How do you set up an LLC for your home or administrative office? It’s important to know the differences between the two, which to choose, and why. Toby Mathis and Jeff Webb of Anderson Advisors answer your tax questions. Submit your tax question to taxtuesday@andersonadvisors.
Highlights/Topics:
- How do you set up a home office under a corporation or LLC? Depends on the type of entity, but if it’s a corporation or S Corp, set it up as an administrative office for that entity where you are being reimbursed for the expenses of using that office
- Is it advisable to have the house you live in under an LLC? Preferably, do not put your house under an LLC because of homestead and capital gains exclusion issues that arise
- When do I switch from wholesaling under my name to wholesaling as a corporation? Sooner than later; do not wholesale under your personal name in case you get sued
- How do I get credit approvals under the business entity? It takes cash, collateral, or credibility to get business credits, so you will need personal guarantees
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Full Episode Transcript:
Toby: All right guys, you have come to Tax Tuesday. If you’re here for Tax Tuesday, you’re in the right spot. My name is Toby Mathis. I’ve got with me, Jeff Webb. Hey, Jeff.
Jeff: Hey, Toby.
Toby: We’re in the middle of tax season. Tomorrow is a major deadline for what, S-Corps and partnerships?
Jeff: Yes.
Toby: Have you lost your mind yet?
Jeff: Yes.
Toby: All right. Jeff is being very kind. Is there no screen sharing?
Jeff: It’s screen sharing now.
Toby: Okay.
Jeff: You look at this CPA guy in this picture and I tell you what, I’ve just wasted away from that guy due to tax things.
Toby: You look good. You’re live right now and that’s the thing. […] like in tax season, now that you guys are all supposed to lose it. But I do like the beard better. Just saying.
Jeff: So does my girlfriend, and she carries a little more weight.
Toby: I don’t know. I don’t know who you were emulating there, Jeff. Anyway, Elliot’s on with us. We don’t have a lot of tax people today just because they’re all losing their mind. It’s Elliot, Dana, who else do we have? Troy and I think that’s it. You’re going to have some people answering your questions. Just know that, usually, we’re just knocking them out today.
We’re about half staff just because there are so many people who are working on final returns. I don’t want to take them away from that. Today should be fun. Tax Tuesdays are always fun, I’m sure of that. I see you should be here in Orlando.
Sherry, I am just about two hours away from you in Tampa, and I should be […] over there. We like Tampa. We like the water. Disney or water? Disney, water. Water. I loved Disney, but anyway, it’s good. Tampa is where we live now. I should have come and seen you.
All right, Tax Tuesday rules. Ask questions live via the Q&A feature in Zoom. Don’t use chat for everything live. If you have questions, you could send them in to Tax Tuesday at andersonadvisors.com. Here’s the deal. If you do not get a question answered today, because we’re jamming through them, we always get hundreds. Hopefully, our guys are able to get through them. But if you can’t, by all means email it. If you need a detailed response, like you’re saying, hey, my tax situation is this and you’re looking for advice on it rather than the issue, like can I write off a house if I had it for whatever, if you’re being very specific to you, then we need you to be a client so we can give you an appropriate response. We can make sure that we have the compliance handled.
This is fast, fun, and educational. We want to give back and help educate. But if you just have a question like, hey, what’s the deal with this or hey, am I able to write this off? By all means, just ask away. If I ask you guys a question like, hey, where are you sitting right now? That’s a good question that I’ll ask. Hey, where are you sitting right now? What city and state? You can just put it in chat. You don’t have to do the question and answer. Go right into chat and by all means put it in there.
So that was a question. Austin, Parkland, Florida, Seattle, Washington. Hey, Scott. Hobbs, Newport, Rhode Island, Honolulu, Richmond, Florida, Fremont, California, Sunnyvale, California, Anacortes where my mom lives, Pembroke Pines, Houston, Almeda, Dallas, Lake City. Now I’m getting blown away.
Southern Oregon Coast, Clearwater—I’m in Clearwater, John. I’m hanging out here trying my best to get a tan. Dana Point, DC traffic. Boom, you win. Baltimore County, I got some houses there. Delaware, Minnesota, Virginia. We got people from all over the place. Whenever I ask that question, like I’m just getting pelted now. You guys are coming through too fast. I don’t even know how many people are on but it’s usually lots, hundreds of people. We have 10,000 people that register for these and then a lot of you guys listen to them. A lot of you guys watch it. You’re making my chat screen go nuts and start to blur.
All right, let’s jump on. We’ll keep going through. We have lots and lots of questions. I’m going to try to read them. I have to apologize because I’m gonna be reading them off the screen. I’m not used to reading them up. Here are the questions we’re going to go through today.
“How to set up a home office under a corporation LLC?” That’s a great question, by the way because there are about three or four things that are being triggered there.
“What should I do now after I made the mistake of starting an LLC in California?” It’s a three-letter word and starts with an R and ends with an N.
“Is it advisable to have your house you live in under an LLC?” We’ll talk about that and what the rules are.
“What are the requirements to count visiting out-of-state properties that you own as a deduction? Such as airplane tickets, car rental, hotel, meals, et cetera. What are the minimum requirements to account as a tax deduction and not as a personal expense?” Great questions thus far.
“What’s the best way to set up a JV partnership when I already own 100% of the LLC used to get the property under contract?”
“How can I become anonymous in my LLC after the fact? I started my own LLC with my name all over it, and one year later, I’m interested in enhancing the corporate shield and getting my name off the record. Is that possible? I have worked hard to build the business credit with the existing entity and would like it to continue.”
“In 2021, we sold my husband’s dental practice and will owe substantial capital gains taxes. Is there any possible way to avoid these taxes through real estate investing or… ?”
“When do I switch from wholesaling under my name to wholesaling as a corporation?”
“How do I get credit approvals under a business entity?” I’m assuming you’re talking about business credit.
“Is it more advantageous from a tax saving standpoint to make charitable contributions directly from our corporation or to pay ourselves, then make the donation from our personal account?”
“Can I do a 1031 exchange when it’s on an investment home that I’ve never lived in or rented out? Is there any way to avoid capital gains tax other than renting it out? I don’t want to keep the house”
“Who handles the paperwork for a 1031 exchange—the lawyer, the realtor, or my tax advisor? How far in advance do I have to plan to undertake an exchange?” By the way, those are separate people. They happen to be like one-two like, boom, boom. I took these ones actually in order off of a second section. I just thought that was interesting. The 1031 exchange questions were about one out of every 200 and they were side by side. I felt compelled to take them.
“A Florida LLC with members consisting of my wife and three of my children made a profit of $65,000 on a residential flip in March. My wife does not have taxable income. Would the profit be protected from tax if it was paid out in full to my wife?” Good question.
“What is more beneficial, to claim or to employ dependents? What are the requirements for employing dependents?”
Lots of good questions. We’ll start right out with how to set up a home office under a corporation LLC. What say you, Jeff?
Jeff: I say my brain is tired, so anything I say could be wrong. Generally, it’s going to depend on what the entity is. If it’s a corporation or an S-Corporation, you want to set it up as an administrative office for that entity, where you’re being reimbursed for the expenses of using that office. You’ve heard us talk about home offices where it’s that portion of the property that you’re using or the business.
If it’s an LLC that’s taxed as a Schedule C self-employment, you’re going to have to do it as a home office. It’s slightly different. You’re going to claim depreciation on it. Whereas with the reimbursement, you can be reimbursed for depreciation, but you’re not actually taking the depreciation. It does matter in the long run. Partnership, I believe they have to do the same way. What’s your view on partnerships that want to do an administrative office?
Toby: You can’t be an employee of your own partnership. You’re a partner, so no administrative office. It would be a home office. The reason this is important, guys, is what Jeff’s talking about is whether you have to file the special home office form that you have to recapture, in certain cases, the depreciation. It sucks. It’s like $5 a square foot for the square footage of the room. That’s the safe haven. Or you can do a percentage of the gross square footage.
The rules are so much easier and so much more beneficial to you if you are at an administrative office and your employer is reimbursing you. This is really important. To be an employer, it needs to be an S-Corp or a C-Corp for tax purposes. When you see an LLC up there, LLCs do not exist to the IRS. They do not care about it. They do not have an LLC tax form.
For an LLC, you tell the corporation, here’s how I’m going to treat it from a tax standpoint. It could be either ignore the thing, it’s a partnership, it’s an S-Corp, it’s a C-Corp. That’s really it. It starts with the C-Corp then you have to file an extra form for the S-Corp. Really what we’re talking about when it’s one person, it’s disregarded or a C-Corp.
If it’s two people, its partnership or C-Corp. Once you go to the C-Corp, then you could make an S-election. The S in the C-Corp tax form is what you want to be on. It’s not even called a home office. It’s called an administrative office. What it does is it unlocks your ability to deduct any mileage that you take between two offices or when you go out on business.
Normally, if you commute to an office place, you can’t write it off. When you have an administrative office in the home, you can. For example, a real estate agent who has an office, normally you wouldn’t be able to deduct just driving over to that office. But if you have an administrative office in your home and an office where you go and meet clients and things like that, absolutely you can do it. Then you’re able to write off the mileage.
Like Jeff said, you get to reimburse somebody, yourself, from the business depreciation on your house without having to recapture it. It’s actually really good, and you don’t have to report it anywhere. When you’re getting a reimbursement from an employer, just pretend your employer said, hey, Jeff, pick up a pizza on in here. When you’re coming in, we’ll feed the office. Jeff picks up $100 worth of pizzas and he throw them $100 cash, he doesn’t have to report that anywhere. Me as the employer, I have to report it as an expense.
That’s it. That’s what we love. We love accountable plans where you’re reimbursing an employee because there’s no paper trail to the employee and it’s so great for the business. You get the best of both worlds, including when your administrative office for the home. You can use net square footage or you could use the room methodology where you’re just writing off a percentage of the house based off of how many rooms it has.
What I see is that it’s usually 15%–20% of all your expenses, including your real estate taxes, mortgage interest, and all those things you could reimburse. It ends up being really, really great for you. That makes sense, Jeff?
Jeff: Yup.
Toby: All right. Did I say anything goofy?
Jeff: No. The only one thing I want to add to that is if you’re reimbursing yourself from your corporation or S-Corp, you just want to document how you’re coming up with that reimbursement.
Toby: Yeah. When we do it, especially under 280A, we have a methodology, but they use a spreadsheet. Our guys, Jeff’s team is really good at this. You all have a methodology. When you do a reimbursement, it’s based on your actual expenses. So you add up things like, hey, do I have a housekeeper? Great, I’m going to add that up. Hey, do I have utilities? Hey, I’m going to add all that up. Do I have real estate taxes? Yup. Do I have real estate insurance or do I have homeowner’s insurance? Yup, I’m going to add everything up. Do I have to pay mortgage interest? Yup. Real estate taxes? Yup. I add them all up.
Let’s say you have a three-bedroom home, you’re probably going to get 1/5, so you’re going to get 20%. You can reimburse 20% of all those expenses, and it works out great. We love that.
All right, great question for number one. Right out the gate. Jeff, you’re on fire. You’re knocking it out of the park. Let me throw you a curveball. “What should I do now after I made the mistake of starting an LLC in California?”
Jeff: When I saw this one, my first thought was, why was it a mistake? I’m assuming that you’re transacting some type of business in California. If it was mistaken, it shouldn’t have been in California, but the only thing you can do is dissolve that LLC. You know more about this than I do, Toby. What about moving that LLC out of the state? Is that possible?
Toby: Depending on where you’re moving to. They call it a conversion. You can convert it to a new jurisdiction. A lot of them, the way they convert is you file a new entity in the new state and then you dissolve the old state.
Remember, there are three things. I always call it the trilogy. There’s the state, there are third parties like banks and stuff, they want to see your bylaws and all that stuff. Then you have the feds. The feds are separate from the state as we know. Your federal tax EIN won’t change, but the state, you just moved. Your social security number doesn’t switch if you move from Nevada to Texas.
If you were in California, I assume you’re saying it’s a mistake because you had the franchise tax. Jeff’s absolutely right. Let’s say that I have California real estate and I put it in California LLC. You may be feeling bummed, but that’s not the wrong way to do it. That’s the right way to do it if you’re using an LLC. If you’re using a Wyoming statutory trust, you might be able to get away from the $800.
But even with the Wyoming statutory trust, we’re going to have an LLC owning it or being the beneficiary, and that’s going to be taxable in California. So it’s not necessarily that you did anything bad. California just charges you up the nose for an LLC. If you set up an LLC in California for a business that does interstate commerce or does business in other states and doesn’t do anything in California, all right, now we may want to be talking about whether we want to use a corporation out of the state. Don’t worry, it’s something that we deal with every day.
Worst case scenario is you can always dissolve an entity, file a final return with California. You’re going to get hit with the $800 and set up the correct entity in the appropriate state. Like Jeff said, there’s what you can convert quite often. We can convert into Wyoming, and then you’re doing the same thing. You’re still paying your $800 for the one year, but you’re filing it as a final return. Anything else on that one?
Jeff: Nope.
Toby: That’s an interesting question. California is just extremely difficult for you guys. The sad part is they’re not even the worst. We used to think they were.
Hey, if you like learning about entities, do you want to learn more? Trust, LLCs, corporations, the appropriate way to set them up, how to use a smokescreen, how to do everything from equity stripping to using land trust and living trust. We get into some of the weeds, but it’s a nice, probably not a 10,000-foot view, but we probably get down to about 1500–1000 feet. We’re not going to dive into the minutiae, but we’re going to show you exactly what these things are and how to use them.
Clint does an excellent job. He handles most of the heavy lifting. I come in to do tax and legacy planning. On September 18th between 9:00 and 5:00, which is really 9:00–4:00. We always give ourselves a little wiggle room there.
It is absolutely free. For you guys, we love our Tax Tuesday folks. You come on in, you’re going to learn all sorts of fun stuff from tax reduction to liability reduction, how to actually own things, and keep your name out of a public record. You’re going to see some of the questions in here today talk about that. One of the best things you could do to never get sued is if they can’t find it.
We like that. Business structuring, how to use the different businesses, how they work, how it doesn’t work, how to create legacies. I love the 200-, 300-year plan. It changes our methodology of thinking so much and it’s not that expensive. It’s actually cheaper than the alternative of doing nothing or doing a will.
Retirement strategies, we do get into some of the use of the 401(k)s, and how to use them, and maximize them, and also touch base on the DB plans. In some cases, we have clients putting $700,000–$800,000 a year into their retirement plan, and many people don’t even know they exist.
Then asset protection. Asset protection is about preservation of the asset, protecting you from creditors, protecting your liability, you creating liability, and protecting the business from that too.
For example, I’ve seen this way too often, unfortunately. Somebody is running a professional business. They have their business, they have multiple kids, one of those kids got into a car accident. Depending on how severe—we’ve seen deaths and things like that—you want to make sure that you have a good layer of protection.
We go over the different layers, everything from insurance to making sure that they can’t take things away without you willingly handing it over. Sometimes they can take away the profits interest in a company, but we want to make sure that they can never take over the management or control it and what that does for settlements.
We look at it as six events in one. There’s a lot that we go over and it’s absolutely free for you all. It’s aba.link/taxandassetprotection. It’s this coming up Saturday. Clint and I teach it. A lot of fun, you won’t be bored. Trust me, you’re going to learn a ton of things that you didn’t already know. Clint does an excellent job and I do an okay job. Together, we do a great job. It’s a lot of fun.
All right, back into the questions. “Is it advisable to have the house you live in under an LLC?” What do you say, Jeff? I know this isn’t your bailiwick.
Jeff: I prefer not to do this, having my house in an LLC. I might be wrong about this, but I think it causes some issues. Perhaps not with the 121 gain exclusion, but I think there are also issues with homesteading. Is that correct?
Toby: You have some homesteads in some states like Texas, Florida. We have to be careful because if you put it in the LLC, you could destroy an unlimited homestead. I don’t like using LLCs in an unlimited homestead state, first off, but I also look at the state and see if you have any equity exposed. Like in Nevada, it’s 575, I believe is what we’re sitting at now. If you have a house that’s worth $500,000, what are you worried about?
Some people say, well, I want to put it in there because I’m going to give pieces of it away to my kid. Stop that, don’t do that. Don’t gift a capital asset yet because the law right now is you get a step up in basis when you pass away. It’s like you’re giving away tax deductions, plus, you may want to sell it at some point.
The 121 exclusion, which is the $200,000 and $500,000 capital gain exclusion when you sell a home that you’ve lived in two out of five years, that does not matter. As long as that LLC is a disregarded LLC, it doesn’t hurt it. Also land trusts. I’ll tell you our personal view. A land trust doesn’t affect the 121 exclusion.
My personal view is that you get way more bang for your buck if you have a trust on your home and just make it some goofy name. If you really want to use a nominee, trustee, or use an LLC that’s doing nothing else than the trustee, it will keep your name out of the public record.
For example, I could set up a Wyoming LLC, my name is nowhere on it. I could call it Blue Dog LLC. I can set up a trust on my home, the 123 Main Street trust by its trustee, Blue Dog, my name is nowhere on it, nobody can come find it. It’s been fairly well-protected, but for tax purposes that whole thing is completely ignored. It doesn’t hurt my 121 exclusion, does not hurt my homestead. I tend to like those.
The other thing is make sure you have good insurance. If you are doing Airbnb, make sure you talk to your insurance agent and that you are getting a commercial policy. You have to for the short-term stuff, otherwise they will not cover. Then also make sure you have a cheap umbrella coverage. Umbrella coverage, a good policy is going to cost you around $300 a year and it’s lawyer coverage.
What it means is it’s not going to protect you from all lawyers, but it’s going to give you a lawyer that you don’t have to pay for to defend you in most cases. That’s almost more important because what gets most people in litigation is the slow drain on resources, the drain on time, and the drain on your nerves because you start waking up at 3:00 AM and want to punch somebody. So you have to make sure that you have some layers of protection in place. Nowhere is that more important than if somebody is coming after your house.
I have seen an individual lose their home after years, and years, and years of running their business because their homestead exclusion sucked. Like in California, you guys’ homestead exclusion sucks. She had nothing. She had a full-time lawyer and an accountant, and nobody saw the issue. She had one liability occurrence on one property, and they took over 15 properties including her house, and boom, she was done.
Somebody says, “Is the aba.link the tax asset protection?” That is a virtual event guys. We’re not going to be doing that one live, but it will be all day. Anyway, do you have anything else?
Jeff: No. I was just wondering how you feel about the QPRTs, the qualified principal residence…
Toby: Yeah, the Qualified Personal Residence Trust, where you just own the right to occupy. It’s very rare that I would recommend it. Let’s just put it that way. You can always replace the home like, hey, I’m going to give this to somebody. It doesn’t give me any control over the asset. I could swap it out like, hey, I could buy another residence inside that same residence. But I always think it’s a little bit of overkill.
There are very few situations where I’d use a QPRT. Things happen and you might want to change your mind or you may want to use that asset. Depending on who drafted it, you could be at severe limitations as to what you can do to access those funds just in case something unexpected occurs. I like control and I don’t like giving away control.
This is one that’s all for you. “What are the requirements to account for visiting out-of-state properties that I own as a deduction, such as airplane ticket, car rental, hotel, meals, et cetera? What are the minimum requirements to account for it as a tax deduction and not a personal expense?” What say you, Jeff?
Jeff: The primary thing is we have to make this business trip. To do so, there is a requirement that at least half the time spent traveling. Say you go for a week to check out your properties in another state, at least half that time. If you’re gone for six days, at least three of those days have to be business-related. A business day is considered at least four hours on business during the day.
If you meet those requirements, you’re going to be able to count the entire thing as business travel. What you don’t want to do is go visit your property in Orlando for one day and then spend the next six days at Disney World in Epcot. No, because then at that point, none of it becomes business travel.
Toby: Jeff, you put it really, really well. It’s documenting the purpose of the trip and it just has to be primarily for business versus vacation. How do you make it primarily? You have to be greater than 50%. Four hours in one day, if you’re meeting on a daily basis, spending it on your properties, which means you’re there, you’re working around your properties, you’re talking to vendors of your properties. If you’re a real estate investor, you’re looking at other properties, like you’re doing things that are associated with your business.
That’s not horrifically difficult to do because you could literally have breakfast with somebody for about half of that that you’re working with. Hey, I’m going to take the vendor out, and I’m going to talk to my real estate agent, and I’m going to do this, and then the others. It’s not horrible. But the way the IRS does this, they have a couple little tricky rules.
They can say, hey, if I’m in the North American region, if I fly to meet with Jeff or if I meet with him at my place. Let’s say that I have the ability to hire a CPA next to my office or I could hire Jeff across the country. Let’s say I lived in Washington and Jeff was in New York. The IRS can’t say, hey, you have to use the guy that’s closest. I could fly out to meet with Jeff in New York and that’s no different than if I went next door. Then I can write off my reasonable travel expenses as long as the reason I went to travel was to see Jeff.
The way that they dictate that is more than 50% has to be Jeff, and those are days. If a day is four hours, plus I have my travel day there and back, I have three days already. I could spend an extra day there. I could spend an extra two days potentially. But what we like to see is when you’re using the rules in your favor for not just the travel expense, but that you’re going to have as many business days as possible and you’re able to combine a little bit of pleasure with business. The way you do that is by splitting a weekend.
Let’s say that I fly on a Thursday, I meet with Jeff on a Friday. I should meet with Jeff or at least another vendor on Monday and then I should fly on Tuesday. What that gives me is Thursday, Friday, Monday, Tuesday, all those are business days, but also it gives me the two days in between those because it’s on a weekend. I get those as business days. If it’s a holiday, you get that as a business day too. You just have to book it.
If you’re willing to do it and spend a little bit of time to learn this stuff, it’s going to be a huge benefit to you. Again, if I wanted to go visit—Jeff said Orlando—then I just have to go to someplace for Orlando for Thursday, Friday or Friday at least, and then have another meeting on Monday. That will allow me to capture that whole weekend. But better yet, that gives me six business days right out the gate.
I have Thursday for flying, Friday for the meeting, Saturday, Sunday, Monday, because they’re split weekends, I get those as business days, and then Tuesday as another Friday. I have six days. I could literally stay another five days and still write-off the plane tickets. I would have to split the hotel, though, because the hotel would only be for the business days. Those other days, the meals and hotel would not be covered.
I didn’t mean to get too deep on that. The other thing is meals right now are 100% if you’re doing it at a restaurant. That was under the Consolidated Services Act that was passed at the end of last year. So make sure that you’re taking advantage of that.
Next one. We don’t really need to do the Q&A because these guys are not going through. Let me just see how bad it is right now. You guys always ask a million questions and I’m scrolling through pages and pages of questions. Holy schmoly. No wonder I was like Jiminy Christmas. Do they even answer a question? No, I’m just teasing. They got 14 questions in the queue.
You guys are keeping up. Dana and Elliot, you guys get to start, and Troy. You guys get a big star. Anybody else that I see there? Troy, Elliot, Dana, you guys are just doing great. Patty is there. Okay, I see that. Perfect. You guys keep it up.
Jeff, “What’s the best way to set up a JV partnership when I already own 100% of the LLC to get the property under contract?”
Jeff: This one actually confused me a little bit because I felt I was a little short of information. What I put together was, it sounds like maybe they’re buying a property and want to partner with either a developer, or somebody to gap fund them, or something to maybe flip the property. If that’s the case, that LLC can be contributed to the joint venture, which is going to be taxed as a partnership. Then whatever the other person in the joint venture contributes will also be their share. I would just put that entire LLC inside this partnership, inside the joint venture.
Toby: What if you just wanted to bring him in as a 50% partner? Hey, I got the property under contract, Jeff. We’re going to do 50/50 on this. You’re the construction guy, Jeff. Let’s just say I put a property under contract. I put $50,000 down, I got a $200,000 property, and we’re going to spend another $50,000 to fix it up.
Jeff: Yeah, you could another number. You will have to file what’s called Form 8832. What you were talking about earlier, Toby, that lets you designate how your LLC is going to be taxed. Then you’re simply telling the IRS that, hey, I was a single member LLC, but now I want to be taxed as a partnership because there are two of us. You could certainly do that.
Toby: Yeah, and if you do that, here’s my caveat. Make sure that you are liening that property. You bring property in and based off of promises for somebody else, you make sure that your money is protected under that property, and that you’re not relying on the LLC agreement, because the LLC agreement is going to say things like, hey, we got to pay things back in a pro rata way. What you’re essentially doing is giving them half, so just make sure that you have a lien against that property if you’re putting it in the LLC.
The other thing we see is the opposite, where somebody will fix up a house and the LLC was still in that ugly outside individual’s name and they go sell it, and they don’t give anything to the LLC. Yes, technically, that’s incorrect. They should not be doing that. They’re violating the partnership agreement, but you still have to sue them to get your money back.
If I’m the person who has the property under contract, and we’re going to close in the name of the LLC, and everybody’s putting money into that LLC of equal, I’m not too worried about it. But if you put a bunch of money down and you said, hey, we’re going to close in the LLC that somebody owns 50% of them, they didn’t put any money in, you are liening that individually to make sure that you get paid back whatever you put in from that LLC if you ever sell that property, and that way you can be protected. It’s just the only way to protect yourself.
Jeff: I often tell the person who is doing the funding to make sure they secure their loan or the money they contribute. But I had never really thought about the other side of the person contributing the property.
Toby: I’m always worried because I’ve seen so many deals blow up or somebody says, hey, I’m going to do this, I’m going to do that. Then you get the property, they say, hey, I’m working on it so hard. I’ve seen this so many times. Then you go out there and all they’ve done is steal all your materials, nothing’s been done, the place is a dung heap, and then they disappear. So now you’re left with the property, bring somebody else in to start fixing it up.
Then right before it sells, here comes the partner that absconded with all the materials who just comes back in and says, hey, I’m 50% and you owe me. You just want to go nuts. You just want to attack that person. You have to make sure that you’re protecting yourself.
The way partnerships work is if Jeff and I each come in, I put in $50,000 and Jeff puts in $25,000, we have capital accounts. In theory, when that partnership, let’s say it makes $200,000, it would pay Jeff back whatever he put in. Let’s say it was $25,000. If I put in $50,000 it gives me back my $50,000 and then it splits the rest.
You have to make sure that you’re never in a situation where you’re at risk of losing yours. I’ve seen that so many times I’ve seen it where you have partners that did commit money. They get behind, and they get underwater on things, and then they’ll go and they’ll borrow money or a third partner will come in saying, hey, I’ll bring in some money, and they’re all expecting like, there’s going to be distributed out pro rata?
You were the one that put the money in the first place. You’re thinking, hey, wait a second, I need to get all my money back. They’re like, no, we’re going to give it to this person and this person. It gets really ugly quick. So make sure that you have somebody advising you on this so you don’t get burned.
“How can I become anonymous in my LLC after the fact? I started my own LLC with my name all over it. One year later, I am interested in enhancing the corporate shield and getting my name off the record. Is that possible? I have worked hard to build the business credit with the existing entity and would like it to continue.”
Jeff: I don’t have an answer for this one.
Toby: I do. If you have business credit, most business credit is going to be built inside of an entity that is not anonymous. It’s going to be transparent to a certain extent. That’s because the bank needs to know that it’s you and not just you representing, hey, I worked for this company. They almost always want to do a check. Otherwise, they are loaning directly to the entity, but they’re really loaning to you, and they’re putting the entity’s name on it. It’s really a personal guarantee on that and it’s personal reporting.
When you get true corporate credit, there’s no personal reporting. It’s not on your credit report anymore. This is different, by the way. You could have an obligation that is in the company’s name and you can be a guarantor that’s not reporting, versus I could do a loan that with me and the entity, and it is reporting. You have to be very, very clear with the party that you’re dealing with, what do they report to. In the personal realm, 95% of the companies that do personal credit report to FICO, TransUnion, and Equifax.
On the business side, flip that around. Only about 5% of the companies report to Dun & Bradstreet, or Equifax direct, or TransUnion business. It’s important to know those things as best you can going in. Once you start building up that business credit, it’s great, but it does need to be transparent. That flies in the face of the idea of having anonymity.
What I would suggest is that you create a separate entity to hold your capital or some of your assets because, yes, they could come after your business, but they can only get what’s inside that business. If you distribute it out to yourself, let’s say it’s an S-Corp or an LLC taxed as an S-Corp, take your profits out on a monthly or quarterly basis on a regular basis and put them aside. Put them into an entity that does not have your name on it. That way, if there’s unwanted attention that comes your way and they come after your business, you’re able to keep your personal assets out of it, rather than having a million dollar account sitting in that business.
There’s nothing worse than when somebody comes after a business and they’re alleging an amount that exceeds what that business has, but it’s such a huge amount that you’re like, oh, I’m worried about a fraudulent conveyance. I’m still going to tell you to take the money out and put it aside. If there’s any business justification you can make, so if it’s a frivolous case, especially.
But most attorneys are like, freeze, don’t do anything. They’ve made this big allegation. If there’s teeth to it, then you can’t. It’s called a fraudulent conveyance. So I’d much rather you get it out of there before that ever occurs, rather than after the fact. Once you’re on notice, you have to be very, very, very careful. Anything else, Jeff? I know you didn’t want to answer that one.
Jeff: That was right on exactly what I wanted to say, Toby.
Toby: Perfect, we love it. All right. “Is a written promise for 35% profit a part of a JV contract?” No. It sounds like one term for something that should be in a contract. You know what? I’ve seen a lot of participating loan agreements. Hey, I don’t want to do anything, I just want to loan you money and I want a chunk of the profit back. You could do that.
Basically it’s a regular loan for interest plus a conditional rider where there’s contingent interest. The rider is a contingency interest. Let’s say that I loaned Jeff money for 4%. I say, you’re going to give me 4%, but then I have a contingent interest that says, and we looked at the total profit, and if 35% of that is greater than 4%, 35% of the profit is greater than 4%, you pay me the extra, or you could do the 4% plus the 35%.
You have an infinite number of possibilities, and that’s where you have people that are doing side money, and they’re really smart. That’s a lot of the places they go. They don’t want to get involved. They just want to know that they have a loan that’s getting a set interest rate no matter what. They want to have security on it. They want to secure the real estate or whatever their assets are, and then they want to know if you hit a home run that they at least get a part of.
When you come out of it and say, how about a 35% cut? If it’s one of my clients, they’re probably saying, how about I loan you the money, and personal guarantee, and we’re going to secure the house with it, and it’s a really low interest rate? If what you’re saying is right, yeah, you’re giving me a 35% cut. So yes. That is one way to do it and I love that. It’s called a participating loan agreement. One of my favorite things on the planet.
All right. “In 2021, we sold my husband’s dental practice.” Congratulations. “And will owe substantial capital gains. Is there any possible way to avoid these taxes through real estate investing or…?”
Jeff: I’m going to give a particular scenario. You sold your husband’s business, so I’m assuming he’s retired, he’s not working. There is the possibility that one of you could qualify for a real estate profession. Now the only problem with this is we’re in mid-September and the clock is ticking for you to make your hours to become a real estate professional.
Toby: You’d have to buy a lot of property.
Jeff: You’d have to buy a lot of property. You’d have to do cost segregations to get the bank right off, which is why it’s important that you qualify as a real estate professional.
Toby: Jeff, with a real estate professional, what you’re really saying is, hey, I can take a huge amount of depreciation on real estate and write it off against my individual income, and lower my tax threshold, and offset some of that capital gain.
Jeff: Correct.
Toby: That’s probably a long-term capital gain, right?
Jeff: I would imagine if he’s had the business for more than a year. Yes, it would be long-term capital gain. That’s the other side of the coin. This long-term capital gain is definitely being taxed at a lower rate than your ordinary rate.
Toby: Capped at 20% plus 3.8% for net investment income tax plus your state capital gains rate.
Jeff: Right.
Toby: And depending on where you’re at, you could be looking at 23.8%. One fact I would want to know and I don’t know if these folks are out there, but why not do an installment sale? Why didn’t you secure it with something and get it over a couple years so that you can lessen the tax bill? Maybe there’s an accountant saying, hey, Biden’s going to raise the capital gains rates, so get it all now. There could be that.
The other side is there’s something called a qualified opportunity zone. In a qualified opportunity zone, you have 180 days from the sale or the date of recognition, which could be January 1st—technically, it’d be the very end of the year—where you can put the capital gains or any portion of it into the opportunity zone fund and defer the tax until the very end of 2025. It would be taxable on December 31st, 2025 and it would be payable in 2026.
If you want to give yourself some time, you could invest it in something else. If you need the money, you can’t do that, obviously. But if you don’t need the money, then you may want to look at a qualified opportunity zone. You have 180 days from the date of sale, or I believe this one, because it’s the sale of a dental practice, assuming those assets, I believe that you should qualify to extend that to till 180 days from January 1st. If that’s the case, you’d have until June, but you need to have somebody really look at it.
Then you have to put it in an opportunity zone fund and you have to buy opportunity zone property, which is great, but that’s the only way we can defer it. If it’s already closed, the deals are already done. Sometimes I’m looking at deferred sales trust, which is way too late to do that. Sometimes we’re looking at doing an installment sale, where you carry back some of the note and you’re getting paid over a longer period of time, so you’re spreading it over multiple tax years.
Jeff: One thing I normally see with a sale of a professional practice—that’s usually contingencies involve contingency payments—they are paid based on how much revenue is collected throughout the years. This may already be an installment sale now. If you sold it for a half million, but you’re not getting all the payments now, you’re going to have an installment sale. You’re not going to pay the tax on the entire gain in 2021.
Toby: It always depends on what you’re selling too. A lot of times, they said I sold my dental practice, but you’re keeping the practice. Tom in here says, “Hey, why isn’t the dentist max out a defined benefit plan?” Usually if they have those for a number of years, but also, you have to have the active business. It doesn’t mean that you don’t necessarily slap that on and say, hey, are we going to continue to operate this business? Maybe you’re doing consulting, you really want to be careful when you do a purchase and sale on a dental practice.
Almost always there’s a non-compete and an agreement where you provide services. You can have an agreement. Those would be ordinary income, but if they run through your company, then you could fund retirement plans, but now you have no employees. Now we could just be completely piggish and benefit ourselves. Especially if this is over a period of time, you could build something like that.
Jeff: I actually had a client who did this exact same thing. They sold their practice. They were paid over several years. They did the DB choice. They were still doing work on the side.
Toby: Jamming in there as long as it’s ordinary income.
Jeff: Yeah.
Toby: The thing the accountants always try to run away from like, oh, we don’t want any ordinary income. Maybe we do. It doesn’t matter how old you are, whether you’re keeping the business because quite often with the business, you’re selling the assets. What they want is your practice. They want your intellectual property, they want your goodwill. Goodwill is taxed as ordinary income?
Jeff: Goodwill is taxed as capital gains.
Toby: Capital gains, it’s 15 years depreciation. This is somewhat goofy.
Jeff: They want your client list, your patient list. That is actually capital gain. But they also usually want you because the patient list is typically not worth much without you continuing the practice.
Toby: The IRS is really good about recognizing that and saying, I want that to be ordinary income even after the fact. They’ll come through and look at an agreement. It doesn’t matter what’s in your agreement. They’re not bound by that. They can say what’s the reality. The reality is I need Jeff.
Jeff has a consulting agreement. He has a non-compete with me, and that’s ordinary income, and he has all these things. The reason that I have Jeff here is so that his clients won’t run off. Anyway, there are so many little pieces to this. When you sell a business, you always want to have a really, really good tax advisor along for the ride.
I like to tell my horror stories. I had a buddy of mine, he called me up on a Friday, and he was about to do about a $6 million deal. He goes, hey, Toby, we’re at the very finish line, we’re about to sign things, and I said, hey, I want my buddy to look at it. I’m not near because he has known me for a long time and he says, hey, Toby, will you come in here and meet with the lawyers? I had a team from New York and a team from California on a conference call.
Team from New York knew what they were doing. He was about to eat his lunch. He thought he could deduct the $6 million and he couldn’t. The first thing I said, I looked at him and I said, hey, so and so—I’m not going to tell you the name—you really just can’t write any of this off. He goes, what? No, I can write it off. I’m like, you can’t write it off.
The lawyers are like, we didn’t obtain a tax CPA to advise on this. We said, we’re not experts. All of a sudden, all hell broke loose because there was an assumption made that he’s going to get a $6 million deduction. He was using that as part of his factoring and what to pay for this thing. We’ve managed to save the sale.
The LA firm got tossed just because they didn’t know what they were doing. There were probably 10 things like that. We ended up bringing in somebody else, and had him spending the whole weekend babysitting the thing. It’s so close, but it was pretty interesting.
Somebody says amortization. Troy. Oh, deduct. I said depreciate. It’s amortized, yeah.
Jeff: One of the first questions I usually ask as soon as somebody says they sold their business, I say, what did you sell and how did you go about it? That’s really something you need to negotiate, what exactly you’re selling and how much the value of each piece that you’re selling. Both you and the buyer have to agree on this. The problem is the tax treatment of each of these items.
Toby: They’re not bound by it, though. The IRS will look at the agreement and go, this is the reality of this because people play games. Hey, let’s call it this. There’s usually one side that has a huge tax appetite and the other side is probably just trying to get some money and get out.
Jeff: A good example of that is, if I’m selling, I don’t mind it being called goodwill because that’s capital gain treatment for me. For the buyer, it’s horrible treatment because they have to amortize that over 15 years. Stock sales are great for the seller, not so great for the buyer.
Toby: There are no 1031s for businesses or business assets that went away 2017. Could the purchase payments be equal to the dentist salary and then the dentist max out the DB? Yeah, it’s up to you. You probably don’t want to purchase. You want ordinary income, so you want the non-compete and the consulting salary.
They usually keep them on to do the glad handing to bring the clients over. But yeah, you could have that be $300,000 if the DB plan would allow it to go in there. You guys get to negotiate that and then sell the personal properties separately. You had a little problem with the personal property. I think they’re meaning business property, the personal business, the 1245 property. If that’s the case, let me think about that. If I’m selling that, I’ll depreciate it at all. If it has any useful life, that’s all ordinary income or would that be a capital?
Jeff: If it’s beyond its useful life, I believe it’s capital gain treatment.
Toby: Let’s say you could do that, but you’re already there. You’re already getting the most of that at 23.8%. If it’s still as useful as life like, hey, I had a bunch of furniture and I wrote it off in year one and then I sold it in year two, I’m having to recapture it as ordinary income four-fifths of that property. When you have longer property or things with longer useful lives, that could even be a bigger trouble. Did you have anything else on that one you want to go over?
Jeff: No, sir.
Toby: “When do I switch from wholesaling under my name to wholesaling as a corporation?”
Jeff: I prefer sooner than later, to be honest with you.
Toby: Yeah, go back in time. Do not wholesale in your own name, because when you get sued in your own name, it sucks. Just figure it’s going to cost you $200,000 to go to trial and they know it. If you’re having any success, they’re just licking their chops at you. So please do not wholesale under your personal name, unless you really don’t have anything, you don’t expect you’re going to have anything for the next 10 years.
Otherwise just wholesale underneath an LLC taxed as a corporation, LLC taxed as an S-Corp. Just don’t do it in your own name, please. Because you’ll be really ticked off when you start hitting some home runs and somebody comes along, and starts making things like, hey, you misrepresented me, you took advantage of me, and you completely saved their tush.
You took over and fixed the house, made it usable again, and somebody sees that you made some money and they just get jealous. You just want to knock that thing out. Sorry, Jeff. Was there anything else you wanted on that one?
Jeff: No.
Toby: This is fun. Follow us on social media. We got a whole bunch of them. Instagram, Facebook, YouTube, LinkedIn, Twitter. My favorite is the YouTube channel. I always talk about that. We’re probably going to start broadcasting these on YouTube Live and then also on Facebook Live so that we can get more and more people some better information.
Yes. If we were a barber shop, we always say we want you to have really lush long locks. We want you to have long hair that grows really really fast because we’re barbers. If we can help you make money, we hope that you’ll allow us to cut your hair, which means doing tax service.
“How do I then get credit approvals under the business entity?”
Jeff: You already answered this, Toby, because it was the exact thing I thought of. You’re going to need personal guarantees to get a business credit. If you want a loan for your business entity, they’re going to give it to you if everything looks right to them, but they’re also going to want you to sign on as a guarantor.
Toby: I’m going to say this. If you’re halfway listening right now, listen up, because this is actually really important. If you understand the world of business credit, you’re going to realize that there are three things they’re always looking for—cash, collateral, or credibility. They either want to see that you have the cash sitting in your account. You have a history, that’s great, but cash works.
If I have $50,000, they’ll probably give me a line of credit if I put that into a CD. I can secure it for a while until they’re happy enough with my performance that they release it. I used to do that. I’ve done that twice now. I just threw some money and instead of funding the entity with cash and using that, I funded the entity with cash and used it as a security for line of credit so that the business could get some history. Then they release the cash collateral requirement. It takes about two years.
Collateral is anything, I could use my house as collateral, I could use a car as collateral, I could use anything as collateral. The business, they’ll give credit to the business and allow that to take place if I’ll give the collateral.
Then there’s credibility, which is they want to see a two-year history, and they want to see a Paydex score or the Experian direct score, and they’re going to give you a certain threshold. The Paydex score is way different than a personal credit score. Paydex is 0–100 and it shows how on time you pay things. It’s best just to ask them what they’re going to be looking for, and then going in and making sure that you meet the requirements.
Now just like a teenager—teenager come up again—and they want to get a car. You have an 18-year-old that says, hey, dad, I want you to help me get a car. Again, the lenders are going to look at cash, collateral, or credibility. They’re going to pull the credit score. They’re going to see there’s not enough credibility there. They haven’t been around long enough in their work history, so they go to the next. Is there any cash to secure it with? Then they go, do you have any collateral?
Then they’re going to say to the teenager, hey, you don’t meet any of the criteria. Do you know anybody who does? Then dad shows up and lays down their credibility. They co-sign on the loan. It’s still in the individual. It’s still in the teenager’s name, but you’re a guarantor on it.
That’s exactly what they do with the business. If it’s a new business, it’s less than two years old or it has no history, I’d say two years with credit history, they’re almost definitely going to ask for the credibility of the parent, which is you, one of the principles. Once you get used to that, it’s really easy to build business credit. I can go get an American Express tomorrow but it doesn’t report my personal name. I don’t think any of them do, unless it’s personal.
All my business, I can get tons of business credit cards. I’m not a big credit fan. I personally don’t like credit in my name, but I don’t mind it with the business. They used me to get through the door, and then eventually they weaned us off. The American Express, they don’t have a personal guarantee on it. They just look at our financials once a year. All that stuff will work.
Jeff: Do you see that with our friend, our strategy? Does it get easier as you do each […]?
Toby: Yeah. When you’re talking about the build, rent, refinance, repeat or the buy, rehab, rent, refinance, repeat, those two strategies, the refi part, you don’t want that all on your name. Personally, you can have about 10 loans before you’re banned from doing anymore. Usually, you’re going to about four and then you’re doing portfolio lenders. There are people that will loan because they know that you’re improving the value of a property.
The money is not always the cheapest, it might be 5.5%, as opposed to 3.5%, but when you’re doing commercial and getting it out of your personal name, it doesn’t affect your personal credit, that’s worth it, especially if you go above 10 properties. When you go to about 100 properties, it’s like you’re in that secondary world of where they’re probably going to do you in tranches of $3.5–$4 million, and they’re going to want 60% debt versus 40% equity, and they’re going to be looking at the after-repair value in some cases.
The more they get to know you, then eventually, they’re going to be like, hey, we don’t need you on these things anymore. A lot of my portfolio loans, it’s secured. It’s a dual entity where they’ll do a loan to the entity holding the real estate. It’s secured by the entity holding the entity that owns the real estate. They don’t want to foreclose on all the properties, they just want to take the business if it goes south, and that’s usually a portfolio loan of at least $5 million and above.
They’re not horrifically hard to get. We have great people. If you’re part of our funding community, you probably already dealt with a bunch of this stuff. We have a bunch of really good lenders that we work with. A lot of them, they’re non-personal types. They want portfolios.
All right, enough of that. “Is it more advantageous from a tax savings standpoint to make charitable contributions directly from our corporation, or to pay ourselves and then make the donation from our personal account?” What say you, Jeff?
Jeff: This is really an ‘it depends’ question and we haven’t said that in a while. The reason it depends is, for corporations a cash contribution is limited to 25% of that corporation’s net income. In 2022, it’s going to go back to 10% of that corporation’s net income. Whereas this year, the 100% is still in effect I believe for 2021.
Toby: 100% cash.
Jeff: 100% cash to charity. Now you have that to look at. Can you take advantage of that full contribution of a corporation? But you also have to look at whether you can take advantage of that on your 1040. Are you able to itemize? Are you in a lower tax bracket than a corporation is? Corporation is at a 21% […] say a 12% bracket personally. Generally, I would say it’s better to make it personally, but that is definitely not a black and white response. You really have to look at both sides and see where it’s going to come out best.
Toby: Yeah, you have to see where you are at from a tax standpoint because a corporation, a C-Corp, can give up to 25% of its net tax or net income, but it’s capped at 21% so you’re getting 21% on, let’s say you have $100,000, you gave $25,000 away, you’re going to save one-quarter of $21,000, whatever that is. There’s not a huge amount of benefit.
Whereas, let’s say that’s $25,000 and Jeff’s accounting at 37% plus state, that’s a much larger amount. It’s better off if it’s Jeff making the contribution, but to keep this Jeff has to pay tax. If there’s $100,000 sitting in a C-Corp and you’re going to keep it there, you may as well go $25,000 to charity. Hey, I don’t care. It’s the corporation writing it off and you’re benefiting a charity, that’s great. Maybe it’s your own 501(c)(3). That’s great, too.
But if I pay Jeff $100,000, Jeff is now paying tax on $100,000. If Jeff gives $25,000, it would have been much more beneficial just to give it out of the corp. If it’s an S-Corp, if it makes a charitable donation, they don’t consider the S-Corp making the charitable donation. They’re considering that the shareholders made the charitable donation at their level based on their percentage of whatever is given.
If I give $25,000 out of an S-Corp that made a $100,000 and I’m 50% owner, the way the IRS looks at it is great, you made a $100,000 and then you made a $12,500 donation for each partner so you’re going to get $50,000 and $12,500 as a donation so it’s going to lower you to $37,500 is really what you’re profit is going to be for each partner.
It’s kind of weird. Same thing with a partnership. Same thing if it’s a sole proprietorship. There’s no difference between you and it. It’s a partnership. The partnership didn’t make the contribution as far as the IRS is concerned, the individual partners did. Did I say it right?
Jeff: To answer this question, it’s not a this or that. It could be this and that. You may max out your corporate contribution then pay out the rest directly to the shareholder who then makes another contribution in his own personal name.
Toby: What you don’t do is you give a charitable contribution, then pay out a whole bunch of money, and ruin your profit so you can’t write it off. You get to carry it forward for five years, but still, that sucks.
Personally, I’m going to tell people I think it’s better for you to make contributions 9 times out of 10 because it’s going to get you over that standard deduction. I don’t want to have a $10,000 deduction individually that I couldn’t write off. A $10,000 deduction charitable donation that came out of a corporation that I can’t write off. I would have been better off to just do one or the other. It’s probably even better for me to get $20,000, then I would have at least something to write off assuming I defeated the standard deduction.
Jeff: One other thing I usually recommend to clients in that case, especially where the standard deduction is coming into play is they front-load their contributions. Say I contribute $5000 to my church every year. Go ahead and do that bigger contribution upfront. Let the church or whatever the charity is know that you’re doing that and they may not be seen as much in the next few years. That allows you to get a little more bang out of the buck of that contribution.
Toby: Yeah, get chunky with your donations. Give three years in one year. Instead of doing once a year, which Jeff just said, is absolutely true. Why not make a five-year equivalent. If you’re worried about that but you still want to get the deduction, you can do a donor-advised fund as long as it allows transfer to your church. Some do, some don’t. You can always put a big donation into the donor-advised fund and then parcel it out. Hand me the deduction this year.
Hey, Tax & Asset Protection Live. Who would’ve thunk it? September 18th, you can come out, spend the day with us. I know I mentioned this earlier so I’m not going to […] to the point, but it’s fun and you’re going to learn a lot about LLCs, corporations, land trusts, living trusts, 401(k)s, C-Corps, S-Corps, series LLCs, which states let’s you do and which one don’t, when is it appropriate time, why do we use statutory trust […] like here in California you don’t want to pay franchise tax or anything. We’ll show you how to defeat that. Register, aba.link/TAP. It’s a virtual event, so you’re going to see Clint’s and Mike’s smiling mug all day until four o’clock.
“Can I do a 1031 exchange when I sell an investment home that I have never lived in nor rented out? Is there any other way to avoid capital gains tax other than renting it out? I don’t want to keep the house.”
Jeff: Before 2018, you could have done a 1031 on this property. The new rules say rental property or investment property, but when you dig down into what an investment property is, it’s a property that’s making money for you. If you never lived in it and never rented it out, I don’t think you’re going to be able to do a 1031 exchange on this property.
Toby: There’s one exception where there was a case that was post, if I remember right, the facts were that some parents have purchased a house. They intended to have it as a family house. Their child ended up passing away unexpectedly so they would never go near the house. The mom said sell it, get it out of here because it was such an emotionally-charged issue.
They tried to rent it, but they could not rent it out. They tried, and tried, and tried. They had some people look at it, but the market was just too soft. I wasn’t really in a nice area that was more of a vacation area. I think it was a new build, so nobody would give them what they needed to get on that side and then they put it for sale.
They could not rent it out, but they could sell it. They sold it and they said the IRS allowed them to treat it as an investment property because they listed it at fair market value, they made a good faith effort to rent it so it was in service. That’s the only time I’ve ever seen that. I would say technically, there’s not a requirement, but realistically, if you don’t want to have to defend it, rent it out.
Even if it’s renting it out to a brother, or sister, or somebody else, somebody that you know is going to be gentle on it, that’s still fine. Just rent it out, probably for six months. I think the safe harbor is two years, but as long as you make it into an investment property you’ll be fine. You must be like how did you get a bunch of gain in it? I never lived in it or I never rented it out but it’s gone up in value in a whole bunch and now I just want to sell it.
There’s another tax-free way to get money out of that. It’s called doing a cash-out refi, and keeping the house and putting it for rent, and just using that equity to borrow from. Anyway, let’s see. How are we doing on time? Am I over already? Oh, I am. Sorry.
Jeff: All fine.
Toby: Last one.
Jeff: I keep asking you questions.
Toby: “Who handles the paperwork for a 1031 exchange? The lawyer, the realtor, or my tax advisor? How far in advance do I have to plan to undertake an exchange?”
Jeff: It’s actually the candlestick maker, no.
Toby: I thought the exact same thing. Do you know how weird that is?
Jeff: Think of this as a normal sale, but you have somebody representing you called the Qualified Intermediary. You’re still going to have that title person who’s dealing with that portion of the paperwork, you’re still going to have the realtor, those other people. But the purpose of the Qualified Intermediary is to keep you out of trouble during this 1031 exchange.
When you sell your property, they get the funds, not you. They hold the funds until you replace your property. Then they represent you in that purchase and that they put that money back in for you. There will be some paperwork done by the QI (Qualified Intermediary). A lot of it’s going to be the standard paperwork that the title company does.
If you’re planning on doing a 1031, you need to do that before you put your property up for sale. You need to talk to them about what you want to do, what the plans are. They’re going to help you with your important dates like 45 days to identify a replacement property, 180 days to actually replace your property, and so forth. And shop around a little. I haven’t heard of many bad QIs, but you do want to get the best deal. They’re not necessarily that expensive. I’ve seen them at $500. What have you seen?
Toby: I’ve seen all over the place $800–$3000. I like Shana. Shana […] in Idaho. She’s not everywhere, but she’s just a really great gal who knows her stuff. We have some clients that actually do exchanges in C-Corps and some bizarre things just because they don’t want any money, it’s some really high net worth folks.
She’s able to handle those without batting an eye, whereas most 1031 exchange facilitators would melt down. I care more about not having to worry about it than necessarily the price. I always look at their expertise, it’s kind of that value thing, like this one’s somebody really good so I can sleep at night if I’m going to do it.
Jeff: Yeah, and the more you get into some of the 1031 offshoots like multiple properties you’re replacing with and things like that, I think it gets more and more important for that to have that good QI in place before you even start the process.
Toby: Yup, QI is your best friend. You can do reverse exchanges. Sometimes when you get into commercial, they’re already doing the math. They’re like, man, I just don’t have enough time to do this. You can acquire a property and then replace it if you have the credit and the cash to do it. As long as you don’t take possession of the new property, as long as the QI is doing it, it’s great. You don’t violate anything. You could buy the replacement property and then exchange the old properties into it. It’s great.
You could do that or you can already have identified your properties that you’re going to exchange for and coordinate the closing date so that you’re not sweating bullets, hoping that you can find something and close on it in time.
Then lastly—somebody on this call actually believes, I’m not going to say the name—you can park it in tenants in common and a tick in certain larger organizations. If you’re selling a larger commercial property, I’ve seen that done on more than once, but I remember going through one with an individual where the attorneys really knew their stuff but they were parking it in a tenant in common with other high net worth folks in a building where they knew that they would be able to exchange that into something else in a portfolio.
Then there’s Delaware statutory trust that you could park it in as well. If you have a good QI, they will help you troubleshoot issues that would normally tank a 1031 exchange.
Jeff: You mentioned reverse 1031s and the reason I like those is I’ve seen a couple of 1031s blown recently because they couldn’t find a replacement property.
Toby: Yeah, or they drag their feet. I’ve seen that where they’ll actually find a way to slow down to stop it. You would get into the last few days and then they start negotiating with you again because they know that you’re about to lose your exchange and you have to pay tax, so hey, you’re going get hit with a tax. Let’s say you’re in California or something, you’re going to get slapped hard. You’re going to be over 30% tax bill and they know it.
Qualified opportunity zones enable you to avoid some of that in certain situations, but you’re still going to be paying that tax pretty soon in the next few years, no matter what. They’ll all of a sudden start like hey, we need this, this, and this. They’ll start asking for additional things just because they’re unscrupulous and they know they got you over a barrel, so you don’t want to do that.
Jeff: Is there any reason to let the seller know you’re in a 1031 exchange?
Toby: I would advise against it. Sometimes the agents do because they’re like, hey, we’re exchanging. If you’re finding replacement properties with a good person and a good organization, it won’t hurt you to say I’m in a 1031 exchange, because what you’re trying to do is find replacement properties that you know are going to meet a certain criteria and that are going to close in time.
There’s nothing wrong. We work with Alpine a lot, hey, I need to put a million dollars into properties, great. What if I want to sell those properties later? We’ll buy them back for you or we’ll bring another investor in, perfect. They already know that they have an out so they’re going to spread that out and then they may be looking and saying hey, rather than rush, I know I have a bunch of properties. I have 45 days to identify, find a portfolio. They’re wholesaling all day long. They’re just, what about this? What about this? What about this one? And they can make a list up to 200% of the value of your sale. So you could do it.
What else? Sharing the Alpine School. I get mad at Aaron just like anybody else, I get mad at Clint sometimes who has been my partner for twenty-something years. Alpine is actually doing an excellent job. We work with him on the Infinity side. What I look at is results. All I care about is are they getting people good cash flow properties? Are people making money?
If the answer is yes, then I like them. If the answer’s no, then I give them a hard time until I like them. Yeah, they said he does. How can I say that? Aaron’s a good dude. The more I get to him, the more I appreciate where he’s coming from, his heart. At the end of the day, it’s not about the money, at least not for me.
Somebody says he is a smart guy. He is a very smart guy. We introduced him to Don, so we said, hey, Don, you should talk to him. We’re always looking for good properties, good deals, and they really do that. He’s not here this time. Oh, he should be. Don? I think that’s it. Let me see. Are there any others?
Jeff: One more.
Toby: There’s one more? No, I think that’s it. Was there another one?
Jeff: I thought there was?.
Toby: Let me see. I’m going to look and see if I missed one. What was the one I missed? Do you remember?
Jeff: About the income coming out of a partnership and wanting to allocate it to the wife when the partner—
Toby: Oh, there was that one? Then there was the dependent versus…
Jeff: Yes.
Toby: Let me see if I screwed up something here. Oh, maybe I did. Sometimes I screw up. So we’re going to go back up to the top. Oh, that’s the one I missed.
“A Florida LLC with members consisting of my wife and three of my children made a profit of $65,000. My wife does not have any taxable income, would the profit be protected from tax if it was paid out in full to my wife?” What say you, Jeff?
Jeff: First off, I’m going to start with the LLC agreement that determines how income is allocated to its members. It can be adjusted. You just have to do an addendum to the agreement, changing the allocation. The one thing I kind of know is, say if you’re 40% owner, and she’s 40% owner, there’s really no advantage that I can think of allocating that income to her.
Toby: If they’re filing a joint return, it won’t matter—
Jeff: If you’re filing a joint return and if you’re thinking about a married filing separate return, there are disadvantages to that.
Toby: Yeah. They’re adding up your income and your wife’s, but your children, if they made money on this and it’s ordinary income, like they’re maturely participating and they’re not passive. If it’s passive, chances are it’s getting allocated back to you anyway. If they were actually doing something for this money, oh, my goodness, let them pay tax on it because they have a standard deduction of $12,000, is it $12,550 this year?
Jeff: That was where I was going to go. I would prefer my children to have 50% profit interest in this because they’re going to have an income of just short of $10,000 each or just over $10,000 each, and they’re not going to pay a dime of tax on that.
Toby: Zero. They might have a little self employment tax if they worked hard on it. Usually, if I’m doing an LLC and doing a flip, I’m going to make it an S-Corp and then I would pay everybody, you’re going to have a little bit of employment tax, but they’re not going to pay any tax on whatever they get paid. Any of the money that comes out to them, they probably won’t pay much of anything on tax and they could fund a Roth.
I remember doing the numbers. If you give somebody 50 years of untaxed growth, they’re going to be probably over $700,000. I think it was at 10,000 at 7% over that long stretch. I’ve seen the numbers, it’s just a huge amount of money. So you just set up a whole great retirement for those kids if you do it now. When I see the wife’s not making anything, well, are you married? If you’re married are you filing jointly? Because what she makes just gets added into yours.
“What is more beneficial, to claim or employ dependents? What are the requirements for employing dependents?”
Jeff: One typically has nothing to do with the other. You’re always going to claim your dependents, any children, any dependent that you’re providing more than half the support. The only interplay between these two would be if you’re providing so much. You’re employing them, and paying them so much in W-2 that they’re able to support themselves.
It’s not an either-or question. You can employ your dependents and still claim them. I’m thinking primarily for children, but there are also other dependents, too, that this would work.
Toby: You have a massive tax credit right now coming out. If they’re under […] $3600 a year. If it’s $2000 a year, if it’s 17 […]. If they’re your beneficiary, great. But also, then you can pay them. It’s the same rules. It’s $12,550 that they can make tax-free, so do both because the tax credit isn’t dependent on anything other than your income. You have to make sure you don’t phase out for it, but it’s a tax credit. Tax credits are worth their weight in tax dollars. It’s not a deduction, it’s a tax credit, like it’s a dollar for dollar. It’s like taking your bill and lowering it.
Jeff: When we talk about claiming dependents and their support, we’re talking housing, education, feeding them, everything that you could possibly spend on these children or that they use.
Toby: Or dependent like a brother or sister you’re taking care of, or mother, if you’re providing more than half their support and they make below $16,000 then you get to claim them as a dependent.
Jeff: Yeah, I think it’s actually much less than that. I want to say it’s under $4000.
Toby: Yeah, I think you’re right.
Jeff: “What are the requirements for employing dependents?” They actually have to be doing something for the business because you’re employing them. You can’t just say, oh, my child is my employee, even though this child has never done anything.
Toby: All right. Let’s get these guys gone because I’ve gone over again. I was thinking ah, hope we can fill up the hour, which has never happened. We’ve never not missed the sad part. I don’t think we’ve ever finished early. Someone says never. Sherry, you’re hurting me right here.
Subscribe to Anderson on our YouTube channel. We’re always putting stuff out. We love it. We’re going to end up doing these on YouTube live because we want to just get more and more people that we can help. We don’t care whether they give us your email address anymore. The way I look at it is just share and help, make life easy for yourself.
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Thank you, Elliot, Dana, and Troy. You guys kicked butt. We were keeping up with all the Qs. They blew them all out of the water in the middle of tax season, the fact that they still have mental acumen, the ability to answer unless it was all smiley faces, frown, maybe an emoji or two if. Unless all their answers were emojis, I’m going to say these guys absolutely killed it because I was watching them typing away. You guys can’t see.
We don’t have sharing with the chat. It’s always somebody who solicits like hey, I got a great business opportunity. We don’t want that going on in our chat rooms. I can see these guys answering the written questions. As long as they’re able to still write and they’re answering things coherently, then that’s great.
Otherwise, thank you for joining us for Tax Tuesday. Jeff, thank you for being a rock star and joining us today before a tax deadline. Appreciate Troy, Elliot, Dana, Patty there, and Ander who does the tech, so thank you guys.
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