine Corps. It was money to pay the Marines that were onboard the ship.
Toby: It was cash?
Jeff: It was cash.
Toby: Somebody says, “Where does he document the gift?” If it’s $16,000 this year, he doesn’t have to. If it was last year, you do a 709 on the gift tax return. That’s pretty easy to fill up by the way.
Jeff: If you’re just giving cash—single person giving to another person—they’re not that bad to fill out.
Toby: They’re just keeping track of how much is being used against the total amount. If it’s two people, again, mom and dad can each give you $16,000. Dad and brother, each give you $16,000. Dad, brother, sister, some other guy over here, and another girl over here, they all give you $16,000, same thing. It really depends on who gave you the gift, how many people gave you the gift.
Jeff: That’s usually my example. Me and my wife can give $16,000 each to each of my son and his wife.
Toby: You can give $16,000 each to your son and $16,000 each.
Jeff: We could give them $64,000 between the two of us to the two of them.
Toby: You can be my dad.
Jeff: I don’t gift them that much.
Toby: Strike that. All right. “When a beneficiary of a Roth, who was not a spouse, receives the Roth, is there a way for them to continue to receive tax-free income that is generated from those Roth investments? What happens when the investments are sold? Is it different for a spouse?”
Jeff: As far as investments being sold within the Roth, it doesn’t matter. It’s when the Roth is distributed. For a non-spousal inheritance, there are a couple of different options. There’s the five-year option, there’s a 10-year option button, both of those have to have money out within the 5 or 10 years. The good thing is if the Roth has been in existence for at least five years when you pull that money out, there are no taxes, there are no penalties, there’s no age requirement. This holds true for spouses also, but spouses have another option that they can turn that IRA Roth or traditional into their own.
Toby: Yeah, they can do an inherited or they can do—
Jeff: They can do an inherit or a spousal.
Toby: They could do it off of their life expectancy, right?
Jeff: Correct.
Toby: This is a situation where I guess the Roth is going to somebody who’s not a spouse. Let’s say it’s going to a child, you can go 10 years and take distributions over 10 years without having any penalties and any tax on the earnings, so long as the parent or whoever it is, the decedent— assuming this is from death—held it for five years. Otherwise, I think you’d have a timing requirement.
Jeff: The timing requirement is five years total. If my mother established this Roth last year, I would have to hold it another four years before I could, but I could still take the non-earnings portion out of it inside that five years.
Toby: Yep. The other thing is if they held it for five years, let’s say they held it for 20 years, passed away, you can just take it all tax-free. There’s nothing that says you can’t. You spread it out over the 10 years.
Jeff: Here’s the funny thing about the Roth is, let’s say my mother established this Roth a year ago, well if she had another Roth she established 20 years ago, the clock starts with that very first Roth, not the one she’s giving me. Once you have a Roth, the clock runs for all your Roth no matter when you start them.
Toby: Yeah, somebody says, what happens if one borrows against their investment portfolio, but never pays the loan back? Are there tax implications then? If it’s in the case of this question, Sam, then there is no loan against a Roth IRA. They’re not allowed or against any IRA. But if it’s against something else, let’s say that is borrowed against my stock portfolio, there’s really no tax implication unless they have to sell my stock portfolio to pay it back, in which case, I would have the capital gains that are from those investments because it’s secured.
I borrow money called a security bank line of credit. I borrow money and let’s say I had a million dollars in my stock account of value at the time. Right now we’re doing this, the S&P is up and down and sideways. Let’s say that I borrow $500,000, the stock market crashes, my account goes down to $700,000, and the brokerage house says oh, we’re freaked out. You need to sell some stock to pay back a portion of it.
The maximum loan to value is 50% or something like that so you would have to sell. In that particular scenario, you’re probably going to have a loss, unless you’ve held that portfolio for a really long time. Let’s just say you had a gain, so I have some gain, add all their capital gains, for sure. It’s just because they’re two different transactions. I’m selling the asset to pay back the loan obligation.
The money I received is never taxable. The money that I’m using to pay off is not taxable. It’s whatever I did to create the money that’s taxable. I could just put more cash into that account. In theory, too, I could contribute to another 401(k) roll it into my portfolio if it’s retirement money, or let’s say it’s not retirement money, it’s just my stock count. I could just put more money in there so that the investments are larger. As what old Buffett would say, when everybody’s scared, be greedy. Maybe I should be going shopping because everything’s on sale. There are a lot of folks that take that approach too. What else you got?
Jeff: My example was, watch the last 10 minutes of the movie Trading Places when they do the equity call?
Toby: They had a margin?
Jeff: They were buying on margin, Mortimer and the […].
Toby: Oh, my goodness. Hey, guys, on Saturday, if you’re a woman, you should go to the Infinity Women in Investing. It is absolutely free. You’re going to see Patti Peery. You’re going to see Nicole DiBraccio. We are going to do a big invite, come out. You’ll have Markay Latimer. She literally took $2000 and turned it into over $2 million. I knew her at the time, still know her, but it’s been 20 something years. I remember she took $1000 of her own dollars, $500 from her sister, $500 from her mom, and blew it up.
That’s not what it’s about. We’re not going to be sitting there trying to show you how to make a million bucks in a year. We’re going to show you how to build up an actual portfolio that pays you out forever, that’s why we call it infinity. You’re going to learn to have an infinite income source. Pia is going to be on, Patti’s going to be on, you might have some other special guests, but it is all about women in investing.
We don’t exclude men, but we give you the weird eye. This is the eye that we give you. If you wanted to show up, that’s great. If you have kids, you send your daughters, send your friends, send your spouse, and send whomever if they want to learn how to build up an investment portfolio. You could do a really good job in both stocks, everything from options to securities to real estate. We’re not talking about risky stuff either. We’re never the buyer of options. We tend to always be the seller because we want to be the casino. We don’t want to be the gambler.
It looks like it’s 9:00 AM to 3:00 PM, Pacific Standard Time. Please register if you haven’t done so, and if you think of anybody that would like to, it’s absolutely free. The more the merrier, it’s going to be. We already have well over 4000 folks registered, it’s going to be a big one, and we love that type of stuff. If you haven’t experienced the Infinity side, we’re really proud of it because people do really well on there. It’s a free service. There are some paid components if you ever go that route, but for the most part, you can learn the basics and be really doing a good job, even for young people without a dollar out of your pocket. You want to come out to spend today do so.
All right, this is a fun one. “I have invested in a multifamily apartment using my self-directed IRA. Will UBIT taxes be applicable when the sale happens? I am a passive investor and the sponsors have taken a debt of 75%. If UBIT is applicable, is there a way for me to avoid the UBIT by moving assets to a QRP?”
Jeff: It’s not UBIT, it’s UDFI, Unrelated Debt-Financed Income. You can’t leverage an IRA by using debt.
Toby: You could do it.
Jeff: You could do it, but…
Toby: You have to pay tax on it.
Jeff: Seventy-five percent of your income, in this case, is going to be subject to this UDFI. It’s going to be taxed at the brackets for nonprofits, the 990-T is the form. Also, when you sell it, that sale will also be subject to UDFI, the gain. Fortunately, it will be limited to 20% rather than the possible 30%, UDFI can go up to 30%.
Toby: We see this a lot where people go out and they’ll do the self-directed IRA and nobody explains to them that Unrelated Debt-Financed Income or UDFI is something they have to be aware of, and they’ll go out and they’ll buy a private placement. The private placement will say hey, we’re going to raise $2 million and we’re going to turn it into $10 million so we could go buy this apartment building, fix it up, sell it, we’re going to exit, we’re all going to make another $10 million, and everybody’s excited.
It just means that you have to pay tax on whatever portion of that gain was attributable to debt. You can’t do that in a self-directed IRA. You can do that in a 401(k), qualified retirement plan, and there’s no such thing as […] UDFI in the plan. You just can’t be signed on to the debt, recourse debt. You have to avoid both those situations. I don’t know a way to unring this bell because there’s a prohibition against transferring assets into a qualified plan that has debt on it. I don’t know a way around that.
Jeff: You would have to have enough cash in the plan to pay off this debt.
Toby: Yes, it sounds like this is a huge amount.
Jeff: Other than that, the market’s hot. I might just bail on the real estate. Go ahead and eat the tax.
Toby: I think you just wait, and when it comes out, you’re going to have a portion of it that’s taxable.
Jeff: They’re also having a portion that’s taxable every year if it’s generating income.
Toby: Yeah. But if they sell, they’re talking about if they sell the asset when the sale happens.
Jeff: Oh, that’s what I mean.
Toby: They’re having UDFI no matter what, but when you sell, they’re going to have it on the gain, and the majority of the money is probably going to be taxable, which is not what you anticipated, I know. It’s taxable, but it’s still in your plan. That’s the good news. The plan pays the tax. What’s the rate on UDFI?
Jeff: If it was rental income or something like that, it’d be 37%. The capital gain would be 20%.
Toby: You’re going to get hit with it.
Jeff: Up to 37%.
Toby: Yeah, and you’re going to get hit with it, but it’s still inside your plan. That’s the good news and then you’ll get taxed again when you withdraw what’s left, which is why I like self-directed IRAs for some things, but real estate ain’t one of them. I tend to say, in our firm, we’re always talking about I don’t want the custodian to have to sign off on everything. They’ll do a checkbook, LLC. They’ll say like, oh, there’s a checkbook IRA and then still flowing in, people still go out and do the exact same thing.
The bad things that we see are people will sign on a note, boom, it’s a distribution. They get debt, boom, UDFI. Nobody ever tells them or they run a business, hey, I’m going to run a business. The old example the IRS gives is, hey, you buy a tree farm. You just pay, it’s going to grow trees, and people come and cut the trees. Then you say, we should run the tree farm and that becomes UBIT. As soon as it becomes an active business, it’s going to be taxable.
We tend to be like, hey, let’s not do these things over here. Let’s make sure that we’re moving into the appropriate vehicle and there are ways to make those things work. Somebody says, “I didn’t ask the question, but I researched this and decided to do it anyway. You can’t do bonus distributions, but you could take straight-line depreciation so you get some deduction?” Yes, absolutely.
What’s going on here is, Ben, you’re saying, when you have the income coming in, you treat it as though it’s not sitting there in an IRA. Usually, when you put money in an IRA, your basis is zero. When you have debt, you get to use your basis in that property and still take the depreciation. You don’t get $168,000, you don’t get bonus depreciation. We get straight-line depreciation, which means you’re probably not going to be paying tax, but then when you sell, you’re going to have that little bit of recapture and capital gain.
The better route if you’re going to do real estate, especially if you’re doing private placements, do a solo 401(k). You’ll be the trustee, you don’t have to have a custodian, and you’ll avoid UDFI, not have to worry about it. That’s one of the biggest differences right there. Plus, mom and dad each have an IRA and you’re putting it into a private placement, each one’s doing it a separate investment, you roll those into a 401(k), one investment. You don’t have to have a custodian sign off and everything. “Do you pay UBIT if you take a nonrecourse loan in your 401(k)?” No, it’s not actually UBIT, it’s UDFI. Enjoy, you don’t have to pay.
All right. “My wife has a dental practice, that is a C Corp. She wants to sell within four years and retire. Will she save money by changing from a C Corp to an S Corp?”
Jeff: I kind of have mixed feelings on this because this is most likely going to be an asset sale. If it’s an S Corporation, you might get away with lower taxation on it, but something you brought up was the built-in gains tax and that is the tax on anything you sell once you convert it from a C Corp to an S corp. If you sell any of your assets at the time of conversion within five years, it’s subject to this built-in gains tax.
Toby: Yeah, right before we were going on, we were going through the questions because we like to wait until the last second to look. I always go to Jeff and say, did you look at any of the questions? And he’s like, what about this one?
Let me back up here. What if they just sold the stock and the company? Somebody comes in and says, I want to buy your practice and I want to buy the company itself because I’m going to continue to run it under the name that it’s under, let’s say it’s Happy Smiles Dentistry.
Jeff: If he sold your stock, it doesn’t matter.
Toby: It does not matter one bit. You’re selling your stock, it’s long-term capital gains. They take all the liabilities, they take all the assets that are in there, you are fine as wine. But when somebody buys your stock, they can’t depreciate your stock. That brings us to option number two.
Option number two is I buy your company, but it has to be an S Corp, and you get to treat it as an asset sale and I get to treat it as though I get to buy the whole company, that’s called a 338(h)(10) election. All it means is that we need to be an S Corp to do that.
Option number three is you just make it into an S Corp, you can just sell the assets and there’s no such thing as can keep your company. If you convert within five years of that sale, those asset sales, you’re going to have built-in gain that’s going to be taxable at the C Corp level.
Jeff: I’m laughing because I knew what I was trying to say, but it was getting jumbled.
Toby: You’re an accountant. Somebody says, “If single self-directed IRAs are not good for real estate, what are the investments that are best to use for self-directed IRAs?” Anything where you don’t have debt.
Jeff: Yeah, I usually recommend if you want to get into real estate in your IRA, I have people who insist on staying with the IRA. You got to have enough cash in there to not only pay for the real estate, but all the expenses involved—maintenance, so forth, notes.
Toby: Loan it to other people that are doing the real estate. Instead of investing in real estate, just loan say, give me a straight interest rate. If they think it’s such a good idea, maybe they’ll do it. Anyway, I’m looking back at this dental practice now, sorry. I see questions and I can’t help it. I’m like, gosh, that’s a really good question.
Let’s go over this real quick because they’re planning to sell within four years. I would be looking at making the conversion. You have to do the conversion of a C Corp to an S Corp, generally speaking, within 75 days by the 15th day of the third month following the end of your tax year. It’s really March 15 rather than counting up days and doing all this. It’s really March 15 you would have to make the election for this year.
Just don’t sell your assets for five years. Write it down, don’t sell because if you do, I don’t think there’s a phase-out. I think it’s like a hard rule, it’s back to the C Corp again. If you sell the company itself and the stock, then you don’t have to care. If you sell the company itself as the stock under 338(h), you have to treat it as an asset sale, you do care. And you really do want to have an accountant walking you through the sale because there’s a huge difference between the non compete portion, which could be ordinary income, the goodwill, which could be long term capital gains, but part of it’s attributed to you that could be ordinary tax. It’s a 15-year depreciation for the buyer.
There are all sorts of goofy stuff where they’re trying to get an immediate deduction and you may be getting an ordinary tax treatment. You want to make sure that you have someone who knows what they’re doing working with you on that or you could have a real negative consequence and I’ve seen deals blow up last minute over the fact that the lawyer drafting it never considered the tax obligations, and you’re like, hey, you’re going to buy that company, huh? You know you can’t write any of that off, right? What? You’re just about to spend $6 million. They didn’t tell you that? No.
Jeff: Too often we get a client that will tell us that, oh, well, yeah, I sold my business and we’ll say, what did you sell? My business. No, no, we needed to know what assets you sold and for how much.
Toby: Then whatever you decide is and what the IRS is required to do. If you said it’s all equipment, they’re going to look at you and go, no, a lot of this is personal goodwill, a lot of it is business goodwill. Those two things are taxed completely differently. A lot of it is assets that you’re going to be taxed as ordinary income on some of it is going to be long term. Some of it’s going to be some capital assets. Hey, I just bought a bunch of equipment in my dental practice under 179, for example, wrote it off a couple of years ago, and now I sold the business and somebody else buys it. I’m having to recapture all that money at my ordinary income tax level.
There are all these little gotchas so when you sell the practice, the cleanest is to say, please just buy my company. If they don’t want to, then you better make sure you got a good accountant.
Jeff: Just tell them you promise there are no skeletons in your dental closet.
Toby: Sure. All right. There are no toothaches.
This is a good question, by the way, I actually love these types of questions. “If I have a manager managing short term rentals,” So visualize, I have two properties that are Airbnbs. “And my wife and I are managing two long term rentals. We have two properties that are just little single families that we’re renting out to people on a month-to-month or on an annual basis. We are materially involved for more than 100 hours. Can we still depreciate the short term assets as we would a long term rental asset? So can we take the Airbnb assets, these two houses over here and depreciate them, accelerate the depreciation the same way we could with the long term assets?” Jeff?
Jeff: If you have somebody else managing your short term rentals, it’s going to be more difficult. The 100-hour test is probably not going to work for you. You probably have to go do the 500-hour test to say that you had 500 hours in your short term rentals. Otherwise, it’s going to be considered passive income. Your losses are going to be limited on how much you can take. Same way for long term rentals would be if you’re passive in those. Can I say what I would probably do? I think you would probably do the same thing.
Toby: Yeah, you can. Absolutely.
Jeff: You talked about accelerating the expenses on the long term rental so I’m supposing that perhaps you’re a real estate professional. If that’s the case, I don’t rent out the short term rentals in my name. I rent them to a C Corp that I own long so they become long term rentals to me. Then I’d let the C Corp do the Airbnb, the short term rental, however, they’re doing it. Then you can group those short term rentals with your long term rentals and treat them all the same way.
Toby: It gets weird. First off, we have to understand that if you’re doing a rental business and you’re going to be a real estate professional, you have to meet prong one, which is 750 hours, more than 50% of your time. That’s just on any business. That could be anything involving real estate, construction, reconstruction, development, buying and selling real estate. It doesn’t have to be yours.
Then we go over here and we say we’re going to have all of our properties and we’re going to treat them as one unit. All of our long term rental properties, we’re going to treat them as one unit. All of our hours, me and spouse, combined get to be used on those so long as we aggregate them together. The problem is if you have a short term rental property, it may not be considered rental property.
If it’s seven days or less, it’s not rental property. It’s just a regular business. Your time devoted to those does not count towards your material participation in all of it. All of a sudden, you go from being over 100 hours to possibly less than 100 hours. You put in jeopardy your ability to take the depreciation and loss against your other income.
There are a few little caveats here. Generally speaking, when you’re seven days or less, that’s ordinary income, it’s not rental income, but you still have to materially participate in it. You have a badger. I can tell you that you’re probably not materially participating on the short term rentals by themselves, which means that would be ordinary passive loss. So that’s passive loss that’s not getting anywhere. You’re like, I can’t use that against anything but passive income.
If you have other rental income, it’s a lot from these other activities, it’s positive, which I doubt because you’re talking about depreciation and accelerating, then you could use that against that. What Jeff is saying is, we don’t want those to remain short term rentals on my tax return. We need another taxpayer.
He sets up a corporation, and the corporation becomes the host for those short term rentals. It’s hiring the manager, it’s doing all that stuff. You’re renting long. I’m going to take my two short term rentals and make them into long term rentals by renting them to the corporation. On a month-to-month basis, annual basis, fill in the blank. Annually, I’m going to pay monthly, I’m going to rent it at fair market rents, and that’s going to make it another long term rental.
I just went from having two short term and two long term to having four long term rentals. Now I can add all my time together so that I can be a material participant in it. If I am a real estate professional, I can now use that against all of my other types of income if I want and I can accelerate the depreciation. I could do cost segregation on all four properties.
I could elect to accelerate my 5-, 7-, 15-year property and write them off in one year. I could leave them as be and let them be 5-, 7-, 15-year property. I could accelerate the 15-year property. I can do whatever I want really, I have a lot of options. The way you get there, what Jeff said, is by crediting the other taxpayer and then making sure that they’re long.
Jeff: Yeah. The more I look at this, in particular, real estate professionals also trying to do short term rentals in their name, I see more and more conflict. It ends up conflicting on both sides.
Toby: Because the weird thing is, when you’re seven days or less, it’s not rental property, you’re a hotel. If you’re 8 to 30 days and you’re providing substantial services, it’s no longer a rental, you’re a hotel. If it’s greater than 30 days and you’re providing extraordinary services like you’re doing recovery, doing the lose weight thing, you’re going out, or you’re doing a three-month program that the accommodations are just ancillary to the main thing that you’re paying for, that’s not considered rental.
Just because you have a property and you say, I’m renting it, doesn’t mean it’s a rental. We always have to look at how many days. The easy one is to say, I just have a single family. I’m renting it out for 30 days at a pop. Don’t worry about it. But the short term rentals get a little money.
Look at that, YouTube and podcast watching replays. You guys can absolutely go in. If you like this information, you want to come back and listen again, pop back in. By all means, pop in and watch it on YouTube. We podcast them too. You can put it on one and a half so we go really fast. It’s Cory’s favorite thing. He doesn’t recognize my voice anymore. He’s always listening to me talking really fast.
Alright. “I have a charter remainder unit trust, which owns a foreign corporation, which is the managing member of a US-based LLC, which uses debt financing to flip bank paper for profit.” You follow that you get an A+ right now. “Will the profits paid to the foreign corporation which in turn are distributed to the CRT as dividends be considered unrelated business taxable income?”
Jeff: I know we’ve talked about this a lot. Dividends are not considered unrelated business income (UBI). There is a very narrow, very, very narrow exclusion that we’re not going to talk about that deals with foreign insurance companies. But no, if you’re receiving dividends, they’re not going to be considered UBIT.
Toby: That’s generally the rule. The only thing that would bother me here is depending on what your involvement is. It sounds like the foreign corporation runs everything in the US-based LLC. I’m not certain if there are rules for you if you’re participating in it. I don’t know of any that would trip you up. But generally speaking, you don’t have anything to worry about so long as the corporation in theory is paying tax on it because dividends aren’t deductible to the corp. You’re getting it at a taxable event.
When you get the dividend, in theory, you’re paying tax on a portion of it because as a unit trust, you’re getting a payout. Generally speaking, you might be getting 7% a year. That’s going to be taxable income to you, so you’re not necessarily escaping taxation. I don’t see there being a trip up. Really funky question was that one.
“How will the new IRS rule on third party payer apps such as Venmo, Zelle, et cetera affect landlords who collect rental payments via a phone number or email that’s linked to one bank account? The landlord presumably will receive a 1099-K for all payments received, which will count as personal income, but the taxable revenues are split among multiple rental entities and not really a personal income. What would be the best way to handle this?”
Jeff: If all of the properties are in your name directly, I don’t think it’s going to make any difference. You’re just going to allocate between the properties. If you have one party collecting for yourself, partnership, S Corp, a corporation, or whatever, then yeah, it’s going to be a little bit of an issue. Here’s what I would do.
You get a 1099 from Venmo for $10,000. You report that whole $10,000 on wherever you need to, probably most likely Schedule E. But then the […] part of that for what went to these other entities. I would have $10,000 of income from this 1099-K. Then I would say, nominee to Jeff Webb PLLC blah blah blah, and so on and so forth, and reduce those 1099-K payments where they need to be.
Toby: I’m wondering, I believe you could probably designate a business as the recipient of the 1099-K so that they’re reporting all the income to […]. I would use a holding company or something along those lines if you have a 1065. Otherwise, if it’s going to you, what Jeff said is appropriate, you would just report it. You’re reporting this income anyway. Regardless of whether you get a 1099, you’re required to report the income. 1099 is just Venmo, Zelle, PayPal, and all these others saying, we gave them some money. It should be on his return.
Then they look at your return and they said, we don’t see the money. If Jeff gets a 1099 for me for $10,000 and he doesn’t have it anywhere on his return, the IRS is going to say, we think you’re underreported $10,000, and they’re going to hit you with a hit. If he reports it to his return and then takes the expenses—even this, I’ve seen this/ I get a K1 erroneously made out to my name for my business or something like that. Quite often, I will report that on my Schedule C as income and an expense for the exact same amount and send it over just so I never have to worry about the IRS saying I didn’t report it.
Jeff: We’re going to see property managers experience this very same thing. They’re actually already experienced it. They are receiving payments on your behalf, this person’s behalf, and so forth. They, in turn, issue 1099s out to all those people that they collect rents for. Like you said, it’s just an in and an out for reporting purposes.
Toby: It depends on who they’re reporting it to. If you’re going to get something, and remember, it’s only $600 or more that they’re being required to send that out. Can you believe it? There are people that don’t report all their income. Yeah, landlords. Every time I meet somebody that says, well, I’ve been getting cash for five years. You’re taking the depreciation? Yeah. Anybody ever looks at you, they’re going to be like, that’s criminal conduct.
I hate to say it. It sounds horrible, but you’re literally evading taxes. At that time, you’re going to have a really tough time. They won’t send you to the Gulag or anything like that. They’ll usually come and hit you over the head and say, you got to report everything and nail you.
“My daughter is a US citizen living abroad. She is planning to come to live in the United States.” First off, congratulations. She’s coming back to you. “If she will rent an apartment in her name, can I still pay her rent from my checking account? If yes, any tax obligations?” So we’ll hit that first. “What about buying an apartment condo for her? I think there are three options”
Actually, let’s go to the first part of her question. Rather than read through the whole thing—this is a long one—let’s just talk about what if you rent a place. What are the tax obligations of you paying the rent for a child?
Jeff: There’s no income tax obligation but there’s a gift tax obligation possibly.
Toby: What if I go above $16,000 a year?
Jeff: Then we go back to what we were talking about earlier and we need to file that form 709.
Toby: Now, here’s the problem I have as a tax guy with paying things for kids. Your kids could be doing something for your business. Let’s say that Jeff has a business on the outside. It may be rental properties. Maybe you have a side gig, whatever it is. Maybe you have a consulting company. Jeff has a CPA firm, whatever. Rather than just give the daughter money, why don’t you have your daughter do something and earn it, then it’s deductible to you and taxable to her?
The reason that’s important is let’s say that your rents are $1000 a month, if she earns $1000 a month, she would be underneath the standard deduction for tax. So if that’s all the money she earned. She’d pay zero tax on it. You’d get to deduct it. You just covered her expenses. If you pay for it, you’d have to figure out your tax rate. But to pay the $12,000 if you don’t get a deduction for it, you had to make probably close to $18,000 if you’re […] income earner down to at least probably $15,000. It’s going to cost you $3000 to probably $10,000 somewhere to make that money.
If you’re in California in the highest bracket, even more. To have $12,000 left in California, if you’re in the highest bracket, you had to make $24,000 because you have 37 Federal and you have 13 states. No, it’s not all deductible. You have a $10,000 limit on state local taxes. You’re getting crushed. Pay your kids. That’s better. All right.
Now let’s drop down to let’s say that they have a lot of money and we’d like to own a condo or something, what about we buy an apartment condo for her? Put it in her name, and I’ll pay for it. What do you think of that one?
Jeff: I’m perfectly okay with that. It is going to generate a gift, a fairly sizable one, that you’re definitely going to have to file 709 on.
Toby: It’s a gift. You buy a property for her. It’s her property now. It’s her personal property. We’re not even dealing with depreciation. You’re going to use it against your lifetime exclusion, so that’s option number one. Number two, I’ll buy it in my name and later transfer it to her.
Jeff: I don’t mind this one so much if by later transfer to her, I would probably put it in as part of my estate rather than just later transfer. As we were talking about earlier, step-up in basis.
Toby: Yeah, the basis where all the appreciation is going to you. If you give it to her, you’re still dealing with the gift tax, you still have to get the appraisal, all that fun stuff. You’re much better off for simplicity purposes, giving her cash to buy the property, as opposed to buying the property and later gifting it to her because now you’re going to have to get an appraisal.
Jeff: I agree with that.
Toby: Assuming that you wait a year.
Jeff: Yep. Going back to number two, though. I could see doing that, letting her live there rent-free, and just working on appreciation of property value.
Toby: Yeah. Number three, I will give her the cash gift to the amount necessary and she will buy it. That’s again what I was just talking about, number one. None of these are my favorite. I still think you have them worked for you and you borrow it, or if it’s me, you buy the property. You can’t really rent it to your kid. I suppose you could and then you just gift them the money or you say, hey, you got to go out. It’s going to be around. It’s going to be a circular issue. You’re not going to get a tax benefit out of it, but at least you get the appreciation on the property.
I had a buddy do this for his dad and he bought the condo and at the end of school, the condo would appreciate it. They made some money when they sold it and he didn’t have to pay rent. He had bought it for cash. Not a bad scenario.
Guys, we’ve reached the end. If you have any questions, by all means, email them to us at taxtuesday@andersonadvisors.com. Visit us at andersonadvisors.com.
We do have a Tax and Asset Protection event coming up. Patti, is it on the 12th? I believe it’s on the 12th. So another Tax and Asset Protection but if you want to learn about Land Trust, LLC, series LLC corporations, and depreciation of real estate, a bunch of real estate specific administrative office, doing 168-K, doing cost segregation and how they break down. Again, absolutely free. Click on the link there: aba.link/tap. We teach that on the 12th.
Otherwise, if you can this weekend, go to the Women in Investing and you’ll have a lot of fun. It;s the first time we’ve ever done that. That’s through Infinity Investing. Again, Nicole DiBraccio, Pia Washington, Markay Latimer, and Patti will all be there teaching all day. Is there anybody else, Patti, that’s going to be there? Did I name everybody that’ll be there on Saturday? I don’t want to forget somebody. You, Pia, Markay, and Nicole are all there. They’re all in the same room breathing all over each other. Hopefully, what could go wrong with all these people breathing all over each other. They’re all good. Anyway, that’ll be a lot of fun. Jeff, thanks as always.
Jeff: Absolutely.
Toby: We love answering your questions. These are kind of fun. I hope you realize that taxes don’t have to be boring and that it’s not always what you think. There are always these little funky things that go out to be fun. No one can actually copy these things. It can only take a screenshot thing here. You guys need to make sure that they can actually click on those links. Oh, the things we learn about or maybe they do in my hand. Okay, we’ll have to figure that one out. All right guys, thanks again and we will see you in two weeks.
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