In today’s Tax Tuesday episode, tax experts Toby Mathis, Esq., and returning guest Jeff Webb, CPA, the CFO of Anderson Business Advisors, discuss some interesting tax questions including questions around gifting your home or property to your children while you’re still alive (tip: don’t do it), passive vs. active income on rental properties, and how/when you’re able to use a loan from your investment accounts to purchase real estate.
Submit your tax question to taxtuesday@andersonadvisors.
Highlights/Topics:
- “Could I still qualify for the Qualified Business Income Deduction for rental activities even if they do not have the real estate professional status?” – Qualified Business Income Deduction, 199A. Could you still qualify for QBI for rental activities even if you don’t have real estate professional status? The answer is yes.
- “I have a question about incurring expenses and paying them with my personal credit card. How do I recoup that money that was used for my business but charged to my personal credit card? My LLC is less than a year old.” The simple answer is yes, you can pay for stuff with a personal credit card and deduct it in your entity.
- “Suppose a Florida LLC has a piece of land bought three years ago and hired a construction company to build a single house when the house is sold.” Can I allocate part of the profit to the sale of the land, long-term capital gain, and the other part to ordinary income?” – You’ve now converted it into inventory that you’re selling, so no. As a matter of fact, it doesn’t play off against ordinary income, it is ordinary income. The entire sale of this property is ordinary income.
- “How do I use my 401(k) or IRA to invest in real estate?” – If it’s an IRA, you need a self-directed IRA, where you’re pretty much the custodian.
- “My husband’s father wants to sign his house over to us. My husband’s sister also owns 65% of the property.” What tax advantages are there for us, his dad, and his sister? And what tax issues does it raise for us? Should we start an LLC or some other structures?” – I’m not a fan of signing over a principal residence to my children. If Dad gives it to you before he passes, he just made it all taxable.
- “What is the best way to use funds from my S-corp to pay taxes? Since the corporation taxes flow through to my personal taxes, I understand I need to pay my personal taxes for my personal account, but the money is really in the business account. Can I use a distribution? And is there a dollar amount limit for such a transaction?” – if you’re profitable and distributing money, you really need to pay some kind of salary.
- “If I elect to aggregate rental properties into one activity, for example, managing, operating single-family homes as rentals and limited partnership interest in a multi-family syndication. What happens if years down the road, one of the assets is sold from the aggregate group? What are the tax and legal implications?” – If I sell a property that I’ve aggregated with other properties, just treat it like any other sale of property.
- “Is it tax-wise to pass on single-family rental home properties before my death to my kids? We have plenty of income, and passing on a few of them to our two kids might even lower our tax bracket. Each rental property is in a separate LLC, and we’ve owned them for 7–8 years now.” – Based on the way we answered the previous question about gifting, I think it’s a bad idea, especially if you had it for seven or eight years.
- “If I elect to aggregate rental properties into one activity, for example, managing, operating single family homes as rentals, limited partnership interest in a multifamily syndication, and electing all of my investment real estate as one activity,” which you can do, it’s called an aggregation election, “what happens if years down the road, one of the assets is sold from the aggregate group? What are the tax and legal implications?” – you wouldn’t aggregate into those circumstances. If you’re going to be selling it soon, but you don’t lose the loss carry forward, you use it against passive income.
- “We have two newly opened short-term rental Airbnbs. We want to do cost segregation and do bonus depreciation for the 2023 tax year. We’re logging our time for the 500 hours rule. I heard that a small business should be taxed as S-corps to save on self-employment taxes, but others say don’t put Airbnbs in an S-corp because they’re passive. What to believe?” – Short-term rentals are a trade or business. If you are materially participating in them, then it’s active ordinary income or loss.
- Send us your questions, and check out the event schedule listed in the resources section.
Resources:
Tax and Asset Protection Events
Full Episode Transcript:
Toby: All right, welcome to Tax Tuesday. My name is Toby Mathis, and I’m joined by…
Jeff: Jeff Webb.
Toby: Yay, Jeff. There we go. So slow on the take there. If you’re looking for Tax Tuesday, you’re in the right place. We’re going to let everybody fill into the room. It’s usually a little bit of a process. In the meantime, why don’t you guys let me know where you are sitting? Not in your living room, but what city and state?
Maybe you could let me know where you’re at. Put it in the chat so we can see where you are at today, city and state. Houston. Castlerock, Boston, Bremerton, Washington, Roseville, Jacksonville, Bellingham, League City, Texas, Adelaide. Actually, my brother-in-law’s in Adelaide in Australia. That’s weird. Chino, maybe it’s my brother-in-law. Clermont, Florida, Las Vegas. Hey, that’s where we’re at.
Anaheim, California, San Diego, Miami, Florida. I’m a little bit jealous. Houston, Texas, New Jersey, San Luis Obispo in California, New York, Seattle, Washington. Twenty years in Seattle, I know it well. Laguna Beach, Paulsboro. You’re over near Clint, my partner who’s up there in Gig Harbor.
Let’s see. Somebody says Nevada, Bronx, New York. We got people from all over the place. If you can do that chat, we even have Sequim. Isn’t it Sequim where they had the use of the Vampires, Twilight, or something like that? Was that supposed to be it?
Jeff: Yeah, up in Washington?
Toby: Yeah, I think it’s Sequim. Who knows? Very exciting. Forks. Somebody knows their Twilight. All right. A lot of people are saying Forks. I don’t think it’s Port Towns, I think it is Forks. It’s way out there.
All right, here’s what we got. If you can chat, then you can always make comments. If you have questions, put them in the Q&A so our guys can answer. When I say our guys, we got Amanda, Dutch, Tanya, Troy. Gosh, I know there are others. Eliot, Matthew, Patty’s even on. They can answer your tax questions. In the meantime, we’re going to go diving into our tax questions if I could make this slide advance.
All right. We already went over. You can ask live via Q&A, and you can always make comments inside of the chat. Email your questions to taxtuesday@andersonadvisors.com in the meantime. We do these every other week. If you have a burning question, and you want to get it off your chest, throw it out here. Every time, we grab about 10–15 of those, and they become our opening questions that we answer while we’re on with you.
If you need a super detailed response, like we’re giving advice to you, not just answering a basic question about what the tax rule is, then you have to become a client. You can do that with our Platinum service. Platinum is about to roll out our knowledge room, which is going to be open every day so you can pop in and ask your questions. It’s all inclusive at a low, low price. It’s a monthly cost for Platinum. You can ask all the questions you want to the attorneys and the accountants, and it’s a ton of fun.
Jeff: I think that the schedule will roll out a week from tomorrow.
Toby: Yeah, it’s coming, guys. It’s coming soon. We’ve been using these hotlines and the portal to ask questions, but we’ve been listening to you guys. Sometimes they listen to me once in a while. I’m like, just get everybody on it. Just have it well-staffed so people would come in and get their questions answered right away.
Pop in, get it answered, boom, done. You don’t need to go through layers of administration. Let’s just get it done. By the way, we have no administration. It’s just Jeff and I. Jeff and I are going to answer questions. Do smart asses get a discount? John, for you, absolutely not. We love John.
All right. There are a lot of names. By the way, if I start talking to the screen, it’s because I can see my chat, and there’s a whole bunch of folks that are on all the time. They’re like family at this point, but they do heckle us, and they make fun of Jeff a lot.
Jeff: We know Sherry’s going to pop up here.
Toby: Where’s Sherry? I don’t think she’s on, because she has a loud chat. I don’t know if she does that, but not in yet. See? There’s a few that are on almost every time, and we actually appreciate that. We appreciate all you guys coming on, but the more interactive you are, the more fun it is for us.
All right, opening questions. We’re going to go through. If you’ve not been on a Tax Tuesday before, we’re going to go through all these questions one at a time. I’m going to read them to you in the very beginning so you know what we’re going to answer. If you’re sitting here going, should I sit and listen, you can pick some questions that specifically relate to you.
“I’m helping my elderly dad manage his rental properties, which he filed as a sole proprietor. I have a joint account with him, where all deposits go into. He files the taxes on the rental income. Would that affect my taxes? Or am I liable for anything associated with those rental properties if I’m the joint owner of the bank account?” Good question. We’ll answer that.
“Could I still qualify for the Qualified Business Income Deduction for rental activities even if they do not have the real estate professional status?” Qualified Business Income Deduction, 199A. I hope you’re on your game, Jeff. I think Jeff is ready.
“I have a question about incurring expenses and paying them with my personal credit card. How do I recoup that money that was used for my business but charged to my personal credit card? My LLC is less than a year old.” A baby LLC. Is it crawling yet? Let’s get it going.
All right, “Suppose a Florida LLC has a piece of land bought three years ago and hired a construction company to build a single house when the house is sold.” Is that the one where you said there was a period?
Jeff: Yup, that was it.
Toby: All right. “Can I allocate part of the profit to the sale of the land, long-term capital gain, and the other part to ordinary income?” Interesting. I’m going to be curious as to what you say about that.
Jeff: I’ll be careful with what I say to that.
Toby: “How do I use my 401(k) or IRA to invest in real estate?” Good question. We’re supposed to have some of these ahead of time. This is like Christmas. It’s much more fun when you just like, oh, what are they asking today?
“My husband’s father wants to sign his house over to us. My husband’s sister also owns 65% of the property.” That’s interesting. We have to dig into that. “What tax advantages are there for us, his dad, and his sister? And what tax issues does it raise for us? Should we start an LLC or some other structures?” Great question. We will endeavor to answer for you.
“What is the best way to use funds from my S-corp to pay taxes? Since the corporation taxes flow through to my personal taxes, I understand I need to pay my personal taxes for my personal account, but the money is really in the business account. Can I use a distribution? And is there a dollar amount limit for such a transaction?” Good question. We’re going to get to that one too.
“If I elect to aggregate rental properties into one activity, for example, managing, operating single family homes as rentals and limited partnership interest in a multi-family syndication. What happens if years down the road, one of the assets is sold from the aggregate group? What are the tax and legal implications?” Good questions there.
Toby: “Is it tax-wise to pass on single family rental home properties before my death to my kids? We have plenty of income, and passing on a few of them to our two kids might even lower our tax bracket. Each rental property is in a separate LLC, and we’ve owned them for 7–8 years now.” Good questions. We’ll get into that one too.
“We have two newly opened short-term rental Airbnbs.” When you see STR, in our world, it’s short-term rental and LLCs. “We want to do cost segregation and do bonus depreciation for the 2023 tax year. We’re logging our time for the 500 hours rule. I heard that a small business should be taxed as S-corps to save on self-employment taxes, but others say don’t put Airbnbs in an S-corp because they’re passive. What to believe?” You came to the right place. We’re going to answer that one.
Toby: Hey, if you guys like this type of content, and you want to go in and get specific answers to questions, there are 682 videos. I don’t know when that is as of, but we’re always putting more. There are 680-plus videos. You can go to my YouTube channel. My partner, Clint, has a great YouTube channel as well, where he spends most of his time on asset protection. I spend most of my time on tax, money, and telling people to stop doing crazy things that are costing them money.
Jeff: I was just watching your video on trading the other day over the weekend.
Toby: I get a lot of love when I post. There’s all your money being a trader and they are always like, you’re so mean.
Jeff: Toby always says, I’m ready for you haters.
Toby: It’s okay. I just say here’s the facts. Who has more videos? I think I blow Clint out of the water when it comes to videos, content-wise or quantity. He would say that his content is much more valuable. Who knows who’s right?
All right, the tax and asset protection workshop. We have virtual events on November 10th, the 18th, and the 30th. And we have our four-day live. I think there are still tickets left. Last year we sold out of our December Tax and AP in Vegas. I think we still have tickets left on this one, it’s December 7th through the 10th. It’s at the Virgin Hotel and Casino, and it’s fun. They’re pretty inexpensive. I don’t know the price of the tickets, but it’s a good reason to come to Vegas and hang out with us.
On Thursday, we always do an investing day. We got the guy from Flipping Boston. I got Markay Latimer coming out. Somebody put up our video count, Toby, 682, Clint, 488. He’s doing good. 488 is not the shake a stick at. It’s a lot of videos. His are probably longer, so maybe the same amount of time. Maybe.
All right. This is really cool. We have all the virtual events, where if you want to learn about land trusts, LLCs, corporations, they’re there. Let’s just jump into answering questions already.
Question one. “I’m helping my elderly dad manage his rental properties, which he filed as a sole proprietor. I have a joint bank account with him where all of the rental deposits go into. He files the taxes on the rental income. Would that affect my taxes? Or am I liable for anything associated with those rental properties if I’m the joint owner of that bank account?”
Jeff: I look at this as I probably wouldn’t have made you a joint owner, I probably made you an authorized signer on the account. Either way, it doesn’t affect you tax-wise. All the income is his. You don’t own the properties or anything. I guess technically, he doesn’t even own any of the cash unless his father passes on.
Toby: Usually when you see a joint account, there’s a gift of the assets that are in it if you’re actually a joint account owner and you have use of enjoyment of that asset. A parent that says, hey, you know what? I’m going to put my daughter on my account, and it’s $200,000. They’re worried about what happens if they pass away, they just made a $100,000 gift to their child.
Here, it sounds like you’re just using it as a business account. If anything, I think the IRS could try to argue if there are substantial assets in the account but not the rental property itself, because you don’t own that. You have no right to those monies. I would say it’s more of a scrivener’s error that there wasn’t any intent to gift you part of that account that you just put them on. You just got put on as a joint account holder. Probably, you might want to check that and see if actually you’re just a signer.
Brooke, the banker is listening and agreeing with you. Okay, thanks, Brooke. I like Brooke. Brooke the banker. Is that Brooke as in your sister, Patty? Let’s see what Patty says. Yes.
Here’s one thing I’ll do when I correct this whole sole proprietor thing. Sole proprietor is an active business that goes on your Schedule C. It is not your rental properties, which go on page one of your Schedule E.
Jeff: I get what you’re saying that he is the sole owner, but he’s not a sole proprietor.
Toby: Yeah, that’s actually a term of art for an active business, but it’s weird. All right, that’s the answer to that. Would it affect your taxes? No. Are you liable for anything associated with those rental properties? You’re not a joint owner of the property, so you should not be liable.
If some horrible event occurred on that property, and somebody put their ears back and was suing, they might say, hey, because you’re a joint owner on that bank account, if you are actually a joint owner, they might try to attribute liability to you. But I think there’s going to have to be control of those properties. They’re going to show you that you’re actually involved and that it’s not just being on an account. I don’t think it’s going to be enough.
Jeff: I think your liability is going to be limited to really bad things like embezzlement, writing bad checks, malfeasance, things of that nature.
Toby: In any case, this is a rental property. As a tax attorney but also as an asset protection attorney, I’m going to say, what’s the worst thing that could happen? A horrible event happens on that property, and they sue you for $10 million, $20 million, or something, you need to have an LLC over that property.
Always put a box around your real estate. There’s no way to control that risk. You never have an idea. You’re talking to someone who’s had a tree fall on my property, literally on top of the tenant. But luckily, one of my North Carolina brick houses, and the tree goes right on top of her. It literally destroyed the roof, but it didn’t touch the tenant. Nice lady, 88 years old. Would have just squished her, but landed on that, and I’ve had three houses burned down.
We have hundreds of houses, but it does happen. We’ve never had a fatality. We’ve never had a mold claim, where they chase after us. But plenty of clients, yes, they have. Plenty of clients. We’ve seen massive lawsuits like deaths of infants and things like that end up being in the tens of millions of dollars. I don’t care how much insurance you think you got, it’s not going to be enough. Just saying, put an LLC around that thing.
Next question. “Could I still qualify for the Qualified Business Income Deduction for rental activities even if I do not have real estate professional status?” Jeff.
Jeff: This is a subject that Congress and Treasury went round and round and round. Fortunately, you can declare that your real estate business is a trade or business for 199A purposes, which is the Qualified Business Income Deduction. Real estate professional is automatically a trade or business and gets the same thing.
Toby: I might disagree with you slightly on that. Real estate is still passive, but for the real estate professional, it becomes non-passive. It’s an exception to the rule under 469.
Jeff: Oh yes.
Toby: Does it make it QBI? I don’t think so. I think for Qualified Business Income, you have to have—let me see if I remember this—it’s 199A. If you have rental real estate, you have commercial real estate, you have triple net lease real estate, and you have safe harbors on each, you have to have 250 hours of aggregating your rental properties or your commercial properties.
Jeff: Triple net lease is out.
Toby: Triple is nothing, so you have those two. You have to keep them separate. You have to keep separate books on them. It’s crazy. QBI, I always look at it and go, why the hell would you want to do that. It’s a 20% deduction on your net income. In real estate, when was the last time you saw net income?
Jeff: With real estate, especially residential real estate or even commercial real estate, you’re usually seeing tax losses, not necessarily cash losses but tax losses. They declare those to be qualified businesses. It actually goes against you if you’re taking losses.
Toby: It toasts you, because they net out all of your businesses. If you have a business that qualifies for QBI, and let’s say it makes $100,000, you get a 20% deduction off the top because Congress said, yay, under the 2017 Tax Cut and Jobs Act. Then you have real estate and you’re like, yeah, let’s call it QBI and it loses money, you have to take the loss against the other just for QBI purposes. You don’t get to take the loss for real. Still, you’ve got a massive loss.
Jeff: That doesn’t seem fair.
Toby: It’s a complete hosing of the taxpayer, but they love to hose the taxpayer. You’d almost have to walk into that, because you’d have to say it’s QBI. Hey, I separated out my books, and I did 250 hours, because you’re not going to prove it for them. If you don’t do that and you don’t aggregate them, then you’d be up yours. Then you have real estate professional status, which is this other thing entirely, which is, if I have passive losses, ordinarily passive losses only offset passive gain.
Now, there are two exceptions. This is for rental real estate. There are two types of passive income, rental real estate and businesses that you do not materially participate in. Just for real estate, there are two exceptions. Exception one is the $25,000 active participation, and it phases out between $100,000–$150,000 of AGI.
Option number two is real estate professional status, which does not phase out at all, but I have to meet the 750-hour test in a real estate trade or business that I materially participate in. And I have to materially participate on the properties that I’m attempting to declare as non-passive. I’d have to aggregate my properties together more than likely.
Jeff: This is one that, really, they went back and forth on and almost said, no, real estate professionals cannot be QBI.
Toby: It’s weird. It came out with no forethought. It’s just Congress doing what Congress does, which they pass things because it’s a pretty shiny thing, and then they forget that there are tax professionals that actually have to advise their clients. The Treasury actually asked to enforce the rule. And nobody knows what the rules are.
There were no rules. It was a little section. I think 199A was a tiny little section. I was like, you just hopelessly complicated something that should be simple. If you really want to give a tax deduction, just keep a tax deduction.
Jeff: Yeah. The way Congress works is they get 10,000 pages of this Tax Act and say, I’ll have my page, I’m going to read it later.
Toby: They screw things up all the time. We’re still trying to figure out the Cares Act. We’re still asking. We’re just dealing with conservation easements and historical properties. You’re like, could you please give us some guidance? They’re like, we’ll think about it.
Anyway, enough of that. Could you still qualify for QBI for rental activities even if you don’t have the real estate professional status? The answer is yes.
Next question. “I have a question about incurring expenses and paying them with my personal credit card. How do I recoup that money that was used for my business but charged to my personal credit card? My LLC is less than a year old.” Jethro.
Jeff: I’m going to start off with a simple answer. The simple answer is yes, you can pay for stuff with a personal credit card and deducted in your entity. However, I would advise you to have a personal credit card that you use only for business. It makes life that much simpler.
Toby: Or get a business credit.
Jeff: Or get a business credit card, absolutely. But yes, you can deduct these expenses. When I go out and buy a computer on my personal credit card for my business, I’m going to deduct that on my business.
Toby: I’m going to reimburse myself for my business. I think the business needs to reimburse you. If it’s a corporation, I think they have to.
Jeff: Absolutely.
Toby: I go out and I incur an expense on behalf of Anderson. I don’t get to write that off as an individual. There are no miscellaneous itemized deductions. They went away in 2017. Anderson could reimburse me. Anderson cannot write off my computer until it reimburses.
Jeff: Correct. There’s no point.
Toby: Your company just needs to reimburse you. If you’re a sole proprietor, which you shouldn’t be, because your audit rate is ridiculously high, and you always lose your audits because of things like this, they don’t know what is personal and what is business. They’re all intermixed. They’re all just a big hodgepodge.
Liability is unlimited. The IRS will go through line after line. Hey, which phone call was business, which phone call was personal? You can only deduct the business. Everything gets torn up, it’s just a mess.
In this particular case, if you have an LLC, just reimburse yourself and make sure that that LLC is classified as the appropriate entity. If it’s a business, it should be taxed—even though it’s an LLC—as an S-corp or a C-corp unless it’s getting zero income, unless it’s just a baby.
Somebody says, it’s less than a year old, but it has no real income. Then somebody says, business credit card or debit card? Either one as long as it’s not you personally. You get something. Do companies reimburse when it’s a corporation taxed as an S-corp? Yes, they do. You qualify as what’s called an accountable plan, 100% deductible to the business. Does the recipient even have to report it, Jeff?
Jeff: No.
Toby: No employment taxes, no nothing. What if I write you a check for $25,000 for your medical expenses? If it’s a C-corp, I can do that. But if I write you a check, do you have to report it anywhere?
Jeff: I don’t have to report any of that as long as I’ve substantiated it with you.
Toby: Which me being the employer. You can’t be an employee of your own partnership. You can’t be an employee of your own sole proprietorship. The only way you do these reimbursements is if it’s a corporation, and then the corporation takes the deduction. If it’s a partnership or a sole prop, it really doesn’t matter. You’re going to write it off on the business, because they just assume it’s you anyway.
I would still do the reimbursement, especially if you have an LLC. Because if you don’t do that reimbursement, they’re going to say, piercing the veil. It’s not equitable to enforce the LLC, because you didn’t respect its separateness, you don’t even reimburse your expenses. You just use your personal credit card for the business. That could come back to haunt you.
The best bet, guys, you incur an expense individually, ask to be reimbursed from your business, write the check from your business, even if you have to put money back. I have to put money into the business, and then it writes me a check. That’s okay. That’s how it works.
I have a contribution. That’s not income, that’s just contribution. I have an expense which creates a loss, and then I can use that loss to offset my other income if I need to. But you always do the right paper. Anything else to add, sir?
Jeff: No.
Toby: Fun. All right, next question. “Suppose a Florida LLC has a piece of land bought three years ago, and hired a construction company to build a single house when the house is sold. Can I allocate part of the profit to the sale or to the sale of the long-term land and the other is ordinary income? What say you, Jeff?
Jeff: I’m going to assume that the entire parcel of land was sold with the house that was built. At that point, that land is no longer capital gain property. You’ve now converted it into inventory that you’re selling, so no. As a matter of fact, it doesn’t play off against ordinary income, it is ordinary income. The entire sale of this property is ordinary income.
Toby: Yup. When you buy a capital asset, you have two choices. You either are buying it as an investor, or you’re buying it for sale to your customers. The decision is always made on the date of the sale. The IRS looks at your intent.
People get bad information out there. There’s a ton of it. If I hold it for a year, then I’m okay. The seminal case on dealer status was somebody who held their property for 10 years before they sold it, but their intent when they bought it was to fix it up and sell it. That is dealer property. You may as well have a car lot. I bought a car and I put it on the lot.
In this particular case, you built the car. You’re saying, but there’s land too. You develop the land, and real estate developers and dealers do not get the long-term capital gain treatment. In fact, there are tons of cases where you can convert land that has tons of gain, you build on it, and you just screw it up.
The way you do this is you set up an S-corp for the construction, and you sell the land to the S-corp on an installment sale. I bought the land, I’m selling it for the long-term gain on the value of that land on that date, and then I put an improvement on that land. That’s in an S-corp. That is going to build that property and then sell it. What that’s going to do is, then you have long-term gain on leg one, and you have ordinary income on leg two.
Jeff: We’ve had a couple of good examples of this lately. I bought a property with the intention of flipping it. Things didn’t work out, mortgage rates are high, whatever, so I’m going to rent it out for a year and then sell it later on. Can I get capital gain treatment for that? No, because your intent was always to flip that property.
Toby: That was the case. They bought a commercial property. Interest rates went Polly Wonkas, and the market fell out. They tried to get their price every year. They rented it out for 10 years.
Every year, they were trying to sell it, and then they finally sold it. They wanted long-term capital gain treatment. They were like, the IRS says no. You are not buying this for its long-term appreciation, you’re buying it to sell it to your customers. That is inventory, period, full stop.
You can’t do installment sales, so you’d lose section 453 I think it is. You cannot do 1031 exchanges. Somebody says, where did you do your report, your intent? It’s facts and circumstances. Usually, they’re looking at you to go on your land developer, like you do this a bunch. You keep buying land, and you keep building properties on it, and you sell it. That’s how they get you.
If you have a whole bunch of single family homes like I do, I like to buy them. Every now and again, we sell one. If somebody comes along and offers the right price, sometimes we peel off, like we’ll buy 40 properties and peel off 10, and sell them to our clients because they’re a good deal. I am not a dealer though, because when I buy, it’s always I’m buying for the long-term hold. They could see, because all of my properties like the vast majority are these long-term holds. I just don’t sell much.
Flip that around. You’re a developer. Even if you have a property that you hold on to, you better put it in a different entity. Separate it from that business, because otherwise the IRS is going to come in there and say, what are you? What was your intent? Nine times out of 10, you sell that thing within a few years. You’re a dealer.
Jeff: And it’s really easy to find that information. If I bought a property and a couple of months later, I put it up for sale but didn’t sell it, they can still see that. They see that it was put up for sale.
Toby: If you’re audited. Here’s the whole thing, if you’re audited. Can you try this stuff? Your preparer is not going to do it if they know what they’re doing. They’ll just look at you and go, I’m sorry, I’m not going to commit fraud on your behalf. But if you did it and you were like, oh, shoot, I really meant to buy this as a flipper, and I’m going to keep it long. I’m probably not going to mention a bunch of facts. I’m just going to say, here’s when I bought it, here’s this, here’s the HUD, prepare the return. Okay.
They might just go about it and say, ah. They might ask you a question or two. Don’t lie, but don’t volunteer. You might be able to get away with it. I’m for doing it the right way and just being straight up. Like, hey, this is what it was. There are ways to get out of it. There are always ways to minimize the damage in a situation.
Again, this is the easy one. Hey, I bought it to flip, prices went down, interest rates went up, I’m going to sell it to another entity where I’m going to hold. Okay, do that. But I have no gain. Great. You switched it. This was the flipping entity, now I changed my intent. How do I know? Because I sold it to an entity where I am changing my intent.
Jeff: Having watched a lot of depositions and court proceedings of late, is it a proper response to their questions? I don’t recall.
Toby: I remember, but you’re not supposed to get coached. You’re not supposed to lie on the stand. We’re not all slippery like some of these politicians. Somebody’s asking a bunch of questions. Nicholas, put that in the Q&A. You ‘re not going to make it in politics with that honesty. Mindset. You’re probably right. They’re really good. I don’t want to get into it, I’ll just get mad.
I clerked in court, and you hear people lie all the time. That’s usually how you know they’re lying. They usually put their right hand up first, and they swear that they’re not going to do it. They go, it’s nuts. This is crazy.
Next question, “How do I use my 401(k) or IRA to invest in real estate?”
Jeff: You buy real estate with the money in your 401(k) or IRA.
Toby: But TD Ameritrade will not let me buy any real estate in my eyes.
Jeff: That’s a really good point. If it’s an IRA, you need a self-directed IRA, where you’re pretty much the custodian.
Toby: You have a custodian, but you’re directing the custodian.
Jeff: Correct.
Toby: 401(k), you can be your own trustee. You don’t need the custodian to tell them to fly away.
Jeff: A couple of points. The IRA can absolutely not have any loans to the IRA, so you can’t get a mortgage on a property that you’re buying in your IRA.
Toby: You can, but it’s subject to UDFI.
Jeff: UDFI, thank you.
Toby: I have to deal with this all the time. I’m always like, stop that. If you have a loan and you make money in the IRA, it is subject to Unrelated Debt Financed Income. If you do the exact same thing in a 401(k), you are not subject to tax in the 401(k).
Our recommendation is if you are leveraging your real estate, and it has to be non-recourse. You cannot sign on that loan individually, or your whole IRA just got disqualified, and you have a taxable event plus penalty.
Jeff: Which brings up another topic for both of these, the 401(k) and the IRA. What you’d like to talk about often is you can’t pick up a hammer.
Toby: You cannot do any work. You cannot use your personal services to improve the value of that asset. You can run the IRA, you can tell other people to do it. If I have an IRA, first off, do not own the real estate directly in an IRA, because you are personally responsible for any liability. If somebody falls over a rake and bust their head, they’re suing the IRA and you, so we need an LLC in there.
Your self-directed IRA, and we know some, The IRA Club, Dennis Blitz, a great guy, you set up an IRA, roll it over, and you put an LLC together that is owned by the IRA, easy-peasy. Put that piece of real estate in there, great investment. A lot of people are doing it, and they make a good, good, good return. That’s what you do.
If you have a loan in it, make sure you’re using a 401(k). If you’re doing a syndication, they all use leverage. That’s a loan. That makes the income that your IRA makes taxable to the extent that there’s leverage. If it’s leveraged 75%, 75% of the income is taxable. They don’t let you use leverage and not pay tax inside of an IRA. If that’s you, we will just roll the IRA into a 401(k).
If I just freaked you out and you’re going, oh, crap, I bought a syndication, say you’re a doctor and you got your big old IRA, and you did a syndication in that IRA, we need to get it out. We need to remove that, roll those funds into a 401(k). We need to move the investment, name only, into a 401(k) so you do not get hit with the UDFI.
Jeff: Another mistake I sometimes see, not that often, but I have a half a million dollars in my IRA, I go out and buy a $495,000 house.
Toby: Don’t do that.
Jeff: Because I can’t pay the things that the IRA needs to pay for taxes. There’s not going to be interest, but repairs, maintenance, and all this stuff. If it doesn’t have any cash to pay for it, gosh, I’d hate to lose that house to the sheriff.
Toby: You’re toast, unless you can get a line of credit or something like that. Again, but then if you’re an IRA, you’re going to have tax issues. 401(k), it’s easy. Anderson is 401(k) by the way, you could do whatever you want. You can invest. You can’t collect your coins and things like that. Go out, buy a bunch of artwork, and put it on your wall. You can’t do that.
Technically, you could go buy gold, you could buy real estate, you could buy syndications. You can go and you could trade in it. You can do whatever you want. You’re the director. You don’t need a custodian if it’s an Anderson 401(k).
If it’s a self-directed IRA, then you’re doing everything through the custodian, custodian signs all the paperwork, and you just pay. I know they nickel and dime you a little bit, and weekends are probably off, but you can still use it. If you’re working with some of our partners, Alpine for example, and you buy single family homes, probably 70% of the houses that they sell are sold into retirement plans.
They’re almost always sold for cash. These are $100,000–$120,000 homes and they’re nice little cash flow machines. They’re usually in the Midwest, sometimes Idaho. But for the most part, it’s North Carolina, it’s Missouri, it’s Indianapolis, Indiana, sometimes Ohio. They are good little cashflow machines, and you could do it directly in your IRA, especially if you’re working with a party that’s not trying to push it down your throat.
But if you need to be fast, and you’re buying, for example, foreclosure properties, you’re buying them at auction, or you’re wheeling and dealing on a weekend, you probably need that 401(k) so you can sign as the trustee under a 401(k). It works great.
Jeff: Generally, you don’t want to be flipping in your retirement account.
Toby: Don’t be flipping in your retirement account.
Jeff: Because that generates UBIT.
Toby: Unrelated Business Income Tax, yes. Jeff is exactly right, you cannot run an active business in your retirement account.
Jeff: Don’t invest in Toby’s pizza shop either.
Toby: But if you do flips, they say it’s about five. Most custodians would say, you cannot do it consistently, you cannot become a business. If you do one, nobody’s going to get mad. Do two, you’re getting the stink eye. Three, you’re in that gray area. Four, now it’s turning into red. Five, you’re toast. Just don’t do it.
If you wanted to do that, you could partner. There’s a way, there’s a company called ROBS transaction, which is Rollovers as Business Startups. It’s a fancy way of saying, I set up a corporation that the IRA is an owner in or the 401(k) as an owner in, and then we go flip. That’s what you could do.
What’s the self-directed 401(k) for? There isn’t such a thing as a self-directed 401(k). They use that because it sounds similar like, hey, we’ll set up a self-directed 401(k). A custodian sneaking in their service when they do it. They’re like, hey, we’ll set up a self-directed 401(k).
Really, what a 401(k) is, you could just be your own trustee. There’s nothing that says self-directed. Self-directed IRA is a fancy way of saying, I’m going to direct the investments and tell the custodian what to buy, and they’re willing to buy different types of assets.
When I go to TD Ameritrade, for example, they’re not going to let me buy real estate. They’re going to say, you can buy things that are on our platform, and that’s it. Hope that makes sense, Larry and Pam. Anything else?
Jeff: Nope.
Toby: Here’s another one. “My husband’s father wants to sign his house over to us. I like your in-laws. My husband’s sister also owns 65% of the property. What tax advantages are there for us, his dad, his sister? And what tax issues does it raise for us? Should we start an LLC or some other structure?” What do you think?
Jeff: I can go one of two ways with this depending on what this house is. If it is his principal residence versus maybe a rental property he owns that he just wants to get rid of. I’m not a fan of signing over a principal residence to my children.
Toby: Is it his house? I don’t know what these people are on to.
Jeff: I don’t know, yeah.
Toby: Is it his personal residence, or is it a house? Because if it’s a personal residence, it sounds weird, because the sister already owned 65% of the property, which means she has the right to occupy the house, too. What tax advantages are there for us? Really none, unless it’s an investment property, but then you’re getting his basis if he gifts it to you. If dad’s on this for a long time and he’s like, hey, I really want to get this house over to you and your sister.
Jeff: And we see that so often. I’ve owned this rental property. I don’t want to deal with it anymore.
Toby: Here’s the thing. If dad passes away with that property, your basis steps up, which means if you guys sell it, or in this case, your sister already owns part of the house. The 35% of the house that she doesn’t own, now you own it. You wouldn’t pay any tax on 35% of the portion that came to you. You wouldn’t pay any tax on it, because a basis would step up when he passes.
Everyone, when they pass, your capital assets step up to the fair market value of that asset on the day of the decedent’s passing. If dad passes away, you would have no tax on that sale. By doing this and he gives it to you, you have his basis and you lose the step up. Dad gives it to you before he passes. He says, hey, I’m doing a great thing. You just made it all taxable.
I know I’ve shared the show a few times, but there were four brothers and sisters. Dad had a building in a major city, and it was worth tens of millions of dollars, but his basis was really low. In fact, he’d depreciated most of the things. The land was on a $100,000 basis when he bought it. He had it for 30–40 years.
The accountant transferred it to the kids via an entity. They used a limited partnership, and they thought it as gift tax returns on it trying to avoid dad getting hit with the estate tax.
Dad passes away in a year where they had no estate tax. Kids now had $20 million or whatever it was. It was millions of dollars of taxable gain when they sold that property. They would have avoided it entirely. I think the tax bill was close to $6 million that they would have avoided, so ouch.
Somebody says, dad needs a living trust, put the property in the trust, easy passage after your passing. Then it’s clearly intended of dad up to the brother and sister arguing, thinking about my sister. Absolutely, but it sounds like you already gave it to sister.
Jeff: I’m just going to bring that up. If he gives you the other 35%, your sister’s going to be the majority owner on this and can make all kinds of decisions without your input.
Toby: The workaround is you put it into an LLC, and you make brother and sister co-managers. But at this point, sister is going to have to agree, because she already has 65%. Unfortunately, it’s like you talk to lawyers before you do this so they can ask you all the nasty questions. How do the siblings get along? Are they going to be nice to each other?
If they do this and you say, hey, you’re co-managers, but your interests are different, and then you could say, in order to make a change, 85% of the membership interest have to agree, now you just made it to where sister can’t bully brother, but brother also can’t bully sister. They’re co-managers.
Jeff: I think if it was me, if I really don’t care about this property, I’m going ahead and taking that gift interest and turn around selling that interest to my sister, so then she becomes 100% owner, and I’ve washed my hands on it.
Toby: You could do that too and just say, hey, sis, do you want 100% of the property? Dad gave me 35%, but then you have gained. You’re going to pay tax on it. It’s so much easier if dad held on to it and just gave it to his kids when he passed and held it in trust. A lot of trustees make that decision. And then they could distribute. They could manage it. Here, I’m going to distribute 65%.
If it’s a primary residence, and this is the house they grew up in, and maybe you’re like, hey, I want you to live here, now you’re going to have the issue. You’re going to have brother and sister at odds, who gets to live there, and all that good stuff. Who’s paying for the utilities? Who’s paying for the upkeep on the house? Sister is residing there. Brother’s not going to be too happy kicking in a bunch of money every year. It’s probably better under those circumstances to give it to sister and find some other way to take care of brother.
Jeff: This question wasn’t asked, Toby, but dad owns 35%, sister owns 65% and saying, this was dad’s primary residence. Is he excluded from 121?
Toby: When he gives it away, he’s excluded from 121. With the sister, if she lives there, you could still get 121, because it’s name on title, brother, sister, and occupancy. You could still do it if they both lived there. It’s just like cohabiting adults who jointly own a property they could both qualify for, but they each get the $250,000.
There are other questions. Somebody wrote in there and said, sister is supporting dad. Here, let me give you guys a horror story. This is not necessarily related to the tax, but I lived this. It was on my mom’s side of the family. Great aunt took care of my great grandfather. Great grandfather passed and left everything to my great aunt. Great aunt got married.
Great aunt passed away, and everything went to husband who was not a family member. Grandpa never intended it, great grandpa wanted to keep it in the family, and it ended up out of the family. In fact, my mom and her sister had to go bid on the sale of the estate sale to get albums and things like family albums, things like that. They wouldn’t even just give them. They were absolutely turds.
The gentleman was older. He was cool, but he didn’t document it either. Great aunt passed away, he inherited. He said, oh, don’t worry, we’ll take care of it. Will that make sure you get your stuff? And then he passed away, and his kids were absolute turds. It gets a little funky monkey.
That’s why when somebody said, do the living trust, yes. Document who gets it, appoint somebody who’s in charge. Easy-peasy, keeps in brother and sister, don’t fight because if they do, they get disinherited, then you could do it.
Somebody says, that’s how my family lost 6000 acres of farmland that it had collected since the 1600s, and it got pissed away. We see it all the time. People are always like, oh, it’s complicated. It’s not complicated to guys like us, because we see it and we can say.
Given the question right now, “What if a business property is inside a trust, one parent dies, and the other has Alzheimer’s? Can there still be a non-taxable event if the property is given to the kids while one parent is still alive? Currently, the trust resides in her name, but it’s managed.”
One parent dies, depending on the state, you may have a step up in basis on that date if it’s community property, state. If it’s a separate property state, parent one passes away, there’s a step up on their interest and the other part doesn’t. But mom has Alzheimer’s.
In a living trust, there’s a trustee who’s managing that property for their benefit during their lifetime. I wouldn’t give it to the kids, because there’s no reason to do it while the parents are still alive. It sounds horrible. When mom passes away, step up in basis for the entire thing, sell it, and then distribute it to kids. While mom’s alive, if you want to sell it and distribute it to kids, there’s a reduced taxable event.
Jeff: In my experience, anytime you have somebody with dementia or some other form of brain impairment, you really need a conservator or guardian for that person, and it probably shouldn’t be any of the beneficiaries.
Toby: Sometimes it’s going to be one of the kids, but then you should probably have a different trustee if that kid is also one of the beneficiaries. Beneficiaries can change the trustee, by the way, but they can’t tell the trustee what to do. The trustee follows your written instructions.
Somebody says, what if your lender won’t allow them to put a rental property in an LLC? Your lender can’t stop you. The lender can do it on sale, but we just use a trust. That usually stops it.
Jeff: I know this is a different question, but I usually find it easier. Form the LLC, then to buy the property.
Toby: Yeah, or just work with portfolio lenders as you get big, after you get over your first 4–10 properties. You’re going to be doing portfolio loans anyway or folks that are recourse. That was so helpful. The dad just passed at 96. Thank you so much. Thank you. I’m glad we’re able to help.
This stuff is serious. We joke a lot. We try to keep it light, but this type of stuff, you really have to sit down with somebody. A lot of times, we just take action. There are a lot of folks that will just transfer things to their kids. Unbeknownst to them, the kid has a huge liability. They have a judgment against him and other stuff. You just gave him an asset, and now they’re going to take it from you.
You didn’t even realize that you expose yourself to all that fun stuff. Or you do it, you put your kid on it, and then something happens on the property. The kid’s liable, you’re liable, and everybody’s liable.
You didn’t think of all the bad things that could happen, because you were trying to do something like, oh, I know there’s something that I should do. But sometimes it’s just, hey, give us a call, that’s why we’re here. We’ll make sure that we’ll get you some straight answers so you can make a very intelligent decision and that you don’t do anything that ends up hurting you.
Jeff: It’s really hard when you lose a loved one. You’ve got enough on your plate already. So please don’t be afraid to ask for help whether it’s a close knowledgeable friend, from a professional, or something like that, because it’s frankly too much for most people to deal with financial, the legal side, and the death of your loved one.
Toby: It’s not a good use of your time either. All right. Next question. I could see up here fine, but down here I’m just toast. “What is the best way to use funds from my S-corp to pay my taxes? Since the corporation taxes flow through my personal taxes, I understand I need to pay my personal taxes from my personal account, but the money is really in my business account. Can I use a distribution? And is there a dollar amount limit for such a transaction?” What say you, Jeff?
Jeff: Yeah, you can always distribute your basis in the company. I’ll keep it even simpler than that. I make $100,000 in my S-corporation, that’s $100,000 that could come to me. Now, if you’re profitable and distributing money, you really need to pay some kind of salary.
We talked sometimes about the one out of three, where $1 of distribution or total distribution should go to salary, and the other two-thirds can go to you. It’s fairly simple. I’m wanting to get your feeling on something else that I’ve seen done. They’re talking specifically about personal income taxes. How do you feel about the S-corporation making those payments?
Toby: I’m really fine with it. Here’s how it works. S-corp, the net profit or the net losses flow on your personal tax return whether the money is in the corp or not. Now, if the corporation pays a bill for you, your accountant is going to say that’s a distribution. Whether it goes to you first and then you pay it, or it just pays it on your behalf, it’s going to be a journal entry. It’s going to be, how does the accountant classify that? As long as you classify it as a distribution, you’re fine.
This is a really important concept. I’m going to perk up your CPA or anybody out here who’s a tax professional, because the IRS tells us the answer. If you make a profit and you take distributions, you have a salary requirement. If you have losses and you take distributions, you’re not distributing net profit, you do not. You’re just returning capital, in which case it does not require a salary. It’s weird.
If you just have an S-corp that makes net profit, and you do not take a distribution, technically you do not have to take a salary. But if you pay the taxes that are owed, and you need the money from the S-corp, it’s a distribution no matter what, whether you pay it directly to the IRS or whether they pay it to you. So then you would trigger that salary requirement.
As Jeff said, most of the courts say it’s a one-third rule. I would say that it goes lower and lower the higher you go. You’re making a million dollars, you could probably get away with paying yourself $250,000, whatever a reasonable salary is for whatever services. But if you’re making $100,000, you better make sure you’re paying at least a third, $33,000 in wages.
I get it. It’s sitting in that business account and you’re like, gosh, but I just want it, there is no limit. If the thing makes $10 million, you could take $10 million out. In fact, I would encourage it because that business, chances are it has liability that you don’t.
Jeff: Are you saying leaving that $10 million paints a target on that S-corporation?
Toby: Yeah, we just had that. We literally had a client with about $10 million sitting in an S-corp. They get sued and they’re like, crap, we have so much cash in here. They’re like, it’s a voidable transaction, it’s a fraudulent conveyance, whatever you want to call it. Uniform voidable transaction, I think, is the new rules that they’re putting out there that most states are adopting. And all they say is, hey, you owe the money. You know you owe the money, but you can’t transfer the money now.
What you do is, if you make the $10 million, get it out of the business, put it in an LLC in Wyoming where nobody can see it, nobody can touch it. It’s not taxable. It puts out there, those are both tax-free transactions. That way, nobody can get to that money.
I run into a busload of nuns, money’s protected. Business gets sued, protected. Business gets nuked and they come after me individually, I still have that money protected. But if I leave it in the company, boom, they’re going to end up hitting that. Or if I do something individually, they can still take my company. You look at it and go, shoot, how do I minimize that risk and again not to beat our own—
Jeff: Toby, if I take all $10 million dollars out and I decide I want to buy some equipment or something.
Toby: I can just put money back in.
Jeff: Wow, look at that.
Toby: It’s magic. It’s like I can put money in my business and I can take it out. Put it in, take it out. Put it in, take it out. It’s like the Hokey Pokey. Remember the Hokey Pokey?
Now, it’s a little different if it’s a C-corp. If it is a C-corp or an LLC taxed as a C-corp, it’s not quite that simple, because a C-corp is a separate taxpayer.
Jeff: We should talk before you do this.
Toby: Yeah. If it’s a C-corp, talk to your accountant. You can still do so. You can have a line of credit. You can say, hey, I need cash periodically, but it’s the corporation that’s going to hold the paper.
What if I want to get it out of the corporation and get it into my protected anonymous LLC somewhere? Okay. You’re going to be paying corporate tax, and you’re going to be paying a dividend. You just got to do these things with your eyes open. Anything else on the S-corp?
Jeff: Nope.
Toby: All right. We mentioned this earlier, so I’m going to mention it again. If you are interested in learning how tax and asset protection works, there are four workshops sitting and staring you right in the eye. Three of them are free, the virtual events are all free. November 10th, 18th, and 30th are all free. The only one that costs a little bit of money is December 7th through the 10th.
It’s hundreds of dollars, and I think we have a buy one get one free event. Do we have that, Patty, still going on? I don’t know. Somebody has to tell me. Yes. Okay. You buy a ticket, then you’ll get a second ticket for a partner or spouse that you can bring along, or a drinking buddy for Vegas. Behave while you’re at the event, though. After the event, go a little crazy.
Jeff: You know the online events are great, but it is such a different feel to the in-person event. I don’t even know how to explain it.
Toby: Is it because everybody’s having a good time, and you’re with a bunch of people that are investors, and they’re like-minded? It’d be like if we did these Tax Tuesdays in person, and everybody got to just ask questions, everybody’s having a good old time, and we’re just trying to get three or four people pushing in and talking about it. You can bring in some experts on different subject matters. It’s just a different dynamic.
Yes, we have a lot of fun. Yes, we roll around there. I talk to everybody and anybody that’s on there. Unfortunately, sometimes people are like, just stop. I’m not allowed in the hallways anymore, but I speak. My partners, both Michael and Clint, speak. We bring in a bunch of other people that are experts in their area. I know we always have Erik Oliver who’s a cost segregation specialist.
Jeff: And a CPA, right?
Toby: I don’t think he works for a CPA firm. I think he’s a CPA himself. He’s just really, really good.
Jeff: He’s very good.
Toby: That’s because they’ve done, I wasn’t. We don’t do the cost segs. They send you to somebody who’s done thousands, because all they do is cost segs and energy evaluations. They do the energy credits, and that’s all they do. There were a bunch of CPAs. They just work with a bunch of CPAs. That’s what all the CPAs are. All right. More fun stuff. I know we have other questions, and we’re probably running late.
Jeff: It’s four o’clock.
Toby: I don’t know how many questions are left. I didn’t really look. “If I elect to aggregate rental properties into one activity, for example, managing, operating single family homes as rentals, limited partnership interest in a multifamily syndication, and electing all of my investment real estate as one activity,” which you can do, it’s called an aggregation election, “what happens if years down the road, one of the assets is sold from the aggregate group? What are the tax and legal implications?” Jeff.
Jeff: Okay, I’m going to make the answer probably shorter than the question. If I sell a property that I’ve aggregated with other properties, just treat it like any other sale of property. The one thing it doesn’t allow you to do is if that property had passive losses embedded in it, it does not release those passive losses until you’ve sold substantially all of your portfolio that you aggregated.
Toby: In other words, if you have a whole bunch of loss that you’re looking at going, man, the only way I’m going to get to use that loss is if I sell the property, don’t aggregate that with your other properties, right?
Jeff: The problem with the aggregation rule is it pulls in all real estate.
Toby: So you’re toast?
Jeff: Yeah.
Toby: So then you wouldn’t aggregate into those circumstances. If you were like, man, I need that because I’m going to be selling it soon, but you don’t lose the loss carry forward, you just use it against passive income. If you have a bunch of other properties that are making money, and you’re like, shoot, there’s no reason not to aggregate, because you could use those passive losses against the income that’s been generated.
Jeff: That’s a really good point, Toby. If I have aggregated property that has passive losses in it, I want to find passive income elsewhere that’s not necessarily real estate to offset my passive losses with.
Toby: Yeah. By the way, it doesn’t have to be just real estate. It could be you’re a silent partner in a pizza shop. I always use Toby’s pizza, because one day I’m going to have a pizza shop. You guys just wait. Toby’s pizza is going to be good. I’ve been practicing my Ooni.
Jeff: Too much cheese on it.
Toby: I know. I’ve learned my lesson with my Ooni. Don’t put too much cheese on those things. I’m the worst pizza maker ever, but let’s just say that I open it. You’d kick out losses like nobody’s business. But if you invest in something and you’re the silent owner, and you have profit coming in, then yeah, I have passive losses sitting over here. I could make sure that that income is not taxable. So it’s going to offset that.
You see a lot of folks that are tax-savvy and good investors, they may have several investments. People are always like, why would you invest in a restaurant? Why would you invest in that? A lot of times they’re saying, because I’m a silent owner, and it’s going to kick me income. These things are profitable. It’s not huge, but I have losses. It’s just tax free money for me.
If it kicks me $20,000 a year, I don’t have to pay the 50% tax if I’m in California or 40% tax if I’m someplace else. I’m saving a bunch of money not having to pay it, so it’d be cool. Somebody says, if I come to Vegas, will all the road construction be done? Holy smokes, it was terrible two weeks ago. Yes, it should be done, because the F1… no, stop it, Patty. The F1 is next week. It will be done.
Jeff: I think Tropicana won’t be complete yet.
Toby: Yeah, but I don’t think that’s messing up the strip. The F1 is what’s screwing this up. The state flower is a traffic cut. That’s about right. I’ve been to Vegas before. It’s almost like they don’t want you out of the casino.
All right. Next question. “Is it tax-wise to pass on single family home properties before my death to my kids? We have plenty of income, and passing on a few of them to our two kids might even lower our tax bracket. Each rental property is in a separate LLC, and we have owned them for 7–8 years now.” What do you say?
Jeff: Based on the way we answered the previous question about gifting, I think it’s a bad idea, especially if you had it for seven or eight years. That’s probably appreciated considerably. I would not gift these properties to my children.
Toby: Remember the rule. These guys need to remember the rule. If I gift Jeff a property, he gets my basis. If I have appreciated property and I die, it steps up, and Jeff never pays tax and all that gain. If I gift it to Jeff during my lifetime, he’s now got this lower basis and all this becomes taxable. It wouldn’t have been taxable.
Jeff: I’m going to propose some and see what you think, Toby. We talked about property managers a lot. There’s nothing that says that your children cannot be your property managers or that you can’t slide income to them to lower your taxes.
Toby: Yeah. You could set up a management, a family LLC taxed as a corp. They could sit on it, you could reimburse them for things like medical, dental, vision, cellphone, any tech that they need that benefits the business. Teach them how to do your business, and you could move money to eliminate some of that tax. Get it over to your kids tax brackets, or in that case it would be zero, so they wouldn’t have to pay tax on it.
Jeff: One other thing I would suggest because it’s come up a couple of times is, if you got all these properties and they’re all making money, you may want to consider cost segregation on one of the properties, maybe. You could do that over the next however many properties to eliminate the tax.
Toby: You accelerate the depreciation. Depreciation is generally on a single family home, 27½ years, and you could break it into a five, seven, 15-year property, and the 27½. A third of that property would be accelerated. Realistically under this scenario, probably the five and seven-year property will be immediately deductible, any amount that you haven’t written off. The 15-year property would accelerate a big chunk of that. You wouldn’t have to bonus depreciate it, you just have a massive loss in the year that you did it.
I’m going to throw one other thing out just because I always liked the charitable stuff. You want to get a nice tax deduction? Set up a family foundation or family charity. Believe it or not, depending on the type of property this is, that could actually qualify as a charitable activity. If it’s Section 8, or if it’s housing for veterans, housing for single moms, housing for residential assisted living, there’s a whole bunch of categories, or just Section 8, affordable housing. That’s a charitable activity.
You can set up a 501(c)(3). If you contribute one of these houses, it is 100% deductible against your adjusted gross income. There’s a limit of 30% of your adjusted gross income that can be written off in any given year from donating appreciable assets. You can carry that forward five more years.
If I look at this and say, hey, we have several rental properties, give it to your charity, your kids run the charity, and they’re entitled to salaries and fringe benefits out of that. Again, think about all of their tech, all their stuff, reimbursements for medical and things like that. But it’s out of your state.
Your kids can’t screw it up there if they have a broken picker and they’re bad at spouses. They can’t lose it in a divorce. If anything happens to you, it doesn’t have to get probated. But you get a nice, big, fat deduction, and your kids get the joy of running a property that has social benefit, and you get this big write-off, and kids get to continue to operate that.
Jeff: I bought this house for $150,000, it’s now worth $350,000. What’s my deduction?
Toby: $350,000. I just live that this year. I did that exact scenario. I bought it for $90,000. What is our Florida property, Patty, the one that we gave away? What was the fair market value? Let’s see. We’ll see if she actually pops it in. She’s listening. $330,000.
Jeff: Wow.
Toby: We needed a tax deduction. It was actually good. I’ve told this story. It’s not to pat myself on the back, but it was a gal that got booted out of her house because her kids used it as collateral on some dubious business dealings. She lost the house, she’s legally blind, and she lived in the house for 30 years. They used it as collateral, she loses it.
It’s a guy I know. I went to the bank, I bought it back, and said, mom can stay there. I know them. I’m not going to get into all the specifics, but it was one of those things where I was like, I’m never going to get paid for this thing. I’m never going to be able to buy it back. Mom can stay in it.
I gave it to one of my charities that does assistance for other people that are in need. I was like, hey, you can just live there for the rest of your life. You’re older, I don’t know how long, but you live there until you can no longer live there. I’m not charging rent or anything like that. It’s like, cool, this works great, I got a big deduction, I held it for a few years before I did that. So I get a nice tax deduction. Pretty much, the deduction paid for the property. That’s why the government does it for you. You can do that, too. I just want to sell it.
And an add-on question. If the kids want to sell it in the charitable institution in the future, what happens then? It is tax-free, it’s exempt, but the money is in the charitable institution and would have to come out either as payment for their services so they could get salaries. If it no longer does charitable activities, probably going to become a private foundation, which means that they would need to give away 5% of its assets every year, and they could charge a wage until the money’s gone. That’s not uncommon.
Jeff: A common misconception that we frequently run across is the nonprofit that I own, time out, you don’t own this profit anymore.
Toby: You control it.
Jeff: You control it.
Toby: That’s it. But anyway, you have options.
Jeff: If you’re going to make a charitable contribution, it has to be done by December 31st.
Toby: And give the LLC.
Jeff: Yes, absolutely.
Toby: Each property in a separate LLC, you get an appraisal done. What’s the form you’re going to file with your 1040?
Jeff: Help me out here, guys. 8283?
Toby: You’re going to file the tax form that says, with the appraisal. The appraiser signs the tax form, I should say, saying here’s the appraised values. If it’s over $5000, it needs that appraisal. You get that appraisal done next year if you really wanted to, before you file your tax return. It just has to be a company and LLC if anybody puts that up. All right. This should be the last question. It’s 8283. Very intelligent sir. That’s good, you plucked that out.
All right. Next question. “We have two newly opened short-term rental Airbnbs and LLCs. We want to do cost segregation and do bonus depreciation for the 2023 tax year. We are logging our time for the 500-hour rule, which is material participation if you didn’t know what that is. I heard that small businesses should be taxed as S-corps to save on self-employment taxes, but others say, don’t put Airbnbs in S-corp because they’re passive. What to believe?” Jeff.
Jeff: Okay, a couple of corrections here. The 500-hour test, all you have to do is meet the 200-hour test for your short-term rental. I’m guessing we’re talking about spouses. The way material participation works, if one spouse meets a test, they both meet the test.
Toby: You add their time together?
Jeff: Yes.
Toby: There are seven tests. There are three that are really relevant. Substantially, all the activities, so nobody’s cleaning it, just you. If somebody else is doing any activities, then as long as you spend between you and your spouse more than 100 hours, and it’s more than anybody else, other individual spends on your property, then you have material participation. Or the 500-hour rule is the, hey, I don’t have to worry about what anybody else does. If I do 500 hours, I’m materially participating. Please carry on.
Jeff: They say, don’t put an S-corp because it’s passive. That is incorrect. Short-term rentals are a trade or business. If you are materially participating in them, then it’s active ordinary income or loss. One of the issues I have with putting any real estate in an S-corporation or C-corporation is that real estate tends to appreciate. If you ever need to pull that property out, even for something like refinancing the property, it becomes a taxable event which you want to avoid.
Toby: Yeah, we don’t put the property in an S-corp. But even if you have a short-term rental and it’s a trade or business, that business could actually be passive if you don’t materially participate. If you materially participate, now it’s no longer passive, but it doesn’t mean it’s subject to self-employment tax. In order to have an Airbnb subject to self-employment tax, you have to provide additional significant services that are similar to a hotel like concierge services, food, or meals. If that’s not you, there’s no self-employment tax, you don’t need the S-corp.
If you’re doing the cost segregation and bonus depreciation individually, and you are materially participating in this, you want non-passive losses to offset your W-2 or your other income, but you do not want it to meet the self-employment test as far as being subject to Social Security taxes. What you just described works, I would just have it in an LLC taxed as a partnership or taxed as a disregarded entity. I would not use an S-corp.
Jeff: I agree.
Toby: I’m going to make it complicated just for a second. If you were not going to meet a bunch of these rules, if you were not materially participating, then there’s a good chance I’d want to keep your Airbnb, the rental property separate from the business. I would set up an S-corp for the host only, but I’d have the property in an LLC renting it to the S-corp. That way, I’m separating it out. My real estate’s over here, it’s all passive. My active business is my S-corp hosting, that’s right here. In which case, I would separate those out, and then I would have the S-corp because I would have a salary requirement.
Jeff: Are you referring to what we call the master lease?
Toby: Yes.
Jeff: I own the property, but I’m leasing a loan to my S-corporation.
Toby: Yes We do this, especially for real estate professionals who have other rental properties, but they may have a couple of Airbnbs, and they may not meet the material participation on the Airbnbs, but they meet the material participation on their rental properties.
Let’s say we had two Airbnbs. We put them in with the other rental properties as LLCs, they rent long to an S-corp, now all those losses qualify as rental. One of the exclusions is the real estate professional status. I meet that, it’s a non-passive loss, and it offsets my W-2 income and my other income. Just to throw a little curveball at you to understand that it’s not 100% straightforward.
If you’re a doctor, lawyer, dentist, salesperson making a lot of money, manager, whatever, and you’re making a bunch of W-2 income, short-term rentals that you own, manage, and you materially participate on, become your friend, because you can offset a ton of your tax by doing exactly what this question is. I put those in there, I meet my test, and I use an LLC that’s taxed as a partnership or as a disregarded entity. Those losses flow through. They’re limited to $500,000 a year. It’s more than 500,000.
Jeff: It’s $540,000, somewhere around that.
Toby: Yeah. You have an excess business loss limitation now, and it’s just over $500,000 that you can use. Somebody’s yelling at us and going, stop it.
Jeff: Yelling at us for going long?
Toby: You. He says you’re very verbose.
Jeff: Does that mean I talk a lot?
Toby: It’s me I know. I’m sorry, guys. I can’t help it.
Jeff: We blame Eliot. He picked some really good questions.
Toby: Eliot picked a really good question this time. By the way, we do have to give a big shout out to Eliot, Patty, Amanda, and Dutch. Tanya is on there. I’m probably missing people. Troy was on there. They’re answering all these questions. They’ve answered over 127 questions in the background. I always like that. Dutch and Amanda. I said Dutch Amanda. Jared’s on, too. We got CPAs just sitting here answering questions. Anyway, somebody says, thanks for being verbose. You’re the only one who’s ever thanked me for being verbose. Patty ridicules me.
All right, if you can’t get it off, we post these Tax Tuesdays, and we’re going to start doing something new this week. We’re going to take each question, and we’re going to post it as a separate video. For those of you who are Platinum, I think that you get the full access. Maybe even if you’re subscribed to the Tax Tuesday, you get the full video if you want to go watch it, but we’re going to break these into their pieces. We’re going to take each question, we’re going to post it as a YouTube question.
If you’re sitting here going, oh, man, there was something that I heard, and I want to go back and listen to it, you can watch the whole thing, or you can wait for the separate question. The question will be the title of the YouTube, and we’re going to start breaking them into pieces. You know that we’re content-rich. I think we’d be posting a video every day on YouTube if we’re doing that, but that’s okay.
Jeff: And thank you to the production team for picking that on.
Toby: I’ve been asking them for two years. They just always look at me like, really, really? I said, I’ll take the question and I’ll say, next question, and then I’ll read the question, rather than bouncing back and forth all the time. I said, we’ll try to make it easy. And then they can cut out all this nonsense that we do at the end.
All right, there’s YouTube. By all means, you can subscribe. Click on that. If you would like to be part of the Tax Tuesday where you can ask the questions and things like that. I would say, actually subscribe to Tax Tuesday. I believe it’s a separate thing.
As always, check us out. We have events going almost every week. It looks like every week, 10th, 18th, 30th. We’re always trying to bring content to you guys. You know us, we like to talk. If you have questions in the next two weeks and you want to get an answer, send it in at taxtuesday@andersonadvisors.com.
Visit us at andersonadvisors.com as well. But if you have a question, send it in. There’s not a cost. I don’t care if you’re a client, we’ll get you an answer. We’ll probably pick it. We answer a bunch. We get probably 400 questions, but we always grab 10. Eliot does it and throws them up there. we’re always trying to bring stuff that maybe you’d never thought of before. Maybe it’s something that can touch you and help you out in some way. Or maybe you know somebody else who could benefit from it. By all means, then share it.
We’re all here just trying to get through this big old tax code together. We’ve been doing this 200-and-some episodes. We’ve been doing this for many, many years. We’re going to keep doing it for many, many more, God willing. We’re going to keep doing everything we can to at least try to shed some light on a very complicated subject. But if you have questions, by all means, shoot them an email. Anything else, sir?
Jeff: I got nothing else, Toby.
Toby: All right, we will see you in two weeks.
