In this episode of Tax Tuesday with Anderson Advisors attorneys Toby Mathis, Esq., and Eliot Thomas, Esq., the pressing tax questions from listeners have a special focus on real estate issues. They dive into the complexities of tax benefits for short-term and long-term rental properties, addressing specific monetary scenarios. Toby and Eliot also explore the nuances of passive losses and real estate professional status, evaluating how a limited partnership investment and syndications impact tax strategies. Additionally, they clarify the effects of installment sales on capital gains tax, the tax implications of long-term capital gains for incomes below $93,000, and strategies for reducing tax liability as a real estate flipper. You’ll hear about the mechanics of 1031 exchanges, the use of solar credits against passive income, and the treatment of repairs versus improvements on rental properties. Tune in for expert advice on optimizing your tax situation in the real estate world.
Submit your tax question to taxtuesday@andersonadvisors.com

Highlights/Topics:

• “Professor One has three short-term rentals, seven days or less.” “He generates $20,000 of profit from each one, but each generates $60,000 of losses, cost seg plus bonus depreciation.” “Can he use 20% QBI?” that’s 199A. “Can you use it on the $20,000 profits, or will those be offset by the $60,000 losses, and the net will be $40,000 each?” –We can’t. We have to take in the $60,000 loss that’s associated with each of those buildings. We don’t take QBI against the loss. No, QBI would not be available here.
• “Professor Two has four long term rentals, and he used line depreciation for all of them.” “His wife is a real estate professional, but there’s not enough losses to offset his $300,000 grand in income. The CPA suggests putting $200,000 in a syndication as an LP. K1 will generate $150,000 of losses. As long as his wife is REP, he can use those passive losses to offset his W-2. Is that true?” – Because we’re introducing a syndication, and this is a limited partner, that’s the LP here at K-1, we’re going to have to meet that test, the 500-hour test. In other words, to get our REP status, if we didn’t use the 500-hour test, we may not be able to do that. That’s why I say it depends.
• “Professor Three has one passive long-term rental and just bought two short-term rentals with seven days or less with cost seg plus bonus depreciation. Next year, 2025, his wife plans to retire and claim real estate professional status. The plan is to keep those short-term rentals as Airbnb with eight days or more, a.k.a passive, and keep the long-term rental as is. The first question is, can the wife manage, clean those Airbnbs and claim the 750 hours without touching the third long-term rental that is far away and group them all together?” – I’m going to say no, because remember, a short-term rental isn’t rental activity. It’s the pizza shop, okay, that Toby keeps talking about. But we have other ideas.
• “The second question is whether we can still use the losses from the cost seg we conducted on those two short-term rentals this year.” – Losses will stay passive into the future, so no.
• “I have a question about capital gains tax. I’m selling a property with an installment payment plan. Only two installments to be received. The first will be received December of 2024, the second and last payment will be January 2025. How will this affect my capital gains tax?” – Simplistically, it’s just going to split them.
• “Paying tax on real estate long-term gain. If my net income is under $93,000 in 2024, will I owe taxes on long-term capital gains from the sale of real estate, a vacation rental? The gain itself is over $93,000.” – if you are below approximately $94,000 in 2024, it’s going to be taxed at zero.
• “How do I reduce my tax liability as a flipper?” – Do it in a C-Corp or S-Corp, besides just immediate tax deductions, we want to avoid dealer status.
• Reverse exchange 1031. “Please help us understand it. How do I choose a QI, which stands for a qualified intermediary? Any recommendations for first-time 1031 exchangers?” – you’re first buying the replacement property and then you’re deciding within 45 days which you’re going to give up. And so it’s just the opposite direction. You have 108 days total from close to close.
• “Is it possible to use solar credits against passive income from real estate rent income?” – Yes. You can have a solar credit. You could do it in your personal home, which would create an ordinary loss. The nature of the activity that the solar is attached to might have something to do with its tax treatment.
• “How do you determine if a repair and a rental property can be treated as an expense in the current year or must be depreciated?” – If you’re making the property more valuable by doing it, that’s not a repair. You’re making it more valuable.
• “Hi, my husband and I want to sell a new construction home business to become full-time investors and manage our five large commercial properties. In the past, we’ve had real estate professional status because we self-managed our commercial properties. If we sell our construction business, do we still qualify for rep status if we start a management company to manage our commercial properties and earn W-2 income from this new company? What type of entity would be best to set up a management company, LLC, S-corp, or C-corp? – using that management company that you own yourself, certainly, you can use that towards your time.

Resources:

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Toby Mathis YouTube
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Clint Coons YouTube

Full Episode Transcript:

Toby:  Hopefully you guys are out there. Let’s see. We’re doing comedy routines here. Let me see if I could pull everybody up. Hopefully everybody’s falling into the room. I can’t see the number. There we go, everybody going in. If you’re here for Tax Tuesday, you’re in the right spot. I’m going to take the gray away.

Eliot: We have some people coming in.

Toby: There we go. Yeah. All right, good. Our technology is working today. All right. Welcome to Tax Tuesday. If this is your first Tax Tuesday, we’ve already started an auspicious beginning. Give me a thumbs up if this is your first Tax Tuesday and you’ve never been to a Tax Tuesday before,  I imagine that we have a lot of old hats here. There’s some new ones.

If you’re new, welcome to Tax Tuesday. There’s a bunch of thumbs. Either they forgot that they’ve attended or they really are first time attenders. It’s great to have you here and I’m excited. Wow, this is good. Hey, wait, I got a button. They gave me my what’s up button, which we might use under extraordinary circumstances. We’ll see.

Eliot: Like the first three questions?

Toby: The first three, like I got to get it out. I got to give it out. We got some buttons here. All right, I’m Toby Mathis and this is…

Eliot: Eliot Thomas.

Toby: We’re going to be your hosts for today. Tax Tuesday is about delivering a little bit of fun with taxes so that you’re not scared of it and that you actually realize that the tax system really is a game. You got to follow the rules, and then you’re allowed to put yourself in a situation where you pay the least amount as required under the law. There’s no reason to leave a tip, although they might be tax free. The idea is to keep more money in your pocket. They’re supposed to be fun.

Eliot usually drinks a lot before we start, so he’s useless. No, he doesn’t drink. I should. I was on my things to do this year. You just go ahead and ask questions. We have a whole bunch of accountants on. I see Troy, Tanya, Rachel, Jeff, Jared, Dutch, Arash. Oh, my gosh. We got a lot of accountants in the Q&A area. When I say accountants, I mean accountants like CPAs. I think we have tax attorneys and we have accountants in there to answer your questions.

It doesn’t cost you anything, guys. Go ahead and ask questions. Get them out there, and we will absolutely answer your questions. This is a public service that we try to do. You can always email in questions to taxtuesday@andersonadvisors.com during the week. Eliot here builds, how many of those do we get?

Eliot: Anywhere from about 150-250.

Toby: Eliot gets an applause. He picks 10 of them, or thereabouts, to do live on these shows where we actually read them and go through them. The whole idea, guys, is to take the snottiness away from tax and make it so it’s actually fun. Somebody says, so I could charge $1 and get $4.99 for tip. Yes.

Is this for accountants only? No. We like accountants. Actually, we really like accountants, but this is for anybody. We use regular language, so you should be able to walk away and understand things. Speaking of understanding things, let’s dive in. What do you got here? Wait, I have a bigger screen right here.

“Hi, from some engineering professors from ISU. We extend our greetings to you and your guests.” There’s a whole group. Is that Iowa State?

Eliot: Iowa State University.

Toby: Thank you guys. Welcome.

Eliot: They beat Iowa.

Toby: They beat Iowa?

Eliot: This weekend, yeah.

Toby: You’re from there, right?

Eliot: Yup.

Toby: You’re putting them on the front of the line.

Eliot: They were good, relevant questions.

Toby: Yeah, all right. We got good questions. All right. “We all have CPAs, but we don’t have as much trust in them, so we want to pick your brain.” Your CPAs are out there like, hey, I heard you got this group of professors that are talking smack. No, I don’t blame you. It’s always good to get a second opinion. We’ll answer your questions. Let’s see. Wow, we have a whole bunch coming through here.

All right. “Professor one has three short term rentals, seven days or less.” We’ll explain what that means. “He generates $20,000 of profit from each one, but each generates $60,000 of losses, cost seg plus bonus depreciation.” We’ll go through all of this so that if you’re first time here, you don’t get nuked on your first question. “Can he use 20% QBI?” that’s 199A. “Can you use it on the $20,000 profits, or will those be offset by the $60,000 losses, and the net will be $40,000 each?” We’ll go over that. What did you do? I don’t even know what to do.

Eliot: Touching the button.

Toby: I think I’m going to have to go like, ah, I don’t even know what to do. All right. “Professor two has four long term rentals, and he used line depreciation for all of them.” We’ll explain what all this means, guys. “His wife is a real estate professional, but there’s not enough losses to offset his $300,000 grand in income. The CPA suggests putting $200,000 in a syndication as an LP. K1 will generate $150,000 of losses. As long as his wife is REP, he can use those passive losses to offset his W-2. Is that true?” Really good question. That’s insane. There’s more. Really should start day drinking before.

All right. “Professor three has one passive long term rental and just bought two short term rentals with seven days or less with cost seg plus bonus depreciation. Next year, 2025, his wife plans to retire and claim real estate professional status. The plan is to keep those short term rentals as Airbnb with eight days or more, a.k.a passive, and keep the long term rental as is. The first question is, can the wife manage, clean those Airbnbs and claim the 750 hours without touching the third long term rental that is far away and group them all together?”

This is intense. Guys, we’re going to answer these, and you guys are all going to get an honorary CPA designation. I don’t even know, EA probably. “The second question is whether we can still use the losses from the cost seg we conducted on those two short term rentals this year.” The confusion comes from the fact that math was divided by 39 and now both are 27 years or 27 and a half.

Eliot: I think there’s more confusion than just that, but yeah.

Toby: These are cool. I’m actually thinking about it now. Stop doing that, don’t think about it. I’m wanting to answer right now. I’ll just refresh. Let’s think of something not tax related. Yes, let’s think about pizza. All right, I want to think about pizza right now. We’ve cleared the brain.

All right. “I have a question about capital gains tax. I’m selling a property with an installment payment plan. Only two installments to be received. The first will be received December of 2024, the second and last payment will be January 2025. How will this affect my capital gains tax?” Interesting. Somebody’s smart.

All right. “Paying tax on real estate long term gain. If my net income is under $93,000 in 2024, will I owe taxes on long term capital gains from the sale of real estate, a vacation rental? The gain itself is over $93,000.”  We’ll answer that.

“How do I reduce my tax liability as a flipper?” We just do the open ended. We like it. We’ll do the open ended.

Reverse exchange 1031. My God, I don’t think I’ve ever had a reverse exchange question. “Please help us understand it. How do I choose a QI, which stands for qualified intermediary? Any recommendations for first time 1031 exchangers?” Thank you very much. Great questions, man.

“Is it possible to use solar credits against passive income from  real estate rent income?  Did you just get hammered by these?

Eliot: Yeah, it was quite a flood this week.

Toby: “How do you determine if a repair and a rental property can be treated as an expense in the current year or must be depreciated?” Wow. This is a good one.

This is the last question that we’ll answer, and we’ll get to these in a second. For your first time, we go through all the questions so you know what to be expected, and then we’ll just answer them.

“Hi, my husband and I want to sell a new construction home business to become full time investors and manage our five large commercial properties. In the past, we’ve had real estate professional status because we self-managed our commercial properties. If we sell our construction business, do we still qualify for rep status if we start a management company to manage our commercial properties and earn W-2 income from this new company? What type of entity would be best to set up a management company, LLC, S-corp, or C-corp?

Great questions, man. Just really good, solid, mind numbingly good questions. We’ll get into them. Thank you to all the professors out there for teaching those students engineering. I always say that the English majors are subsidizing the engineers, basically. There’s a disparity in the value of those two. No offense.

Eliot: Sure, none taken.

Toby: I know. The engineers are like, they’d kill it, especially the computer engineers. I’m always like, man, they’re paying the same price for the tuition. This one, they’re going to make $300,000 coming out of school, and the other one’s going to get $30,000.

Eliot: Yeah. I got a D in English.

Toby: Not surprising. Hey, guys, we have YouTube. That looks like my channel. Join my channel there. This is just free and just subscribe. We also live stream this on YouTube. If you’re on YouTube, thank you for being on our YouTube. Absolutely free. Share it with as many people as you can because frankly, financial literacy is something that we need a lot more of in this country. It’d be great.

Clint Coons, my partner, how long have Clint and I been practicing together? I guess it’s 25 years now. He does a great job doing asset protection. His channel is a little more geared towards real estate asset protection. Mine tends to be a little more geared towards tax and financial. I’ve been losing my mind lately and doing a lot of rules of money because I can’t help it, and people seem to like those, and I like them. I like just doing those. Together, we’re pretty good.

If you want to learn how LLCs and all the things that we’re going to be talking about today work and learn tax strategies, join us at a tax and asset protection event. The virtual ones are free. The live ones have a small ticket cost. I think it’s usually less than a couple of hundred bucks. You can come spend three days live with us. We have one coming up in September this month. We have one coming up in December, and these are going to be a lot of fun.

If you haven’t been to one, you’re around a lot of investors. It’s usually several hundred people. We just get around and we talk a lot about real estate, real estate taxation, real estate asset protection, legacy planning. We bring in a bunch of different groups that talk about things like cost segregation and different types of tax strategies. We always bring in Spartan who does a great job on self-storage. They’ve just exploded over the last three or four years. It’s a lot of fun.

If you can, join us. If you just want to do a virtual event, it looks like we have two coming up on the 14th and the 21st. They’re absolutely free. I would strongly recommend that you learn that subject. Making money is the easy part, keeping it is the hard part. You’ll realize this that that’s true. As you get better and better at making money and you realize you have holes in your boat, you’ll be a little ticked off for your bucket. You’ll be like, why is there always a hole in my bucket? We can clog some of those up like our friends, the professors here. Your money goes a lot farther. All right, let’s have some fun.

“Professor one has three short term rentals, seven days or less.” You’re going to have to break this down, definitely. “He generates $20,000 profit from each one, but each generates $60,000 loss. Cost seg plus bonus depreciation, plus overhead expenses. Can you use 20% QBI for the $20,000 in profits? Or will those be offset by the $60,000 losses and the net will be $40,000 loss each? What say you?

Eliot: Okay. Normally I just go out and blur out the answer, but we really do have to step back and get the table set here a little bit. What are the STR or short term rental? If there’s a short term rental, there must be a long term rental. The two are really under the code, completely separate and unrelated. That’s one thing we just want to take away at the beginning of our talks today or all these questions, because that’s going to come up a lot.

Short term rental, there’s basically three types for our purposes, but there’s one that we usually use most of the time, and that is if the average stay throughout the year is seven days or less. If we meet that standard and our average stay is seven days or less, and if we materially participate, which means we basically do all the work or a lot of it, managing it, self-managing, et cetera,  then we can change it into what we call non-passive activity or active, either way, as opposed to being passive. The reason we care about that, if it’s passive, which is by the way the natural standing if you have a long term rental, but we are in the short term rental world here, if it’s passive, you may get a lot of losses from these things that we have listed here, the cost seg, bonus depreciation, overhead expense. We’ll expand on what those exactly are as well.

If you have that loss and it’s passive, most of the time you’re going to be limited. You can only use a passive loss against passive income. There’s a few exceptions like anything in the code, but that’s the general standing. You could have a lot of losses as we do here. We have $60,000 loss for each of these three buildings. It’s going to create a loss. If we’re not actively managing this materially participating and it’s not a short term rental, then we can’t take those losses. That’s really critical to understand as we go through not just this question, but a lot of the real estate related questions.

With that in mind, cost segregation, it’s just a form of depreciation. Your normal status when we depreciate, if it’s a short term rental, is over 39 years. We only do the building, we don’t depreciate land. Let’s say we bought a building for $500,000, $100,000 for land, you divide the $400,000 building by 39 years, that’s what we call the straight line depreciation.

You take an equal amount each year, except for the first year, depending on what time of the year you got into the adventure. That will be a big deduction. However, cost segregation is a type of depreciation that says, hold on, that building has a lot of components. It’s got carpet, lights, framing, all kinds of different things going on. Each of those on their own have their own depreciation life.

Cost segregation is a study. A group comes in and they say, let’s break it into its components, five-year property, 10, 20, and some will be 39 years in the case of a short term. That speeds up our depreciation, we get to take more right away. Then we could hook onto there’s something called bonus depreciation. Right now, that says, if we did it here in 2024, 60% t of all of that property that’s 20 years or less, we can deduct 60% right away. We get this massive deduction.

I’m not surprised that we’re seeing deductions here of $60,000 losses. That would ring true with a lot of these cost tags and bonus depreciation. Of course, we have the overhead expenses, which can be power, electricity, property taxes, what have you.

All that aside, now we get into this thing called QBI, Qualified Business Income. What QBI is, it’s something for us as individuals or if we have an S-corporation or a partnership, does not apply to our C-corporations, and basically it says that you can take up to 20% deduction if you have a business that is profitable. That’s the real key.

Again, it’s the US tax code. It’s not always that simple. There’s a lot of calculations that can go into a QBI, but we’re going to really simplify and just keep it at, you get a 20% deduction. If you had a hundred dollars of income, it qualified as qualified business income, you’d be able to deduct $20 or 20%. Now, your taxable income is only $80 in my simple example there.

Moving forward in our question, we’re asking, can I do this special qualified business income deduction on that $20 of profit? I got three rentals, each of them making $20,000 of income. We just want to know if we can take the QBI deduction against that. We can’t. We have to take in the $60,000 loss that’s associated with each of those buildings. If each made $20,000 times three and each has $60,000 of loss, you’re going to have three billings with $40,000 of loss, and we don’t take QBI against the loss. No, QBI would not be available here.

Toby: Dang.

Eliot: That’s a lot. I hope I didn’t lose you too much.

Toby: Just to reiterate, and I’m just going to paraphrase some of what you just went over, when you have rental property, the typical way it’s treated is passive activity, a typical rental. What’s not a rental is when you’re using an Airbnb or a Vrbo, where the average stay is seven days or less. The way you do it is you say the total number of days it was rented. If you did it for 200 days divide it by the number of unique rentals.

If you had 30 unique rentals and you rented it for 200 days, you’re going to be somewhere below seven days or less. You’ll be six point something. That is not a passive activity anymore. That is a trade or business.

My favorite example of a trade or business is pizza shop. We are a pizza shop at that point. Just like in the pizza shop, we might have ovens. We may have stuff that we want to depreciate, which means deduct. Now we have these structures, the houses, and we could deduct them. Generally speaking, on a short term rental, it’s 39 years.

Residential, you’re going to say, wait a second, it’s 27 and a half when it’s a hotel, which is what is considered. It’s not a rental activity anymore. It’s a business, it’s 39 years. We could break it into its components. You correctly pointed out, like carpet. That’s a five-year property. Carpet’s not going to make it 39 years.

The improvements that you put outside, you planted some new trees, you put a new driveway, put in a walkway, put in a fence, none of that’s going to make it 39 years. That’s a 15-year property, and then you can accelerate that. You could take 60% bonus of that amount in this year, unless you put it into service in a previous year, which case you could go up to 100%. It’s a fancy way of saying you get a big deduction. That’s all it is.

When professor one has three short term rentals, think of it like this. They have three pizza shops. Each one, before you take the expenses, it’s making about $20,000 gross profit, but then they have all these other things they can write off as a deduction. It’s going to make $40,000 dollars each. Each pizza shop is losing $40,000 dollars each. That’s the easiest way to look at it. That’s a $120,000 loss.

Now, this is where it gets fun, that could still be passive. If Eliot and I start a pizza shop, and Eliot works in the pizza shop but I don’t, I’m looking at Eliot going, I’m not going to flip a pie. I’m passive. I don’t materially participate. Eliot materially participates. Same business.

Let’s say it kicked out losses to both of us. Eliot’s is ordinary. He could use it to offset any other income he has. Non passive because he’s a material participant. Me, if I’m in the pizza shop and I didn’t materially participate, it’s still passive. Passive losses can only offset passive income with a couple of exceptions, active participation and real estate professional.

When we look at these, we’re first trying to say, is this a business or is this rental? Because there’s different rules. This is a business. They’re creating big losses. Fantastic. The only question I would have here is, is  that $40,000 loss non passive or is it passive? If it’s non passive, do we have other income to offset like W-2 income? If this is a professor, then probably going to offset their income, which means more money in their pocket, which is great.

I hope that they’re doing a little bit of calculation and saying, is it worth it? I tend to not do a whole bunch underneath $200,000. If I get some of the $200,000, like they’re $400,000, we get them down to $200,000, it’s usually good. We’re not paying in an order amount of taxes. Where it really gets bad is when you get into the highest brackets, but I don’t want to offset 12% income with deductions. It’s up to you, you get to make that decision yourself. Is the juice worth the squeeze?

Here, QBI is not an issue because there’s not going to be profit out of these entities. These are all going to be trading net losses. Those losses, if you’re materially participating in it, chances are, if they’re working in them, they’re going to be able to meet one of their seven tests. The easiest one is you do everything. The second easiest one is other people help you do work on those short term rentals, but you do a hundred hours and it’s more than anybody else. Those are the easiest ones, and that’s a husband and wife combined or two spouses combined.

What a big, huge benefit. These guys are sitting on a tax goldmine, which is absolutely fantastic. Really, these questions from these guys, just stellar. We could probably spend the entire day going over just the concepts that are there.

“Professor two has four long term rentals.” Now we know that there’s trader business like Airbnb and other types of just rental. When you see long term rental, that means it’s not short term. It means it’s passive rental activity. They used line depreciation, meaning I didn’t accelerate it. I’m going to write off the carpet over  27 and a half years, since this is a long term rental and residential. His wife is REP, but there are not enough losses to offset his $300,000 of income. His CPA suggests putting $200,000 in a syndication as an LP. K-1 will generate $150,000 of losses. As long as his wife is real estate professional status, he can use those passive losses to offset his W-2. Is that true?

Eliot: It could be. In this case, if we have REP status, and now we’ve introduced the syndication in here, we got to ask, how did we get to real estate professional status? That test is a little bit more involved. This individual, the spouse, has put in over 750 hours in a real estate trade or business that she materially participates in. It’s over 50% of her work hours throughout the year, and she will have to materially participate in the management of their rental properties.

To get that material participation, the test that Toby was talking about earlier, he talked about the over 100 hours and more and everything else, there’s also the 500-hour test. Because we’re introducing a syndication, and this is a limited partner, that’s the LP here at K-1, we’re going to have to meet that test, the 500-hour test. In other words, to get our REP status, if we didn’t use the 500-hour test, we may not be able to do that. That’s why I say it depends.

If we did get 500 hours to meet our material participation test and we aggregated, which we pulled them all in, it’s an election you make to get your REP status, and I’m going to suggest they probably did when they have four rentals struck in a lot, in that case, then yes, it will pull in that loss from the syndication, $200,000. It will become a loss against the income. That’s correct.

Toby: There’s a big difference between limited partnership syndications and LLC syndications. When you’re a limited partner, there’s two tests that you can meet for LP, one of them is the 500 hours and the other one is five out of 10-year?

Eliot: Yes, the historical.

Toby: Right. There’s seven tests for material participation. If you’re an LP, not a GP but an LP, one of the ways you get around it is by being a GP if you’re an investor. Sometimes the syndicator will let you have GP units. Syndication is a fancy way of saying a group of investors together. A syndication is like an LLC that’s buying an apartment complex. Under reg D of securities is allowing people to invest with me and then put money into that LLC in exchange for ownership in that LLC. They’re owning a piece of the LLC.

In this case, it says LP, so they own a piece of the limited partnership, and they’re a limited partner, which means they have no management rights or whatsoever. When they do that, then there’s a regulation called the regs under 469 that says, aha, if that’s your case, unless you’re a GP or you spend 500 hours in material participation, that’s going to be passive.

I think there’s another solution, by the way. Hopefully this professor’s on. This is what I’m going to suggest you do. If you don’t have enough losses and you did straight line, then look at doing a cost segregation and unlocking more depreciation now, and it’ll wipe out some of that income. You may not even have to do the syndication. If you feel like, oh, gosh, this indication isn’t something I necessarily want to do, then you might look at other investments that create non passive losses. Oil and gas is a great one.

Other things you could do to offset your income is short term rental. We don’t have to worry about real estate professional, but you have an appetite for that. I’d probably look at acquiring additional long term rentals. Even if I was going to do a short term rental, I may do it like this. I may buy the property and lease it to a corporation that is the host so that I can keep it as a long term rental and group it with my other long term rentals if I’m a real estate professional. Otherwise, it’s considered a pizza shop. Short term would not be aggregated with the four long term rentals.

With a little bit of knowledge, you could do some great things here. My guess is that you actually have a couple of options. Number one would be the lowest lying fruit is just to change your accounting method and get a cost seg. The second level is do the investment in a syndication as an LLC rather than an LP and not have to worry about the 500 hours. Third is, if you really like that LP investment, do that.

When it creates its loss by doing cost segregation and bonus depreciation, I guarantee you that’s where that loss is coming from, then it’ll offset your other income. A $150,000 loss against $300,000 of income cuts your tax bill by more than 60%. Fantastic. Great job.

Professor three. We should all go to Iowa State because you guys are smart, but engineers are always super smart. Invariably, you guys are always the ones that send me my book back with three edits. You miss this, Toby. Always an engineer. It’s never the English. I’m sorry, English majors. We love you too. But engineers, holy crap.

“Professor three has one passive long term rental and just bought two short term rentals with seven days or less with cost seg plus bonus depreciation.” Now you guys know this language. You’re looking at it going, oh, this is a long term, which is real estate, and he bought a couple of pizza shops. We have two pizza shops, seven days or less, and he’s writing off. The house is much faster. Next year, 2025, his wife plans to retire and claim real estate professional status. The plan is to keep those two short term rentals as Airbnb but with eight days or more, aka passive.

Can I just stop real quick because we’ll go through this question then I’ll let you answer? There are actually three other ways that it could actually be a business. It’s not just seven days or less, that’s automatic, but eight days to 30 days was significant participation. I think it’s extraordinary participation, 30 days or greater, if you’re doing a rehab clinic and it’s not a rental activity. Just because it’s eight days or more, it depends on what services you’re providing with it as to whether it would be passive. I just wanted to get that out of my head before I forgot.

“The plan is to keep those short term rentals as Airbnb, but with eight days or more and keep the long term rental as is. The first question is, can the wife manage, clean those two Airbnbs and claim the 750 hours without touching the third long term rental that is far away from the group altogether? The second question is whether we can use the losses from the cost seg we conducted on those two short term rentals this year. The confusion comes from the fact the math was divided by 39 years and now both are 27 and a half years.”

Eliot: All right. Just starting off. The first question is, can the wife manage the two Airbnbs? Remember, we’re talking next year when the spouse is attempting to get that real estate professional status. Remember, real estate professional status refers to long term rentals. Can the spouse manage these short term rentals and add those hours towards the tests required for real estate professional status?

I’m going to say no, because remember, a short term rental isn’t rental activity. It’s the pizza shop that Toby keeps talking about. But if they’re managing a long term rental, yes, those hours would go. However, we do have a fix for that. Toby talked about it earlier. Why don’t you set up maybe a C-corporation? You rent the short term rentals long term a year to your C-corporation, and then you conduct the short term activity. You sublease it from the C-corporation. That makes your short term rentals now long term rentals.

As we talked about before, you can aggregate or pull all your long term rentals together. Now the spouse can manage those rentals through the C-corporation. That will count towards our hours. By just making a slight twist, yes, we are able to get there. For question number one, yes, we would aggregate. I don’t want to use a term group. That actually has a different meaning with material participation, but here we’re going to aggregate them together.

Second question. Can we still use the losses from the cost sake we conducted on those short term rentals in 2024? The confusion comes the fact that the math was divided by 39 and now are both 27. Really, the confusion doesn’t have anything to do with the answer here. The second question, can we use those losses? If we incurred them in 24 and if they were passive losses, then they’re going to stay passive into the future. We’re never going to change them. They keep their identity.

If these were in the short term rentals, we materially participated, and they were non passive losses, they would probably be used this year. But if there was any carry over, they would continue to be ordinary non passive losses. In that sense, you wouldn’t have to worry about anything.

The idea that we’re going from 39 to 27, what that has to do with is that we were a short term rental, and we divide by 39 years to get our straight line depreciation. Now we turn it into rental, which is actually 27 and a half years for long term rentals. To do that, just as a bonus here for anybody wants to learn this, we’re going to take what’s called the adjusted basis at the end of whenever we made this conversion from short term to long term. Short term is under 39-year straight line depreciation.

Let’s just say we did it at year end. January 1st of 2025, it’s now long term. We’re going to divide that adjusted basis. That is whatever has not been depreciated yet. We’re going to divide that amount by 27 and a half years and continue on. The code does give you a provision though. If you’re going from 39 years down to 27, you can. You do have the option to retain your original 39-year depreciation life. That’s a little bit of a special thing going on there.

To get back to the two main questions, can we do the 750 hours, not without that master lease? We’re going to need to have that master lease, turn those short terms into long term. Yes, our activity of managing those will count to our 750 hours to get that REP status.

Second, can we still use the losses? If they’ve already been incurred, we took the studies, we incurred it, and they were passive in 2024, they will retain being passive and follow those passive loss rules. They very well might not help us for some time in the future. If they’re from the short term rentals, we materially participated, and they were already ordinary losses, they will have been taken in 2024. If there were too many losses, they will continue as an ordinary net operating loss going into 2025. That was a lot.

Toby: Oh, my God. I do have one issue with something you said. If they manage the Airbnbs, I believe that would work for the 750 hours, but it wouldn’t work for material participation on it because it wouldn’t be considered a rental activity.

Eliot: It could be. I just have never found it. We’ve actually asked this and looked at this a couple of times out there amongst ourselves here. I never found the actual answer, so I also don’t know.

Toby: I do. I know.

Eliot: He knows it.

Toby: Yeah, for a hundred percent, because you can take multiple trades or businesses and grab that management towards it. If you’re managing an Airbnb, that’s no different than managing anybody else’s activity in the IRS is how that you could count that. It’s just not towards your properties. Usually you grab those and count them. If your management and you count the hours towards the 750, and then if it’s self managed, you count those towards your material participation on yours as well.

Here, you can’t count the material participation hours, but you could count the 750 hours. It sounds like she’s a real estate professional anyway, so I’m not too worried about it. You don’t have to do the cost seg. If you did have a loss, you could wait until next year actually to do the cost seg.

Eliot: Yeah. You could have had the study done, just hold off, and then use it this year.

Toby: Yeah, we can claim it at any time. Let’s say I put a property into service in 2020, and you’re looking at your 2023 taxes. We’re coming up upon the deadlines. You’re like, shoot, I really wish I could get some of the money I paid last year back, 2024 hasn’t been what I really expected, or I could just really use that cash. You could actually make an election for your 2023 taxes to choose to take your cost segregation and change your accounting all the way up until you file the tax return. Either the partnership or if it’s going straight on your return, October 15th, you can make that election.

The year that you use for determining whether it’s a hundred percent bonus depreciation is the year that it was put into service. My example was 2020, which would give you a hundred percent bonus depreciation. You grab it all, and you get yourself a big fat loss. Here, they could wait. You could wait. It’d be interesting to see and play around with it a little bit, but I get what you’re saying.

Eliot: They’d be fun cows, literally for us.

Toby: Yeah. We like to play different scenarios and that’s actually pretty cool. Anyway, that’s the first three.

Eliot: Yeah. They get easier.

Toby: Wow. We’re going to be here till midnight. “I have a question about capital gains tax. I’m selling a property with an installment payment plan, only two installments to be received. The first payment we received in December of 2024, the second and last payment received in January of 2025. How will this affect my capital gains tax?” What do you think?

Eliot: Simplistically, it’s just going to split them. Assuming that you have equal payments, what’s really going to happen is you’re going to have your gross profit percentage. You take the amount of profit. Let’s just say you sold it for a hundred thousand. Your basis was $60,000, so you gain $40,000. $40,000 is your profit. You divide that $40,000 profit by the original sales price, $100,000, that gives us 40%.

You take whatever amount you received in installment one times 40%. Whatever amount you received installment two times 40%. Typically, that will be the amount of gain that you will recognize, 40% of that amount each year.

Toby brought up a really good point before we started here about this question. What if it had been a rental and you had some depreciation, or it was an asset that had depreciation? You’re going to have some depreciation recapture, and you must handle that first. Pay that in the first year. We will have that contingency here as well.

That aside, the simplistic answer is that, let’s say there were equal payments, the first and second payment. You take it times, in my example, 40%. That’s the amount of gain you’ll recognize in each year. What you’ve done here has been able to streamline your income, so you’re not in a higher tax bracket overall typically. It’s a good plan.

Toby: You should know that, it’s this code section is 26 USC 453, you could choose to elect out of it. If this year you’re going to be in a lower tax bracket the next year, you’re just doing this because the other party doesn’t have the money, you’d rather have it all taxable in this year, and you could be closed this year, you could tax it this year. You can elect out of the installment and then have it all taxed this year if it’s going to be better for you. It all depends.

Sometimes long term capital gains, if you’re married filing jointly and you’re less than $94,000, you’re at 0%. Anything up to about a half a million is in the 15%. You may be looking at it going, shoot, I have a bunch of 0% that I want to use up. You might be able to use it even with the two installments, but it’s up to you as to whether you choose to spread it out over the two tax periods or not. You should know that.

We do this also when we sell homes that have a 121 exclusion. Sometimes we opt out of the installment sale and have it taxable all in the one year because you have no capital gains. Even if you’re carrying back a note, it makes it a lot easier for your accountant. Plus, you’re not paying tax on it. You’re just grabbing it all right now. Well put, good one.

Eliot: Next one says building off of that.

Toby: “I’m paying tax on real estate long term capital gain. If my net income is under $93,000 for 2024, will I owe taxes on long term capital gains from the sale of real estate vacation rental? The gain itself is over $93,000”

Eliot: I threw this in there because it’s an extension of what we just went over in the previous question. As Toby pointed out, if you are below approximately $94,000 in 2024 in total income, your total taxable income, that’s all your ordinary income, your interest, income that you’ve had, capital gains, et cetera, if it’s below $94,000, approximately, then any capital gains that you have, it’s going to be taxed at zero.

I think what we’re trying to get out here is if we’re below approximately $93,000, approximately that $94,000 amount, is there some way we could get in there and have zero on here? The problem here is whether or not that gain of $93,000 is being contemplated in the total income of the net income of $93,000. If it’s not, and a lot of people do this, my ordinary income was $93,000, my net income from all my work was $93,000, so I’m below the amount of $94,000.

I have this $93,000 capital gains, so I can get that at zero, right? No, that’s incorrect. You have to add the capital gains on top of your ordinary. Here, we would have $93,000 plus $93,000. That’s going to give us 186, and we’re well above the $94,000. We’re not going to get most of that at zero, it’s going to be largely at 15%.

Toby: Also the $93,000, it’s a closer to $94,000 for married filing jointly. You’re about half of that if you’re single. I look at it, but it does get added. I remember I had this with a client who thought that, hey, I’m going to keep my income below this so I never have to pay capital gains. Looks like it doesn’t work that way. They got really mad when you didn’t. I don’t write the law.

Eliot: Was beat up on the messenger.

Toby: Yeah. I tried to follow it, but I’m below this. You can’t have a million dollar capital gains at zero. You can borrow. That works. Don’t sell it or 1031 exchange it and borrow against it. Lever it up, go for it.

Next one. “How do I reduce my tax liability as a flipper?” A dolphin?

Eliot: Right, exactly.

Toby: I immediately start thinking about it. Remember Flipper? Those were great. I always wanted to have a boat and jump off it.

Eliot: There’s those Jim Carrey with Snowflake. I remember Snowflake also in Flipper. Anyway, the first thing we’re going to suggest here, at least I am, is you do it in a corporation. Besides just immediate tax deductions and things like that, we want to avoid dealer status. You don’t want to be flipping a lot in what I’ll call your personal name directly hitting you. If you get hit with dealer status, there’s a lot of negativity to that.

I’m going to recommend doing in a C-corporation first, maybe an S-corp, depends on what your goals are. The idea of doing it there in the corporation, number one, it will prevent you from hitting that dealer status. There’s protection to that. Number two, both C or S corporation, or this includes LLCs taxed as S or C. You’re going to have things like the corporate meetings that you can do at your home that we talk a lot about under section 280A.

You can have an accountable plan, which just means reimbursement for maybe an administrative office in your house. Both of those are going to give you lots of opportunities to get a lot of cash back to you tax free, that’s going to be a deduction against any income you had originally from your tax liability. That’s why I’m going to recommend a corporation again, S or C. Toby had some really good insight, and I’ll let him handle that as far as S versus C. Which would you pick?

Toby: There’s a question that’s actually going on in chat that I was also paying attention to. I’m just going to say, hey Patty, get Robert with somebody. Robert, when you have a self-directed IRA that you’re doing syndications in, you have unrelated debt finance income. If that syndication has loans against it, you do not have that if you roll that into a 401(k). If we can avoid that little tax hit on you, it might be good. One of our accountants will explain how that works.

UDFI is for IRAs only, not for 401(k). Sometimes you could take a self-directed IRA rolled into a 401(k) and avoid that tax, and it could save you thousands of dollars. It might be worth doing. If you’re doing a syndication, I assume it’s not small.

Flipper. They’re sitting there doing an active trade or business. They’re a pizza shop. What do we use for pizza shops? Same thing that we’d use for any major business. We’re going to write everything off we can. We’re going to use an accountable plan. We’re going to be a corporation of some kind, an S or a C. The question is, do we want the money to flow onto our return or do we want to keep it separate? That’s going to be a question of what other income do you have as an individual.

If I am in the highest tax bracket through my job, I may want to just keep my flipper income in a C-corp and have it taxed at 21% as opposed to 37% plus my estate. I may be saying, hey, I want to just keep building that up over there and letting it grow and grow so I can do my flips without hard money, or maybe I can loan money from that corporation to my other entities to create lanes against those properties, et cetera, and start to build up its value. There’s a misconception out there about taxation of retained earnings, but if you have a reasonable need for the cash, you can have as much cash as you want. Look at Warren Buffett in Berkshire Hathaway. They got $200 billion.

Eliot: Not pay the dividend.

Toby: Yeah, probably more. The same thing with Apple and Microsoft because they always keep money on hand, because they might want to do acquisitions. You just have to say, hey, I might want to keep money on hand so I can do acquisitions. The only thing I would say to you is if you’re flipping is create sub LLCs to do the actual flip. If you are flipping multiple properties, you do not want a bad flip that happened two years ago to ruin your day  tomorrow. You don’t want it to come back and haunt you.

What we suggest people do is use LLCs for each flip. When it’s done, you dissolve it, and then your liability goes bye-bye with it. If somebody comes along in two or three years and tries to go after anybody that was in chain of title, you can avoid that. If they try to say you were supposed to do something that you didn’t do, you could say, okay, go ahead and sue the dead entity. See where that gets you. It’s not going to get you anywhere.

As far as things that you could do to reduce liability on an active trade or business, I like 401(k)s. I like defined benefit plans. If you need to put more than a hundred thousand dollars a year away, a defined benefit plan is great. I work with Jeff Mason over at Redwood.

It was really interesting. He had a client that did a defined benefit plan, and they put $1.2 million away last year. Yes, you can do that. It’s all based on the actuarial tables. That’s what Jeff is. I’ve done some videos with him. He’s on my YouTube channel. If you look for any of the retirement plans, it’s usually a hundred thousand plus retirement plan. That’s going to be on cash balance plans, defined benefits.

You have to work with a licensed actuary. That’s what Jeff is. That’s why I always bring him on because he’s the number cruncher, not somebody promoting a financial product. That would also reduce your liability, writing everything off that’s 162 deduction, all ordinary necessary deductions, plus bring your family onto the board, paying for their expenses, possibly doing a side business, or managing your other entities. All that can be integrated into this as well if there’s an appetite for it.

We’d like to take a look and see what stuff’s coming out of your pocket because something is innocuous. It’s just like one of these little cell phones. If I’m paying for that out of my pocket, that company could be reimbursing a hundred percent of it if I’m considered an employee of it. Even though you’re already paying for it, there might be $2000 or $3000 a year that you can immediately deduct. Okay, that starts to add up. It’s usually right around $20,000 that we find between 280A, administrative office in the home, cell phones, technology, cars, mileage, all those things. You start adding them up and it’s usually right around $20,000 that you’re already paying.

The tax savings on that depends on your tax bracket. If you’re a normal person, the Tax Foundation says the average is about 29% tax between employment taxes and and income taxes. At a minimum, spend about $6000 a year, that would save you. If you have to do an extra return so it costs you $1000, $1500, $2000 a year, whatever it is to run it, then you’re getting three times your money. The old question is the juice worth the squeeze, and you can start doing that calculation and then.

Eliot and his team, all day long, they do something we call Tax Saver Pro, or they’re running scenarios, returns through computer software. They’re analyzing and crunching the numbers, looking to see how much they can save people. If you’re ever curious, then you could talk to somebody about Tax Saver Pro.

They’re sitting there running those scenarios, and your guys’s average right now is about $47,000 a year in federal and it was about $7000 a year in state. That’s the average that they’re finding in missed deductions. A lot of times it’s things like retirement plans. It’s doing things like HSAs, it’s putting money aside in a tax deferred account, or writing things off. You already have an expense, and let’s just find a way to deduct it on something else. All that stuff works. Long answer to a short question.

“Reverse exchange 1031. Please help us understand it. How do I choose a QI? Any recommendations for first time 1031 exchangers? Thank you very much.”

Eliot: Reverse 1031, it’s the opposite of a 1031, which we probably want to define that. 1031, the idea is I’ve had a property that’s in a trade or business. It’s got to be real estate, my property. I want to sell it, but I don’t want to pay tax. If I do sell it under 1031 rules and I pick up, I acquire replacement property that’s basically the rule of thumb, more expensive than what I gave up, and I pick up more debt on that new property than what I gave up, then I don’t have to pay any tax.

I don’t have to do depreciation recapture. It doesn’t mean that won’t stay long. It still totes long until I sell. But as long as I didn’t have any gain, I’m not going to incur any of those things. That’s a regular 1031. Reverse, all you’re doing there is you’re first buying the replacement property, and then you’re deciding within 45 days which property you’re going to give up. It’s just the opposite direction.

Toby: You have 108 days total from close to close to get rid of that property to sell it.

Eliot: Yup, that’s your 1031. The reverse just means you’re picking up first, then selling as opposed to selling, and then picking up. It’s just a difference in the order.

Toby: Yeah. The only recommendation that I have is be careful. You don’t want to tell people, I’m 1031 exchanging necessarily, because they might figure it out. You don’t want to go out there saying, I’m looking for a 1031 exchange, because there’s people that will mess with you a little bit to try to squeeze you. Knowing that you can lose tax liability, they may start jacking around with the price saying, I think we really need a discount or we’re going to delay this, and you’re going to miss your 180-day window. They do things like that, so just be careful with it.

If you’re finding some replacement properties, you want to line them up, I have no problem with that. But when you’re going out to the general public, you don’t want to accidentally get somebody that’s going to hurt you in any particular way. We’ll just work with somebody that’s a QI that’s done it before. There’s a lot of folks that magically hang out shingle and say, I’m a 1031 exchange qualified intermediary. You want to work with somebody who’s probably done at least a hundred of them. You just interview and see who you like.

Speaking of people who we like, there’s Clint. Feel free to join us for a free tax and asset protection workshop. It looks like there’s one coming up this weekend and the following weekend. We have live events, September 26th through the 28th in San Diego. We have another one here in Las Vegas in December. Those are the fun ones, guys. It’s just fun to hang out. They’re pretty inexpensive too. Hey, Kareem, are you rolling around out there? I just heard that Kareem’s out here.

Kareen: Yeah, I’m here.

Toby: Where are you?

Kareem: I’m right next to you, Toby. I’m sitting right next to you.

Toby: You’re like in a studio.

Kareem: All right. Yeah, I’m in the other room. I’m in the studio.

Toby: You realize that it doesn’t matter that you’re here physically now because you’re on a camera? We could do this whether you were in North Carolina or in Las Vegas.

Kareem: Yeah, I realize that, but I’m usually booked up about that time when Tax Tuesdays are all around.

Toby: I just have to let you know, this is my chance to use my new button.

Kareem: All right, not the eject button?

Toby:  That’s my new favorite button. That’s for John.

Eliot: You scared him.

Toby: I’m sorry, guys. The cat just jumped. Buckle up. All right. What brings you out to Las Vegas, Kareem?

Kareen: I’m here to shoot some videos. We’re doing videos for these new modules that we’re creating for nonprofit organizations. It’s going to help organizations come up from startup to success. We’re going to provide resources and content, articles, and videos to help organizations, from setting up the organization to effective board meetings, to writing effective emails, to grant writing and grant applications. We’re going through these videos to create content and resources for our nonprofit organizations.

In addition to that, we’re also going to do a workshop, which is going to be on Thursday. We’re going to start and run a nonprofit, and we’ll be going over the many types of nonprofit organizations you can set up.

Toby: Is that an all day workshop?

Kareem: It’ll be four hours. It’s from 9:00 AM to 1:00 PM Pacific. On the East coast, it’s from 12:00-4:00.

Toby: All right. You should definitely join Kareem. Who’s going to be teaching it with you, just you?

Kareen: Gwendy will be presenting and so will Savannah Wallace as well, three of us. It’s going to be great. A lot of content, a lot of resources, a lot of information out there. You’re going to learn a lot. You’re going to be inspired, you’re going to be motivated, and you’re going to want to set up a nonprofit.

Toby: They used to invite me to those and let me speak at them.

Eliot: Yeah, what’s up with that, Kareem? Not that I’m trying to throw you under the bus or anything.

Kareem: He’s always invited. He just conveniently has a conflict at that time.

Toby: Never invite, never. Absolutely, free access. Yeah, it’s free access. You guys can come in and learn about nonprofits. We love our non profits. We actually sometimes like Kareem.  We love Kareem. Everybody loves Kareem. The whole division over there, if you’ve ever wanted to figure out whether there’s something you could do that’s help society and also get a bunch of tax benefits, they go like this. They do really nice things together. Kareem and his team are the ones to check it out. You can invite more people to watch, absolutely, as many people as you want.

Believe me, this is one of those weird areas, especially as you have success, it’s where everybody ends up going. It’s like, all right, now, I’m not so worried about me anymore, how am I going to create my legacy? Those nonprofits are really great vehicles for your family to actually get together and carry on something that you think is really important.

There’s always some goofy nonprofits out there that we point out like Ikea. Rolex is actually owned by a nonprofit. The Green Bay Packers is a nonprofit. There’s some funky ones, Major League Baseball, NFL was. But it’s always interesting when you start diving in saying, what is actually a nonprofit? What could I do? It’s always cool. Kareem, anything else?

Kareem: Bring as many people as you want. It’s free. The content is free, the education is free. Come one, come hundreds, bring everyone. They’re all invited, you’re all welcome. Just a word of  warning is that you’re going to get some bad dad jokes. I’m going to sing. I’m going to sing some of these songs, probably. You’re going to be entertained.

Toby: I don’t know if we should be scared.

Kareen: Come on, Toby. We’re like the three tax amigos, the three of us. We make tax less taxing. We’re like tax-perts. Come on, yeah, what do you think?

Toby: All right, enough of you. How do we cancel Kareem’s feed?

Kareem: You can’t undo it. Sorry, Toby.

Toby: All right. Thank you, brother. Appreciate it.

Kareem. Thank you.

Toby: I think we skipped one. No, there we go. All right. “Is it possible to use solar credits against passive income from real estate rental income?

Eliot: Yes, you can have a solar credit. You could do it on your personal home, which would create an ordinary loss, and that’s going to offset any income on your return. But what if you put a solar on your rental? Yeah, that’s going to offset against that. It’s going to be a passive deduction, but yes, it will offset passive income.

Toby: Yes. Here’s the one thing. If you ever go and you’re doing solar, for example, on your rental properties, and it’s passive activity, then it stays passive as a solar credit. But if you get an individual solar credit, you use those against anything. Just know that the nature of the activity that the solar is attached to might have something to do with its tax treatment. I don’t want anybody to get out there and have a bunch of solar credits on a bunch of rentals they have and then be disappointed that they can’t use it on everything. But if you’re doing it individually and you’re entitled to that tax credit against your individual tax, it’s ordinary,  non-passive. You don’t have to worry about it.

“How do you determine if a repair in a rental property can be treated as an expense in the current year or must be depreciated?”

Eliot: There’s a couple of different ways to look at this, but generally speaking, a repair is you’re just fixing something that maybe it wasn’t broke last week, maybe a window got busted. You’re just fixing it, doing a quick fix or something like that. That’s usually your repair. You brought it back to how it was before it got broken.

Example of something that needs to be capitalized or that’s going to be depreciated will typically be you have a situation. An example I often give clients is you call me over to fix some stairs. I fix them and they’re going to be okay. They’re going to get by, but I realize there’s a lot of wear and tear. They’ve really broken down over the years. I bring a lot more to shore it up and recreate almost the stairs. That’s going to take on the flavor of being something as the capitalization, which means we’re going to have to depreciate. Those are the two opposite ends of the spectrum.

There are things such as if it’s under $2500, we may not care. There’s what’s called a $2500 de minimis election, where you can automatically deduct each invoice. In other words, window one breaks, if it’s under $2500, I can certainly expense that. Window two or something else, the curtains break, or whatever, if it’s under $2500, that’s a separate invoice, I can expense it. Those little offsets on this rule as well.

Toby: If you are keeping financials that are not related to tax, that actually doubles that amount to $5000 per invoice, but it is per unit. I have a whole bunch of air conditioning units. I can’t just fix each one for $2500. They’re going to lump those puppies together.

For most everything, you’re just in the safe harbor at $2500 or below. For anything else, it’s common sense. If you’re making the property more valuable by doing it, like you’re doing a remodel and you redo the kitchen, that’s not a repair. You’re making it more valuable. Here’s the thing, there is a way to get a big tax deduction out of that, and that is by retiring the old one, but you’re going to have to figure out what portion of the property you’re able to deduct. If I have a roof, that was 20%.

The way you do this is you look at the repair value of the entire house, replacement values of everything and said, hey, if I was to replace it, I’m going to get a new roof. Let’s say it was $20,000 and the house is $200,000 to replace, then it’s 10%. Then you go back to your original purchase price. Let’s say it was $150, your roof is $15,000. Figure out the depreciation you’ve already taken. Whatever amount you haven’t taken, you released as an ordinary loss or non-passive loss.

There’s lots of fun things that you get to do with this. Just know that you’re not always out. It’s not always, ah, shoot, I can’t write it off as a repair. It doesn’t mean you’re toast. It means that we may have to take a look and do another analysis to see whether we can create a better deduction. Then you always have cost segregation in your back pocket.

There is one other thing, which is if you’re going to have to repair it or replace it three times out of 10 years, then you can treat it as a repair if it’s something that’s always doing. Somebody says, if you’re replacing carpet due to water damage, can you deduct it immediately?

Eliot: Yeah, I would think so. Yeah, certainly.

Toby: It honestly depends. With carpet, usually you plan on replacing it three times or more in 10 years, otherwise it’s 27 and a half years. You would take a deduction for the depreciable value of that carpet that you haven’t taken and subtract off any depreciation. That would be something.

Regardless, there’s a good chance that you’re going to be writing off a big chunk of that. If you’d really needed to, you would just cost seg it and write it all off. Somebody says, what about resurfacing a pool due to a leak? Yeah, you’re fixing the pool.  You’re fixing it, you’re okay. I think it’s the last one, right?

Eliot: Yes.

Toby: We’re a little bit over.  Hang out with us, guys. “My husband and I want to sell a new construction home business to become full time investors and manage our five large commercial properties. In the past, we have had real estate professional status because we self-managed our commercial properties.” I don’t know why that would change really, but let’s just keep going. “If we sell our construction business, do you still qualify for REP status if we start a management company to manage our rental properties and earn W-2 income from this new company? What type of entity would be best to set up for a management company? LLC, S-corp, or C-corp?”

Eliot: Once we have REP status, we probably still have it going forward. We’re putting over 750 hours. It’s over 50% of our work week. We’re materially participating probably 500 hours. I’m sure it’s probably a foregone conclusion with that many properties being large commercial. I’m with Toby, I don’t know why the rep stats would change. You certainly set up a C-corporation managed through that. That’s just going to give you the added tax benefits. Using that management company that you own yourself, certainly you can use that towards your time.

Toby: The only thing I could think of is that they were doing a construction business, and that’s where they were getting their 750 hours. The self-managed did amount to that amount of time. You have a couple of different ways that you might be able to qualify for this. You’re going to have to do the 750 hours, but you can count the time that you self-managed. Self-manage means you or an entity that you’re greater than 5% owner of.  If I’m setting up a management company, I’m probably doing an LLC taxed as a C-corp just as a starting point, and then I can make an election later. There’s no reason not to.

I can count that time towards my 750 hours and my material participation, both of them, because they’re my properties. You could if you can hit the 750 hours. You’ll be fine. If you can’t and we don’t have the 750 hours, then yeah, you’re going to have a trouble. You can’t do the 750 hours to try to hit the 750 hours. There’s a funky little rule that says if the reason you’re doing the time is to hit the 750 hours, it doesn’t count. It’s dumb.

They put a threshold and they said, if you’re trying to hit that threshold, it doesn’t count. They’re looking at you saying, hey, would you do the 750 hours regardless? It’s what they’re really saying. I always find that a little bit maddening. I don’t know how they know. I would just say no. It’s crazy.

Your self-management counts for both the tests. If you’re not familiar with real estate professional status, it’s a fancy way of saying, normally a passive loss that you can only use against passive income with real estate professional becomes non passive loss that you can use against any other type of income you have, including your W-2. Real estate professional is great if you have big depreciation and they have losses.

The way to hit real estate professional status is to do 750 hours. There’s about 10 different trades of businesses, construction, development, management, being a real estate agent, all those types of things, qualify, and you have to do 750 hours. One spouse, 750 hours in a year.  It’s more than 50 percent of your personal service time. If you do 750 hours  in real estate and you did a thousand hours as a chef, you don’t qualify because it has to be more than 50% of your time. But if you did a thousand hours in real estate, 750 hours as a chef, you would qualify. There’s that, and that’s test number one.

Test number two is, did you materially participate on your rental properties? Here, we have five large commercial properties. Those are your rental properties. You have to materially participate on those. You’d group them as one activity. Did you meet the first prong? It sounds like they may have some trouble with the first prong, but we’d be able to help you if we knew more.

Guys, if you have questions, send them in. I know that the accountants, Troy, Tanya, Summer, Rachel, Jeff, Jared, Dutch, Arash, Patty was on, Matthew was on, I know this guy’s been answering questions. There’s well over a hundred.  Ask a question quick if you want. They’re in there. I think there are four open questions and they’re getting them. We’ll make sure that your question gets answered.

If you like this type of information and you want to learn more, go to my YouTube channel. Please subscribe, share it with anybody that you can. There’s a lot of different content on there. There are 886 videos, just a few.

Clint has a channel, over 650 videos on his that are more geared towards asset protection. If you want to learn how to invest in real estate, you want to learn the tax ins and outs and how to structure it, these are great places to start. You could always join us at a tax and asset protection workshop. We go over LLCs, land trusts, corporations, tax, and estate planning, including legacy planning. Lots of fun. If you have questions in the next two weeks, send them in. You’re answering all those questions, right? You’re making sure that we’re getting everything.

Eliot: They’re supposed to go through Platinum. Yup.

Toby: Okay. We want to make sure that we get all the questions for Tax Tuesday. There’s somebody saying that they didn’t get an answer, that they’d emailed into Tax Tuesday. It’s probably an outlier, but I want to make sure that we get their questions asked. This is what we like to do. We make sure that we’re doing the best thing we can for folks out there. In the meantime thank you guys for joining us. Any last words?

Eliot: No. Yeah. Thank you. See you next time.

Toby: Thank you guys, and we will see you in two weeks. Actually, you’ll see them in two weeks. I’m not sure I’ll be here. I think I’ll be in California.

Eliot: I think we’re going to have miss Amanda here.

Toby: Yeah, Amanda Wynalda. You guys are being great hands. Also, go see Kareem. He’s here on Thursday. I think I’m going to have dinner with him that night. I want to be able to poke fun at him. If he does anything irregular, please email me and let me know. No, these guys did a great job, and I really appreciate you guys coming in and hanging out with us.

Let anybody else know that we could benefit from this type of information, that there’s a free resource. We’re just doing this to help as many people as we can. It’s a lot of fun. You can’t tell that we get a little goofy, but we do enjoy making sure that we’re demystifying the tax code. We’ve been doing this for, I don’t even know how many shows, over 200 and some shows. We’ll keep doing it, and we’ll see you guys later. Thanks, guys.