In this 201st episode, Eliot Thomas, Esq., hosts, along with Jeff Webb, CPA, Vice-President of Professional Services at Anderson Business Advisors. The looming filing deadlines in September and October are almost here, but we’ve still got our experts online to help answer your questions. In this episode, you’ll hear answers to questions about HELOCs, when to take social security, the Augusta rule, bad debt, and legacy planning tools, to name a few. Submit your tax question to taxtuesday@andersonadvisors.
Highlights/Topics:
- “What’s the best structure for a management company? C-corporation or partnership? Also, if you were not concerned with obtaining loans, is it more advantageous to have a holding company as an S-corp or a partnership?” – My rec is C Corp, not partnership, the downside is creating passive deductions and income at the same time…and anytime you take those properties back out, and sometimes you have to do that to refinance, that’s a taxable transaction.
- “I have a HELOC on a rental property. I used the funds from it as a gift for a down payment on a home purchase for a family member. Can I use the HELOC interest payments as part of an expense for the rental property?” – You shouldn’t be gifting money from your HELOC. Can you take money out? Yes, but it’s a distribution; it’s not a gift.
- “I’m getting ready to retire in three years. I own a small business that’s a sole proprietorship. As a single proprietor, when I receive social security, will this show up as personal income?” – What you don’t want to do is start taking social security before your full retirement age while still earning money from a wage or from self-employment.
- “Can you use the administrative office and Augusta rule deduction? Or is that considered double dipping when purchasing a property? – commonly referred to as 280A. That’s the corporate meetings. You can rent your house out for 14 days a calendar year—no more—and the income that you receive is tax-free.
- How does bonus depreciation affect a present tax bill for back taxes owed to the IRS? So if we took bonus depreciation in the current year without […] with the prior liability I have with the IRS.” – IRS will keep taking your refunds before they ever touch your bank accounts until they have that back liability paid up.
- “We made a $5000 business loan. The business shut their doors. How do we document this bad debt? Is it bad debt loss or is it a tax write-off?” – Yes, it is a write-off, but the question is, how do you write off…
- “Is a charitable remainder trust a good legacy and tax planning tool?” – I like the CRUT (Charitable Remainder Unitrust). It’s considered a split-interest trust. The tax returns are very complicated. Don’t ever, ever, ever try to prepare one yourself.
- “I bought a house last year with the intention of renting it out. I bought rental property insurance and never lived in it. It was so expensive to repair everything that I sold it before I could rent it. Can I still deduct my expenses on my taxes? I read that there has to be income to be deductible, and I didn’t get it to a space where it was rentable. Please help. I wasted a lot of money on this house.” –Your intention was to rent. The more you can have to substantiate that intention, the better off you are…But yes, you would write it off as a capital gain or loss…
- “Could you please explain what basis is? I recently became an S-corporation after 12 years as a sole prop. I can take out tax-free my equity injection of money I put in to start the new S-corp, and the inventory that I basically carried over from my sole prop days into the new S-corp. We have no debt on the S-corp, other than the inventory and cash injection. It owes me back.” – Basis typically is your cost…it could be your entity, it could be a property, it could be any kind of asset.
- “Can an LLC taxed as a partnership write off travel and other expenses to intend to invest in seminars such as Alpine CFS, where one would look at several properties, perhaps commit to purchase? – Basically the code says you cannot deduct the expense of any education that is helping you to do something new, that you didn’t do previously.
- Check out our events coming up later this month.
Resources:
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Full Episode Transcript:
Eliot: Good afternoon. Welcome to Tax Tuesday. I’m Eliot Thomas, manager, tax advisor here at Anderson, filling in for Toby, who’s at another event right now. Joined by our standby, Jeff Webb.
Jeff: Standby.
Eliot: Regular, I should say, not standby. Anyway, regular Jeff Webb. He is our Vice-President of Professional Services. My boss is what I call him. Anyway, this is episode 201. Welcome.
Those of you who know the routine, our questions that we have here today were ones that you sent in. We had over 200 questions that we piled through for this episode. We can only take a sampling of them, but we try and do ones that are very broad, carrying a lot of the interest that you have coming in.
A little bit of information about Tax Tuesday today, some of the rules we have here. You can ask questions live through the Q&A section. Please open that up and you’ll be able to put your questions in there. We ask that you don’t put your questions in through the chat—that’s just for regular commentary—but if you have particular questions, put it in the Q&A.
We have a whole staff here. We got Dana, Dutch, Jared, Tanya, and Troy, all answering questions from our various departments. We are under a deadline right now. We have a big deadline coming up this Friday. Is that right, Jeff?
Jeff: Yeah. Big deadline for passthrough entities. Those tax returns are due on Friday.
Eliot: No long weekend or anything like that to even finish them up. A month from now, October 15th, approximately—I think that is on a weekend so we have a couple of days or so after that—we’ll have the 1040s due. That’s another big deadline. And calendar year in C-corporations on extension. So it’s a very busy time. We have a lot of events going on.
Anyway, we will hop right to it. Again, if you want to email questions, please send them into our taxtuesday@andersonadvisors.com. That’s where we draw the pool from our questions. If you need a more detailed response, something that would require a lot more consideration, things like that, you will need to be a platinum member, perhaps a tax client. But we’ll look through those and do the best we can to answer.
We try and get as much of this information out; as Toby says, bringing the tax knowledge to the masses. Is that what our slogan is?
Jeff: Like Toby always says, fast, fun, and educational.
Eliot: Exactly. This is fun.
Jeff: But a couple of things before we get into the questions. One, we are thankful for those tax people who are helping us. These two deadlines coming up are probably the worst that any tax department anywhere has. This may be a break for them to be doing something else besides working on tax returns just for an hour.
Eliot: Absolutely, it is. It’s a nice mental break for them, but nonetheless, it’s more work for them that we greatly appreciate their efforts.
Jeff: The other thing is as Eliot said, he is head of the tax advising department. And if you are needing tax planning or tax consults, now is the time to start scheduling for that. Our slots tend to fill up fast and we often have frustrated clients because there are no slots available for them because they wait until December to try to find an opening; there’s nothing open.
Eliot: They have until December, don’t they?
Jeff: Yes.
Eliot: Exactly right. We don’t want to wait until the last minute. I’ve had tax consults on December 31st, and I’m happy to do them, but there’s not much help I can provide at that moment. So, just exactly right. Get in there, get your scheduled tax advising sessions in because we will book up fast.
Jeff: And the main goal here is yeah, you can get advising and consults after the 31st, but if there’s anything you need before the calendar year ends, we want to give you time to take our advice or suggestions and get that accomplished.
Eliot: Exactly. All right, with that, looking at our questions, the opening questions, we’re just going to run through the questions first, then we’ll come back and answer them all.
“What’s the best structure for a management company? C-corporation or partnership? Also, if you were not concerned with obtaining loans, is it more advantageous to have a holding company as an S-corp or a partnership?” A lot of issues to tackle there. We will come back to that one.
Second question, “I have a HELOC on a rental property. I used the funds from it as a gift for a down payment on a home purchase for a family member. Can I use the HELOC interest payments as part of an expense for the rental property?”
Number three, “I’m getting ready to retire in three years. I own a small business that’s a sole proprietorship. As a single proprietor, when I receive social security, will this show up as personal income?” Certainly address that one.
Next, “Can you use the administrative office and Augusta rule deduction? Or is that considered double dipping when purchasing a property? How does bonus depreciation affect a present tax bill for back taxes owed to the IRS? So if we took bonus depreciation in the current year without […] with the prior liability I have with the IRS.”
Next, “We made a $5000 business loan. The business shut their doors. How do we document this bad debt? Is it bad debt loss or is it a tax write-off?”
“Is a charitable remainder trust a good legacy and tax planning tool? We’ll talk a little bit about that strategy.
Next, “I bought a house last year with the intention of renting it out. I bought rental property insurance and never lived in it. It was so expensive to repair everything that I sold it before I could rent it. Can I still deduct my expenses on my taxes? I read that there has to be income to be deductible, and I didn’t get it to a space where it was rentable. Please help. I wasted a lot of money on this house.” We’ll certainly try and help you out on that one.
“Could you please explain what basis is? I recently became an S-corporation after 12 years as a sole prop. I can take out tax-free my equity injection of money I put in to start the new S-corp, and the inventory that I basically carried over from my sole prop days into the new S-corp. We have no debt on the S-corp, other than the inventory and cash injection. It owes me back.”
“What is basis and how does that affect any cash I take back out?”
Those are our questions, or one more. “Can an LLC taxed as a partnership write off travel and other expenses to intend to invest in seminars such as Alpine CFS, where one would look at several properties, perhaps commit to purchase?
Same question about the cost, the fee to attend, mileage associated with local real estate investor meetups, where we talk about specific deals and opportunities. If and how we can deduct those?” I think that is the gist of that; we’ll get to that.
Before we begin, just a reminder, we have Toby’s YouTube page. This is what it looks like and you can subscribe. Toby puts out a lot of videos. He’s well over 600 right now. A lot of good information there. Always recommend taking a look at that.
Jeff: And Clint also has his YouTube channel.
Eliot: Yup. I guess we don’t have a page for that, but yes, we have Clint’s as well. I think Toby kicked them out of the slides here. Clint has one as well. Lots of great information about structuring and asset protection that Clint always has there.
In general, at Anderson you can subscribe to our YouTube page here at aba.link/youtube. Got a lot of replays, including this event. Just tons of video content up there, so all kinds of things.
Jeff: If you miss a Tax Tuesday, you’ll usually find the questions broken out into the YouTube.
Eliot: Yeah, they section them off sometimes. Or we’ll have spacing in them. So, a very good resource. A lot of good information out there.
All right, first question. “What’s the best structure for a management company? C or partnership? Also, if you’re not concerned with obtaining loans, is it more advantageous to have the holding company taxed as an S-corp or a partnership?” What say you, Jeff?
Jeff: This question felt like it had a little confusion between the management company and the holding company, so I’m going to hit that real quick. The management company operates just like any third-party property manager would. You’re paying that company a fee, even though it’s your own company, to manage your properties or your entity or whatever it may be.
If it’s rental property, it’s going to manage the properties and may receive the income, pay expenses and stuff like that. But that income and expenses are not that management company’s expenses. Their income is what you pay them as a fee.
The holding company is quite different. The holding company usually holds the properties in some form or fashion. Typically in LLCs disregarded to the holding company, is that how you see it most often?
Eliot: Exactly right.
Jeff: So that’s the real difference between this. I’m going to go ahead and answer the second part about which is better. My recommendation for a management company is a C-corp, not a partnership.
I personally don’t like the partnership because when you pay a management fee to a partnership, you’re just taking money out of one pocket and putting it in the other. The downside of that is you’re creating passive deductions and non-passive income at the same time, so it could really play against you.
What about the holding companies? Whoever asked was S or partnership or?
Eliot: We often talk about the holding being a partnership because it is more advantageous for loans. If you’re not concerned about that, would we make it an S-corporation? No, we would never do that. Why? Because you never, ever put appreciable rental property into a corporation, S or C.
The one exception that we have out there is if you’re selling to your S-corporation because you have a personal residence that’s gone up over the section 121 exclusion. That’s a very rare situation. We don’t run into that a whole lot, though it’s a very popular topic; we answer a lot of questions about it. But here we’re just talking about traditional rentals and those go up in value. You never want to put them in a corporation. Why do we not want to put those into a corp?
Jeff: Because anytime you take those properties back out, and sometimes you have to do that to refinance, that’s a taxable transaction. Your basis is cost, but you’re going to have to pay the tax on the difference between basis and fair market value. We would rather you not do that.
Eliot: Yeah, as we always say, it’s so easy to get things into a corporation, very difficult to get them back out without paying taxes. We would never do a holding as an S-corp or C-corp, heaven forbid. We’re going to keep it as a partnership or disregarded to either one.
As far as the management corp, I’m with Jeff. I’m not even a fan of using an S-corporation as a management corp. Jeff and I talk about this a lot. It’s one of the things we do agree on. C-corp’s really nice because it’s a separate taxpayer. It has a lot of better deductions and reimbursements that we couldn’t do with the partnership. We got the accountable plan which leads to the administrative office.
Jeff: The 105 plan.
Eliot: Yup, medical reimbursement plan, the 105 plan. And corporate meetings under 280A. There are a lot of things that we would do on the C-corp that we have available to us that just wouldn’t be available to you if you did it on a partnership.
To be sure exactly what Jeff pointed out, if that management fee that it earned went to the partnership, it could have been that it was just passive rental income. But now you put it through a partnership and when it comes out, it’s going to be taxed with extra employment taxes. So just another reason not to use a partnership.
Jeff: Now, in regards to the holding company, there’s actually a third choice here that wasn’t mentioned. It doesn’t have to be S, it doesn’t have to be a partnership. It can be disregarded to you. If your properties are owned by just you or you and your spouse in a community property state, and you’re not concerned about loans, I don’t think I create a partnership. I don’t see any reason to do that.
Eliot: Yeah, It’s just an extra return?
Jeff: It’s an extra return, it’s an extra cost. I probably skip that if you qualify.
Eliot: Very good point. Hopefully I helped out. Excellent question. Moving on to the next one.
“I have a HELOC. I put it on a rental property. I used the funds from it for a gift, put it as a down payment for a home purchase for another family member. Can I still take interest payments as a deduction for that expense on my realty?”
Jeff: First off, you have the HELOC on the property. That’s great. But then you took money out for personal use for a gift. You have now, in my opinion, tainted your relationship with your LLC, your entity that’s holding this property. You’re mixing assets.
You shouldn’t be gifting money from your HELOC. Can you take money out? I think that’s probably okay. It’s a distribution; it’s not a gift. Can you use that HELOC’s interest from that gift? No. That’s strictly forbidden. It’s not like the mortgage on a primary residence. You don’t have to use it to improve or build or whatever your home. But it has to be used in that business.
Eliot: Yeah, in a business at the very least. Gifting, I would say, takes it out of the picture. You take the HELOC on the rental right there, you haven’t done anything wrong. You even take the cash out arguably and go buy another rental or put it into some business. I think some preparers would say at least you can trace the funds and still take the interest reduction somewhere, if not on that rental property, at least on the business where you used it.
But here, we didn’t do any of that. We took the funds and we gave it away as a gift. Well, now we can’t deduct that. No, we cannot deduct the interest on that portion of the debt.
Jeff: And what Eliot was saying is, if you’ve heard of the BRRRR method (buy, rehab, rent, refinance, repeat), the idea behind that is you buy a property, you start making money, it goes up in value, you refinance it, or like in this case you get a HELOC, and you use the money from that property to buy your next property.
Eliot: Yeah, that’s fine. As you’re tracing it, it’s still used for a business purpose. By here we throw in that word ‘gift.’ If we gifted it away to someone else, then we lose the ability to take a deduction against, at least that portion.
Jeff: How do you fix this, Eliot? Do you put the money back?
Eliot: That’s what I would try and do if I could, yeah. That would be my guess. I would get that paid off, at least that portion of it so that we could use that HELOC for business-related investments and things.
All right, moving on. Next, “I’m getting ready to retire in three years. I own a small business as a single proprietor. As a single proprietor, when I receive social security income, will this show up as personal income?” Any ideas there, Jeff?
Jeff: It sounds like by retiring you mean you’re just going to start taking social security and still run your business.
Eliot: That’s why I took it.
Jeff: That’s all fine and dandy if you are at full retirement age. What you don’t want to do is start taking social security before your full retirement age while still earning money from a wage or from self-employment or stuff like that.
The reason I say that is there’s a floor, I think it’s $18,000 or $19,000. If you make above that and earn income, for every $2 above that, social security will reduce your income by a buck.
Eliot: So we’re going the wrong way as far as getting social security. In any income that you have, be it a sole proprietorship, and your social security is all subject to tax.
Now, there is a little bit of a leeway. If all you had was social security and it wasn’t that much, there’s a chance that maybe none of it was taxed or at least a very small amount. But the more you make, they tax a higher percentage of your social security income up to 85%. Any income that you add will be put into that calculus.
Jeff: I sometimes tell a mom story. My mom was used to not paying tax on her social security. However, she sold her property at a nice profit. And that caused her social security to be taxable. Not only does she have a little higher tax bill because 85% of her social security is now taxable, but I also have to deal with an irritated mom and try to explain to her why it is taxable.
Eliot: Don’t you love those family conversations about tax when you do tax? They won’t talk to me the rest of the year, but when they’re interested about their taxes, oh, let’s talk to Eliot.
All right. Moving on. “Can you use the administrative office in Augusta rule deduction? Or is that considered double dipping?” Can I do both of those?
Jeff: What’s the Augusta rule?
Eliot: That is what we commonly refer to as 280A. That’s the corporate meetings. You can rent your house out for 14 days a calendar year—no more—and the income that you receive is tax-free.
Jeff: Did this have to do anything to do with the Masters?
Eliot: It did and big business still does. Rents out all those houses around the Augusta Golf course. What would happen is that they came and they wanted to be able to deduct it.
One thing we got to say for typically in the tax code, they try and have an equity balance of things. If they were going to give big business a deduction for that, they had to do something for those who are renting out the houses, that is the common taxpayer. They said, okay, well you can do that for 14 days and we won’t charge taxes against you on it. That’s where it all started from.
Jeff: The person who asks this question probably wants us to answer his question. When you do an administrative office, it’s for a specific amount of space that is used regularly and exclusively in your business.
In my case, it used to be that I have one of my bedrooms I use for office work. It doesn’t have to be your principal place of business, but it does have to be something you’re using in your business regularly and exclusively, meaning you can’t use it for anything else.
Eliot: And you do your administrative function from there.
Jeff: The Augusta rule says you’re actually renting out a portion of your property to somebody who wants to rent it for 14 days or less. If you’re saying the Augusta rule or the administrative office is your entire studio apartment, you’re not going to be able to use the Augusta rule, too. But if it’s just a portion of your property, maybe one room in a five-room house, you can use the Augusta rule, absolutely. You’re not really doubling up on deductions because you’re saying, this is my administrative office, but I’m renting this out to my corporation or whoever.
Eliot: Exactly. An example, those of you who’ve had a two-year review or something like that with me, I always give, I just had a thousand square foot home or apartment, got the back bedroom, that’s a hundred square feet. That’s where the administrative office is that’s just talking about. That’s where I use it exclusively on a regular basis as my administrative function for that business. I can take a reimbursement for that from my corporation.
Now, mind you, I am not renting that from my corp. I’m just using it as an employee on behalf of the benefits going to the corporation that I work for, and that’s why I can get reimbursed.
The Augusta rule is saying, now, if I’m going to have a corporate meeting, I’m going to rent out some other part of my house, and that’s going to be my kitchen, my family, my living room, my basement, wherever I’d have people congregate for a meeting, but it’s not going to be in that office. It’s very important that we distinguish the two. You can do both, but you got to keep them separated.
Jeff: Some people will say, well, this administrative office looks a lot like the home office. It does. You can be reimbursed for your depreciation on that administrative office.
One of the big differences between the administrative office and the home office is you’re required to take depreciation on the home office and it gets recaptured. You hear us use that word all the time. For administrative office, you get reimbursed by your entity for your administrative office. That includes depreciation, but that depreciation does not get recaptured.
Eliot: You’re not the one taking the deduction. The entity is. As a homeowner, you’re not deducting anything. You’re simply getting reimbursed. To come up with that reimbursement value, you’re simply putting that into an element of depreciation into the calculation, but you’re not taking depreciation. There is a distinction.
It’s just one of the reasons that having an S-corp or C-corporation, we do it on either one of these. It’s just such a superior method so many times because you can do administrative office, you can do Augusta rule, you just got a lot more working for you.
Next, “When purchasing a property, how does bonus depreciation affect a present tax bill for back taxes owed to the IRS?”
Jeff: The reason we’re talking about bonus depreciation here is because it usually will increase your refund or create a loss or, or so. So I’m going to bypass that. The real question is if I have a deduction that creates a larger refund for me and I owe back taxes, what happens? Simply put, the IRS is going to take that refund.
Eliot: I think we can all guess what’s going to happen there. Any refund that you have in the future, if you owe the IRS from (say) 2020 $10,000, if you had a refund in 2021, they’re going to take that first before you ever see it. If you get a refund in 2022, same thing. They will keep taking your refunds before they ever touch your bank accounts until they have that back liability paid up.
To the quick question, just exactly as Jeff, we’re not going to get into the details as Jeff said, but any deduction which could be from bonus depreciation that creates a loss that gives you a refund of some nature, they’re going to use that refund to help you with your back liability, maybe it pays it off, and then anything above that would be refunded.
Jeff: I had a client years ago that I asked if he wanted a check or direct deposit for his refund, and he said, don’t matter. I’m never going to see that money. The reason I bring that up is his wasn’t money owed to the IRS, his was child support payments he owed. If you owe money to the state, the IRS might be involved. What are those called? Setbacks or…
Eliot: I just call it no refund. I don’t know there’s a term for it.
Jeff:. There are a number of items that if you owe any government agency money, it could hit your IRS refund.
Eliot: Yup. Hopefully, that helps clear that up.
All right. Moving on. “We made a $5000 business loan and the business shut down their doors. How do we document this bad debt loss? Is it a tax write-off?”
Jeff: There are two answers here. Yes, it is a write-off, but the question is, how do you write off? In this case, you made a $5000 loan to another business. Are you in the business of lending money? Why does that matter? Because if you’re lending money and you don’t get the money back, that’s what your business is. It’s a bad debt. It gets written off in the year of loss. You have to make a concerted effort to write off this debt.
If you’re in the business of real estate and you make a loan with your extra cash to another business (which is perfectly fine), and they don’t pay you back, it’s not a business bad debt. It’s called a non-business bad debt because that’s not what your business is. You’re not in the business of lending money. Yes, it is still deductible, but unfortunately as a capital loss. If you’re familiar with capital loss, the most you can deduct of a capital loss is how much?
Eliot: $3000 currently because it was never adjusted for inflation over the last 20–30 years.
Jeff: Oh, at least.
Eliot: Yeah, and I just saw Jeff when we were looking at this. About two years ago, I was taking a break between platinum questions and I did a little calculation. It was something like $5000 a day would be worth close to $30,000 if they had adjusted that. But nonetheless, you’re going to be limited to $3000 loss each year of cap loss against ordinary income.
But it’s $5000, so the good news here is that $3000 will eat well into that. You just may not get the full $5000 immediately in the first year. You’d get it the next year, the additional $2000.
Now, they ask about the documentation. This is something we get. I would say, to any kind of bad investment, bad loan, anything bad like that, you want to document that you’ve tried to get it. All those emails, all those phone calls, document, document, document. All the times you reached out. Any and all responses. Hey, yeah. The checks in the mail or whatever, you’ve heard from them.
Any court proceedings that show that this actually was finalized and adjudicated to show that this is not coming back. Or if it was a BK that it’s bankruptcy if they’ve dissolved it. Anything that shows that there’s really no chance that you’re going to get paid. That’s what we’re looking for, documentation.
Jeff: If it’s a loan to a company, and the company just shut down and walked away, I would at least do a certified letter chasing this money. Some people are going to suggest you need to do even more than that. The IRS is saying you have to make an effort. We’re not just going to let you write it off.
Eliot: Yeah, and just because you say so. You want to, again, like anything, document anything and everything that you have showing that you’ve tried to get it, and that there’s really no substantial chance that you’d ever get it back later on.
It almost falls along the same reasoning that they used for (say) Ponzi schemes and things like that. You got to show that it’s not coming back and there’s good reason to believe so.
Jeff: Yeah. Bankruptcy actually makes it much easier.
Eliot: That pretty much says it all right there.
Jeff: If you’re lending to your children, you know you’re never getting that money back.
Eliot: My parents were still waiting, and that’s not happening.
All right, next. “Is a charitable or remainder trust a good legacy and tax planning tool?” What say you?
Jeff: I like the CRUT (Charitable Remainder Unitrust). It’s considered a split interest trust. There’s actually a whole bunch of them. There are CRITs, CRUTs, GRATs, GRUTs, and CLUTs (Charitable Lead Trust) instead of a remainder trust. On and on and on. But we’re talking about CRUTs because I think they’re about the most prevalent.
I’ll start with the legacy part. What’s your thoughts about the legacy?
Eliot: Well, I like it. I can’t remember which of all the different acronyms that Jeff just went through. There is one I will say that I have found that is actually on the IRS’ dirty dozen list. I apologize I don’t remember which one it was, but I was looking at that for another item that happened to be on there, monetary installment sales agreements, just to see if it was still on there. I knew it was, but I checked it anyway.
I would look to make sure which charitable remainder trust you’re using because there are different varieties. I think they’re a good idea. You put money in, you get a certain deduction like putting into a charity because that’s what you’re doing. You get some payments over the years coming back to you. Then at some point it ends, and all those assets or whatever, if they’re sold, whatever, the capital of money goes off to a nonprofit. It’s a nice tool to use.
Jeff: Here’s how a CRUT works in particular. As Eliot said, you contribute an amount of money to your charitable remainder trust, let’s say $100,000. You might get a deduction for (say) $70,000. The reason for that is each year that you remain alive, this is why it’s called split interest. Charity’s going to get part of it, and you’re going to get part of it, the money that’s in there.
Depending on your age, there are different percentages. It’s 2%, 4%, 6%, or 8% that you get back every year from that trust. We’re talking about the percentage of assets. The tax returns are very complicated. Don’t ever, ever, ever try to prepare one yourself.
You are going to get a portion of this money back and it may be income to you. If the CRUT had a profit and you have a distribution coming that’s required, you’re going to get a K-1 with your share of the income from that. Hopefully, you’re investing your CRUT assets in assets that are going to continue to grow in value. You never run the money out, unless you live to be 150 or something like that. Overall, I like the idea of it.
Eliot: It can be a good tool in the toolbox that we use. We use a lot of different things. This is one nonprofits themselves. Maybe we have clients who do both. It’s something that we definitely put it up there as an option. It just depends on one’s particular situation. We certainly wouldn’t scratch off and say, no, we’d never do that.
Jeff: And this is one of those weird ones, because we always talk about nonprofits and pension plans, IRAs. You can’t make money off of them or you can’t have personal benefit from them.
This is the exact opposite because you’re controlling the investments, how much income it is to you. The more value your assets have in that CRUT, the bigger your distribution is going to be next year.
Eliot: You get a deduction putting it in, you get a stream of income coming out. In the end, it’s a charitable contribution. It’s a nice tool. It is. You just want to make sure it’s right for you.
Jeff: Yup.
Eliot: A little reminder here is Clint with the Tax and Asset Workshop coming up here. We have the live one here in Vegas this week, actually starting Thursday through Sunday, September 14th through 17th, over at I think it’s at the Virgin Hotels, the Old Hard Rock. It’s been remodeled.
And then some virtual events coming up here is September 23rd, online, one day, and as well as on the 28th. So a lot of activity. I think we’ve nearly sold out the Vegas event here. A lot of people coming into town were excited. I know a lot of our colleagues are going to be there too, and they’re anxious. This is a great time to meet with the clients face-to-face. Those who are coming, please by all means enjoy and have a great time. We wish you the best. Safe travels.
Jeff: And this Tax and Asset Protection workshop is a great example of how these partners work together. They both know a lot of stuff. I think Clint’s a little stronger on the structuring side and Toby’s a little stronger on the tax side.
Eliot: They’re both strong on both.
Jeff: But they’re both strong on both, absolutely. That’s what I was thinking. And they really play off of each other, sometimes in a bad way. But they really play off each other in these workshops and all. If you haven’t been to one, I know we used to require everybody that worked here to go to them.
Eliot: Yeah. We’re just bigger now, so we couldn’t fit everybody in there.
Jeff: We’d have to have our own workshop. Please sign up. I think Patty’s provided information, but you can also find us on the website, I believe.
Eliot: Absolutely, andersonadvisors.com and get up there. We have all kinds of things. Again, this is just for the month of September. We have a lot more activity going on. There’s a structure implementation series workshop, learning a lot about how compliance of all the things that we set up. But this is the big one, these live events. I’ve never heard a bad comment from a client about it. They always love it. Hopefully, you can get there. Love to see you.
All right, next. “I bought a house last year with the intention of renting it out,” so we got a rental. “I bought rental property insurance, never lived in it. It was so expensive to repair everything that I finally sold it before I could rent it. Can I still deduct it and my expenses on my taxes? I’d rather there has to be income to be deductible and I didn’t get to it to be rentable. Please help. I wasted a lot of money on this house.”
Jeff: No, you don’t need income to have a deduction.
Eliot: Yeah. Not a thing at all about that.
Jeff: Your intention was to rent. The more you can have to substantiate that intention, the better off you are should you ever come under audit. I don’t think it’s going to be an issue. But yes, you would write it off as a capital gain or loss, depending on if you got a gain or loss.
Eliot: Yeah, the sales price. Whatever you bought it for, all the repairs, all that’s going to your basis, and you would simply subtract that dollar amount from whatever your sales price is and your selling expenses. That’s going to determine what gain, if any, or loss you had. And because it was your intent to rent, it’ll probably be a capital.
Now, if you changed your mind and decide, no, I don’t want to use it as a rental, and I decided to flip it. Well, that’s a little bit different. We would call it active income subject to employment taxes. Either way, though, you’re going to be able to deduct that amount you put into there.
The idea about there having to be income to be deductible. I think where you’re getting that from is the idea if you’d lived in it. If it had been your house, we do have something called the vacation rental rules, and I think that’s where maybe you heard some of that talk. That’s not what we got going on here, so it’s not related to your question.
That would be if you had a second house and you stayed more than 14 days in it, let’s say it’s a vacation, but you also rented it. Well, if you stay there too much personally, the rules say that you can only deduct expenses up to the amount of rental income you have.
I suspect that’s where you’re hearing that, but that is not what you have going on. In this case it’s a rental, and as you note here you never lived in it, so we don’t have any of that going on here. I think that was that deal.
Jeff: I’m going to be a bad person here.
Eliot: There you go.
Jeff: Something we talked about earlier.
Eliot: Be your old self there, Jeff.
Jeff: Let’s say, if I sell a gain, it’s capital gain, and I want capital gain. Let’s say I bought this house for $400,000 and I put in so much. I put $200,000 into it trying to fix it up. There’s no way I’m selling this at a profit.
Eliot: Not going to lose.
Jeff: I’m losing money. As we discussed before, capital losses aren’t great.
Eliot: We saw that earlier in one of our earlier questions. You’re limited to $3000. Unless you have a lot of capital gains, there could be a play there, but what if you don’t?
Jeff: And this is the only property you have that’s actually important. Could I call it a flip? And why would I want to call it a flip?
Eliot: Well, if you change your intention, that’s going to be a flip. Then you have a loss on a flip. That’s an ordinary loss. You’d be able to take all your income, your loss that year, maybe create a net operating loss, just depends how much income you have. Nonetheless, that’s typically a far better situation in capital gains.
But if you got under audit, you’re going to have to explain to the IRS or document how you changed it. Was your initial intent was to rent it? And now you’ve got to show where you change your intent to flip it. That may be easier said than done, but that is a situation that you have available there. With that, we’ll move on.
“Can you please explain what basis is? I recently became an S-corp after 12 years of being a sole proprietorship. I can take out tax-free my equity injection of money I put in to start the new S-corp and the inventory I basically carried over from my sole prop into the new S-corp. We have no debt on the S-corp other than inventory and cash injection it owes me back. What is basis and how does that affect any cash I take back out?
Jeff: Basis typically is your cost in whatever it is. It could be your entity, it could be a property, it could be any kind of asset. For example, your basis in cash is almost going to be whatever the face value of the cash is. Your basis goes up by money that you put into that asset or money you take out of that asset.
Now, if it’s a business or a property, your basis is going to change on a property by depreciation. If it’s a business, like an S-corp or a partnership, your basis is going to change based on a couple of things. Profit and loss of the business will change your basis. Also, money you contribute and money you take out of the entity will change your basis. We never want that basis to go below zero because that creates taxable capital gain. Now tell me your reading of the gist of this question.
Eliot: The first thing I want to address is towards the end there, the second to the last sentence. We have no debt other than what it owes me. S-corporation doesn’t owe you anything. You put assets in that gives you your shareholder basis in the S-corporation. It’s not a loan. It doesn’t owe you that. That is what you’ve contributed to it.
However, you are allowed to take that amount back. If you ever sold it, you’d be able to take that amount in cash back or something like that. So it’s not like you don’t have value there. You do, but it’s not a loan.
When you put those assets in, it goes in at the basis that you had as a sole proprietorship. If you put inventory in, as well as other equipment, all that at whatever is your basis was at those items as a sole proprietor, go into your basis as your shareholder stock basis. Any income that you have over the years raises basis. Any losses you have, lowers basis. Any expenses, out, gains, losses, it goes up and down. It’s a moving target, what your overall basis is.
Now, can you take out? Again, you’re allowed to take those out, but I don’t know how you would do it. Because if you put assets in not cash, you have no cash to take out in the business. If you make income, you made $1000 of cash, well your basis went up. So yeah, you can take that a thousand now. You still have to pay taxes on it as far as the income, but you could take any additional cash out as a basis distribution. But it doesn’t owe you, it’s not a loan.
Jeff: Don’t loan money to your S-corporation. Just contribute to it. You gave me an example earlier today that I take my assets from my sole proprietorship. I got $1000 in cash, $3000 in equipment or whatever. And I contribute that to the S-corporation. But why does that limit how much I can take out?
Eliot: In and of itself, that doesn’t. You have now $4000 shareholder basis, one of them being $1000 in cash. You could take that cash out, but you don’t have anything else to take out other than the equipment itself, which you just put in, so that would be illogical. Why would you just put it all in there in your new S-corp just to take it back out?
I think what you’re going to learn in time is that you’ll never really take out what you put in. In time if you ever shut down or sell your S-corporation, then that is all going to come to your aid in reducing a deduction against whatever your sales price is, because that’s your shoulder basis.
Jeff: So if I have a sole proprietorship, the first thing I’m going to do is I’m going to wrap an LLC around it.
Eliot: Absolutely.
Jeff: But as far as distributions from the sole proprietorship versus the S-corporation, I was going to say there’s no difference. But actually you have a little more freedom in the proprietorship, what you take and put in.
Eliot: That is true.
Jeff: What would be a good reason to change from sole proprietorship to an S-corporation?
Eliot: If we’re looking for a monetary benefit here, your S-corporation, as we talked about earlier, it’s got a lot better deductions that you could never do as a sole prop. You can do that administrative office, which falls under what a bigger item we call an accountable plan, just a fancy IRS term for reimbursement.
You can be reimbursed for mileage, for administrative office, cell phone, internet, things like that, as well as have 280A corporate meetings in your house, get paid a little bit tax-free to your deduction to the S-corporation.
We want real meetings. We’re not just doing this to shank the IRS or anything like that. We want to make sure we have a good meeting, and so on and so forth, people there, et cetera, topics to be discussed. But all those things you couldn’t do as a sole proprietor.
Jeff: Toby and I talked about this a couple of weeks ago, that until you’re making at least $20,000–$25,000 in profit a year, it really doesn’t pay to turn your company into an S-corporation, because you’re going to end up paying more in fees and tax preparation. What we’re doing there is comparing the new fees on the S-corporation pretty much to what might be self-employment tax on the sole proprietorship.
Eliot: We do see as a rule thumb, everyone, you talk to different CPAs, they all have a different one, but anywhere from 20 to 50 is what I’ve heard.
Jeff: I see 50 a lot.
Eliot: Yeah, but you’ve made the leap. It sounds like you already did it. Once we’re there, just know now that there are a lot of things that you can do to get back as reimbursements and corporate meetings, get money back to you tax-free, that are a deduction to your S-corporation. That’s even better than ever having a loan that got paid back from your scorp. You can’t beat free.
Jeff: Here’s a suggestion for everybody that is considering this. Anytime somebody says, oh, you have a sole proprietorship. You need to be an S-corp or a C-corp, or whatever. The first thing you should always ask, whether it’s our Anderson people or your local CPA or whoever, is why. Why is it going to make a difference to me?
Eliot: Quite frankly, usually that is the answer in S-corp, but not always. And we really have to look at that because it’s not for everybody, but it is for a lot of people, so it is a popular choice.
Jeff: Especially if you’re making a lot of money.
Eliot: Exactly.
Okay. “Can an LLC taxed as a partnership write off travel and other expenses to attend investing seminars such as Alpine CFS, where one would look at several properties and perhaps commit to purchase? Same question about the cost—fee to attend, mileage—associated with local real estate meetups where we talk about specific deal opportunities? We’re moving around, going to maybe education events and things like that. It’s on a partnership, though.” What do we have going on there? Any ideas?
Jeff: If it’s travel expenses for education of something new that you’re doing, it’s not going to be deductible. Basically the code says you cannot deduct the expense of any education that allows you to do something that you didn’t do previously.
If you’re an HVAC guy and you go to find out how these new controls work and all that you’re going to use in your business, absolutely deductible, the whole kit and caboodle.
I see here they said Alpine CFS and they’re going to look at some possible investment properties, but they’re probably doing it with a group. Does it matter if they’re doing it by themselves versus a group of people?
Eliot: I think you’d have to look at what the exact travel purpose was, and if it’s education, again, as Jeff said, for a first year business, you’re not going to be able to deduct it.
Going down the line, you might say it’s a business trip or something like that. I don’t know if I’d call it a seminar on my return, but there’s a little bit more flexibility for continuing education in those types of things, which we might be looking at in that vein if it was past the first year of business or so. We really do these types of deductions on corporations. That we can do pretty much very easily. We don’t like it in a partnership.
You mentioned the part here about seeing several properties and maybe buying one. Cost related to travel to go to see a property that you end up getting, let’s say, as a long-term rental, that all goes to the basis of that property, actually.
Now, you’re putting together different items. We had the seminar part and then we’re looking at properties. It may be for some preparers, they would put that whole thing towards basis. Yeah, you can deduct it, but it’s going to be over 27½ years.
Jeff: You bring up a good point. Let’s forget the whole education thing. I go to San Antonio to look at a property that I’m considering buying. There’s the cost of travel, lodging, and so on and so forth, but I don’t buy. Where’s that cost going to go?
Eliot: Right now, most preparers really just put that aside, and you don’t do anything with it. Now you go a second time down there, and that property you looked at got sold but you bought the one next door to it, and that one you actually bought.
Typically, they’ll take the cost of that first trip, again put it to basis of that second property as well as the trip to that second property to get it, and you’re going to depreciate it.
Jeff: We know how wrong that sounds, but that’s what they do.
Eliot: You don’t have really any argument to do anything different on the partnership, I would say, if you had a C-corporation geared towards business expenses or something like that. That’s why so many times we use a corporate management company, a corporation, C-corp. We don’t like S-corp, but at least a management corporation dedicated for that thing. You might have an argument to put some of that there.
Jeff: A little explanation behind that. Coach O’ Harris talked about the benefits of having a C-corp management company. But there are a couple of other things that come into play, such as if you have a business and you’re not making money and you’re not really trying to make money, hobby loss rules come in.
Well, what happens in a corporation? The IRS doesn’t care how much money you lose because you can’t deduct it anywhere. You can lose $100,000, a million dollars a year, and they’re okay with that. I’m sure they’d rather see you make money.
Eliot: Amazon?
Jeff: Tesla?
Eliot: Right?
Jeff: That C-corp has those benefits. If I throw another expense in there, travel expense, I just make my loss bigger. The IRS doesn’t care.
Eliot: Yeah. You’re not really under the same scrutiny. Now, that doesn’t mean it can’t be a legitimate business purpose trip. It has to be for business. We’re not there trying to get our personal expenses deducted there.
To the follow-up part here, the questions of just fees to attend a mileage associated with the meet-up, if there’s not a reason to be there, you’re really struggling for places where you would deduct this on the return. I wouldn’t even be able to call that probably legal and professional if it’s just a supervisory meet-up just to get ideas.
Jeff: What if I am meeting up with a group for networking purposes?
Eliot: Maybe marketing? I don’t know. Perhaps?
Jeff: Because I’ve seen groups that they’ll have a lender in there, and they’ll have this and that. It’s not all just a bunch of real estate people. It’s different aspects of that.
Eliot: There’s an argument there, I suppose. But again, this becomes so much more simpler if you have a management corporation. We can work with that then. But just strictly talking about deals really isn’t a deduction in and of itself.
Again, if you’re traveling, you’re looking at that property and didn’t get it, and the next time you travel you do get it, remember, you’re going to have to take those costs. You’re going to have to put at the basis of that property to depreciate. It’s not going to be a business expense in the sense that I think you’re looking for. Hopefully, that helped a little bit.
Another thing about partnerships, we always talk about there’s not a reimbursement plan. We don’t set up accountable plans because you have to be an employee. You’re not an employee of a partnership. Just so you’ll go out there and look on Google and whatever you’re googling around. You might see something there.
If a partnership agreement says there are certain expenses a partner pays for themselves, then they can take it as a deduction. But that’s very unique. That takes a specific writing. I think that’s beyond what we’re talking about here.
All right, moving on. Back to Toby. I think that was our last question.
Jeff: Hey look, it’s Toby again.
Eliot: Yeah, Toby. Here’s again the YouTube channel. Please feel free to take a gander and subscribe. Again, look at 275,000 subscribers, 600 videos, all kinds of things going on here. Very good stuff.
Jeff: Here’s my problem with our YouTube channels. Not that there’s nothing good on it, there’s just too much good on it.
Eliot: It’s information overload. It really is. But I don’t think you’re going to slow Toby down. We’ll be looking at 700 videos, probably, who knows, next week or something like that. It is a lot of information, but it’s good information.
Jeff: Yeah. There’s a good chance, whether it’s Toby or Clint’s YouTube channel, that if you have a question, you’re going to find the answer out there somewhere.
Eliot: Absolutely. And again, while they’re both very strong in both departments, Toby really does a lot more towards the tax. Clint takes care of the asset protection and things of that nature. Just a wealth of information. They had their books and things like that.
We’ve got Coffee with Carl that’s still out there, too. Carl’s done a lot of videos there, too, so all kinds of things. And then getting back to what’s coming up here, the Tax and Asset Protection Workshop, four day event starting on Thursday, going through Sunday here in Las Vegas, live at the Virgin Hotels. Then the virtual event on the 23rd and the 28th. Those are free, one-day events, online only. Anything else?
Jeff: No. We’re getting done a little early. I’m thinking maybe the problem of us going over is not me.
Eliot: The changing factor here was me. This is probably my fault that we ended up early. My apologies.
Jeff: We got any questions in the chat?
Eliot: We have only six questions open. Over 112 questions answered. Again, we got Amanda in there. We got Dana, Dutch, Jared, I’m sure we still have Troy, Tanya, and whomever else. I’m sorry I can’t see the rest of the list. Thank you all. I guess that’s all.
Jeff: As I brought up at the beginning, if you do need those tax consults or tax planning, give your tax coordinator a call and then I think that’s who’s scheduling them, right?
Eliot: Yeah. Reach out to your CTC. They’ll get you on the right path, anyway.
Jeff: And get you going. You don’t want to wait until the last minute because either you won’t be able to do what we suggest if we suggest something, or you just won’t get a slot at all.
Eliot: Yeah. It’s going to get really tight in the next couple of months for a time on our schedule, so please reach out so we can help you out as best we can.
Jeff: Yes, the tax advisor’s busy season starts right after the tax department’s busy season.
Eliot: I’d say it started already. Just a reminder, if you’ve got questions, please email them to us at taxtuesday@andersonadvisors.com. This is our website, andersonadvisors.com. We look forward to those questions and we’ll have a bunch for you for Jeff and Toby in two weeks. Thank you.
Jeff: See you next time.
