Toby Mathis and Jeff Webb of Anderson Advisors talk about how to avoid taxes from borrowed money and other tax-related questions. Submit your tax question to taxtuesday@andersonadvisors.
Highlights/Topics:
- Is the money I get from a line of credit or loan taxable? No, proceeds from or payments back on a loan are never taxable. What’s the best way to avoid taxes on money borrowed toward investment? Utilize interest and repay your loan to avoid taxes.
- I am a co-owner of a property. I don’t get proceeds from rent but want to invest in the renovations. Are there any tax advantages for me? You can get tax advantages/deductions for repairs, but renovations may depend on your income, operating agreement, and other factors.
- If I move my paid-off condo to a trust, will the trust pay taxes on it? Don’t put your condo into an irrevocable trust. If it’s a living trust or land trust, neither are considered disregarded entities nor pay taxes. If I sell it one year after owning it then put it in trust before I sell it? Also, it is not recommended to change a title shortly before selling it.
- Should I put my college kid on my payroll for $24-to-30,000 a year rather than just pay their rent out of my pocket? Makes perfect sense to do this, but your child actually has to be doing something for your business that is worth $24-to-30,000 a year.
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Full Episode Transcript:
Toby: All right. Hopefully, we are going to live now. We’ll see how many people start popping in. Welcome, Jeff.
Jeff: Thank you, welcome.
Toby: Welcome to everybody else. Welcome to Tax Tuesday, your place where you get some tax knowledge. We are going to go over a lot of things today. We have a busy session and we have a computer that’s doing weird things as they […] want to do. We should have everybody flowing in. We are already seeing a bunch of folks. This is for fun and giggles, somebody’s put in Claremont, Florida. Tell me where you’re at today.
There’s Texas heading to Wisconsin. Tell me where you are sitting, what city and state. Ohio, Los Angeles, Hazard, Kentucky, California, Raleigh, Houston at 102, Orange County, Parkland, North Carolina, […] Springs, Chicago, Mississippi, Stone Mountain, Georgia, Arizona, Minnesota, New Jersey, Tampa, Florida, Auburn, Washington. Congratulations. I know that area pretty well. We lived in Seattle for a lot of years.
St. Charles, Houston, Greenville, New York City, San Francisco, we got everything. Smoky Mountain, Newport, Tennessee, Tacoma, Washington. That’s Carter. What are you doing brother? Little Clint. That’s pretty funny.
We got to dive on in. Jeff, anything you want to go over before we dive in?
Jeff: I don’t believe so.
Toby: That’s no fun. Let’s go over the rules. I like this, somebody says hey, any creative ideas to write off the purchase of a camper van? We always have good ideas. We also have Ian, Troy, Eliot, Dana, Piao, Dutch. Who else is on? We got Patty. We got everybody. We have a bunch of CPAs, tax attorneys, accountants, and support staff. We got a lot of people to help you guys. If you have any questions, by all means, go in. If you have questions, go into the Q&A. Go in there and ask your questions. They’ll answer them.
Somebody says, Eliot and Christos. I didn’t say Christos. We got a bunch of really good people to help you. If you have comments, by all means, do like Patty is doing and go onto the chat and do emojis and really weird GIFs.
Ask live questions through the Q&A in Zoom. You can also email in questions during the week. There are two weeks in between this, taxtuesdays@andersonadvisors.com. That’s where we get our questions. You will see that we answer a bunch of questions today. We usually get around 10–15, depending on how long we want to be here. If we want to be here until midnight, sometimes Jeff grabs more.
If you need a detailed response. like something that’s very specific to your pattern and involves prep, then you have to be a Platinum client. Platinum is a whopping $35 a month and you can ask all the tax questions you want in writing.
Here’s the reason we do that, we want to give you a written response so there’s no question about what we are saying. Plus, people do like to ask us the same question five or six times because they may have forgotten the answer. Or if it’s a technical answer, it’s going to go over their head. So we want to keep it there.
Off talk, I’m referring a tax person to your company from […], please do. Sheryl, we are always needing good people. Jeff, do you need good people?
Jeff: I need good people.
Toby: We actually turned off our accounting for bringing in people through October. We are at capacity. We have a waitlist and that’s it. We just can’t bring in a bunch more tax clients because we got to be of service to everybody. If you know somebody that’s good, they’ve done investing, preferably they have that experience. Otherwise, we are going to train the heck out of them.
If you know anybody who’s a good accountant or you are a good accountant, reach out. We have 45 states where we have employees now, so don’t worry. Somebody says she’s in the State of Washington. We have an office in Tacoma, by the way, so if you have somebody good, by all means.
Anyway, this is supposed to be kind of fun. You can see we’re a little cheeky. Jeff, usually I have to hold him down because he gets rambunctious. We want to help give back and educate, we want to have a little bit of fun while doing that, and we want to take the fear away from taxes.
Taxes aren’t something to be scared of. The tax code is literally like the mountains full of gold. You just have to go dig a little bit, and then you usually find great things. We’re going to strike it rich—maybe—but usually, we are keeping money in our pocket and it’s one of the more lucrative times spends that you can.
If you’re going to go out there and you have to choose between watching Netflix for an hour or learning about taxes, Netflix will yield you no return, taxes will yield you a nice return. I’m not saying don’t watch Netflix. I’m just saying watch it after you watch Tax Tuesdays.
Opening questions, and these are the questions we are going to go over so don’t worry. I’m just telling you what these are and we’re going to hit one at a time. Just know that when I read these, every now and again you get somebody panic and goes what is the answer? What is the answer?
There was a good question, by the way, that I just saw that popped up in question and answer about PadSplit properties as an aside. We know those guys; they’re absolutely fantastic. PadSplit’s great. It’s a tech platform. I think we might even be investors in them. I have one client who bought over a thousand units and it increased their net operating income by about 100%, it doubled it.
All right. “Is the money I get from a line of credit or a loan taxable? What’s the best way to avoid taxes on money borrowed towards investment?” Easy answer on that one, but we’re going to go through and break out some nuances.
“If 100% of your income comes from royalties, which aren’t subject to the 15.3% self-employment tax, at what point does it make sense to create an LLC-S Corp now that the royalties go to the business and you pay yourself a salary and distributions?” Really interesting questions and we’ll dive into that one.
“I want to sell my property that belongs to my private foundation and buy as a 1031 exchange my own primary residence with this foundation to avoid selling taxes.” I think the better way to say that is to avoid any taxes on sale. “Do I have to have a corporation to do this or a private foundation will be okay?” This is called stepping in it, and we have to go over all the little rules are when you start talking about private foundations, but we will definitely get into that.
“I am a co-owner of a property. I don’t get proceeds from rent, but want to invest in the renovation. Are there any tax advantages for them?” We’re going to have some questions for you. Hopefully, some of you that wrote these are on.
By the way, someone says I’m watching Netflix […]. What is it doing? They came on and had a lot of people fall off. I’m just kind of curious. Did Netflix take a hit or did they do really great since? I think they are reporting their subscribers today. I’m just curious.
Jeff: It seems like the market is […] up quite a bit.
Toby: It went bunkers today, so going up I assume they went down 90%. I missed out on that one. If we wanted to stay low, I would have purchased it first, then I would have stayed low. That’s just the rules.
All right. “I started a vending machine business as a franchise in 2020 through an LLC. Because of my material participation, I wrote off 100% of my vending equipment against my LLC earnings and my other employment W-2 earnings within the first two years. If I can no longer qualify under the IRS rules and be considered passive, what are the implications?” Really good question, we will answer that. There are little pieces of that that we will break down.
“What is the best way to set up an LLC for a partnership if you want to be considered as a VOSB?” Veteran-Owned Small Business?
Jeff: Yeah.
Toby: Veteran-Owned Small Business. Somebody says it’s a gap stock, we’ll see tomorrow. Up over 10%. They were expecting to lose $2 million, but they only lost $1 million. That’s awesome. I always just look at the revenue of these companies and when they were worth the most, they had fewer subscribers, no revenue, and then they actually started making revenue, and then their share price drops like a rock. I’ll never really understand that. I only understand cash flow. If you’re profitable and you make me money, that I understand. Everything else, I’m like meh.
All right. “How can I write off finishing expenses on my primary residence that will be purposed late this year as a furnished short-term or midterm rental property?” I hope you know the answer to that. Do you know the answer to that?
Jeff: I got my feelings.
Toby: All right. “If I move my paid-off condo to a trust, will the trust pay taxes on it. If I sell it one year after owning it, then put it in trust before I sell it?” We’ll go over that.
“Can you provide specifics around capturing a capital gain loss short-term for digital assets? Is it simply sell and repurchase? Is there a certain waiting period before I can repurchase?” Great questions and we’ll get into that.
“I’m looking to invest in multifamily syndications. There will be quarterly returns and potentially a lump sum return when the property is sold in five years. Is there a way to transfer and reinvest the profits from the sale into another syndication without being taxed, similar to a 1031 exchange on rental property?: Good questions. We’ll dive into that.
“Should I put my college kid on my payroll for $24,000–$30,000 a year rather than just pay their rent out of my pocket?” Good questions and we’ll get into all the answers. Here we go. Are you guys ready?
Before you do that—Patty already did this—if you like digging into these types of questions, we’ve been tracking and I think we’re over 400 videos on our YouTube channel. Just go to the YouTube channel. I’ll make it flash, this is really exciting, the red thing kind of flash.
You can come to my channel and watch a lot of videos there. A lot of them are the Tax Tuesdays, where we break out the questions and quite often you can find good answers to burning questions or at least give yourself some background so that when you talk to us or if you’re asking questions, we’re getting it narrowed down so you can go right to the big issue.
Speaking of big issues, are you ready?
Jeff: I’m ready.
Toby: All right. “Is the money I get from a line of credit or a loan taxable?” Let’s just answer that one. Is it ever taxable to get money out of a line of credit or a loan?
Jeff: No, it’s not. Proceeds from or payments back on loan are never taxable.
Toby: You can always borrow against something. The old adage for rich people was to buy, borrow, and die. The only question is are you in a type of entity where you might have taxable income if it’s more than what you put into the entity? As an individual, it’s never an issue because you’re at risk. It’s you. If you own a home, you can refinance to take that money out. It’s never taxable to you. The only question is whether you can write off the interest.
Here’s a fun one, Jeff. Let’s say I have a house, and if you guys are like me, I hate having credit, I hate having loans against things really. I buy a house. I don’t have loans against the house. Let’s say I want to buy a couple of properties that I saw that are investment properties. Could I take a loan out against my house and buy those properties?
Jeff: Yes, you could.
Toby: Can I write off the interest on that home loan?
Jeff: Yes, but you would write it off on the properties you wrote, not as a principal residence, more of interest.
Toby: I’m going to speak to those of you who have a loan that’s greater than $750,000. I’m going to speak specifically to you guys. Listen to what Jeff just said. You’re writing off the interest as an investment expense.
Jeff: Exactly.
Toby: Not as a personal mortgage. Let’s say that I have a house that’s worth a couple of million dollars. and your accountant says yeah, but you can only write off interest on the first $750,000. So you’re like, oh crud. But I have a HELOC on it. Let’s say I have a loan of $750,000 plus a HELOC for another $300,000, and you want to buy other properties and you’re like, but I can’t write off the interest. Yes, you can.
What we care about isn’t the nature of the security. What we care about is the nature of the loan and a primary mortgage loan on your personal residence is one thing. It actually has to be to purchase or improve that property. Everything else can be an investment expense as long as I’m taking and using it.
Jeff: You can even use it. Let’s say you don’t own rental properties, you have a business. You can take equity out of your house and lend it to your business, your pizza shop.
Toby: There you go, and it could pay you interest?
Jeff: It could pay you interest.
Toby: Then it would deduct the interest that it cost. Absolutely. “What’s the best way to avoid taxes on money borrowed towards investment?” That’s it.
Jeff: I’m going to throw in one other thing, though. The best way to avoid taxes is to repay your loan. You don’t repay your loan, they cancel your debt on you, and that becomes taxable income.
Toby: That’s true unless it’s your primary residence.
Jeff: There are some exceptions for insolvency and bankruptcy.
Toby: In other words, if I take a loan against something and I don’t have to pay it back, they treat it as income to you, especially if it’s investment properties.
Jeff: Sometimes people, especially with credit cards, get in trouble that way.
Toby: Yes, I don’t have to pay it back. How come I have to pay tax on it? Because somebody just gave you $50,000. But it was a credit card? They gave you $50,000. You bought a bunch of stuff with it. You have to pay tax on that
Jeff: $50,000 worth of Tacos.
Toby: All right, now here’s the thing. This is what I want you guys to really pay attention to right now. Security is different from a loan. I could get a loan. Jeff could give me a loan and I have zero security for it. He’s just hoping that I pay him back.
He could give me a loan on any asset I have. I have some art, maybe he writes a loan against the art. Maybe he writes a loan against my stock. Maybe he writes a loan against some other properties I have. You can borrow against just about any asset and if you’re somebody, for example, who has a large stock portfolio.
I was just talking to Jill, who’s a really great client I have in Honolulu, a really nice lady, and she was talking about a product that they have what’s called a security-backed line of credit. We’ve been dealing with this for years over and over. It was right around 2%. Some of you guys are going to be like wait a second. How come that’s 2% but mortgages are so high? Mortgages tend to follow the 10-year treasury rate.
Anybody could decide what they want a loan on. So if a financial institution—I think she’s at Morgan Stanley right now—says hey, as an investor here and you have a portfolio here, I’ll loan you up to 70% of the value of your portfolio, and they want to charge you some stupidly low amount, you could do that. They want to charge you 1.5%, they can, 2.5%, they can, 5%, they can. It’s just a commercial transaction, but you can borrow that money with zero tax.
When you’re borrowing against there, you actually have the underlying asset, you have the stock and it can still go up. Now, it could do the opposite, too. People that borrowed money and did a security-backed line of credit in December are probably having a little bit of a heart attack, like my portfolio is down. Don’t worry, historically, 100% of the time it comes back. No reason to think differently this time.
You can borrow against these things and use that money. I’m making money on the security, plus I’m making money on what I’m borrowing, and my debt service is a really small amount. The one that she quoted me was right around 2%.
Just think about that for a second. Inflation was 9% so your cash is getting squished. Here’s a situation where you’re paying 2%, and now you can go out there and deploy additional resources. You still have an investment and you’re still borrowing.
I like that. I don’t really like borrowing against my house and things like that unless I have some place to put it. I don’t mind HELOCs having powder dry the ability to use that money if I need it, but I don’t really like paying that interest and paying the mortgage interest deduction.
Sometimes you don’t even get a benefit out of it depending on your standard deduction. Quite often it’s actually better so I don’t really look at that as being a really positive thing. A lot of taxpayers get no benefit out of their home loan, so I tend not to like home loans. That’s just me. I do like investment loans because it allows me to lever. All right, do we belabor that one?
Jeff: Absolutely.
Toby: Buy, borrow, and die. Are you ready? That’s what all the rich do. They buy an asset, appreciate it, borrow against it, live off of it, and pay no tax. When they die, they pay no tax. There’s a step up in basis. They or their heirs can sell those assets and they never pay any tax.
That’s why really rich people, you always see them leveraging their investments rather than selling them. If I sell a piece of real estate, I might lose 8%. I have transaction costs, I have taxes, and I lose the opportunity and all that stuff. I’d rather just borrow against it and keep that.
Then when I die, that property value gets reset at the fair market value when I pass and my heirs can sell it and pay no tax. Literally, that’s the best thing you can do. I want you all to be rich people.
What do you think is a reasonable percentage to charge over the 2% to lend from a security-backed line of credit? Oh, wow. So you’re taking that, you’re loaning it out again. Commercial loans right now, stuff like that are 7%. Anyway, I don’t know if I would do that, Tracy, unless it’s really, really, really your business.
If it’s somebody that you know and a really good asset and it’s low value, I do 50% loan to value on real estate right now, just because we’re in that weird situation of is it going to go up? Is it going to go down? I think that we’re underbuilt. I think that there’s not enough inventory, but that doesn’t mean that the prices aren’t going to go down a little bit because the cost of debt keeps going up. If I was borrowing that, I’d probably be looking at making at least 5%–6%.
Is the home equity line of credit taxable? No, and is the security back line of credit taxable? No, zero, goose egg.
“If 100% of your income comes from royalties which aren’t subject to the 15.3% self-employment tax, at what point does it make sense to create an LLC-S Corp,” so it’s an LLC taxed as an S Corp or an S Corp, “and have royalties go to the business, pay yourself a salary, and distributions?” What’s say you, Jeff?
Jeff: I am not forming anything else for these royalties unless it is substantial in income, especially not an S Corp or a C Corp. If they’re not subject to self-employment, there’s no reason to put them in an S Corporation.
Toby: But are they not subject to the self-employment tax?
Jeff: It’s going to depend on what they are. If the royalties from oil and gas, they’re not going to be subject. If the royalties from writing a book, recording royalties, or things of that nature, those are going to be subject to self-employment tax and that’s usually when you see the higher royalties being paid out. I produced the song. It’s making me a fortune in South America and so forth.
Toby: The question is always, was it in your business when I created something that creates a royalty? If so, chances are it’s a trader’s business income. If it was a one-off, let’s say Jeff wrote a book on roses. He’s an accountant and he writes a book on roses, chances are that’s going to go on Schedule E and not be subject to self-employment tax. Jeff writes an accounting book, it’s going to be subject to self-employment tax. The reason that you would use an S Corp or an LLC taxed as an S Corp is to avoid the payment of self-employment tax on a portion of that income, especially if Jeff retires.
This is how sad it is. Let’s say that Jeff writes the most famous tax book ever and it’s making $100,000 a year. Even when Jeff retires, because he created it as part of his trade or business, he has to pay self-employment tax on it. How many kids do you have?
Jeff: Three.
Toby: Your kids inherit that because it was a trade or business. It maintains trade or business income. I believe that they’re going to be paying self-employment tax on it. Stick that thing in an S Corp, only a portion of it will be subject to the self-employment tax, old age, disability, survivors, insurance, and Medicare. Only a portion so we avoid a big payment.
If you’re not subject to tax on your royalty, so maybe it wasn’t part of your trade or business, it was a one-off, or you bought an investment that has a royalty like Jeff said, then I’m with you. I’m probably not putting that into an active business. I might put it in an LLC just to isolate it and protect it so nobody can take it from me, and I might have a business that owns a piece of that, so I can write off some expenses.
That’s depending on how many expenses you have, whether you have other income, whether you have other things that I could be managing, but it’s facts and circumstances. Just by itself, I’m kind of with you. If I have royalty income, probably sticking it into an LLC.
Is it better to generate royalties from inside an S Corp or C Corp? I would say that it’s always going to be better to have royalty in an S Corp if you’re creating it. If it gets stuck in a C Corp, you have two levels of taxation. You also have the potential to have too much cash in the business depending on what it’s doing if you have substantial royalties.
If all you’re doing is expensing stuff, let’s say that it’s Jeff. Jeff has a royalty of $10,000 a year, but Jeff also has uncovered medical, dental, and vision expenses in his family for him and his dependents. He can’t write it off on his Schedule A, but he could have a health reimbursement plan out of a C Corp. He may choose to do a C Corp because that’s the only entity that allows you to do that, or an LLC taxed a C Corp. Then you might do that saying, hey, this little bit, I’m never going to pay tax on it ever again. I have so many expenses I can write off and I want a tax benefit.
Again, facts and circumstances. This is why you sit down with somebody like a Jeff or somebody who knows what they’re talking about so that they can look at your scenario and say, what do you think about this?
Jeff: One caution I would go for is putting in the C Corporation and it’s not necessarily because C Corporation is losing control of that royalty source income. We’ve seen a lot of the entertainers and all who have lost the rights to what they can do with their music and their material.
Toby: If they sell it and transfer it.
Jeff: Correct. Of course, if you’re the sole owner, you’re a C Corporation, it’s not going to make a difference.
Toby: If you have some weird person that’s in the corporation with you and somehow they have control, then yes.
“Is it possible for the IRS to pay you back any money if your S Corp did make a profit?” I don’t know what that means. One of our guys will take that. I have no idea. I see these questions popping through and I want to answer them all because I’m like that. All right, enough of that.
“I want to sell my property that belongs to my private foundation and buy as 1031 exchange my own primary residence with this foundation to avoid selling taxes. Do I have to have a corporation to do this or a private foundation?” I like the way they answer. They’re giving you two options and both are wrong.
Jeff: Let me make sure I got the backpack. They have a property in their private foundation. They have rental properties.
Toby: Okay, yeah. It’s for charity. Private foundation is a charity. It’s just classified as a private foundation.
Jeff: They want to do a 1031 exchange with that property ending up with a principal residence for themselves?
Toby: No, they want to buy their primary residence. I live in a house and I want to sell it to my foundation. I think that’s what it says. I want to sell my property. I want to sell my property that belongs to my foundation and buy as a 1031 exchange my own primary residence with the foundation.
Jeff: I feel like they’re wanting to buy their own primary residence.
Toby: Let’s make it really easy, because if you have a private foundation, you cannot transact business with your private foundation at all, zero, zilch. You cannot sell a, my house is worth a million bucks. I’ll sell it to my private foundation for a dollar. You cannot. It’s an absolute prohibition against doing business with a private foundation. Public charity, you can do business as long as it’s arm’s length, but depending on what you’re doing.
Is this person out here, by the way? If you are, can you put something in chat? Maybe you just let us know, is it your home? Because you don’t do a 1031 exchange in a charity. It’s already tax-exempt. A 1031 exchange is a tax deferral and if there is no tax, then there’s nothing to defer.
Jeff: One thing you have to keep in mind—I went through this with my mother with her trust—same thing with a private foundation. Once you put that property in that charitable organization or trust, you don’t own it anymore. It’s not your property.
Toby: I think John saying I think they want to swap their primary with a home in a foundation. This is just ambiguous. I want to sell my property that belongs to my private foundation so there’s a property in there and they want to buy with that property, their own primary residence. They want to sell this one to buy their primary residence.
I would say you’re never going to do a 1031 in a private foundation and you can’t engage in transactions with your own private foundation, so we don’t have to worry about it. You cannot do that. Period, done, zilch.
If you want to sell the property and the foundation and sell your primary residence to a third-party, and then buy that same property from that third-party you could potentially do that, although the IRS may say step transactions really examine it closely. If you want to get your personal home into that foundation, you’re going to be a little bit tough because you’re a disqualified party.
What you can do is make sure that you qualify as a public charity. If you work with us, you know that we are very bullish on public charities and qualify as a public charity. You’d have to qualify and seek change on your private foundation to become a public charity or you might already be a public charity you just don’t even realize it because you keep calling it a private foundation, but maybe it is doing something.
The easiest way to look at it as a private foundation and I’m not talking about a private operating foundation; there’s even that. A private foundation basically is doing nothing. It’s just supporting charities and a charity that does something is typically a public charity.
If you have something that’s doing veteran homes, or low-income housing, or runs an amateur soccer league, or does services for the poor, whatever it is, fill in the blank, it’s probably a public charity. In which case you could sell a property out of it and use it to buy your home for the charity as long as it’s fair market value, which means you would just get an appraisal. You’d also do a conflict waiver with your board. I’d say you’d want to have a third-party look at it and make it opine that it’s an arm’s length transaction.
Jeff: One other thing about 1031 exchanges and primary residences. I’m not saying you can’t do them, but you can’t go directly from primary residence into a 1031 nor can you receive a primary residence into a 1031.
Toby: A hundred percent. What does it have to be?
Jeff: It has to be an investment property in between.
Toby: Yup, and so you can take your personal property by the way—your primary residence—convert it to an investment property and 1031 exchange it. In addition, you could still get the capital gain exclusion for having a primary residence that you lived in and owned for two of the last five years. Technically, you can do both.
If you live in a highly appreciated house and you’re bar in excess of your capital gain exclusion, if you’re single, maybe you have $750,000 of gain and you only have a $250,000 exclusion, you can knock out that extra $500,000 if you make it into an investment property and then sell it. Yeah, that’s actually a really good idea.
Look, if in any of that stuff, you go oh my God, what do I need to say? We’ve done specific videos on that exact issue in our YouTube channel. You can go in there and just start looking at personal residences. You’re going to see a bunch of videos on the Taxation 121 exclusion, how to partner up a 121 with the 1031 exchange. It’s actually the IRS’ rule. You can go read about it from the IRS and they’re pretty good.
Somebody says, “I am a co-owner of a property. I don’t get proceeds from rent. I want to invest in the renovations. Are there any tax advantages for me?”
Jeff: I wasn’t sure where this was going when he said co-owner of a property but doesn’t receive rent so maybe this property is not placed in service.
Toby: It says proceeds. I don’t get the proceeds from rent. I’m wondering whether somebody else is running it or maybe we don’t make anything. It breaks even. “We want to renovate it. Do I get any tax advantages for renovations?”
Jeff: Tax advantages. If it’s repairs, yes, it lowers your income. If this is not a rental property if you’re not receiving rent.
Toby: I’m thinking, maybe it’s a break even. I have it, but we don’t make any money, so I don’t get any money or we’re leaving it in there because we’re going to renovate the property. Do I get any renovations? I want to put more money into it. Do I get a tax advantage?
Jeff: You’re at least going to get the advantage of increasing your cost basis by those renovations.
Toby: Yes, and what Jeff means by that is once the cost basis goes up, your depreciation goes up. If it’s a repair like I’m renovating and I’m actually fixing stuff, it’s an immediate expense. You don’t have to spread it out over 27½ years or over 39 years. If you don’t want to wait 39 years or 27½, depending on whether it’s residential or a non-residential property, if I just want the deduction right now, I could do a cost segregation on the property. Depending on the type of renovations I’m doing, there’s a very good chance that you could write it all off in year one like that because lickety split, I’d be able to get it.
It is all, again, facts and circumstances. Your facts matter and knowing this stuff ahead of time may change the trajectory of this. A lot of people do renovation, and they talk to their accountant and they say, we’re going to write it off over 27½ years.
Then you talk to a guy like Jeff who actually digs in this area, and he’s going to say if you’re renovating something and retiring like let’s say I redo the roof. When retiring in the old roof, I get a deduction for that, and then I put a new roof on, Now we’re going to spread that out over many years. We’re not going to get an accelerated depreciation on that, but you get this big deduction for whatever portion of the old roof you didn’t appreciate. You got to know that, it has a huge impact on your taxes.
Yes, if you’re a co-owner, that could be an advantage to you, depending on what type of organization it is, or whether you’re at risk. If it’s a partnership, you’re going to be at risk. If it’s something else like an LLC, or something, depending on how you own it, if it’s an IRA, or retirement plan, or something, then it could change things. For the most part, it’s just you and your TIC (tenant in common), or you own an LLC with somebody, it’s partnership, yes, there are tons of tax benefits that could benefit you.
Sometimes it depends on the operating agreement. You want to make sure of the losses, because that’s what it would be. It would be a deduction that would come through as a loss or pro rata depending how much you guys invest, and it’s not going to any particular individual. You take a look at these things, they’re not rocket science. You can tell pretty quickly what your benefits are going to be. Talk to guys like Jeff.
All right, vending machines. Everything’s in a vending machine now. They have cupcakes. It look like a pharmacy half the time in these things.
Jeff: They have cars and vending machines.
Toby: I saw that with Carvana. “I started a vending machine business as a franchisee in 2020 through an LLC, because of my material participation,” it’s a magic word, by the way; we’ll cover that, “I wrote off 100% of my vending equipment against my LLC earnings and my other employment W-2 earnings within the first two years. If I can no longer qualify under IRS rules to become considered passive, what are the implications?”
Jeff: The primary implication is if you become passive, you’re considered being passive, and you have a loss, you’re not going to be able to deduct that loss unless you have passive income.
Toby: Passive losses only offset passive income.
Jeff: Correct.
Toby: Two exceptions. If you’re a real estate professional or you’re an active participant in real estate, you make less than $100,000. Jeff’s pointing out that if you make this into a passive business. In other words, I am a silent owner because I am not materially participating. There are seven tests for material participation. If you do not meet one of those seven tests, you are passive. If you are passive, it just means that those losses flow through as passive loss and can be used against your other passive income. It doesn’t mean that you lose the deduction. It means you’re going to be carrying it forward.
The big question, Jeff, is does it affect the deduction they’ve already taken? Let’s say that they bought a vending machine for $100,000 or multiple vending machines for $100,000, and they wrote it off in 2020. And now in 2022, they are no longer materially participating. Does it have any impact on those losses?
Jeff: It has zero impact on that. If you went out and bought another $100,000 worth of vending machines in 2022, but you didn’t materially participate, you would still get that bonus depreciation which may create a loss on your business. Because you’re passive, you may have to carry that loss forward until you can use it, but it doesn’t really change anything that happened in the past.
Toby: Absolutely, and the only thing that you could do to cause the 100% deduction that you took on the vending equipment, to make it taxable to you is to no longer use it in the business. If that vending machine has a useful life, more than likely it’s five years—I’m not sure with vending machines, but I’m assuming they’re like five or seven—if you take it out of service before it’s useful life, then you have recapture of the deduction that you took that you accelerated.
The equipment you’re taking is generally under Section 179, or you’re taking under Section 168(k) as bonus depreciation, depending on which one you took. In 2020, probably bonus depreciation, I’m going to assume, because 100% bonus appreciation. Would they have an issue with recapture under?
Jeff: I don’t think they would if they took it out of service, if it was broken, or if they sold it now. If they sell it, it’s ordinary income.
Toby: I wrote off $100,000 and then I sold it for $20,000, then you’re going to have $20,000 of ordinary income, but you throw it out because it had no value, then you just retired it, so you don’t have to worry about it.
Jeff: Now, you mentioned Section 179 and 168(k) for bonus. Next year in 2023, Section 179 is going to come back into play because bonus depreciation is going to drop from 100% down to 80%.
Toby: Yeah.You might be looking at writing off the whole thing under 179 instead of 168(k).
Jeff: Or some combination of it.
Toby: Absolutely, which is why you get good accountants to play around with these things. But yes, some of these things are sunsetting. When they were done in 2017, they said, oh, it’s going to sunset in 2025, some gradually sunset and some just immediately boom. It’s up to Congress as to whether they’re going to extend it or change it.
Somebody had a good question. “If your amazing significant other is passive in all five businesses and you file jointly, shouldn’t 50% be passive?” So they have five businesses and you’re filing marriage, filing jointly. Material participation is for the group, I believe. So yeah, material participation counts, both spouses.
Jeff: Are these going to be all passive or all non-passive?
Toby: I stole that one out of chat. Somebody’s going to be sending me an email going, I don’t see that question. Because I’m reading it behind the camera.
Jeff: Literally.
Toby: Yes. It’s like over there. All right, let’s do this. “What is the best way to set up an LLC for a partnership if you want to be certified as a veteran-owned small business?”
Jeff: This is a case of the structure means less than all the rules that go along with being a VOSB, which means you got to be working on it full-time. The veteran has to be working on it full-time, has owned at least 51%, has to be drawn and a reasonable salary.
Toby: Has to be the highest-paid employee.
Jeff: Yes. I forgot about that one.
Toby: Yeah, it has to be the highest executive and highest-paid employee.
Jeff: Let’s say we form a corporation that is a VOSB. I have to be the president. I have to own at least 51%. I am a veteran so this works for me.
Toby: In other words, I can’t set up a business and say, hey, Jeff, you’ll be 51% and we’re going to go get government contracts.
Jeff: You’ll pay me $10,000 a year while you make $100,000.
Toby: Yeah, they don’t let you do that. No. Jeff has to actually be in control, too. They don’t just say 51%. Signing checks, in charge of contracts, in charge of employees. They have to actually be the one running the place.
Jeff: It does say that you got to be running the joint.
Toby: Yeah and if you’re looking, I think SBA has, I remember there’s a thing where you can ask questions and they’ll tell you whether or not you qualify. It is probably 30 or 40 questions, if I remember right. It’s been a bit since I actually dug into the certification because they call it a verified veteran-owned small business or certified veteran-owned small business. You’re basically, again, 51% in control, highest paid, you’re the top executive. It’s not that I can just pay somebody a small amount and say, hey, you’re a veteran, come here and lend me your veteranism.
Jeff: There is another classification called the DVOSB (Disabled Veteran-Owned Small Business). I have not looked into that, but I’m sure there’s probably only got to be 100% disabled, or at least a certain percentage.
Toby: If anything, that if you’re certified disabled, I don’t know the threshold as far as to how much. I think I might just say, are you a disabled veteran? If you’re a disabled veteran and you’ve had permanent disability, then you’re going to qualify and then this is the same thing. You got to be in charge of it.
Jeff: Both of them are great marketing tools. They also have lender preference, that you get better rates with certain lenders.
Toby: Yup, and you get to bid on contracts and nobody else gets to bid, or you get preferential treatment almost.
All right. Hey, we have a couple of events coming up. It looks like July 30 and August 13. It is the real estate tax and asset protection workshop. There’s my partner Clint Coons’ smiling face. He does a great job in the mornings. We’ve been partners for 25 years. We do a very good job. I’m going to toot our own horn. We do a very good job of breaking down the different types of entities, the tax ramifications of proper structuring.
I go over the section where I say the top three things CPAs miss that we see over and over and over again. How can you take advantage of a bunch of the tax codes? Clint does a great job on showing how to use anonymity for your house, for your investments, how to get your name out of the public record. I always say keep lawyers snoops and Uncle Sam out of your stuff.
Let’s just make sure that you know where your stuff is and nobody else can go find it unless you want them to. Personally, I don’t want people knowing what I have. I don’t want people digging around. So a really good workshop, if I do say so myself. There are lots and lots of five star reviews and we’ve been doing this for a long time. Jeff, what do you think of those?
Jeff: I went to it when I first started here, and yeah, there are a lot of good information provided.
Toby: We’re doing them in a day, like he literally would do 9–4. Clint does the morning. I do the afternoon. Clint does a great job and I do a pretty good job. So we’ll make sure that we give you a really good idea of the rules if you are an investor, and especially make sure that instead of being subject to somebody else’s opinion of how to do things that will show you the different options you have so that you can choose.
Jeff: One of the best reasons for attending that is it is a great balance of tax and asset protection, whereas if you go to an attorney, you may just get the asset protection. Decide to go to the CPA, you may just get the tax.
Toby: They used to do ping pong. When we first started, we were just being lawyers and we would deal with the accountants. The accountants always like to send you, like they would always confuse the hell out of somebody and send them on to the financial guy who would then confuse them even more then send them back to the lawyer. The next thing you know you’re going to, and you’re just trying to like, will somebody tell me what to do?
Somebody says, “It has made me feel more confident in my investing future perfect. Renee, you are awesome. Martha says you both do a great job and Sherry says you are the best, Mr. Toby, and Sherry is awesome.” Hey, Sherry, Sherry and friends.
All right. “How can I write off on finishing expenses on my primary residence that will be purchased late this year, as a furnished short- or mid-term rental property? So it’s my primary house, I live in it and at the end of the year, I’m going to make it into an Airbnb.”
Jeff: Here’s my problem with this one. At the time I made the improvements so forth, it was my primary residence. It wasn’t a business property. I think that goes into your basis, your costs for your primary residence then when you section off that portion, whatever it is, that’s going to be your short-term and mid-term rental property. Assuming that you’re still living in part residence, then that portion would get part of that property for depreciation.
Toby: What if it was the whole property? I move out of my house and I make it into an Airbnb? Do I have to worry about the 14 days? Do I have to worry about any of that stuff?
Jeff: No. You only have to worry about if it’s some days or less, if you want to keep it in short-term versus long-term.
Toby: No, I’m thinking about if I personally use that property.
Jeff: You’re talking about the 14 day rule, comes with two ADA or the personal use?
Toby: I’m talking about the vacation home, whether it is an investment or not.
Jeff: No, if you are renting it out completely and not using it for personal use at all, you don’t have to worry about any of that.
Toby: Right, because it’s from once it’s available. So once I make it available for use and I make it into a trade or business. So what Jeff was referring to about the seven days or less, if you rent a property and the average use, so you take the number of days that it was rented, divided by the number of unique renters or rentals. The same renter could come back, but you’re looking at it saying how many unique rentals were there.
Let’s say that I rented it for 90 days, and I had 30 unique rentals, I rented it over and over and over again multiple times per week, my average would be 90 divided by 30 so three days. Seven days or less is considered an active trade or business, it is not a rental property anymore. So you are in the business, almost like a hotel. It’s Airbnb VRBO and what that does is it gives you the ability to take your depreciation and write it off much faster against your W-2 income.
In other words, the passive activity loss rules where your passive losses can only offset passive income are no longer applicable. You can take your losses and they would be considered active ordinary losses or ordinary non-passive losses would offset your W-2 income or other income sources.
Jeff: Let’s go back to your 14-day question and say this is either my primary residence that I’m renting out part of, or it’s a vacation home that I use three weeks out of the year. At that point, what that means is you can’t generate a loss from personal use property that goes to exceed the 14 days.
Toby: Yeah. I think that actually would be counted. If I lived there for six months, made it into an Airbnb and met the rules, would that prevent me from being able to write off my expenses?
Jeff: You lived there for six months, you moved out and turned it into a rental? I don’t think that would. I think the way we’ve treated that in the past is you cut it off after the first six months. So for the first six months, it’s a primary residence.
Toby: Then once it becomes an investment property, the question is, are you using part of that? Here’s the rule, if it’s more than 10%, 14 days or more than 10%, then you exclude that portion in those days, and you only get a partial deduction for the depreciation. So if it’s ⅓ time use personal use, including my family and things like that, ⅔ business investment property, you would write off ⅔ of the depreciation and expenses, ⅔ of the property taxes, things like that.
Here, what Jeff is saying is, it was your primary residence, we don’t count any of that. That’s your primary residence, you treat it just like you sold it to a third-party and you bought a new investment property, which is actually a trade or business, because it’s not an investment property when you Airbnb it. Now it’s just part of the business and we love that.
Then what would they do with their furnishings? Would they treat that as a startup expense? There’s still value in all those items if they fix it up, they paint it. All that sounds like they would get to write that off because it’s a trade or business.
Jeff: I really haven’t run into that. I know exactly what you’re saying so I just leave all the furniture there.
Toby: What if it reimbursed you the fair market value of that furniture?
Jeff: It could do that, and what you just said is really important. It’s not your cost and the furniture. It’s the current fair market value of the furniture.
Toby: Yeah. Or you say it’s a startup expense. You figure out how much you put in, and it basically owes you the money. So you take money away from the Airbnb as it’s made, pays it to you, but spread it out over a longer period of time. The first $5000 can write off in year one. Anything above that, you’re amortizing over 15 years.
Jeff: I think if it’s furniture rather than startup expense, I’m going to say it’s an asset.
Toby: I would probably say, you don’t want to sell it because you’d end up paying tax on that. What I probably do is be looking at it—then again, we’re spitballing here—I’m going to say reimburse me for the value of the furniture, and just get the fair market value back to myself.
Since I have Eliot, Troy, Ian, Dana, Piao, and Dutch, do you guys have anything that you’ve dealt with in this situation? I’d be curious. Since we have a whole bunch of accountants, tax attorneys and things like that. If you guys could put it in chat, that would be great.
If anybody has experience and has done returns on this, I’d be curious. Just because I’ve never seen somebody personally just rent a house out furnished that was their primary home. Usually they’re buying for an Airbnb, but let’s say you decided to make your house into an Airbnb, what would you do with the furniture? I’m just curious.
So Dana, Eliot, Troy, Piao, Dutch, Ian, any of you guys, just throw it in chat and if you don’t know, c’est la vie. If you could take a look because I’d love to get a little more, maybe there are some answers out there.
Somebody says, “One bought a storage unit, put their personal items.” That’s not an Airbnb and I’m going to give you the stink guy.
“What if we wanted to get money back for their stuff? Couldn’t the owner leave the furniture to the LLC?” Yeah, but then they have income, Renee. Just did the model myself, first rental is Thursday. Very good. “I think it’d contribute to fair market value but finding that fair market value would be tough.” Troy, I’m with you. I’m thinking too that you’re contributing, you’re getting reimbursed or you just have a basis in it, which means you can always get that money back. Tax Free too.
All right, here we go. “If I move my paid-off condo to a trust, will the trust pay taxes on it?” First off, what do you say?
Jeff: Don’t put your condo in a trust. Well, I’m thinking irrevocable trust.
Toby: Right. How about this? Is it your home or is it a rental? Because if it’s a home, you paid off the condo, put it in living trust. No problem with that. No, there is no tax. If I sell one year after owning it, then put it in trust before I sell it, question mark.
Jeff: I usually caution people about changing title right before trying to sell it. I think it causes a lot of issues. One thing to keep in mind is the trust. The trust has the same tax brackets as individuals, I believe. However, they start much faster. You maximize the tax bracket. I think it’s like $12,000.
Toby: $12,000 you’re at the highest tax. You’re busting through. That’s an irrevocable trust. I think they’re talking about living trust here or land trust.
Jeff: If it’s a living trust or land trust need, they’re both considered disregarded entities. Neither pay taxes.
Toby: It doesn’t cause you to have a tax. Trust is a grantor trust, meaning that the grantor, whoever put it together, includes all the income or expenses on their return, so it doesn’t matter.
Jeff: Once I put my condo into my irrevocable trust, that belongs to the irrevocable trust. It’s a gift to that trust.
Toby: Separate taxpayer under that circumstance. Although, if I have an irrevocable trust, I could be an intentionally defective grantor trust and still be ignored. Even that isn’t etched in stone. Let’s just pretend this is a living trust because I think they’re talking about their condo that they live in. If I move my paid-off condo, so I live in a condo and I put it in trust, will the trust have to pay taxes on it? No, it’s you. It’s grantor trust.
If I sell one year after owning it, then put it in trust before I sell, I have no idea what that means but it doesn’t do you any harm. It doesn’t do you any good. From a tax standpoint, it’s neutral. It’s just ignored.
All right, let’s talk about this. “Can you provide specifics around capturing a capital gain lost short-term for digital assets? Is it simply selling repurchase? Is there a waiting period for which I can repurchase?”
Jeff: It sounds like we’re talking about loss harvesting. So yeah, if you have Bitcoin that you bought at $69,000 and it’s currently at $23,000 I believe today. Yeah, you could sell that and recognize a loss there. Now, you asked about how long you have to wait, you don’t.
Toby: On crypto, it’s considered capital assets, but it’s not considered a security. When you buy and sell securities, if you sell securities at a loss and you have basically a 60-day window before you sell it and after you sell it. It’s called a loss sale wash rule or the wash-sale rule is what most people call it. Then if you buy back the security that you sold it at a loss, you just add that to the basis. They don’t let you take the loss. But with Bitcoin, Ethereum, and with all these cryptos, not the same rule. The Build Back Better plan was trying to undo that, was trying to make the wash-sale rule apply, but is yet to pass.
Jeff: I think the one thing I would do because I don’t want the IRS getting crazy on me is I’d make sure that the one transaction the sale transaction closed before I make the purchase transaction. I don’t want them to look at my transaction sheets that says oh, well, all you did was sell something you bought 15 minutes earlier.
Toby: I don’t know if I would even care. I think you could literally sell it. Take the loss. Buy it right back.
Jeff: Yeah, there are numerous ways to report gain and losses. There’s specific identification—first in first out. There’s another method and I can’t recall what it is, but it’s a hybrid method.
Toby: Or you can do tax laws. You could say that this is for this. It’s just basically saying, let’s say I was buying stocks and I’d bought stocks over a 10-month period and you’re going to sell one of those lots. All of them are short-term. But that one that’s at 10 months, you only have a couple of months before it goes long-term. You might sell one of your most recent purchases and you can designate that tax lot and say, use this, and get maybe a higher basis so you don’t have as much gain.
Somebody says, “Does wash-sale rule cause problems in an LLC as a partnership?” Yup. Any securities, anytime you sell securities at a loss, even if it’s an IRA, believe it or not. Somebody says, “Wash-sale for 30 days not 60 days.” Edward says it’s 30 days prior to the sale and after.
Jeff: He’s not wrong.
Toby: Yeah. So it’s actually 60 days. Sorry. Everybody thinks of it because they always say 30 days after but some people buy the security back at an earlier time and then sell the earlier ones that they had at a lower at a higher basis and they sell it and try to capture a larger loss. They look at it before and after. That’s one of those big piles of poop you can step in, but you could check it out. You could do a little research on the IRC. Anyway, I do appreciate the comment.
Let’s do this. Now I get that checked a lot by the CPAs out there. Sometimes they’re very, very helpful. But yeah, most people know it is 30 days, and you don’t count the day of the transaction. It’s 30 days before and 30 days after. All right. It’s always fun. In other words, if you have Bitcoin that’s down, sell it and buy it back. There we go. That’s the punch line and good one.
“I’m looking to invest in multifamily syndications. There will be quarterly returns and potentially a lump sum return when the property is sold in five years. Is there a way to transfer or reinvest the profits from the sale and other syndication without being taxed, similar to a 1031 exchange on a rental property?”
Jeff: I came up with two ideas, and I’m not sure that one actually works for what you want. 1031 obviously works. Here’s the problem with 1031. Everybody in the syndication has to agree to do the 1031 exchange.
Toby: You could do a swap and drop. The entity selling has to be the entity buying. You could have an agreement amongst the partners that, hey, I’m going to buy you out then you fund it with the sale. Potentially you could do that, but it’s really difficult. I’ve never seen anybody really do it.
Usually in a syndication, there are a lot of people and that’s not what they want to deal with. They want to deal with not finding replacement property and trying to close within 180 days. What they’re trying to do is ramp up the net income, get that cap rate jammin so that you get this big, huge chunk of value so you can sell it and make a million dollars. They’re not too worried about your taxes. They pass it on.
Jeff: The reason that this happens from what I’ve seen is a lot of these syndications will have IRAs, retirement plans and stuff like that. They get to that year five that you’re talking about, where you’re going to get this big lump sum payout because you’re selling at a huge profit. The IRA just wants the money. They’re not going to pay tax on it. They don’t need a 1031.
Toby: Yeah, a lot of these people are real estate investors. What they’re doing is they’re taking their other real estate investments. So for example, it’s year five, I might be buying in year five. I should probably be looking at other real estate. I can create some loss to try to offset. If you’re a real estate professional. Otherwise, it’s not really going to help you. You’re just going to have some capital gains, and you can defer capital gains. You still have the qualified—what is it?
Jeff: Opportunity zones.
Toby: Yeah, qualified opportunity zones. The clauses, and you could defer it for at least a couple of years now and and then exclude gain as long as you hold the new property, which can’t just be a flat investment property to improve its value by doubling the amount of the improvement on it. But you could do that and defer the taxes for at least a couple of years.
There’s really nothing else, like if you’re in a syndication, you’re at their mercy. If it was you individually, you might say, hey, I want to do an installment sale and take it over a long period of time so that you’re not recognising the tax all in one year. I have doctors clients all the time that deal with this. They’ll go in, they’ll buy a bunch of syndications. I’m explaining how it’s going to be taxed in year five, then they go, why the hell would I buy them all in one year?
You want to stack them out, and then maybe do some tax reduction. Hey, maybe I’m buying an Airbnb, making sure I’m managing it, harvesting a big loss, offsetting my gain from exiting one of my syndications, then I just do that same thing every year. I’m just watching when my investments mature and every year that I have a maturity event, I’m looking at something that might reduce that. Let’s say this is you, and you have the year that this big capital gain is coming. This is why sometimes you harvest losses, even if you don’t have to use them.
Let’s say Jeff here has a bunch of Bitcoin and he harvests $200,000 loss, and he just carries it forward. He has no capital gain. Now when capital gain comes along and you exit a multifamily syndication and there’s $200,000 to gain, wipes it right up. So you can do that, too. Sometimes you’re doing gain harvesting, sometimes you’re doing loss harvesting.
Somebody might say, but you get no tax benefit from the loss. You didn’t have any gains. Carry it forward. We never know. If you’re a syndicator or you’re investing in syndications, I should say better. If you’re doing that, then yeah, you should be looking at it. The other issue and I say you’re pointing this out this way. I would love to have accountants there. If you aren’t able to use the losses, your losses, you don’t lose those.
Let’s say I’m in a syndication and passive activity loss rules restrict my ability to use the losses. That loss still flows down to me and carries on my return. When I liquidate it, I get to use that loss against the syndication, against the gain. So all those things. Hopefully your brain is still on. Hopefully it didn’t just knock it out of your head. But again, it’s never a super simple, easy answer in those. Again, it’s facts and circumstances.
“Jeff, should I put my college kid on my payroll for $24,000–$30,000 a year, rather than just pay the rent out of my pocket?” What do you think?
Jeff: Makes perfect sense to me. With one caveat
Toby: Big caveat.
Jeff: Your son actually has to be doing something for your business for $24,000–$30,000 a year.
Toby: Yup. Your child has to actually do services for the $24,000 to $30,000. But that’s a big benefit if I was paying. Let’s say, Jeff was paying for my college and I’m his kid and I make zero income. Jeff’s big baller making big income, right? He’s 24% plus and if you live in California, it’s even worse.
Let’s say that Jeff is paying 30%, because you have all sorts of Social Security, and Medicare and all these things that are part of it. If Jeff was to pay for the $30,000 and just pay 30%, Jeff’s going to have to make about $43,000 to have the $30,000 left over. In other words, after tax dollars of $30,000, Jeff had to make about $43,000.
Now let’s say that I worked for Jeff’s business. Now Jeff doesn’t pay tax on that. He’s getting a deduction or the business is getting a deduction, assuming that it flows down to Jeff and Jeff’s getting it. But let’s just say it was a separate business, even a C-Corporation. I worked for it. I still have to worry about the employment taxes, but I’m going to get the benefit of that. I’m paying into Social Security. I’ll have access to that. I’ll get that money back when I retire.
But that $30,000, I’m going to pay substantially less tax than Jeff is because I have a standard deduction right now and $12,950. Then I’m going to be at 10%, maybe some at 12%. My tax on this thing is going to be instead of Jeff who’s paying about $13,000 in tax, I’ll probably pay $2000 or $2000. So I’m going to save about $10,000. Not a small amount of money. If your kid’s is $10,000 a year, that’s even better because they’ll pay zero tax on it.
There is a way to avoid the employment taxes even depending on what type of business you are. If you’re a partnership or a sole proprietor and it’s your child, then you can pay them without even having to worry about the employment tax. But the whole idea is taking it from high income, high tax rate and moving it into a lower tax rate. But I do have to make sure I’m doing the work.
I did the same thing when my daughter was going to school. She had to work. I made her all through undergrad. Same thing. And I made sure that I paid her through a business that I was the manager. This is the fun part. If you want to still control those proceeds and make sure that they go to the place they’re supposed to. You can still be in charge of the LLC, even though they’re the owner.
Somebody says, “Can I put my retired mother on payroll just like a college student?” Jessica, actually, you can, as long as they do something. Put them on your board and actually make them participate in board meetings. Get the family together and make decisions. We talk a lot about legacy planning and I don’t just give it lip service.
There are clients that I have where they get their kids together with the parents. They talk about their investment portfolio and where they want to go in the next year. They have full-on meetings and they do that on a quarterly basis. We always have a big one during the year. That stuff I think is invaluable, so that everybody feels like they’re part of it and also so that if something happens to you, you’re not just giving a big portfolio to somebody who’s never had any experience with it. You’ve shown them how to do it.
Jeff: More caution about the parent, takes a little more planning than paying the kid, especially if they’re in that 62–67 or whatever their full retirement age is. Because whatever you pay them could reduce their Social Security.
Toby: Oh yeah, you might make up to 80% of their Social Security taxable.
Jeff: Well, they reduce it. For every $2 I pay you above $18,000, that reduces your social security by a dollar. It actually reduces your security payment.
Toby: All right, so we have to look at that. That’s why you have smart guys like Jeff looking at it, making sure that that doesn’t pop up. A lot of times what you’re doing, though, is you’re just trying to get you to give them benefits. So mom might be getting $5000, but what I’m really giving her is the Health Reimbursement plan.
Jeff: If I’m in that 37% bracket and my college-age son, I’m paying enough that he can pay for his own college. We haven’t really talked about that tuition credit, but if I’m in that high bracket, I’m not getting that credit.
Toby: But he would.
Jeff: He would have if he was paying his own college tuition.
Toby: Somebody says, “What would be the minimum age for kids?” We have cases in the books that’s at nine years old. They have to be able to do something. The nine-year-old was a question of reasonable compensation and they got screen actor guild rates for photography used in the marketing of the business.
“Can I put my mom on payroll, even if she’s a resident of Canada?” You have to be an employee. Potentially, you could. If she resides in Canada, I don’t think so. I think that you have to be in the United States for the period of time that she’s working but we could dig into that a little bit for you. It’s interesting.
Somebody says, “Can Toby say I can claim my retired mom on my taxes.?” If she’s your dependent, you can. Even if she’s on your board, yes absolutely.
Jeff: As long as you’re providing more than half their support, they don’t even have to live with you.
Toby: It’s kind of weird. Again, see smart accountant? Dumb tax lawyer, smart accountant. Listen to the smart.
“We have three teenagers. The first one is in college. We give her $800 a month. We talk about business while they’re alive. The younger, 16 and 14, have different conversations but still the same. Can all three be considered employees?” Absolutely. But you have to have them do something. You just have them work.
It could be running a broom. I suggest you do social media because the kids tend to be really smart on tech issues. You’re looking at YouTube, right? I can’t edit a video. You know who’s really good at editing video? My daughter is really good at editing videos.
Your kids could probably learn to do some of this stuff. Whatever your organization is—I saw a reverend so maybe it’s church or something like that; or whatever it is, it could be the supermarket, it could be your rentals—you say, hey, I want you to be handling this component of it.
If it’s a high-value item like social media, you can be paying people $300–$400 an hour. You just want to make it reasonable. You look at what their experience level is, but it allows you to get over that hurdle. Right now we have people on the Internet making $20 an hour. It’s much easier to qualify them for a much larger amount.
If you say hey, $800 a month and this is what you’re going to do. Very easy to qualify. Just make sure that they’re kind of documenting it and making sure that they’re doing the work. So talking about your business is great. Having them involved in decision making and actually involved in the business is even better.
“At what age was the youngest age?” Jackie, the youngest age we have on the books for court cases is nine. But I would say it has to do with their ability to conduct activities. If they’re 12 and again, there are things that they can do, whether it be cleaning, whether it be folding, whether it be stuffing envelopes, whatever it is, get them involved in your business.
I think that we answered that. On YouTube, by the way, if you like this type of information, by all means, you can see right there. We livestream this on YouTube. If you don’t want to do the Zoom thing, you could just go watch it on YouTube. We have a lot of folks that do that, too.
If you have questions in the next two weeks, you just want to ask questions, you have something that’s been bugging you that you’ve always wanted to ask of accountants, shoot it over at taxtuesday@andersonadvisors.com where we’re literally answering at this point, it’s hundreds of questions a week. We just do it.
I know that the accountants love to do it. We ask a lot of our staff and we ask a lot of our people, but a lot of it has to do with doing this type of outreach. We believe in reaping and sowing. So we tried to give as much information back and be as transparent as humanly possible. Here’s the answer. We’re not going to hide it. We’re not going to make you jump through a lot of hoops. If you ask a general question, we’re just going to answer. If you get too specific, we’re going to say come on in, because there’s liability for this answer to it. We want to make sure we do it right.
Again, our programs are fairly economical. Again, to be a platinum member, it’s $35 a month. It’s been that way for a long time. We’re not going to move it any time soon. You get to ask questions. You can meet with the lawyers. You could have documents reviewed. You can ask questions of the accountants in writing, and there’s never a cost. There’s no hourly cost to it. We make sure that we’re getting you there.
“When is this meeting likely to be up on YouTube? Already ready to re-listen.” It should be in the next two or three days. It’s always typically by the end of the week. All right guys, anything else Jeff?
Jeff: No, I got nothing.
Toby: All right. So first off, thank you to Ian, Troy, Dana, Piao, Dutch, Patty, Christos. I can’t see everybody that’s on there because my Zoom is being evil as well. And even Ander. The tech is driving us crazy. I know that’s not you. You have to do it all the time.
Everybody did a great job, but those are the ones who are answering the questions in chat and the Q&A. You have no idea, they answer hundreds of questions. All the time, they’re just going through investing their humps. They do a great job, so thank you guys.
Until we see you again in two weeks. By all means, go look at some of the videos and if you have any questions, taxtuesday@andersonadvisors.com. Thanks, guys.
