On today’s Tax Tuesday episode of the Anderson Business Advisors podcast, Eliot Thomas, Esq., is joined by Anderson CPA Barley Bowler. Barley and Eliot will cover some listener questions including strategies around deducting startup costs and choosing a business structure for loan eligibility, tax breaks like depreciation and claiming real estate professional status, paying taxes as a contractor on 1099 NEC forms, and when capital loss carryover deductions can be taken.
Submit your tax question to taxtuesday@andersonadvisors.
Highlights/Topics:
- “I joined Anderson and Infinity Investing in 2023, I established my first real estate investment, C-corporation, in December of 2023 for an official 2024 start date. What, if any expenses, membership, fees, et cetera, do I submit for 2023? ”We started to form the company in 2023. Do I hold out to list everything including the courses, business cards, opening expenses after the fact, or do I add these expenses to 2024?” – After the date of incorporation, everything’s expensed as usual. “Pre-incorporation or pre-startup” costs are allowed to be deducted as long as they don’t exceed $50,000
- “I’ve heard we want a pass through real estate holding company that produces a K-1.” That’d be a partnership. To enable easier lending on properties in the future. We talk about lendability. How do we get the most favorable lending criteria? Of course, it comes down to the bank, but we’re certainly going to be covering that as well about bonus depreciation. We’re trying to get a loan on a property. Depreciation is one of these expenses we have to pay attention to.” – in a partnership as they mentioned here, You’re allowed on the federal lending guidelines to have up to 70% of value.
- “We got cost seg and bonus depreciation to offset. Can it offset 1099 income and your social security income?” – If we’re talking about a traditional long term rental, we first need the real estate professional status, then material participation.
- “Hey, my tax is so high. What can I do? How can I reduce it?” – We potentially want to incorporate the business if the numbers are right, then we just look for all available deductions.
- “Why did I have to pay employment taxes when receiving a 1099 NEC?” “I knew I’d have to pay, but it wasn’t taken out during the year. I don’t have a business, so why do I have to pay taxes?” – an independent contractor form, 1099 NEC, is subject to ordinary income and employment taxes.
- “When selling an investment house like a rental property with some gains, what’s the best way to protect our gain without sharing a good part of the check with the IRS?” – This is going to be your 1031 exchange, like-kind exchange.
- “Can capital loss carryovers be chosen when to use?” “Can we pick and choose when we do our losses?” – With capital losses, you can use them up to the amount of capital gains you had plus $3000 that will go against ordinary income.
- “Can I reduce my income tax from capital gains from selling stocks by using a loss in a real estate income or loss business? – If you have your real estate going on, some losses from there perhaps and expenses from that, there are some times where we can use that and times where we can’t.
- I just created a business at the end of March.” When is it a preferred time to contact a tax specialist and set up a meeting to ask questions, have things explained, and see if we were a good fit for this individual? – If you need some specific guidance or calculations, that’s when we may push you to do a billable tax consult or tax planning. In the meantime, hop right into the Platinum knowledge room.
Resources:
Tax and Asset Protection Events
Full Episode Transcript:
Eliot: Good afternoon. Welcome to Tax Tuesday. This is the right place, but we don’t have Toby with us today.
Barley: Where is Mr. Mathis today?
Eliot: Yeah, where is he? Actually, we don’t know. I don’t know where he is, but he’s not here today. I am joined by my colleague, CPA extraordinaire, Barley Bowler.
Barley: Hey, welcome everyone. Toby’s out in the field gathering tax knowledge for all of us to use. We’re going to be filling in for him today. Got a lot of ground to cover.
Eliot: Yes, we do. We got more questions from you that we picked out. But before we get to all that, just a little bit of background again. This is the Tax Tuesday show trying to bring that tax knowledge to the masses. We take your questions that you’ve submitted. We go through them as best we can pick some of the ones that are most representative of the questions that you had as a group or ones that maybe have some particular twists to them, and we’ll go through those.
While you’re here on the program, remember we do have our Q&A function. That’s where you can submit questions live here. We have a whole staff. We got the accountants, CPAs, attorneys, everything in the background. We have them all, the full deck. They’ll be answering your questions again in the Q&A.
If you have questions and want to get them on to the show, remember to email us at taxtuesday@andersonadvisors.com. That’s where we pick from. If you need a detailed response through those, or even yet today, if you need a more detailed response, you may need to become a tax client, a platinum client, or something of that nature because we can only do so much in this forum to answer your questions.
We’ll certainly do the best we can to assist. We just try and make it fast, fun, educational, and teach you a little bit about tax as best we can. With that, I think we move on to some of the questions.
Barley: Yeah, absolutely. Yeah. Thanks for tuning in. Toby is going to be back, don’t worry. We didn’t get rid of him or anything like that. I appreciate you guys being here today. Like Eliot said, I’m a CPA here in the state of Nevada. I hate it when people do that. It stands for copy, paste, and attach it to the email.
I’m a certified public accountant here in the state of Nevada. Also, I have a master’s business degree from University of Montana in Missoula. My real passion is small business. We have such a great team here with so much varied experience. We’ve got people that are specialized in certain areas of the tax code or financial advisors.
My passion is small business. I really believe our main street businesses are our primary foundation in this country. I love talking with you guys about business. Just to let you know who’s up here talking to you. I do have a CPA, MBA, but my real passion is talking with all of you about your small business activity.
Thanks for having me here today. Look forward to meeting every one of you guys and working with you one on one as we go. Let’s hop right in, Tax Tuesday rules. We’re here in Zoom virtual format. Please email your questions. Like Elliot said, if you need a more detailed response, typically we’ll say, if you need calculations or specific guidance, we may set up an additional call or something like that, or submit a question to the Platinum Portal. Yeah, fast, fun, and educational. Let’s hop right in.
Eliot: Yeah, let’s do it.
Barley: All right. We’re going to read through the questions. We got about 10 questions. We try to pick questions across the board, different topics, stuff that’s relevant to all of you guys. Let’s hop right in.
“I joined Anderson and Infinity Investing”. Our sister company. “In 2023, I established my first real estate investment, C-corporation, in December of 2023 for an official 2024 start date. What, if any expenses, membership, fees, et cetera, do I submit for 2023?” Great question.” We started to form the company in 2023. Maybe didn’t have a lot going. Do I hold out to list everything including the courses, business cards, opening expenses after the fact, or do I add these expenses to 2024?” Essentially it’s the question, so we’re definitely going to be covering that.
“I’ve heard we want a pass through real estate holding company that produces a K-1.” That’d be a partnership. To enable easier lending on properties in the future. We talk about lendability. How do we get the most favorable lending criteria? Of course, it comes down to the bank, but we’re certainly going to be covering that as well about bonus depreciation. We’re trying to get a loan on a property. Depreciation is one of these expenses we have to pay attention to. What else we got, Eliot?
Eliot: When talking about short term rental property and cost segregation, you mentioned a case study. This is in the past. We have often talked about a case study. We also call it the cost segregation study.
You’re usually going to go to the third party, have them prepare this nice form deliverable, if you will, that has a lot of specs here. We’re going to talk more in depth about that. What does it look like? What’s in it? What needs to be shown in it to be valid, et cetera. Good question. We talked so much about that study. Maybe we talk a little bit today about what’s in it.
Barley: Yup.
Eliot: Next, “We got cost seg and bonus depreciation to offset. Can it offset 1099 income and your social security income?” Another common question. There are some peculiarities to social security income, and it’s a very valid question. How would a cost seg bonus depreciation situation maybe impact that?” We’ll look at that more in depth.
Another good question. We get this one a lot. I finally picked it. We get this generalized question. “Hey, my tax is so high. What can I do? How can I reduce it?” The only reason I picked this because they added a little bit more here telling us what income it is. You’re a 1099 subcontractor. We work with that a lot. Barley and I answer those questions as well as the rest of our staff all day long, so we’ll certainly tear that one apart.
Barley: A number of ways we can report that list.
Eliot: Yes, sir.
Barley: All right. “Why did I have to pay employment taxes when receiving a 1099 NEC?” Another 1099 question. A lot of questions on that. “I knew I’d have to pay, but it wasn’t taken out during the year. I don’t have a business, so why do I have to pay taxes?” We’re definitely going to go over that.
“When selling an investment house like a rental property with some gains, what’s the best way to protect our gain without sharing a good part of the check with the IRS?” We’ll definitely be going over that. It’s our bread and butter here at Anderson, as you’re aware.
“Can capital loss carryovers be chosen when to use?” This is a great question. “Can we pick and choose when we do our losses?” It isn’t necessarily a first in, first out thing to use an accounting term. We have this very mind numbing capital loss carryover worksheet that you can certainly dive into anytime, but essentially we have an ordering of operations for how and when we report the losses. A couple more here. What else we got?
Eliot: “Can I reduce my income tax from capital gains from selling stocks by using a loss in a real estate income or loss business? Pretty standard question, we get that one a lot too. A lot of capital gains.
Barley: Yeah, capital gains, 1099s. Great.
Eliot: Lastly, “Hello, I just created a business at the end of March.” It’s April 9th, so you can see this came back from the last show. “When is it a preferred time to contact a tax specialist and set up a meeting to ask questions, have things explained, and see if we were a good fit for this individual? I doubt it’s this week. I actually was looking at this probably around that time of tax deadline, and it was not a good week then.” We were very busy. It was a great week, but a little busy. We’re going to go over what we do and as far as when is the time to tax plan.
Barley: Not the week of deadline.
Eliot: No, that’s probably the wrong time.
Barley: The only wrong time.
Eliot: We have done it though. We’ve had a deadline, but we’ve done some tax plan on that deadline. I do not recommend it. Anyway, we’ll cover that more in depth.
Barley: Before we hop in here, guys, of course we have tons of great content on the YouTube channels. Everyone, if you want to shout out in the chat, where are you tuning in from? We always are curious where you guys are all listening in from, whether it’s on the road, your home office, your second home, or wherever you, entrepreneurials, are in the world. Tons of great content.
Excellent. Houston. I love having Texas in the chat. Make sure you subscribe to Toby’s YouTube channel. Tons of great content, current events, lots of great interviews all across the board too. Toby’s obviously obsessed with tax law and how we can make that work for our clients, but really all across the board, a number of different trades, and industries focused, plus tax asset and protection workshop.
This is pretty much the basics right under our structure implementation. How do we make sense of all this tax and asset protection stuff? Clint breaks this down. This is his lifelong pursuit of structuring businesses that work, that we can feel confident operating without a lawsuit, paying too much taxes, and have a have a plan that we’re moving into our legacy planning into the future.
Eliot: We got a few events coming up here.
Barley: Look at this. Yeah.
Eliot: April 27th and May 4th. Those are going to be are ones that we do online, and then we have the big event. Here’s Dallas, we’re coming to you. June 27th to the 29th, that’s going to be the live in-person show. Looking forward to it. It is a fantastic event.
Barley: Yeah, these are fun events too guys, networking. Get out and meet your fellow entrepreneurs, meet the partners. A lot of synergy and a lot of great energy at those events. I love those.
Eliot: Good times.
Barley: Yup. Make sure you subscribe. Follow us on YouTube. Follow us for the latest updates. A lot of great information. Let’s hop right in.
Eliot: Let’s do it.
Barley: All right, let’s go. “I joined Anderson and Infinity Investing in 2023, established my first real estate investment, C-corp, with official 2024 start date. What expenses do I submit for 2023?” Great question. Or do I hold out everything and submit everything in 2024? Very common, including real estate investment courses, education. That’s a ding, ding, ding. We got to pay attention to that. Business cards, normal operating business expenses for the real estate investment court, which seems after the fact, I feel like I’m chasing my own tail. I know how that feels when we’re doing taxes.
Suggestion on how to keep everything and ready for the C-corp’s first October filing. Let’s start. I call it the line in the sand. That’s our incorporation date. Most times, typically this will be our start of business operations officially or technically speaking. I see this as a line in the sand. On this day, I incorporated my business. Everything up to that date before the fact, I have to figure out what category that goes in startup costs, organizational costs. Maybe it’s not deductible. We’re going to try and take everything as we can for a deduction.
After the date of incorporation, everything’s expensed as usual. There’s really no issue after, after that with the expense reporting, especially with a C-corp so flexible. As long as it’s reasonable and necessary to the business, we can generally take a deduction. But what about up to the date of incorporation? What options do we have there?
Eliot: First, I’m just going to back up a little bit. While that is commonly what we do here at Anderson, your date of formation, your date of incorporation, that’s where we have that dividing line, it really doesn’t have to be so. It can be that you’re incurring these things, you’ve incorporated, you’ve formed, but maybe you haven’t started the business yet. Commonly, we will use that date of start. I just want to clarify that if you’ve been told different things. Normally, we will use that date of incorporation.
In this case, we started to do some stuff in 2023. We were set up it sounds like, but we’re calling our official start business day of being in 2024. Anything up to whichever you do pick for your startup day, it’s going to be just as Barley was talking about, a startup expense. That’s going to be the majority of your costs. There are some costs that don’t fit into that pile. We’ll talk about that here in a second.
Anything you incurred prior to that point, you’re getting your employees, yourself educated or whatever, if you’re a C-corp, which we mentioned here, this is important distinction, for C-corp, you can do education for these other businesses. You may not be able to do the education. Education aside, basically any other startup cost is the same for any other entity, whether it be a C-corp, S-corp partnership, what have you. We’ll pick all those up. How are we going to deduct that? What’s our calculation on startup costs?
Barley: These are pre-incorporation or pre-startup costs. We are allowed to take a deduction as long as they don’t exceed. $50,000 is our threshold here. If your startup costs are less than $50,000 in the year, then in most cases, we’re going to be able to take a $5000 deduction in the current period. Remember, these are up on the balance sheet. These aren’t expenses on the profit and loss. These are startup costs required to be amortized over time, but we’re going to take a good chunk in the current period of $5000, the rest is amortized over time.
Eliot: Exactly right. We have, you mentioned, alluded to organizational costs. That’s just almost identical calculation. Organizational costs are real simple, it’s what you paid the attorney to set up your entity. Maybe the first year of filing fees for that state, we throw that into there, sometimes depending on who your preparer is, but we never get over that $5000. It’s very rare unless you had some big organization you’re putting together.
In Anderson, we set up smaller entities. We’ve never had an organization that I’m aware of over $5000. But same rule, $5000 immediately. Anything over that amortized over 15 years. That’s how we calculate it.
This individual question here, I was also asking about organizing everything. How many times do we say good bookkeeping? Even if you haven’t started yet, you can put together a good balance sheet or something to the effect where you can organize your expenses of what type they are and categorize them. These are all travel related, this one’s educational related, et cetera, to make it real easy for your tax preparer later down the line. I would always start any question that we have here today, you can just assume good bookkeeping needs to be behind it.
Barley: Yeah. That’s the scaffolding, the skeleton of our operations for sure. What else on that? Do you want to go on anything else, sir?
Eliot: I think we beat that one down pretty good.
Barley: Yup, good. Just keep your receipts, turn them into your tax preparer. You want to just follow that startup cost. The rules there are pretty straightforward overall. All right, what do we got next?
Eliot: “I’ve heard we want a pass through real estate entity that produces a K-1, i.e. a partnership to enable easier lending on properties in the future. Is this true? How does this work if we’re operating with a paper loss, bonus depreciation, et cetera, for properties that flow to our partnership?” When we start something like this, first of all, I want to distinguish pass through entity. Yeah, we’re talking a partnership. We would never do this with an S-corporation, which happens to also be a pass through entity.
Barley: Because it’s holding real estate.
Eliot: Exactly. We’d never want to put appreciable assets into a corporation S or C unless we’re flipping. Aside from that, these are long term holds, maybe short term rentals, or something like that. We wouldn’t want to put it in an S-corporation, so we’re going to go with a partnership as they mentioned here.
It is true. You’re allowed on the federal lending guidelines to have up to 70% of value. If it’s not in a partnership, that is if it’s disregarded to you on your Schedule E page one, as we often talk about, that’s where it’s in a disregarded entity, maybe through a Wyoming holding that’s disregarded to you. However, if it’s in a partnership, then they can give you a hundred percent of that value, whichever they determined in the calculations that they do to lend to you. You just get a chance to have much better lending. We’re at it with this little twist here on the losses. What’s going on there? What’s creating losses most often in our rental real estate?
Barley: Right. When we’re talking about depreciation losses, these are called paper losses because you don’t write a check for depreciation. It’s just an expense on the income statement that’s going to lower your income. It could perhaps lower your income down to a negative amount. If we have a pass through loss, how are we going to get a loan with a negative income balance reporting?
That’s where we work with a bank or work with a good lender that’s going to understand the nature of our operations. Hey, this is all depreciation. We could potentially back that out and then look at those numbers to base our lending criteria on. Although it is showing a loss, if you work with a real estate specific lender, they’re going to know how to track this and how to treat this.
Eliot: Yeah, they’ll know what they’re looking for. It can’t promise you a loan, but we can tell you that a good lender who understands your business will be able to give you the best options. Strictly to your question about the partnership, yes, you can have typically better lending through a partnership than you could if you didn’t. To the heart of the question there, that is it.
Barley: Just a quick basics refresher on that one, guys, remember that a disregarded LLC that holds the rental report, just as Elliot said, on Schedule E page one, that’s where we list the property, how much we made, all the expenses. It looks like a profit and loss statement right in your tax return. Schedule E page two, that’s where we report the K-1s. It can report the same activity, it’s just reporting from another entity like a partnership.
Eliot: Just one more point on that, Clint actually has a specific video about this, which is what I watched right before. It’s called Disregard LLC versus Partnership for Rental Real Estate. You can’t be more on topic than that answer right there. That’s the title of it. Look for it, Clint Coons. We saw it earlier, his YouTube page, so we got that out there online.
Barley: Yeah, Clint’s the master at that one. All right, what else we got?
Eliot: “When talking about short term rental properties and cost segregation, you mentioned a case study about it. What does this case study look like? What needs to be shown for it to be valid?” I think what we’re talking about here is the study we get from a cost segregation study. We work with a group. We recommend one particular group that’s really good at this. Do you remember who they are?
Barley: Yeah, Cost Segregation Authority. Cost Seg Authority will give you the cost seg report.
Eliot: They will do this pretty in depth case study. It’s a packet. I’ve seen many of them. They can maybe be 10-11 pages or something like that. It has a lot of the descriptive details that the IRS requires, such as valuations based on recent appraisals or something like that. They will look into all the detail and the structure itself. These are pretty significant when you have these done.
Some people will go out there and do their own type of study or something of that nature. I don’t recommend it because they won’t have the case law that’s written in there. There’s an actual case law that allows you to do bonus depreciation and cost segregations. One of them is health Corporation of America. One of them, HCA, it’s a famous case that started this trend way back in like the 80s, I believe it was.
There’s a lot out there that you need to have in there. You’re going to want to work with a specific group to do it, but these will have pictures of it, the type of building it is, descriptions of that building. They also have some numbers or some depreciation. They break it up. What kind of categories do we have on that?
Barley: If we haven’t broken out these various assets, everything’s being depreciated under a 27½ or 39-year timeline, that’s what we depreciate a rental property. For example, over 27½ years. But there’s multiple components within the rental, as you’re aware, furniture, fixtures, landscaping, flooring, all that stuff. Those are separate assets with a shorter life.
What does that even mean? The house has a depreciable life of 27½ years. Let’s say specialized flooring has a depreciable life of seven years. Put your tax hats on. I know you guys are used to this because you deal with Toby. But if we take seven-year asset and stretch it out over 27½ years, we’re going to get this much deduction each period. If we take a seven-year asset and spread it over seven years, we’re going to get a larger deduction each period moving forward. That’s accelerated depreciation.
The report is going to break out all the various assets. It’s going to show the house, the roof, and the driveway. That’s typically going to be along with the house, but then it’s going to separately state all those less than 20-year life assets and show how much more depreciation we can add if we accelerate those at the life they’re supposed to be at.
Eliot: Yeah, year five, year seven. Typically, what we see is year 15. Those are the ones that are typically eligible for that bonus depreciation here so much about 60% I believe because that what we’re working with here in 2024. There’s always a talk that maybe it’ll go back to a hundred. We don’t have any insight to that, it will or won’t.
Barley: One thing I love from Cost Seg Authority, if you go to the IRS, there are audit procedures for their internal auditors to follow when they audit you in a cost seg study that you’re doing. There’s a list of things they have to follow. Cost Seg Authority takes that list and addresses it point by point in the study. Checking the things off the box. The IRS auditor makes very little work for them if you use cost seg authority. I really liked that aspect. They explicitly address the audit risk.
Eliot: But we don’t recommend doing this yourself. You are actually allowed to, but we don’t recommend it. What’s in it, it’s going to have the breakdown of these costs just as Barley was going through your five and seven. Remember, that becomes, for those are really into the code, what we call 1245 tangible personal property, and then the rest is still your house, your frame. It’s going to be your 27½ or 39 in the case of commercial, your more solid parts if you will of it.
That is still what we call 1250 property, and that all will come to play later on if you ever sell it. We’re looking at bonus depreciation or things like that, but we’re getting away from it going down in the weeds here. That case study, it’s going to have all these different aspects we talked about. It’s going to be based on good appraisals and things like that. That’s what goes into that report.
Barley: Yup. All right. “Can cost seg or bonus depreciation offset 1099 income or social security income?”
Eliot: It could. It depends. Guess what, big surprise there. What are the things that are going to determine whether or not you can offset an ordinary income with your cost seg or not? How are you going to get there?
Barley: Number of little pathways we could go down here, but let’s start here. If we’re talking about a traditional long term rental, we first need the real estate professional status, then material participation. If we’re talking about an Airbnb or a short term rental, we only need the material participation status. What are we talking about here? This is how we reclassify a loss from passive potentially to non passive or active.
Can accelerated depreciation offset our other forms of income if we materially participate in the activity? Just remember, if it’s a traditional rental, we have to have real estate professional status, then materially participate. A couple of steps there.
Eliot: We just have a good question coming here. Raj asking what’s 1099 income. Bow, that’s a loaded question. There’s a dozen different types of 1099 forms and things like that. Generally, the aspect that we’re looking at is if you’re an independent contractor, it’s going to be ordinary income on the amount of ordinary tax rates on that amount coming in, and then you get hit with the great bonus of employment taxes. They’re 15. 3%.
Let’s go back. If you have a rental, the first natural state of it is that it’s passive income. You’ve got to prove as Barley was pointing out that it’s not passive, it’s non passive, and that is that real estate professional status. That means that you’re putting in a ton of time over 750 hours materially participating in real estate related businesses.
As he pointed out, you got to materially participate in each rental activity you have, or maybe you bunch them what we call aggregation. That will give you a rep status for your long term rentals. If you get that, then that will create an ordinary loss on your rental that would offset your 1099 or your social security income. In fact, it will offset any income on your return if you have that non passive loss.
Barley: Yeah, and who’s following along in the tax forms right now?
Eliot: Right, exactly.
Barley: If you have your 1040 open though, you’ll have your wages, all your forms of income, retirement, distributions, dividends, then you’re going to have capital gains, capital losses. I think that’s line seven, then other income. That’s where that potential loss comes from.
If that’s an active loss, it’ll carry all the way up to page one of your return and offset that other income. just to let you know where that plays out on the return. If not, you’ll use form 8582 for passive activity loss limitations. Just file that one away for later. I know you guys have heard that term as well. Moving on?
Eliot: Yeah, I think we’re good.
Barley: All right. What do we got next?
Eliot: “Why is my income tax so high?” Good question. “How can I reduce my income tax as a 1099 subcontractor?” This is just an extension of what we were just talking about. I tried to put the questions in order here so that we have a nice flow here. We got 1099 subcontractor coming in here. He or she is receiving income. It’s going to be taxed.
The income amount, let’s say you get paid $10,000 as a contractor, that’s going to be ordinary tax rates, but it’s going to be hit with employment tax as well. Ouch. What can we do to possibly offset that? There’s a lot of things out there, but maybe we can boil out just a few here.
Barley: I love this question because this is really where we get into the nuts and bolts. How do we actually apply these principles? I got a big tax bill. How do we deal with this? Where do we want to start first? Let’s look at incorporating first. Let’s say we have over $30,000-$40,000 positive net income after expenses, net income. If we report that on Schedule C, a hundred percent of it’s going to be subject to that additional 15% plus self-employment tax.
We get a little deduction for it back, but all else being equal, we’re paying roughly another 15% with a little deduction on that income. If we were to move that over to an S corporation, we could potentially pay a smaller, reasonable wage. The rest of the distribution is not subject to the extra self-employment tax.
How can we reduce our income tax? First, we’ll look to structure. We potentially want to incorporate the business if the numbers are right, then we just look for all available deductions. We can report that 1099 income on schedule C. There’s a bunch of good deductions.
You’ll hear us say that it may increase your audit risk. There are several restrictions on Schedule C, a number of factors there, but we can certainly report on Schedule C. It would depend on the level of income really and probably your level of expenses as well.
Eliot: Absolutely. Just with that, there are other things we can do. Barley, rightly so went straight to setting up an S corporation with all the other deductions like corporate meetings and accountable plan for reimbursement.
Before we even get there, there are other things. Maybe you can set up an HSA, a health savings account. You could put money into it, contribute money into it. It’s not really a donation, but contribute money. That could create a deduction on your return, maybe put into retirement plans, things of that nature, which could lower overall income that will help you. But then really, I think the most common approach would be hitting that S corporation that Barley’s talking about. If you had significant medical expenses, maybe you’d think of C-corporation because they do have a medical reimbursement plan that a lot of our clients enjoy.
Barley: Move to a C-corp.
Eliot: Yes, absolutely. Just jumping back to one more thing on the S-corp versus Schedule C. You just had a return. Again, as Barley pointed out, all that income and Schedule C, on your 1040 comes through all of it’s subject to employment tax, all of it’s subject to ordinary tax rates. If we take the S-corp approach, two streams of income typically, one is a paycheck, W-2 wage, another is the distributions.
Both aresubject to all the income tax that the IRS is going to throw at you, but that paycheck, the W-2 reasonable wage we call it is subject to employment tax as well, whereas the distribution is not. So you get some extra tax savings there as well. You just need to talk to somebody who’s familiar with this on taxes to walk you through that. Most people are going to guide you to the S-corporation. Of course, we’d want to look at your situation in total to see what we have all over, but it’s time to S-corp.
Barley: Yeah. A lot of factors here, guys. Calculate, calculate, calculate. What did I want to add to that? QBID, qualified business income deduction comes into play here. I don’t want to get too in the weeds, but you’ll see us do this. Toby does this too. Put up a Schedule C, S-corp, outline where the expenses go, what our tax liability ends up at the end. It’s going to depend on your level of income, but a number of options. If you’re going to leave it on Schedule C, you can certainly take advantage of self employment, health insurance deduction, et cetera.Those are certainly optional as well.
Eliot: Very good.
Barley: All right. Why did I have to pay employment tax when receiving a 1099 NEC, non employment compensation or non employee compensation? When I received a 1099 NEC for sales, I knew I’d have to pay what wasn’t taken out during the year, but I do not have a business.” Great question. Another 1099. I don’t have a business set up, and I just got it. Somebody sent me a 1099 in the mail. What do I do with this thing?
Eliot: Yeah. You put it on your return, you pay tax. As we learned here, you’re going to have to pay employment tax. This is just a cousin of what we just talked about. One thing you could do here is you can check with your employer to see, or whoever’s paying you this amount, see if they could maybe put it through an S-corporation. We’ve had some clients who’ve been able to do that.
You get to the spot we just talked about in the previous question, it flows to an S-corporation. We got a lot of great deductions we can take advantage of. We have less employment tax, at least theoretically, if we’re doing a lower reasonable wage that we talked about. With that reasonable wage, you could probably pay into bigger retirement plans, depending on how much, maybe a sole 401(k) or something like that.
Why are you getting it? Because this is again an independent contractor form, 1099 NEC, and it’s again subject to ordinary income and employment taxes both. If you don’t have the option of having this applied to maybe an entity that would be tax favorable, well then we’re just going to hit other places on your return. Any ideas what some of those things might be?
Barley: If we can report that on Schedule C, there are obviously some good deductions there, but then we can look at maxing out retirement accounts. We can look at, just like we were talking about before, other ways of offsetting our other income, which includes all other forms of income, really. We’re going to look for Schedule C deductions or incorporating it most typically there.
Eliot: We can hit other things like an HSA again. All the employment, obviously the retirement plans that we spoke about.
Barley: Traditional IRA.
Eliot: Exactly, right. A lot of things to go there, maybe charities, things like that. If you have other investments like we talked about with real estate, if you materially participate in things like that, or have a spouse that has rep status, perhaps you can get those losses to offset. There’s a lot of options, you just have to see what best fits you and what you’re allowed to do on that.
That is why a 1099 NEC is an employment. It’s your personal self-employment amount, and it is subject to employment taxes. Even though you don’t have technically a business, that’s why you got hit. That is why we say, if you can talk to them and see if they might pay you in an entity where you can be your own boss, your own S-corp, you can maybe take advantage of some of the better deductions. Again, you want to talk to somebody to see if it’s worthwhile because there’s a little cost to that and see if it’s worth it, the tax savings.
Barley: Yup. Remember the 1099 filing requirement if we pay a non incorporated individual more than $600 in the year where we are required to file that form 1099, which means first, we got to get a completed W-9. I’m sure you all remember this, but we want to make sure we follow those steps. If we do have any contractors hired, that’d be the reverse situation here. But certainly make sure we get all the proper paperwork filled out there. Moving on?
Eliot: Yup.
Barley: All right. “When selling an investment house with some gains, what’s the best way to protect our gain without sharing our profits?”
Eliot: Yeah, good question. Again, go figure someone who wants to save on their taxes here. We’ll hit the ones that first come to mind. This is going to be your 1031 exchange, like-kind exchange. You have a property, it’s a house, it’s land, or a house. It’s used as an investment as we point out here in the question.
You can defer that in a 1031 like-kind exchange. That’s a very popular answer. You’re basically giving up what we call the relinquished property. That would be the investment property you’re getting rid of, and then you pick up a new one. We call that the replacement property.
Just to boil it down, basically, if you picked up a property that has more value, and maybe if you picked up more debt than what you gave up on the relinquished property, normally you’ll be able to defer all your taxes. Anything short of that, then we start getting some extra cash back from our exchange, and then we might incur some tax from that. That’s a popular one, the 1031.
We also have what’s called UPREITs. Those are popular investment. Depending on your situation, you might be able to invest in that. That’s umbrella partnership real estate investment trust. It’s like a 1031, only you’re going into a big pool of other of other real estate out there.
Delaware statutory trust, that’s usually a little bit smaller. Do give up some control here because you’re not the one determining what’s going on, when they sell or something like that, or if they sold your property or anything like that, but it is a 1031-like exchange going into those. You’ll definitely need to talk to some people who know your property.
If you’re in the 1031, you’re going to have to use a qualified intermediary. They’re always a good source to look at. Those are ways, and then the opportunity zone. We’ll stick with the first three because that’s a trading of things, but any thoughts on those?
Barley: Yeah. UPREITs. That’s a real estate investment trust, DST, Delaware Statuary Trust. These are just other options. We hear the phraseology, I don’t want to be a landlord anymore, but I still want to own real estate and get the benefits of it.
Eliot: We get that a lot, don’t we?
Barley: Yeah, because you can still take the depreciation losses. All these losses still pass through to you. Just backing up half a step here, guys. I don’t mean to be a flippant here, but what’s the best way to deal with this when selling? Don’t sell. Pass it on to your heirs, 1031 exchange.
Eliot: What happens there if we pass along?
Barley: We get this stepped up in basis. If you’ve held this property for 20 years or something, you could have a massive difference between your basis, which is essentially what you paid for it minus the land plus some improvements versus the fair market value today. That could be a huge spread. We can avoid that by a 1031 exchange or stepped up in basis by passing it on as inheritance.
Again, not to be flippant, the best way to be to not sell. But if you are selling, if you’re going to sell and you’re going to get a large capital gain, that’s when we just get into just good old fashioned tax planning. We can look at other capital losses to offset, maybe another investment that isn’t performing as well, and just a bunch of different options. You just got to start from the place of we’re expecting this amount of realized gain, what can we do with it?
Eliot: I alluded briefly to the opportunity zones. You got anything that you could say on that?
Barley: Yeah, qualified opportunity zone fund. I’m sure you guys have heard of these. Essentially, we’re investing in economically distressed areas of the country. They’re incentivizing us. The IRS, the government, the treasury is incentivizing us saying, hey, if you put some cash in here and you don’t touch it for 10 years, you leave your money invested, you meet a couple other steps, certain level of investment, you got to reinvest, put some money into it, if we keep that for 10 years, the appreciated gain will be non taxable. That’s our primary remaining benefit there. 2026 is coming up pretty fast.
There is a little bit of a fractional benefit due to the original timeline and how the conservation easements were set up. The primary benefit now is if you hold the property for 10 years, the appreciated gain is excluded. That’s qualified opportunity zone, and then you’d set up a qualified opportunity fund within the zone. Some steps there, but let us know if you have any questions on that.
Eliot: Yup. Just to recap real quick, 1031, qualified opportunity zone, UPREIT, or Delaware Statutory Trust, all popular ways to defer that tax gain.
Barley: Or pass it on to your heirs.
Eliot: Don’t sell it all. Barley put it exactly right.
Barley: As Ross says, 1031 for life.
Eliot: Right.
Barley: All right. Hey, just in case anyone wasn’t with us right at the beginning here, I just want to make sure this is really how we can dig in deep and get to the nuts and bolts of this stuff. I realize this is a big ask as if you didn’t study law and accounting. We’re asking you to learn both all at once.
Eliot: You can do it.
Barley: Having Clint and Toby at the helm certainly makes that a lot easier. Join this workshop. Obviously the live one, it’s a lot of fun, a lot of energy, a lot of synergy. Meet your fellow entrepreneurs, network, meet the partners. Coming up in Dallas. That’s you, Texas. Keep an eye out.
Eliot: Cowboyland.
Barley: That’s right. Of course the virtual ones, you can join those too. It’s great information. Just got a pencil to the paper and apply these techniques. Ready to keep moving?
Eliot: Yup.
Barley: All righty. What else did we got?
Eliot: All right. This is a long one, but I picked it. “Can capital loss carryovers be chosen when to use? For example, if I only had income from capital gains in 2023 of $13,850, which is the amount of the standard deduction, my taxable income would be zero. However, if I had capital losses, carryovers greater than that amount, I would rather save them for another year when my taxable income would be greater than $0, but the tax software wants to use it despite resulting in a waste of the capital loss.” Fantastic question.
This is really neat. I like this one because it gets the mechanics that you guys don’t often hear about from your tax preparer of what’s going on here. First of all, capital losses, you can use them up to the amount of capital gains you had plus $3000 that will go against ordinary income. In this case, they had some capital gains, but they had to use their capital losses first, even though they’re going to get a standard deduction. Standard deduction is just an amount the government says you automatically get to take based on if you’re single or married, finding joint, head of household, a certain dollar amount. You’re going to do that just simply for doing a tax return.
Barley: But as indicated here, it can’t bring our income below zero, so we’re in a sticky spot there.
Eliot: No refund on this. That’s a great point. Here, what happened is that the way that they calculate, earlier, Barley was talking about the way your 1040 form flows. Unfortunately, we have to hit our capital gains first, our Schedule D, and we calculate that out before we get to the standard deduction, which is exactly what this individual is asking about. No, we don’t get a pick and choose when we want to use our capital losses. They’re going to come out, and you’re going to have to use them unfortunately.
I can understand the frustration with this because it would be better if our capital gains were maybe down below that after the standard deduction, then we might have something here to work with perhaps, but we don’t. Here, you’re going to have to have income above that and then be able to use your capital gains in order to take effect both.
Barley: Yeah. That’s exactly right. We add up all our forms of income, get that adjusted gross income line, and then comes out the standard or itemized deduction. Yeah, just going to do a little bit of tax planning. If we had capital gains, we can do a little bit of tax planning when we’re looking at that Schedule D. That’s just a little bit of a forward looking process. We can harvest tax losses potentially.
On the flip side in this situation, you could potentially even sell another stock that you had gained on. Maybe even depending on your AGI, you could buy that right back. A couple of techniques you could look at there. I don’t want to get in the weeds too much, but it’s a great question.
Eliot: Yeah, a strategy Toby talks about a lot, get that basis back up there by rebuying into it. We’re victims here of the way things present on the tax return, which is not by mistake. The IRS has an ordering of these things. Unfortunately, we got to do that capital gain, capital loss calculation before we get to our standard deduction. That’s what’s being applied here. That’s why, unfortunately, we can’t choose when they use those capital losses. They just automatically go into the calculation.
Barley: Let’s go into this one because this is a perfect follow up. “Can I reduce my income tax from capital gain from selling stocks by using loss in real estate rental income loss or expenses?” Good question. Although there are different categories, they will indirectly offset, right?
Eliot: They can, perhaps. It depends. This ties back everything we’ve been talking about all day long so far today. You got your capital gain. First, it’s going to be offset by capital losses as we just learned in the previous question. Now, if you have your real estate going on, some losses from there perhaps and expenses from that, there are some times where we can use that and times where we can’t. When do we get to use our rental losses against other income like this?
Barley: If it’s a traditional long term, we got to have that rep status, real estate professional status. That’s our ticket to the fair, but it doesn’t get us on the ride. We then have to materially participate in each individual activity, unless it’s a short term rental. A pretty strict definition of that, unless it’s a short term rental, we skip that real estate professional status. You still have to materially participate. What’s the result of that? We reclassify the losses. They go from passive where they can only offset other passive income to then eligible to basically offset any other form of income.
Eliot: We have our long term roles with rep status. We have our short terminals with material participation. Those can create losses. We forgot about the passive. There is another rule. If your AGI is under $100,000, you are allowed to take up to $25,000 of passive losses from your real estate against your other income. We brushed over that one.
In all these questions, wherever you’ve had real estate in there, it will be the rep status for your long term and the material participation. It will be material participation for your short term rentals. Or if it’s still passive rental activity and you’re less than $100,000 of adjusted gross income, we can take up to $25,000 loss against that. All three of those would write off against your capital gain in this situation, if you sold the stocks and provided you a little bit of tax relief there.
Barley: Isn’t this fun guys? Then you got to look at where we are. Adjusted gross income, therefore our tax bracket, where that lands. That also depends on how much tax we’re going to pay on the capital gains. Remember, these are favorable tax rates. We’re going to pay significantly less on capital gains. We like that.
Eliot: Everything we’ve talked about like the AGI, the $25,000, $100,000 AGI, capital losses of $3000, none of those are adjusted for inflation. These numbers are way old in the code.
Barley: The $3000 one, that’s terrible since I was in school.
Eliot: I one time did the calculation on a reasonable…
Barley: Inflation?
Eliot: Yeah. There was something like $27,000. I thought it was, that it should have been instead of $3000, but it is what it is.
Barley: I’m almost at the age. Like a senior citizen, you pay more than $600? $600? Good lord, okay.
Eliot: It means everybody.
Barley: We covered this one?
Eliot: Yeah. I think we’re good.
Barley: Yeah. Good work. Great questions, guys. “I just created a business at the end of March. It’s April 9th. When is a preferred time to contact tax specialists here at Anderson advisors to set up a meeting to ask questions, have things explained, and see if they’re a good fit for me?” I love how you put that ask questions, have things explained to me because asking questions and getting an answer doesn’t always put us there, does it? As you guys know from asking tax questions.
Eliot: It does count.
Barley: Right. I ask a tax question, I get an answer, and I’m like, oh, okay. I don’t know what to do with that, really. Have things explained and see if it’s a good fit. Depending on our goals, what’s our overall? We look at legacy planning, asset protection, tax planning, and all of those things. I doubt it is this week. You never know. It can be this week.
We certainly have tax advisors available for tax planning and tax consulting. That’s part of our tax package billable against your tax package there. You’ll hear me say a lot, use the platinum portal, use the platinum knowledge room, knock out all those base questions. Build your base knowledge.
When you’re ready to really make a commitment to an investment, or you need some specific guidance or our calculations, that’s when we may push you to do a billable tax consult or tax planning. In the meantime, I want to hop right into the Platinum knowledge room. I love bragging about that service. Maybe we’ll talk about that here at the end. When is the best time to do tax planning?
Eliot: Right now. Yesterday is the perfect time. You want to get in there, we’re really trying to emphasize trying to get it across the clients and potential clients that you really should be looking at it quarterly. Get a tax plan going on every quarter. We got estimated tax payments that need to be made. Some clients choose not to for investment reasons, but at least they can come in and ask us questions and be made aware of these different things.
We can’t do that if you don’t reach out to your tax provider and set up some tax planning sessions. We do do that. We do it all year round. There’s never a wrong time, but the less preferred time is at the last minute in the late fall or the winter. It makes it very tough. I have had to do it on December 31st or December 30th, last day making decisions, whether or not to buy a vehicle, or something like that. We do run into those still.
You know what, you could have saved yourself a lot of time and anxiety if you’d done it earlier. You would have had a better result. You just get better answers when given more time and more clarity to your situation, and that takes planning over the year.
Barley: Yeah, and it’s true. I joke saying, that’s the wrong time. We can always help you come up. Even at the last minute, we have donor advised funds ready to go. There are several options you can take advantage of right now, of course just for your own peace of mind. Part of our whole job, our goal, or our mission here is just to make you focus on your business operations and not be as afraid of taxes. If we can get the tax planning checked off, then you can focus on business operations the rest of the year, just like you want to be doing.
Eliot: Exactly right. Give you a nice landing pattern into year end.
Barley: Yup, absolutely. Of course, Platinum knowledge room, Platinum Portal, build up your base knowledge, ask as many questions as you can tax wise. All right. What else did we got?
All right. Make sure we subscribe to everything. Let me take two seconds. I know you guys have hopefully used the Platinum knowledge room. I have to take two seconds to brag about this. I really don’t know of another firm that’s offering anything like this, guys. You have a CPA and an attorney basically on staff at your disposal, five days a week, five hours a day.
Eliot: Usually several, not just one. There’s several on there.
Barley: Did you guys hear that right? Every day, you have a CPA and attorney. Come ask us questions. There really isn’t another service like that, so please take advantage of that.
Eliot: Absolutely.
Barley: I know I certainly would if I was still out running small businesses.
Eliot: It’s a lot of fun.
Barley: It is a lot of fun. We have a great synergy. We have such a variety on the team. We just address such a wide variety of issues. Of course, like I said in the beginning, just talking with you guys as small business owners, talk with CEOs, CFOs, CFAs, CPAs. That’s certainly my passion, so I love that.
Let’s wrap up and let these guys get out of here. I know they miss having Toby, but it’s great to have you guys on board. I think we covered this one. Come see us in Dallas, guys. Live event in Texas. We’d love to see you there. Any questions we can go over? Open questions? Are we all good?
Eliot: I think we’re good. There are only 10, and they’re clicking them away right now.
Barley: It looks like you guys’ questions are being answered in the background. Thank you so much for posting questions. Of course, if anything doesn’t get answered, you know where to go. Platinum portal, submit your written questions there. Platinum knowledge room, come in and type your questions there. Zoom virtual meeting format there. Plus, of course, we’re always available for tax planning, tax consulting, if you have a tax package here with Anderson.
Eliot: They get them here on Tax Tuesday. Email us at taxtuesday@andersonadvisors.com. That’s where we pick from. Again, we try and hit the ones that hit the widest range of what you’re asking, or if they have a peculiar little twist to them, try and pick those out. It doesn’t matter if you’re a client or not. I just pick them blindly. I don’t look at the status or anything like that. You can always hit our website for any further information at andersonadvisors.com.
Barley: Yup. Thanks so much, you guys. Great work today. I think we did good. We’ll see you for the next tax wise workshop, the next Tax Tuesday. Keep coming back. We’ll see you next time.
Eliot: Thanks to our staff in the background, everybody who’s answering those questions. I have a list of everybody.
Barley: Jeff, Dutch. Yeah, we got a great team in the background. Submit any remaining questions in the portal. We’ll see you guys next time. Bye.
