This episode of Tax Tuesday with Anderson Advisors attorneys Eliot Thomas, Esq., and Toby Mathis, Esq., tackle pressing issues faced by business owners and real estate investors. From the implications of switching health care reimbursements from a C-corporation to an LLC, to short-term rental strategies, Eliot and Toby discuss the 100-hour participation test and how to select the right property. Other topics include the intricacies of real estate professional status, the deductibility of expenses for damaged properties, and the mechanics of Qualified Business Income (QBI) deductions. Finally, listeners learn about tax management for online businesses (at 46:17) and the potential tax liabilities of renting secondary homes through an S-corp.
Submit your tax question to taxtuesday@andersonadvisors.com

Highlights/Topics:

• “I currently reimburse myself for health care expenses through my C-corporation. I have another completely separate business that I run through an LLC registered in Wyoming. Are there any issues if I switch my health care reimbursement from the C-corp over to the LLC?” – It depends- who is it disregarded to? A C-corp can reimburse health expenses.
• “We want to take advantage of the short-term rental loophole strategy. If we buy a house in October and close in November, would I have enough time to reach the 100-hour test? What kind of house should we focus on?? – There are several different tests for material participation, one of them being at least 100 hours and more than anybody else. But there are 7 total tests.
• “Regarding real estate professional status, the code says you have to participate 500 hours materially or have been rep for the last five years.” Actually, there are seven tests, but we’ll get into that. “Does that mean if a spouse has been a rep for the past five years, he or she can be hands-off for the next three to five years and still claim rep to offset the other spouse’s W-2?” – Long-term rentals are passive income normally, but REP status changes that, although it has certain requirements
• “We bought a small house. The house was in a fire and had a lot of damage. We spent a lot of money on structural engineering, services, roof, and other support of construction. This was needed for the safety of workers. They would not be able to work otherwise. My CPA told me I can’t take any of those expenses as deductions because I have not rented the house yet. Please be so kind and tell me why I can’t deduct structural engineering expenses of more than 12,000. My CPA told me I can only deduct utilities such as water and electricity. That’s it.” – The code is the code, you can’t deduct for a rental until it is in service…the write-off comes over cost seg
• “Can you go over QBI in detail? And do I deduct 20% QBI from net or gross profit? Also, do I deduct 20% first, then my expenses, or do I choose either 20% or my expenses?” – First you find your net, then there are five different qualifications
• “If I sell a house on an agreement for deed, how are the monthly payments that I receive taxed?” – If you used it as a rental, you’ll have depreciation recapture. “For deed” means you’re selling it over time.
• [46:17] “I’m considering starting an online business. I’d like to know strategies and how to manage taxes as best as possible.”- Start by putting it in an LLC, tax it as S or C-Corp, be aware of state requirements…
• “Could I have my S-corp rent my secondary home when the business takes clients on retreat? While this may create an expense on the business side, does it also create a tax liability on our 1040?” – How is the second home currently being used? If it’s already a rental, you may hit some limitations…
• “Does changing the floor and painting the walls count as repair, or is it a renovation?” – Painting is usually a repair, you can write that off. Flooring has other requirements.
• “Can I take a six-figure distribution from my S-corp and have it not affect my social security? If the corporation shows a profit and I’m the CFO, will this affect my social security?” You have to take a reasonable wage in order to get that credit.

Resources:

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Tax and Asset Protection Events
Toby Mathis YouTube
Toby Mathis TikTok
Clint Coons YouTube

Full Episode Transcript:

Toby: All right. Welcome back. If you’re looking for Tax Tuesday, you’re in the right spot. My name is Toby Mathis, and I’m joined by…

Eliot: Eliot Thomas.

Toby: We are here to bring tax knowledge to the masses. For the next hour, what we’re going to be doing is dousing you with the goodness of tax questions and tax answers here. We got about a week before the real deadline, so hopefully you’re getting your taxes done. I know all of our accountants are burning the midnight oil going around the clock, losing their minds, trying to meet that October 15th, which is the extension deadline. Most of our clients, we like to put them on extension so we can make sure everything that comes in over the summer is included. We’re figuring it out.

All right, guys. What are the rules? Give me a thumbs up if this is your first Tax Tuesday. If you’ve never been on a Tax Tuesday before, give me a reaction. I think you can give me a thumbs up or something. Do they have thumbs up? They’re down there. They’re hiding from me.

Welcome to your first Tax Tuesday. I’ll just go over some rules. The Q&A feature, we have a bunch of accountants over there right now. I got Jeff, Patty, Matthew, Jared. Let me see if I can get more names. They like to make this hard.

There’s Dutch, Arash, Rachel, Tanya. Oh, my God. We got a whole bunch of folks. You have a bunch of accountants even this time of the year. Yes, these guys are great. They come over and they answer the questions. What did I do? I’m dragging things all over the place. I don’t know. There it goes. I’m trying to put on everybody’s face. Now I can see us again. And Eliot, who’s a tax attorney. I’m a tax attorney.

Should I be able to see something on the screen? Yes. You should. Hopefully you should see, it says Tax Tuesday rules. All right. Can you guys see tax Tuesday rules? Can you give me a thumbs up if you can see Tax Tuesday rules? Somebody says they can’t see anything, I lose my mind and start thinking nobody can see. Yeah, all right, so everybody can see it.

If you’re having an issue seeing it, it’s on your end, let’s figure it out. Our guys will help you troubleshoot it. If you’re in the path of the hurricane, I just want to say, stay safe, get out of there.

If you’re suffering from the remnants of Helen, I hope that you’re doing okay. We have a bunch of clients that were affected. Just prayers go out for you guys that people stay safe and that you recover quickly. Do everything you can to help. People are going through a lot of bad stuff right now, so anything we can do to help them. I’ll answer tax questions because that’s about all I can do. But if I could, I’d saw some trees.

Q&A, you could ask questions. In the chat, you can make comments. I see a bunch of people there. Hi, Sherry. For kicks and giggles, just put in where your city and state is right now, where you’re sitting in the country. We have a pretty good size group on today. It’s that time of year. Detroit, Michigan. Somebody is in Tampa. Antonio, what the heck are you doing? Get out of there, brother.

My brother, by the way, lives in Slidell, Louisiana, and every year it was the same thing. He’d be like, his house would go underwater. I said, why do you stay there? He goes, I like to redesign the house. God bless it. Maine, Detroit, Michigan, Woodland, Claremont. Murfreesboro, Tennessee,  New Jersey, Sun City, Arizona, Oceanside, a bunch of California.

There’s Seattle, you guys never get hurricanes. Rose Hill, Kansas, Kingston, Long Beach, San Jose. He says he’s safe in Tampa. Las Vegas, that’s where we’re at right now. It’s not a hundred degrees, it’s 99 or 98. Madison, Alabama, LA, California, Chico. We just got a ton of them. Now they’re going too fast. [inaudible 00:04:29]. I know how to say that. You guys are just in-dating us, and now we have hundreds of comments, so I’m going to stop looking at those.

If you have a detailed question, like you had something that’s very specific to you, you can go into the Q&A and ask general questions. But when it starts to get too specific, you really should become a platinum client. It’s a monthly cost. It’s less than a hundred bucks a month, and you could ask all the questions you want. Feel free to ask anybody in there like, hey, how do I become platinum? They’ll explain it or put in chat, hey, I want to become a platinum. And Patty will send you a link where you can talk to somebody.

Otherwise, you can put general questions and there’s no cost to this. We just answer them. Again, if you start getting like, how do I fill this out, I’m doing this form, and I need to do line six and seven, join us. We’re not going to answer those, but we’ll answer all your general questions until we turn purple.

All right. Here’s the opening question. If you’ve never been on Tax Tuesday, what I’m going to do is I am going to read the questions that we’re going to be answering today, and then we will go back and we’ll go through each one by one. We’re going to go over all the questions first, so you’ll see all the questions we’re going to answer today, and then we go through them one by one and answer them.

All right. The opening question is, “I currently reimburse myself for health care expenses through my C-corporation. I have another completely separate business that I run through an LLC registered in Wyoming. Are there any issues if I switch my health care reimbursement from the C-corp over to the LLC?” Good question.

“We want to take advantage of the short term rental loophole strategy. If we buy a house in October and close in November, would I have enough time to reach the 100-hour test? What kind of house should we focus on?? Again, great questions. Those are the first two. Eliot and I will be answering them, mostly Eliot.

“Regarding real estate professional status, the code says you have to participate 500 hours materially or have been rep for the last five years.” Actually, there are seven tests, but we’ll get into that. “Does that mean if a spouse has been a rep for the past five years, he or she can be hands off for the next three to five years and still claim rep to offset the other spouse’s W-2?” Good question. We will answer that.

“We bought a small house. The house was in a fire and had a lot of damage. We spent a lot of money on structural engineering, services, roof, and other support of construction. This was needed for the safety of workers. They would not be able to work otherwise. My CPA told me I can’t take any of those expenses as deductions because I have not rented the house yet. Please be so kind and tell me why I can’t deduct structural engineering expenses of more than 12,000. My CPA told me I can only deduct utilities such as water and electricity. That’s it.” Sounds weird. Lots going on there.

“Can you go over QBI in detail? And do I deduct 20% QBI from net or gross profit? Also, do I deduct 20% first, then my expenses, or do I choose either 20% or my expenses?” We’ll answer that. It’s not what you think.

“If I sell a house on an agreement for deed, how are the monthly payments that I receive taxed?” We’ll go over that one too.

“I’m considering starting an online business. I’d like to know strategies and how to manage taxes as best as possible.” You might be better to answer that one because of the OnlyFans that you have.

“Could I have my S-corp rent my secondary home when the business takes clients on retreat? While this may create an expense on the business side, does it also create a tax liability on our 1040?” Really good question. I actually really like that one.

“Does changing the floor and painting the walls count as repair, or is it a renovation?” You get really good questions.

“Can I take six-figure distribution from my S-corp and have it not affect my social security? If the corporation shows a profit and I’m the CFO, will this affect my social security?” Really good questions. Eliot picks all the questions. Yes, it’s something. Yes they want to DM me for pictures. That’s for Eliot.

All right. How do we do this? Hey guys, if you like this type of Q&A stuff, by all means go on to YouTube. We have a few, but Clint and I do the vast majority of it. I do more tax and finances. You can absolutely subscribe for free, and you get this stuff all the time. Hey, look, there’s Kamala and Trump. Hi, guys, and their biggest tax difference. It’s just a video that we put out along with a bunch of others. We put about three a week out.

Clint, my partner of 27 years I think we started, 25 years with Anderson, has a really great channel on asset protection. He’s definitely focuses more on asset protection. I tend to go nuts on the finances and tax. Together, we’re pretty lethal. Speaking of lethal, there are great events all the time that we put on absolutely for free, and then we have a couple of low cost events that are live workshops.

We do live on Saturdays and sometimes on Thursdays, tax and asset protection events. You can see here that there’s Saturday, October 19th and Saturday, October 26th. We’re going to be teaching the tax and asset protection event. Also, we have our live tax and asset protection event. It’s a three-day workshop, and we’re going to do a added fourth day on this one. I don’t know, it’s not on there.

We’re going to be doing a client appreciation event on December 8th.  It’s actually the night of the 7th. We’re going to have a cocktail party, then we’re going to have some cocktails, and then we’re going to do a bunch of networking exercises on Sunday. If you’re interested in that, you’ve been a client, reach out. If you’re not a client, by all means, come to the tax and asset protection workshop. If you like networking with like-minded individuals that are investors, stick around for Sunday and let them know that you’re interested.

It’s going to be fun. We’re going to do a bunch of exercises. We’re going to build mission-vision values. We’re going to do a bunch of problem solving. We’re going to have a couple of experts in there running through some fact patterns that we’re going to troubleshoot. Together, we’re going to figure out how to overcome some of life’s challenges.

Speaking of life’s challenges, this is question number one. “I currently reimburse myself for healthcare expenses through my C-corporation. I have another completely separate business that I run through an LLC registered in Wyoming. Are there any issues if I switch my healthcare reimbursement from the C-corp over to the LLC?” Eliot.

Eliot: All right. This is going to depend on when we talk about LLC being disregarded, who is it disregarded to? If it’s disregarded to you personally, that doesn’t have a medical reimbursement plan like we’re talking about in this question. We’d want to stick with the C-corporation allowing for that healthcare expense reimbursement. If this LLC happens to be disregarded that is owned by your C-corporation, then not really an issue there because it all flows up to the C-corporation tax return, and you’ll be able to do your reimbursement for medical there.

Toby: You nailed it. A C-corp can reimburse health, dental, vision expenses, a hundred percent. They can’t discriminate. If you have employees, you can’t kick them out, but you can absolutely reimburse. The issue here is that LLC also a C-corp? Is it disregarded to that C-corp? It says completely separate. My guess is that they said LLC. We just don’t know how it’s taxed, so it really depends.

Would I just switch it willy nilly? No, please make sure you talk to one of us before you do that. Somebody just wrote in the chat, can an S-corp reimburse employee health expenses? It’s taxable. The big difference between a C-corp and an S-corp is that if you’re the owner especially, if it covers your insurance even, it’s taxable to you as wages, and then you write it off on your personal tax return for the insurance premiums only. All the reimbursements, you have to pay.

If you’re an S corp, our strategy more than likely would be an HSA, do a high deductible plan, allow to write off at least the insurance side, and then create a deduction for the money that you put in the HSA that then you can use to reimburse yourself for your medical. Does that sound about right?

Eliot: Absolutely. If that just went over your head, please stick around. We’ll do it to you about 10 more times. It will start to make sense. As you hear these things, we get these questions, and you’ll start getting the gist. A C-corp is very different than any other type of entity when it comes to health reimbursement, and that’s why we like to use them. A lot of people think they’re dinosaurs and we’re not.

Can you get reimbursement if you’re not an employee but a director? You have to be an employee, but a director can be considered an employee. Officers are definitely, but you can rise to the level of employee. It depends on what you’re doing for the company. Am I saying that right?

Eliot: Absolutely.

Toby: All right. Good first question. All right. “We want to take advantage of the short term rental loophole strategy. If we buy a house in October and would close in November, would I have enough time to reach the 100-hour test? What kind of house should we focus on?”

Eliot:  I think we got to go back and look at what a short term rental is, and you hear us talk about that strategy a lot. Generally speaking, it’s where the average day of someone staying there renting it is seven days or less. If we have that going on, it can put us in a different category of where this activity is going to show up on a return, maybe to our benefit.

If we’re seven days or less short term rental, then we also want to materially participate. That means that you’re the one running the show, you’re managing it, et cetera. If we meet that standard, then the activities, what we call non-passive and often we can get a really good deduction through bonus depreciation and things like that, creating a loss that’s non-passive, and we can set that off against any other income on our return. That’s why we always talk about this short term rental loophole strategy. That’s what we’re looking at.

Getting to the call to question here more about the 100 hour test. There’s several different tests for material participation, one of them being at least 100 hours and more than anybody else, but there’s other tests too. Certainly, you could mush in your 100 hours between October, November, et cetera, till you’re in and try and get 100 hours. But also if you’re the one who substantially did everything there more than anybody else, there is that test as well.

Toby: Yeah, so there are seven tests. The easiest one is if you just self manage and nobody else provides substantial services, then you don’t have to worry about how many hours you spent. You’re automatically qualified. If you’re putting a house into service in November, the thing to remember is, as soon as I put it in service, this is no different than pizza.

Let’s say we opened a pizza shop and we bought an oven. We put it into service on December 31st. Guess what? It’s deductible this year as long as it’s in service before the end of the year. Same thing with short term rentals. It’s not like a regular rental. Short term is you’re a hotel, you’re putting the property into service. Before the end of the year, you do a cost seg and what’s called bonus depreciation.

Cost seg is going to break out the property into 5, 7, and 15-year property along with its 39 years because it’s considered a hotel.  The 5, 7, and 15-year, you’re going to be at a write off. It’s usually about 40% of the house, the improvement, and then you’re going to be able to write off 60% of that. It’s going to be about a quarter of the value of the house. You’re going to be at a write off as long as you put this puppy into service before the end of the year.

Now, we have to qualify it as a short term rental. We need to have enough rent to where we can say this is definitely what it is. If you can’t, we’ve had people who they get a property, they put it into service, but it’s the end of the year, and they’re in a summer place. They’re like, it’s a short term rental. I’m like, sure it is. The next year, we got to make sure that it’s a short term rental. Then we’re going to be in it to win it. We want to make sure that we’re going to be seven days or less. We want to make sure that there’s no question, the nature of that property.

The best thing for you to do, get it into service in November, rent it seven to eight times before the end of the year. You do everything, you’re good. You get to take that big, fat deduction this year. Like Eliot said, it’s not a passive deduction. When you do everything yourselves, you’re materially participating, it’s a non passive deduction, it will offset your W-2 income.

We have a bunch of doctors that like to do this. It could be the spouse doing it. Sometimes these doctors lose their minds and they say, I’m going to do it, because they’re making too much money, some of these guys, the surgeons especially, They’re like, hey, if I could get an extra $100,000 deduction, that’s going to save me, in some cases, $45,000-$50,000. Okay,  I get it.

They do this once or twice a year. They usually buy expensive properties on the water places or in high risk areas. What does he mean by we do everything? You clean it, you rent it. You’re the one putting it on to air Airbnb. Nobody else is running it. You don’t have a manager managing it. You’re doing it. You’re doing everything. Otherwise, you and your spouse combined would have to do a hundred hours or more.

I could hire a manager, but then I would have to really worry about that 100-hour test. I’d have to make sure that our time combined is more than 100 hours and more than any other individual, so they count us together.  Did I miss something?

Eliot: Just on the end of it here, what kind of house? Just a couple of thoughts there, things that I’ve seen in the past. Remember when we buy that house, a portion of it is land. We can’t deduct that. That real big deduction that Toby was talking about, the depreciation, is going to happen on what we call the improvement, the building part. Just be very aware of that.

Toby: If you’re a condo, it may be the whole thing.

Eliot: Yeah, it could be.

Toby: I’ve seen that, where he had zero land value. For the most part, usually 80% of the house is the improvement. You can look at your property assessment or you can get an appraisal, and you do the ratio. If your property assessment says, hey, about a house for a half a million dollars, but it’s assessed at $300,000, and the land is $60,000, then okay, that’s 20%. 20% of $500,000 would be a hundred, so you could use the land value of a hundred.

I have a $400,000 improvement. Cost seg, that’s going to be about $160,000. Of that $160,000, you can write off 60% in the first year. Plus, you’re going to write off everything else accelerated, plus you’re still going to get your 39. You’re going to get a big chunk of that in that first year.

Somebody says seven days or less on average. Yes, on average. You could have somebody I rent it to for 30 days, then a whole bunch of people that I rent to for two days, and still meet the short term. It’s seven days or less. You take the total number of days it was rented. Hey, I rented it for 300 days, and I had 60 individual rentals. That’s five days average. That’s not investment activity, that is trader business activity.  You have become the pizza shop.

Eliot: Just another thing, usually just as a practicality idea, try and keep the short term rental near where you live. It’s not that you couldn’t have one across the country, but you got to imagine that the IRS is going to be a little skeptical. The courts are a little skeptical that you actually manage it from afar, so just keep that in your back of your mind as well.

Toby: Yes. If it’s far away from you, you can still materially participate, just it’s going to be very difficult.

All right. “Regarding real estate professional status, the code says you have to participate 500 hours materially or have been rep for the last five years.” No, it doesn’t. You can answer this. Does that mean if a spouse has been a rep for the last five years, he or she could be hands off for the next three to five years and still claim rep to offset the other spouse’s W-2?

Eliot: On this one, just getting to the real estate professional, we’re talking about long-term rentals. Long-term rentals are the opposite of short term rentals. Long-term rentals, the most natural state is that activity is going to be passive unless we find something in the code turning it to non-passive.

That big thing that turns it into non-passive is real estate professional status. You put over 750 hours at least into a real estate trade or business that you materially participate in. It’s over 50% of your workweek doing that business, those trades or businesses, and you materially participate in the actual oversight rental of that rental property itself. You meet all those criteria, it’s now no longer passive where we have passive loss considerations. It’s now non-passive. Much like a short term rental, you can write it off right away with the cost segregation, bonus depreciation, et cetera.

What are those material participation tests? There are seven. There are multiple ones, one of them over a hundred hours more than anybody else. 500 hours is another. For over 500 hours, we don’t care what anybody else did. That’s a really nice one.

There’s one we don’t often talk about. If you’ve made rep stats for three of the last five years,  then they’ll come in and they’ll consider you as having been rep for that next year. That sounds like an easy go. We like that, but if we were planning on not having real estate professional stats in one year, we’re actually going to be pulled in. It’s not an election, you get pulled in. You could be rep stats in a year where you really didn’t want to be for some reason, so just be aware of that.

Toby: I can’t imagine of a single reason.

Eliot: It would be difficult to find, but just so you’re aware.

Toby: All right, guys, somebody’s writing about 750 hours. Real estate professional, there are two prongs, prong one, prong two. Prong one, you have to be in a real estate trade or business either spouse. One spouse has to qualify all the time that they’re in a real estate trade or business. It can be three real estate trades or businesses, but it has to add up to 750 hours in more than 50% of their personal service time. It just means it has to be the thing I do more than anything else. That is prong one.

Real estate, trades or businesses, development, construction, management, hey, I’m flipping that house, I’m a real estate agent, I’m brokering it, I’m fixing it up, or any of those things. It’s an active business, and I materially participate in that business. I can’t be a passive owner in a real estate brokerage and qualify. I have 750 hours, more than 50% of my personal time for the year, my personal service time, so my work time, and I materially participate in those.

Prong two, I materially participate on my real estate rental activities. This is 469(c)(7) of the Internal Revenue Code. Passive activity, rental activity. If I meet those two, non-passive. I meet one and not the other, passive. I have to meet them both.

The material participation on my rental is per rental property, unless I elect to aggregate them all together and treat them as one activity. I know we’ve said that ad nauseum. Hopefully, you hear it enough, it’s going to start to embed in you. The 750-hour test, if I’m working part time as a teacher and I do a thousand hours, and I do 800 hours as a real estate professional, I do not qualify because I have to do 750 hours, and it has to be more than 50% of my personal service, so I would have to do 801 hours.

We just had a court case, where a guy got denied because he was an engineer. He did 1400 hours and then he documented 1200 hours. This is why you don’t represent yourself in tax court because you try to be like, oh, I meant here’s the extra time. No. He had a swing at it and he missed.

There’s 750 hours, 50% and then the material participation. Here, he is talking about material participation. They met the real estate professional status five years already. He’s been a rep for the last five years. That just means that you don’t have to worry about it for five years, you’re a real estate professional on the material participation. You still have to meet the 750 hours and 50% test.

The only thing I would take issue is that it’s not automatic. I think you’d still have to elect it.  The material participation would be, I don’t have to worry about it now. I don’t have to worry about prong two. I got prong two. I’m good.  Maybe I don’t have to worry about it if I’ve been a realtor for five years and then I take a year where I do a sabbatical. I don’t have to worry about it as long as I own 5% or more and I spend at least 750 hours in that business. How do you spend 750 hours and not maturely participate?

Eliot: That is the intention. You read some of the background on the code, why they put that test in, is they’re contemplating that someone has spent a lot of time building their business, and then they start to maybe take some time off a little bit less. They wanted to continue that ability to have a material participation, even though maybe we’re not meeting the traditional old tests every year. That’s why they put that in there.

Toby: Yeah. Okay. Good questions. Can real estate professional status, anytime you get it? That’s what it sounds like, yeah. Cash register, because you take those losses and you’re offsetting whatever your highest tax rate is. It comes right out the top.

All right. “We bought a small house. The house was in a fire and had a lot of damage. We spent a lot of money on structural engineering, services, roof, and other supportive construction. This was dated for the safety of the workers. They would not have been able to work otherwise. My CPA told me I can’t take any of those expenses as deductions because I have not rented the house yet. Please be so kind and tell me why I can’t deduct structural engineering expenses of more than $12,000. My CPA told me I can only deduct utilities such as water and electricity. That’s it.”

Eliot: All right. What we have going on here is a situation, where we have a lot of things that are rightly still going to pull on us and say, there’s got to be a deduction in here somewhere, Eliot. But the code is the code, and it says, what we got going on here is you don’t deduct for a rental until you place it into service. All those expenses beforehand typically go to basis. You’ll get a deduction later on as a depreciation, but we can’t deduct them. That’s what the CPA is saying here. As harsh as it sounds, that is the rule. That’s why one of the reasons I picked this is because it just goes against everything that we think is right, but that’s the rule.

Toby: You get to write it off, it’s just going to be over the next 27 and a half years or 39. It sounds like this is going to be a rental property. I don’t know for sure. Here’s something else you could look at. If the property was already in service, you bought it, it was rental, and it caught fire, it’s a little bit of a different situation because you have depreciated assets that are being taken out of service. If you had a fire and it wasn’t compensated by insurance, the destruction cost would be deductible.

If I get rid of a roof and I replace it, I am taking a deduction for the cost of the roof that I haven’t depreciated yet. You have to figure out the ratio. You usually do that with an appraisal, or you get someone to quote on the repair value of all the components of the house and then you can figure out the ratios. You could use that same ratio.

Let’s say the roof ends up being a $15,000 item and you spent $12,000 on it, you’d get a $15,000 deduction and then you’d start depreciating the $12,000. There is that. I don’t know whether that’s your case, but I’d be looking at whether or not you put it into service. If it was never in service, then you’re going to have a little bit of a tough road because all those expenses are going to be capitalized. You’re going to write them off, but it’s going to be over a long period of time.

There is a difference between expenses and things that have to be added to basis. When you do an improvement, it has to be added to basis. When you have expenses like water and electricity utilities, those can be written off immediately as a startup expense. As long as had this property been in service that could have written it off as a deduction, then you can write off up to $5000 of startup expenses so long as this rental meets the definition, rise the level of a business, which most do.

You should be able to write off. I don’t think you can write off water and electricity in the meantime. But again, if it was already in service and we’re just putting it back in service, then you probably could. If it was already in service and you’re doing this, then we’d be talking about taking major components, retiring them, and depreciating them right now, in which case you’re going to get a huge tax deduction, a big bun, biggie, biggie. Anything there that I said that you think is goofy?

Eliot: No.

Toby: I have to check once.

Eliot: Like I’d say anyway.

Toby: You would. All right. “Can you go over QBI in detail? And do I deduct 20 percent QBI from net or gross profit? Also, do I deduct 20% first, then my expenses, or do I choose either 20% or my expenses?”

Eliot: All right, I’m going to hit that last part first. First of all, you’re going to find the net for your business. If qualified business income deduction, which I’ll describe here in a second, is applicable, that will come after you’ve netted out your expenses. It’s not an either or.  You get your net activity, your net income, then if there’s a qualified business income deduction, you take that. That’s the easy part.

Toby: Remember when Trump and Congress enacted the Tax Cut and Jobs Act, and they lowered corporate taxes to 21% from a high of 39%? This was what they did for past dues. They said, hey, we’re not going to lower taxes on C-corps and not give something to everybody else. They did this for sole proprietors, partnerships, and S-corps. It’s just a flat out 20% deduction after your net income’s figured out with a bunch of limitations.

We have taxable income limitations, different types of services get treated differently, if you’re like a one man shop, or you’re doing health, legal, engineering, or things like that. It says QBI useful for rental as well. If you make money as a rental, then it can be used if you meet 250 hours. QBI is still floating around. I think it goes away.

Eliot: End of 2025.

Toby: Yeah, at the end of 2025. Right now, the Tax Cut and Jobs Act’s going to expire and it’s going to take that with it. Miscellaneous itemized deductions will come back, the standard deduction will be cut in half, the estate tax will be cut in half, 21% rate stays with us, that was permanent, but most everything else goes away. This QBI was the, here’s my love letter to the S-corps partnerships and sole proprietors. Eliot has a methodology that they use. You can go over your crazy methodology.

Eliot: Just five major points about it. (1) It’s not for C-corps. As Toby pointed out, C-corps already had a benefit in the code, so this was to try to level the playing field. We’re talking about your sole proprietorship, your S-corp, your partnership, that type of thing.

(2) What is QBI, qualified business income? It’s basically going to be the income from that business, less what we would typically call portfolio income. That’s dividends, interest, capital gains, things like that, that aren’t really part of the operation of your business or what your business is making. If you make widgets or whatever, make pizza, the pizza shop, that kind of thing.

(3) It’s purest form, it’s just a 20% deduction between your overall taxable income, less capital gains, or 20% of your business, that particular qualified business. We take the lesser of that, and that’s what your deduction is. Of course it’s tax code, it’s not always that simple. There are some other parts.

(4) You have two different types of business. You have what’s called a specified special trade or business, SSTB. That’s the doctor, the accountant, the lawyer that Toby was talking about, or you have anything that’s not, non SSTB. That’s everything else. I have a pizza shop.

(5) We have pizza. This is probably where everybody gets really stuck on that. There are three levels of income. How much your taxable income is overall. It changes each year according to inflation, things like that, or what have you. It’s approximately $360,000 right now if you’re married filing joint, cut it in half if you’re single. If you make less than that taxable income, it’s real simple, it’s the 20% of taxable income or 20% of your business. Whichever is less, that’s what your deduction is going to be. It’s real simple.

That middle pile, the next category is the $360,000 plus $100,000, so we’re about $460,000. We call it the phase in. That’s where we get those things that Toby was talking about, phasing in on whether wages were paid or if we’ve gone too far into the $100,000. Let’s say we had $60,000 into that 100,000 zone, it’s going to be where we don’t allow 60% of it. We only allow 40% of the deduction, and you have all these limitations that hit in this middle group.

We get to the end of that group, $464,000 approximately, married filing joint, and we have the last pile. That last pile, we will have fully phased out for SSTB, the specified special trades or businesses. They’re not allowed any deduction then, and we just have the non SSTB over there. There, it’s going to be simply a calculation of the lower of 20% of your QBI or 50% of your wages, versus 25% of your wages, plus 2.5% of your unadjusted basis and assets that you have in that business.

We do a little greater than, less than. This is simply something you’re going to have to work with a tax professional. This is where you come in and you get your tax planning because it is very complicated, but you asked we’re going in detail. That is the detail behind it. It’s an excellent deduction if you can take advantage of it, but as you can see there’s a lot of moving parts.

Toby: With that, let’s move forward.

Eliot: It’s mostly my bad.

Toby: No, I love it. “If I sell a house on an agreement for deed, how are the monthly payments that I receive taxed?” We’ll go from something that’s open ended to a very closed ended.  Hey, Eliot, how is that treated? Thirty minutes or less.

Eliot: Here, it does matter how we were using the house. Let’s assume it was a rental. If we sold a rental, we’re going to have something called depreciation recapture. We took depreciation over time. If we have a hundred dollars of gain, we had $30 of depreciation. That first $30 is going to be recaptured. That could be divided into two categories, whether or not we took a cost segregation or not of its

Toby: You make it so hard sometimes. I’m going to nix you. Agreement for deed means you’re selling it over many years. First off, if it’s more than one tax year that you’re paying over, you’re in something called an installment sale. 453, that’s the code section. You’re spreading it out over time, but you have to recapture your depreciation year one.

Even if I said, hey, Eliot, I’m going to sell you my house, I bought it for a hundred thousand, it’s worth $500,000, and I sell it to you for $500,000, I have to recognize whatever the recapture is. I bought it for a hundred, I probably have maybe $20,000 or $30,000 of recapture. I got to recognize that, and then Eliot’s paying me over the next.

Let’s say we did a 10-year contract, then Eliot is going to be paying me, return at basis, the hundred thousand I paid, minus the recapture. I’m going to get that tax free. The recapture I just paid tax on, I’m going to have to recognize it. I better make sure that I get a down payment, otherwise I might be in a bad spot.

Also, I own tax. I’m like, but I didn’t get any money. Then Eliot’s going to be paying me a portion of the payment every month. There’s going to be capital gains. It’s going to be long term capital gains. A portion of it’s going to be interest. Because he’s paying me, we have to charge interest, at least federal AFR rates, which are published every quarter. We do that, we’re golden. Now I’m stretching the payment out over 10 years.

I think that’s what they’re doing, unless this is a personal residence. If it’s personal residence, you have something called a 121 exclusion, $250,000 of capital gains that as long as you lived in that as your primary residence, not the last two, two of the last five.

It could be, hey, I lived in as my primary residence for two years, then I rented it for two years, so I lived in it as primary residence two of the last four years, that works. The rule is it has to be a minimum of two of the last five, so 24 months of the last 60. I get a $250,000 capital gain exclusion if I’m single, $500,000 if I’m married filing jointly, as long as I occupied it and it’s in our name. Boom, I get a nice, big deduction.

If I’m getting a payment over time, I may say, I don’t want that. I want to recognize it all right now. I could opt out of the installment sale treatment. I could say, treat it as though I’m getting paid everything today. In which case, that capital gain would be recognized today. It’s exempt under section 121, assuming that I made less than $500,000 and I’m married, which is great. Now I don’t have to worry.

I’ll have some interest that I have to recognize every year that I’m being paid because I’m still getting the payment. But from a tax standpoint, it’ll be treated as though I sold the whole thing and recognized it all in the first year with the exception of the interest.

Eliot: Absolutely.

Toby: These are moving pieces, and this is why I say it to you guys. Ask your questions in Q&A. They’re almost up to a hundred right now. Jeff and the team, Jared, and Rachel, everybody’s just absolutely kicking butt. I should actually call them out. Arash, Rachel, and Tanya. Thank you, Dutch and all you guys because it’s the middle of tax season, and these guys are answering questions on our YouTube live and on the Tax Tuesday Zoom, so I really appreciate you guys.

If you want to talk to somebody about your specific situation and let somebody dive in, then reach out to us. There’s several options. We actually have an option. Eliot and his team do this all day, where we’re looking for anything that you’ve missed, and we’re looking at projections going forward. It’s called TaxSaver Pro, where they run you through a computer program. What do we do, 1500 different strategies?

Eliot: Yup.

Toby: I’m not kidding, it’s a computer program that goes through it, then the tax attorney or the accountant. Is it all CPAs and attorneys that are doing this?

Eliot: And EAs too.

Toby: And EAs are digging into it, seeing, what are the taxes we could save? On that one, it’s really great because whatever you pay, we find you at least twice as much in tax savings or it’s free. Or you just join us, do platinum, ask questions, or you become a tax client and have us prepped. Whatever the case, if you want to talk to somebody, Patty has a simple link she just shared. It doesn’t cost you anything.

I would encourage you. I see these questions week in and week out. We’ve been doing this, it’s about 200. Hey, Matthew, how many episodes are we at? 230 episodes, so we’ve been doing this a long time. You start seeing things, and you see people that are out there trying to do it themselves and it’s costing you money. Talk to somebody who knows what they’re doing. Even if it’s a free consult, talk to somebody, make sure they’re pointing you in the right direction.

All these little nuances, it’s not something you’re going to find reading the code. The tax code now is up to 4.1 million pages. Put that in context, the King James Bible, I think, is 783,000 pages. It’s like reading four Bibles and trying to remember everything that’s in there. I figure that Congress only writes when they’re drunk. The ways and means of the Committee is they write the laws, and they got to get a little sauce to do it, because they want to make sure that whatever they write…

Eliot: Can’t come back on them.

Toby: It’s ambiguous. How do you write something and make it so it could be interpreted in 10 different ways?

Eliot: It’s an art.

Toby: Yeah. Somehow they do it. I don’t know how they do it, but they’re magic. You get millions of pages of tax court. Yeah, I think they drink. I’ve just decided that they all get sloshed in and then start writing code.

All right. “I’m considering starting an online business. I’d like to know strategies and how to manage taxes as best as possible.”

Eliot: Just real quick to the things we run into here. (1) Make sure you have your asset protection. Put it in an LLC at the very least. (2) How do we want that LLC taxed? Probably an S-corporation or a C-corporation. Again, that will depend on your overall operations, but that would be one idea for your tax savings, a lot better deductions in their corporations and reimbursements. We have accountable plans, corporate meetings. If it’s a C-corporation, we got that medical reimbursement plan, things like that.

Be very aware of what’s going on in your state taxes. If you’re online in one particular state, you might be reaching out to other states. If we have enough reaching out, it may rise to the level where we have to look out for sales tax, so make sure you have good software. Those are the things I hear about the most in your online businesses.

Toby: Okay. The online business, how would you compartmentalize it? What are the main things that anybody that’s starting up a business should be considering?

Eliot: Again, definitely the asset protection or what kind of entity we have. If we make enough income and that becomes really questionable, but I might want to make an S selection, how it’s taxed…

Toby: The big question is, what are your projections? Do you have experience in this already? Do you have funding coming in from third parties? Are you using any debt to start this business? What is your exposure starting this business?

For example, you would never be a sole proprietor if you’re going to have employees. Just because the liability is too extreme, you got to try to isolate it to the extent you can. Even then, there’s certain types of liability that you can’t escape as an individual if you’re in control of the company and you have employees.

The only way this thing works is if you take your assets and preserve them, like a Wyoming trust or a Wyoming LLC for your safe assets like your stocks, bonds, and things like that. If you’re trying to remove it so that if something bad happens over here that they don’t end up taking everything you own, your house may have a homestead, you might have 401(k), which has a risk of protection. You look at those types of things.

(1) You’re looking at what’s the worst that could happen with this business, and then you look and say from the tax standpoint. Let’s say that I knock it out of the park, what is it going to do to me? It’s a very different question. If I’m dealing with a husband of a surgeon, maybe the wife is making $900,000 a year, it’s real life situation, and they’re making $100,000-$200,000 a year on a side business, that’s a very different scenario than somebody where the $100,000-$200,000 is the primary source of income. They may be treated differently from a tax standpoint.

In other words, the surgeon spouse may not want that income ending up on their 1040. They may want to make it and be at that 21% corporate tax. There’s all that fun stuff, but that’s why you talk to somebody else. They’re going to bounce this around. I’m giving you just a partial test.

Eliot: That’s what we do. We tear it apart like that.

Toby: Yup. Somebody has pointed out, do not put your home address on the website. Somebody will show up at your house robbing a hundred percent. We are the freakishly private people who say, always use a registered agent, use a state. We like using Wyoming, where the members and managers aren’t listed anywhere. We’re maniacal like that because we happen to believe that your privacy is a paramount concern, and nobody really needs to know where you live.

We have a lot of clients that are in mental health and other things. I’ve learned my lesson listening to them. Just talked to a few psychiatrists, and somebody shows up at their house at 2:00 AM.

Eliot: Anonymity is looking good.

Toby: Anonymity is looking great. Speaking of, if you want to learn about how LLCs, corporations, Wyoming, all that interplays together, plus get a good dose of tax and estate planning, come to the tax and asset protection workshops. They’re free on October 19th and 26th. December 5th through the 7th, that’s a three-day event here in Vegas. It’s Clint, myself, Michael Bowman, I’m sure Ryan Gibson’s there. He does storage syndications. They have over 750 million dollars of syndications. He always comes out and talks.

There’s a fundability coming out, which is they can show you how to build business credit. All these cool components are going to be there in Las Vegas. We have a fourth day that’s not listed here. You could always ask Patty for it, which is a networking events. The first one we’ve done in a long time, where we’re going to do a client appreciation.

Just to give you an idea, if you’re titanium, the tickets are less than $100. It costs us more than that to give you the drinks because we’re going to feed you on day four. That’s all a working day of networking problem solving together. We’re going to do a 100-day goal, journal, and mission-vision values for your investments, your family, and a bunch of problem solving. We’re going to do that on Sunday.

Anybody’s invited to that one, again, if you’re interested in doing networking and working with a bunch of our people, come on out. Patty will share that. It’s a lot of fun. There’s a few of you guys that I know pretty well. You should come out and just come hang out in Vegas because we always have fun in Las Vegas for the good reasons, not because we do anything wrong, I live here, but because it’s always cool to get together and get to see everybody. If you haven’t been to a live event, you don’t realize how really cool our community is. Everybody is really nice.

All right. “Could I have my S-corp rent my secondary home when the business takes clients on retreat? While this may create an expense on the business side, does it also create a tax liability on our 1040?”

Eliot: All right, here we’re looking at that second home. The first question I have, how are we using that home? Meaning if it’s just a vacant beach house that my family goes to, something like that, or am I already renting it, it does make a difference. If it’s already a rental and then you go and you try and rent it out to your business, if you start to use it, we can run into some limitations, perhaps. If we turn it from a regular rental into a vacation home, if you use it more than 14 days, the greater 14 days, or 10% of the fair market rental days, we might get a limitation to how much we can deduct up to just the amount of income we have.

If we had plans for it as a rental for other things like cost segregation or something like that, we might run into problems there. What if it was just a personal second home that we use as a beachfront or something like that? Then we want to at least use it 14 days. That makes it a personal residence.

Under the code, we can do our 280A meetings there. Now, we have our S-corp conduct meetings there. S corp pays us for the fair value of having that meeting.  It’s not income on our 1040, but it is a business expense deduction on the S-corp. Either way, you’re going to hit the allowance of free income into your pocket from the meeting, and it will be a deduction. Whether or not we can take that deduction might be hampered if this is an actual rental that we’re using out there.

Toby: I want to just make sure something’s really clear. If this is a second property where you’re residents, you’re just going to rent it to the corp, and it’s 14 days or less, you don’t do anything. The corp can pay you, and you don’t have to recognize it anywhere. You don’t have to report it anywhere. It’s an expense to the S-corp and it’s not reported. It’s just like a reimbursement.

If your boss said, hey, pick up some donuts on the way to work, you pick up some donuts and they slap you a $20, you don’t report that anywhere. It’s the same thing, but you do have to get values on the comps for that to make sure that it’s reasonable.

There are two cases last year that came out in the IRS. They didn’t have comps. People had one cases, they were using 280A on four different houses. They wrote off over $100,000, which they were allowed to do, but the IRS reduced it to $500 a day because they had no backup at all. They went through tax court and they didn’t bother to get comps. Knuckleheads because the attorneys are dumb.

That was the issue. The court just said, hey,  you didn’t have any basis. The IRS said it was unreasonable. They said, here’s the reasonable amount. It was crazy.

There was another case, the folks that do Planet Hollywood got $500 a day too. Just get a comp on it. It’s going to be more than $500. The last time I had a court case was, it was North Dakota, it was $500 a day, and that was 15 years ago. I just look at those things going. They’re going to default to a really low number if you don’t have some backup.

By the way, we give you that stuff. When you’re our tax clients, we have something called the tax toolbox where we have a bunch of forms. You can go through all that stuff, but we’ll make sure that you got your Ts crossed and your Is dotted. We’ve had that come up on audit twice in 20 years, and we won both because we had them backed up. I don’t know why these guys go to tax court without basic backup.

Eliot: Never a problem with the deduction. It’s always on the valuation.

Toby: It’s always on the value. You’re allowed to have it. I used to say it’s per residence. It doesn’t say it’s per tax year, but I’ve never felt comfortable. I always thought that you’d get hammered if you try to do it on more than one. There’s a court case allowing them to do it on multiple. It’s weird.

Long story short, I could rent my secondary house as long as it’s a residence, which you could have multiple residences. You could have an RV, a boat, and a second house in your primary. Those are all residences. I would just say keep it to 14 days or less. I don’t feel comfortable doing 14 days per residence, but just because I think you’re asking for trouble.  But that 14 days, tax free, and you don’t have to report it anywhere. Life’s easy.

If you do rent it to the S-corp and it’s more than that, then you’re correct. You’re going to have to recognize it as income, but you’re going to have depreciation to offset it. You’re going to have restrictions on your ability to take it as a loss, and I think it’s going to be considered non passive self-rental if I’m not mistaken. Does changing the floor and painting the walls count as a repair or is it a renovation?

Eliot: Typically, painting is almost always going to be a repair. What’s the difference? A repair you can expense immediately that year. Renovation might go into where you have to capitalize and we have to depreciate over many years. I think that’s really the cusp of what we’re trying to get at by this question. It’s rare that painting is going to be considered anything but an expense. Unless it was part of an overall redoing of the whole house, remodeling of the whole house, then they might call that into question.

Toby: You still get to write it off, it’s just you’re writing it off over 27 and a half years for residential property, 39 years for non-residential. It’s just a long term write off. For the most part, the IRS is going to say painting, but flooring is different. It has to be removable flooring, or you have to be expecting to replace it at least two times in the next 10 years.

There’s a couple little provisions or if it’s $2500 or less, than under the regs, you can treat it as a repair. It’s a safe harbor, they can’t contest it. If you are doing financials for a loan, a non-tax reason, then that goes up to $5000 that you could do per invoice. You could do painting and changing out the floor. If they’re both underneath $5000, they’re a repair. You don’t have to mess around with it. Safe Harbor. I think you have to elect the safe harbor.

Eliot: Yeah, 2500 De Minimis Safe Harbor.

Toby: It’s $2500 if you have financials for a reason, non-tax related. Again, if you have a loan, then it’s $5000. Can I still take six figure distributions from my S-corp and have it not affect my social security? I just like the way they said that. Can I still do that? No, you could never do that. If my corporation shows a profit and I’m the CFO, will this affect my social security? You can answer this one.

Eliot: All right. Two ways of looking at this. (1) Will these distributions from the S-corporation have anything to increase my social security benefit maybe later on? That has to come from earned income. We got to have social security taxes taken out on it. A distribution from an S-corporation doesn’t have any of those, that’s why people like S-corporations because they can take out some portion, distribution, and not be subject to those. They’re only subject to an income tax on it. If we’re looking at the question from the angle of I’m trying to get some kind of credit for it, we have to take a reasonable wage in order to get that credit.

(2) What if we’re already retired, we’re receiving Social Security, but we do have this other S-corp out there where we have money coming in? What’s going to hamper us there is that’s income that’s going to raise our total taxable income, which will typically require a higher percentage of our Social Security to be taxed. Those are the two ways I’m going to see getting impacted here.

Toby: It doesn’t matter whether you take the distribution or not, it’s going to affect your Social Security.

Eliot: It’s going to be an impact.

Toby: It’s going to flow onto your tax return regardless. I always try to read it like, can I still take, no, you can’t or you could never. You never could. I think that’s it. Look at this, if you’re fixing and you’re like, oh, my gosh, I need some more tax stuff, there are nine tax deductions for rental properties. You go watch that.

Eliot: You get a QBI in there?

Toby: I don’t like the QBI. You can do a QBI. You could go look about Kamala and Trump’s tax plans, lose your mind about tariffs. There’s always somebody’s yelling at me. The importer pays the tariff. Stop it. Stop it. It’s just making things more expensive. We’re trying to bring it back on shore.

All right, but go ahead. I just love the fact that Trump will never say that it’s actually the importer. They press him on it. No, we’re making a ton of money, China’s paying all this. Actually, China didn’t pay anything. It was us that paid it, but don’t let that bother you. You just keep doing what you’re doing. It’s bugging the hell out of people.

All right. If you liked this stuff, like and subscribe to the YouTube channel. It’s fun. If you want to learn more on the asset protection side, Clint’s channel is absolutely fantastic. It dives into LLCs, living trusts, land trusts, how to use them, all sorts of different scenarios, a lot of good information. He has some pretty good interviews on there. I’d recommend that you do that.

Please join us at the next tax and asset protection event. They are generally on Saturdays. There are a few other days when we hold them. You’ll get notified if you’re part of our organization, I think just because you signed up here, you’ll probably get notified, but those are free events.

The live events, the three days in Vegas are very inexpensive. They’re a couple hundred bucks, $300, something like that. Depending on whether you’re a client or not, it’s even cheaper. Feel free to come join us for that, hang out in Vegas, and hang out with a bunch of investors who are actually really cool. We always have fun.

I think this one’s at the Green Valley Ranch, which is actually just there at Henderson, and it’s always fun. If you get a chance to come out, make sure that you go up and say, hey, I watch your Tax Tuesday, and do that in front of Clint periodically, just to watch him go, ehh, it’s fun. No, I’m just teasing. It’s always good. Just remember we have that fourth day. You’ll get notified on that fourth day. If you have questions, you guys are answering these, right?

Eliot: Yes, we are.

Toby: Taxtuesday@andersonadvisors.com. Feel free to shoot in questions anytime. General questions, we just answer them, and then we grab your questions out of the mix and put them as part of the questions that we answer live. We do this every other week. That is it. Thank you guys.

I want to do a special shout out because they’ve answered over 132 questions. There are six open questions left that they’ll be answering. Jeff, Matthew, Jared, Tanya, Rachel, Arash, and Dutch for taking time during tax season. You guys don’t realize what these guys go through during tax season. Everybody tries to act like they gave their stuff in early and all this stuff. The last minute, there are always 20 things you could do differently, but they are doing this.

They get a whole bunch of stuff, and there’s well-earned confetti. It’s tough to be a tax professional in the United States. They make you walk through the same door all at the same time, and they speak in riddles. With the IRS, it’s always like this. I always feel like when I’m asking the IRS, what do I need to do, and then, I don’t know, what do you need to do?

Eliot: Go talk to your tax people.

Toby: Yeah. How much do I owe? I don’t know. How much do you owe? That’s what I always feel like the IRS. Is this enough? I don’t know. Is it enough? They just nuke you whenever they get a chance. It’s a crazy system. Hopefully we can fix it someday.

That’s what our tax professionals deal with. They’re walking that line, so thank you guys for doing that. For those of you who still have questions pending, we will answer them. I’m going to say farewell, Eliot.

Eliot: Thank you, guys.

Toby: We will see you in two weeks. If you have a question unanswered, hang tight. We’ll make sure that we answer it and then we’ll be done.

 

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