Did you happen to watch Saturday Night Live with Elon Musk? Was it a waste of time and money? Maybe you should ask Toby Mathis and Jeff Webb of Anderson Advisors to answer your questions about buying a Tesla, investing in bitcoins, and other cryptocurrencies. Submit your tax question to taxtuesday@andersonadvisors.
Highlights/Topics:
- I would like to make my investment condo my primary residence for tax benefits upon its sale – without sleeping there 731 days over five years. Is that only a safe harbor measurement or a hard-and-fast rule? Refer to Section 121 – Capital Gains Exclusion because your primary residence is where you spend the most nights
- How can I take profits out of an S Corp without paying a lot in taxes? If you are the 100% shareholder of the S Corp, whatever profit that S Corp has, that’s your income and you pay tax on that income, regardless of whether you take money out of that S Corp or not
- How do you account for remodeling expenses versus maintenance expenses for a rental property? Maintenance expenses or repairs are expenses for keeping the asset at its current value; remodeling expenses are improvements such as renovations or a betterment to increase the value of the asset
- Can an employer contribute to a profit-sharing retirement plan if there was no profit for the year? It has nothing to do with profit, but it does help to have profit to pay the contributions or create a loss
- If my business and house are in my revocable living trust when I die, what kind of tax will my kids (the beneficiaries) have to pay on getting the business or the house? When you die, a portion of the assets in the revocable living trust go into an irrevocable trust, so your estate may pay tax, but beneficiaries will never pay tax on inheritance or gifts
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Resources:
Infinity Investing: How The Rich Get Richer And How You Can Do The Same by Toby Mathis
Real Estate Professional Requirements
Section 121 – Capital Gains Exclusion
Unrelated Business Income Tax (UBIT)
Unrelated Debt-Financed Income (UDFI)
Anderson Advisors Tax and Asset Protection Workshop
Anderson Advisors Tax-Wise Workshop
Anderson Advisors Infinity Investing
Full Episode Transcript:
Toby: Hey guys, this is Toby Mathis.
Jeff: And Jeff Webb.
Toby: You are listening to and watching, possibly, Tax Tuesday, where we bring tax knowledge to the masses, everything you could ever want. Welcome. I hope you guys are having a great Tuesday. If it’s not Tuesday for you, I hope you’re having a great day wherever you may be. We’re going to dive right on in, we got a lot to go through. We’re actually trying to be on time this year. I think we’re doing pretty good. Don’t give me that look. I think we’re doing great. Let’s see who we got on here.
Hey, guys. If you’re willing to go to the chat, just tell me where you’re from. Raleigh, New York City, Elohim, Phoenix, Sacramento. Wow, another flying through. Winston-Salem, I got a bunch of properties there. Castle Rock, Tyler—Tyler, Texas, I blew some stuff up in Tyler Texas. […] South, Houston with the client. Philly, that’s my hometown. Atlanta, Honolulu, O’ahu.
We got a couple in San Luis Obispo, Austin, San Francisco Bay, Portland, Anacortes. Really Anacortes, Washington? Because that’s actually where my mom lives. Florida, New Jersey, Iowa, Grand Rapids, we got them all over the place, Miami, San Jose, New Hampshire, Queens, New York. How many of you guys can’t find gas right now? Let’s see. We had San Diego, Thousand Oaks, Chicago, DFW—Dallas-Fort Worth. We got people from all over the place.
Are you guys having any trouble around? On a serious note, is anybody here having trouble finding gas? Because you read about it. We’ll just do an informal poll here, we got people on from all over the place. If you’re on the East Coast, you’re having trouble finding… somebody says, “Indiana, no problem, no issues.” Gas is okay in Texas. No gas problems in California.
Jeff: East coast has a problem with the Colonial Pipeline shut down.
Toby: Yes, Raleigh. Raleigh has issues, it filled up on Saturday. Good in Chicago, over $4 a gallon. You’re having people on the East Coast who had some issues. “Oil in Alaska is okay.” Atlanta has some issues. Looking for Total and gas right now in Chicago. New Jersey, okay. It’s always $4 a gallon if you’re lucky. We should all just go electric, and we should all buy our cars with Dogecoin. All right, don’t give me that look either. All right, anybody picks up on Mr. Musk.
All right. You can ask your questions. If you have a tax question, put it in the question and answer, everything else. If I ask you questions, you can answer them in chat. Let’s see if you guys can figure that one out. If you have a tax question, we have tax attorney, Eliot Thomas. We have Dana Cummings. We have Piao, we have Christos Zattas. We got a bunch of accountants on. We have four accountants on plus Jeff—who’s a CPA, and we have Patty on too, she’ll do that.
It says, “I email my questions, I’m a titanium.” We’ll get to them.
“I was going to the Moon, Toby, with Dogecoin, joking.” No, we could. Because I bought Doge when Elon Musk first sighted out. He’s one of the few people I follow and I was like, I’ll just go buy some. I sent Clint, it was like 900% something. I was like, dude, you got into this, right? Then I watched Saturday Night Live and it was […]. It was actually doing okay, but I have no idea. I just think it’s hilarious.
Jeff: It was never intended to be a real virtual currency.
Toby: It’s going to be.
Jeff: It was created as a joke.
Toby: They’re realizing that if you have a fiat currency, as long as you have people believing in it. It’s like Charlie Munger said, if people think a turd is worth something, a turd is worth something.
All right, send your questions in to taxtuesday@andersonadvisors.com during the week. Shoot it on in. If you need a detailed response like it’s really specific to you, we’ll want you to be a platinum or tax client. Otherwise, we’ll just answer it. We go through a lot of questions every week. I usually pick about 10–15 questions. What I try to do is grab 10 now because if it’s left up to me, we’ll be here until midnight. They’ve asked me to make sure I only do 10 questions a session, so we’ll see. People have lives, they don’t want to sit here on taxes all day.
All right, “I understand that if I want to set up my own Qualified Opportunities Zone Fund, it needs to be in a partnership of some kind with an LLP, LLC, C-Corp, or some other entity structure. Can I form a viable partnership for this purpose with my IRA-owned LLC?” Good question. This is going to be fun. I’m going to test your knowledge, Jeff.
“I would like to make my investment condo my primary residence for tax benefits upon its sale without sleeping there 361 days over five years. Is that the only safe harbor measurement or a hard and fast rule?” We’ll answer that. Good questions.
“How can I take profits out of an S-corp without paying a lot and taxes?” Good question. Kind of an open one. I like those. Sometimes I grab those because we could talk about those all day.
“How do you account for remodeling expenses versus maintenance expenses for a rental property?”
“If you mine Bitcoin, how is it taxed?” That’s a good question for today. Is it taxed at the price of Bitcoin minus electricity, then turned into US Dollars?” Really good questions.
“Can an employer contribute to a profit-sharing retirement plan if there’s no profit for the year?” I like those types of questions too, play on words.
“If my business and house are in my revocable living trust when I die, what kind of tax for my kids?” The beneficiaries have to pay on getting the business or the house.
“Has the IRS relaxed the 750-hour requirement for real estate professional status for 2020 in light of the difficulties of the COVID pandemic.”
We’ll get through all those. I can already see our guys are answering lots of questions. Go on into the Q&A feature if you have questions and we’ll get through those.
All right, the opening questions, let’s jump into this. “I understand that if I want to set up my own Qualified Opportunities Zone Fund, it needs to be in a partnership of some kind with an LLP, LLC, C-Corp, or some other entity structure. Can I form a viable partnership for this purpose with my IRA-owned LLC?” What say you, Jeff?
Jeff: I wasn’t sure that I understood this question, because basically, there’s no reason to have your IRA as part of a Qualified Opportunity Fund that I’m aware of. The tax is already deferred. If you had capital gains in the IRA, they’re going to be deferred until you pull that money out. I would not partner with my IRA for our Qualified Opportunity Zone.
Toby: Here’s a little bit of a different spin on it. I like to unpack things a little bit. The first thing we do is go to 26 USC 1400Z, which was the Qualified Opportunity Zones, that came about the Tax Cut and Jobs Act. It’s the special section that if you have capital gains, you can invest them into a troubled area that all states have now designated certain zip codes where they need infusions of capital and investment.
To do that, they say, hey, you can defer your taxes and you’ll get a step-up in basis on a portion of those. Right now, you can get a 10% step up, and you can defer it until 2026. If I have taxes that I would owe on a transaction on capital gains I can invest it—subject to some rules—in something called a Qualified Opportunities Zone Fund and defer those taxes for, right now, looks like 5 years. Then if I invest in that Opportunity Zone Fund for a minimum of 10 years, it steps up the basis to the fair market value of those assets. In other words, you pay no tax on capital gains. I think that goes until 2040, 2041, or something along those lines.
The idea is that Congress creates this incentive to go into this area, you don’t have to pay tax right away. You can defer some of your capital gains, and then if you invest those capital gains into something and keep it there for a long time (for 10 years), then you could sell it in 20 years and pay no tax on any of those gains. That’s the layout is this tax incentive area.
What’s the issue? How do I get in there? Well, you have to invest in a fund, which fund has to be a partnership or corporation for federal tax purposes. Federal tax purposes are not the end all be all. States have entities like LLCs that don’t exist in the code that you could say, hey, I want an LLC taxed as a corp or I want an LLC tax as a partnership, that works. I want an LP taxed as a partnership, that will work. I want an S-corp, I want a C-corp, I want something that I can use as my fund, and then that has to invest a portion of the money, I think 90%, in Qualified Opportunities Zone property.
The property doesn’t mean just real estate. It could be a business, it could be having employees there, 50% or more of those employees are there, all that stuff starts to qualify. Then you get into all these crazy rules.
Going back to the question then, yes, it has to be a partnership or corporation. Can that then partner with something else? Here’s the big question, can I have non-opportunity zone monies, going into an Opportunity Zone Fund, and investing in opportunities zone property? The answer is yes.
If I want the benefit of a qualified Opportunities Zone Fund, I have to have capital gains that I’m deferring. If you are in an IRA, you’re not deferring anything, so it’s just an investment. The weird answer is yes, I can actually partner with my own IRA in the initial transaction. This is where people get screwed up because they think, oh, I’m a disqualified individual. If I have an IRA, I can’t do business with myself.
You’re correct, but setting up the business is not engaging in continuous transactions. You’re allowed to set it up as long as it’s one-time funding. If Jeff is my 401(k) or IRA, and I am me, we’re just qualified people from each other to do continued transactions. We could set up a one-time business and he could put in half, I could put in half, whatever it is. We could go into business together.
What Jeff said was absolutely 100% correct. There’s no reason for the IRA to try to do a Qualified Opportunities Zone Fund. It can’t because it doesn’t have capital gains. But if I need the funds, could I partner with somebody who’s not taking advantage of the Qualified Opportunity Zone? Yeah, I could. We have to keep track of our different bases. We have an inside basis and an outside basis of the deal. Jeff loves this stuff because he’s an accountant. We just partner up together. That’s the long answer. Sorry.
Jeff: I saw what you did there. You didn’t assume that they knew what we were talking about, the Qualified Opportunity Fund.
Toby: I already see all the questions popping.
Jeff: I just jumped.
Toby: Jeff is like, didn’t some of the benefits of the Qualified Opportunity Fund already end like the 15% step-up? No. What it was was you had a step-up in basis that you’re five and seven. You had a 10% and a 5%, and now that we’re so close to 2026, there are no seven years. If I roll some money and I’m not going to make it seven years before its automatic trigger of that tax. It’s still there unless they move the recognition date.
Could you imagine somebody that deferred their tax at 20%? Then they walk right into 39.6 plus 3.8. There are going to be some interesting conversations going on with accountants when they realize that you just doubled their tax. Anyway, you guys get that? I confuse myself sometimes. Anyway, that’s what the Qualified Opportunities are.
All right, here’s a good one. “I would like to make my investment condo my primary residence for tax purposes upon its sale without sleeping there for 731 days or for 5 years. Is that only a safe harbor measure or a hard and fast rule?” Yes.
Jeff: That’s a hard and fast rule, and you actually have two problems there. If you don’t sleep in it at least 185 days a year, you’re never going to make that your principal residence. Your principal residence is always where you spend the most time, most nights. In section 121 exclusion of which what we’re talking about here, requires that to be your primary residence. And then to take the 121, you have to have 2 years of living there out of the last 5 years. It doesn’t have to be consecutive.
There’s no way around this unless you meet one of the exceptions for you’re forced to move for work or something of that nature where you could get a reduced exclusion.
Toby: Yeah, this is another one of those ones where we’re going to have to step way back from it to give you guys the layout of the rules. I think what they’re talking about is the 121 exclusion, which is a capital gains only exclusion when you sell a residence that you lived in for 2 of the last 5 years. That’s number one.
If you have an investment condo and you make it into your primary residence, over the next 5 years, you lived there for two of those 5 years, and it’s actually a number of days. It’s 365 times 2 over that last 5-year stretch. I don’t know how those things add up to be, but it’s something along those lines. Then you would qualify for at least a portion of the safe harbor.
But what we’re hitting on here, and I think what they’re getting at, is that if you have a period of disqualified use. In other words, you invested it, it was a second home, it was not a primary residence. Those days are prorated compared to how many days you live in it, so if I lived in it for 731 days but I had it as a rental property for 731 days, then I would get ½ of the exclusion because I had 50% non-qualified, 50% qualified.
There’s no way around that unless you fall into an exception. The exceptions, if I remember them all correctly, (1) is if it was your primary residence and you turn it into an investment property, so long as you lived in it 2 of the last 5 years before selling it, then we ignore the period of disqualified use.
So if I lived in it for two years, made it into an investment property for three years, and sold it right before the end of the fifth year, I would have 24 months of that 60 months that I used it as a primary residence. And I would get my entire capital gain exclusion the entire amount which is $250,000 for an individual, $500,000 for a married couple. Remember, the recapture or the unrecaptured depreciation—technically it’s called that recapture—is not covered by the capital gain exclusion, just the capital gains. That’s number one.
Number two is what Jeff said. If you have unforeseen circumstances, and you had a forced move, death in the family, or things like that. Then they could prorate it or they may say, hey, we’re not going to hold it against you, that portion. The other one is if you’re in the military and you’re actively deployed, then they say ignore that time too. There’s one other which is if it’s a 1031 exchange. I could 1031 exchange it. I can’t use my 121 exclusion for 5 years, but I can add my 121 to the previous basis if I do another either the sale or the 1031 exchange.
Jeff: When we’re just looking at that the other day about the 1031 exchange, from what we were reading, you can’t even start counting time until about 5 years or so. You actually have to go at least 7 years in that exchange property.
Toby: If you 1031 exchange into an investment property then you make it your primary residence. What Jeff’s saying is there’s going to be a big section of it. Again, if it’s a $1,000,000 of gain and you’re allowed 2/7 of that as a capital gain exclusion, then my understanding is that of the gain, you would get to 2/7th of it. Gosh, I used a stupid number. What is 2/7th? Somewhere around 30%. I guess we got 2/7 goes into about 28%. All right, somebody’s helping us. Twenty-eight percent, we get a $280,000 capital gain exclusion that we should be able to use. That’s kind of a goofy rule.
For this case, I started out at an investment property, I turned it into a primary residence. I have two areas that I have to be careful of, disqualified use, and I have recapture that is not part of it. In other words, you got to talk to your accountant before you sell and know the numbers before you pull the trigger. Don’t just say, oh, I don’t have to pay for it.
Come join us. As always we do the Infinity Investing Workshop. They’re free. We have another one coming up on the 15th, is that this weekend? Yeah, four days away. Come join us, it’s absolutely free, aba.link/iw. If you’ve never been to an Infinity Investing Workshop, you’re in for a treat. We had a lot of fun going over stocks and real estate, and everything is designed around cash flow. An asset is something that puts money in your pocket, a liability is something that takes it out, so we don’t fall for all the shenanigans that those financial people like to sell us.
Jeff: You don’t do too good to be true?
Toby: Dogecoin is not an asset. Dogecoin is a cash or cash equivalent. You’ll learn all this fun stuff. If you want to invest and speculate in currencies, virtual currencies, or whatever they may be, that’s like 1%–3% of your assets, it’s a small, little sliver. Still kind of fun though when they go crazy. Questions. I’m going to see if there are any questions popping around out there.
Somebody says, “Clarification, we never allow AMF deal sponsor GP of a multi-family syndication to use and I ran his own deal, are we wrong?” Technically, if they’re going to be involved in the transaction, you might have an issue, right? If the GP is involved, technically you possibly could, but I wouldn’t because they’re getting paid on it. I’d actually say if they’re a GP, no. If it’s somebody who’s investing their own money and some IRA money, then I wouldn’t really care. But if they’re going to be involved in continuous transactions, they’d be a disqualified party. I’d be on the safe side of that one.
Even partnering with your IRA. Here’s what people do, they go into an investment property, I can’t go pick up a hammer and work on that property. I would disqualify my IRA. The other thing is we use the term IRA on those deals, I would be using a 401(k). Because IRA is if there’s any debt on it, you’re going to have unrelated debt-financed income flowing into the IRA, and I’d prefer not to have that. A 401(k) is not subject to the same rules, they don’t have unrelated debt-financed income. You’re much better off, if you’re going to have IRAs and syndication, to tell them to roll it into a solo 401(k). If they don’t have one, we could set that up.
It’s going to avoid a couple of things: the custodial fees, you’re not going to have to worry about somebody else signing on the syndication documents, they can sign themselves, and you don’t have to worry about UDFI.
“I put $500 into crypto that is now worth $16,000, how is that treated from tax? The year it went up or the time you take the money out?” It’s the time you take the money out. Cryptocurrencies are treated as a capital asset, so pretend that’s stock. Heather, let’s say that you put $500 into Ethereum and it’s now worth $16,000, until you sell it there’s no tax. Here’s a hint, the rich folks don’t sell their crypto. They put it into an account and borrow against it because it is not taxable. The day you sell it, is the day you pay the tax, or is the day that it’s a taxable event. Kind of fun.
Jeff: Kind of.
Toby: All right. “How can I take the profits out of an S-corp without paying a lot of taxes?” Jeff.
Jeff: Well, the way an S-corp works, say you’re the 100% shareholder of the S corporation. Whatever profit that S corporation has, that’s your income and you pay tax on that income, regardless of whether you take money out of the S corporation or not. We sometimes see this as a problem with growing S-corporations when they’re making a lot of money but they’re reinvesting that money into a vast corporation. Sometimes the owners get saddled with a big tax bill that they haven’t considered taking money out for.
Let’s say you had a small profit in the current year and you took out all your past year’s profits, you’re only going to be taxed on the current year’s profit not what you actually took out of the company.
Toby: I think what Jeff’s saying is it doesn’t matter whether you take the money out of the S-corp or not? Kind of?
Jeff: Yeah.
Toby: You’re paying tax on the profit no matter what. The only time you have to be scared is if you take more cash out
Jeff: That you have invested.
Toby: Then you have basis. What you have invested, use English, right? Everybody’s asking how you borrow against crypto. We’ll get to all that guys. We have some crypto questions coming up. There are these places. I forget. Grant had one that he thought was pretty good that he uses. Somebody is saying Nexo bank. There’s another one too that’s pretty good that we’ve seen. But yeah, you can borrow against it. They pay a pretty good interest too. I mean, you could borrow against it and pay, but other places will actually pay you on your crypto, pay you an interest rate, if you let them use it. Kind of like a bank, right?
Whether we take the money out of the S-corp is immaterial. If I want to take profits out, then I don’t want to pay a bunch of withholding, then I would take it out as a distribution. If I had a bunch of income and I don’t want to pay tax on it, I might set up a 401(k) and defer my salary, run it through payroll and defer up to, if I’m under 50—$19,500 this year. If I’m over 50—another $6500, and that’s deferred plus the company could match 25% if you have a solo 401(k).
Jeff: Right
Toby: The other fun one is if you have anything that’s a flow-through, just remember the earnings. It doesn’t have much to do with the amount of cash you have. I could buy a piece of equipment, finance it, and come out of pocket nothing. I’ve done this with copy machines. Think of when you do one of those really long leases with the dollar payoff, it’s called a capitalized lease, and you can actually deduct it in the year that you acquire it. Under either 168 or 179. You get this huge loss in one year, but you may have a bunch of cash.
Jeff: Yay.
Toby: Again, you have to have basis. Did you want anything else to add on?
Jeff: No.
Toby: If you have an S-corp and you’re taking out distributions, just remember, if you have profit, you should be taking a reasonable salary. Lots of questions popping up. Everybody’s crypto crazy right now. I’m going to coin that term.
Jeff: Crypto crazy?
Toby: No, no pun intended. Do you get it? I’m going to coin. It’s pretty funny. “Can you define reasonable salary?” No, neither can the IRS. Somebody says, “Can you define a reasonable salary?” I say it’s about a third.
Jeff: We’ll say the reasonable salary is what you would objectively pay somebody else to do the same work that you’re doing.
Toby: Nobody knows. The courts always say 1/3. The accountants that took $200,000, he made $200,000 out of an S-corp, didn’t take a salary.
Jeff: Going back to your point about it. I could pay myself $20,000 a year, defer almost all of it into 401(k), and have almost no taxable income coming out of that.
Toby: It’s what we like. I like it when we defer. We have folks putting a—what’s the biggest we have in a defined benefit plan? I know we have some folks putting $600,000, $700,000 a year into a defined benefit plan.
They don’t pay any tax, but yet, they will pay tax eventually when they’re forced to take it out of the other retirement plan, but we’re deferring a lot now. Usually, it’s because they don’t need the money.
Somebody says, “How do you determine if money is being invested back into the S-corp?” Here’s the thing, if you don’t take a distribution out, you don’t have to take a reasonable salary. If all the money is staying in the S-corp, you don’t have to take a salary. It’s only if you’re taking distributions, that’s the actual rule. A lot of people say, well, if your S-corp shows a profit, you have to take a salary. That is not true. It’s only true if you make a salary and you take distributions.
Somebody here says, “I love defined benefit plans. I’m putting in about $400,000 a year since I’m in my 60s.” That’s exactly what you do, it’s a big makeup. If you don’t know what they are, come to a couple of our events, we’d love to explain them to you. They’re fun.
Look at all these questions, all of a sudden. It’s probably all crypto.
All right. “How do I account for remodeling expenses versus maintenance expenses for a rental property.”
Jeff: The simple answer is maintenance expenses or repairs are expenses for keeping the asset at its current value. When you’re talking about remodeling, you’re talking about a couple of things, are you talking about improvements? Is it a renovation where you’re adding to it? Is it a betterment where you’re increasing the value of the asset and so forth? You have to watch some of them because let’s say, you bought a house for $100,000, you didn’t really take care of it. You had to do some remediation because the foundation was sinking or whatever.
Toby: That’s probably going to be a betterment.
Jeff: That’s going to be a betterment because any type of deterioration over time that you repair later, that’s going to be betterment, that’s not a repair anymore.
Toby: There’s the tangible property regs, I have a few other little caveats in there. If you’re spending more than like—gosh, I’m not going to pretend like I know all their different rules. It depends on if you’re going into a particular area and you’re not improving more than 30% of its total value. The example that I’ve heard is if you’re doing AC units, don’t replace them all at once. But if you go and fix one at a time, if you have five different units, you can expense them.
The other thing is, remember that an expense, all that’s doing is offsetting your income. For the most part, if we really want to create a loss in real estate, it’s easy to do with the cost segregation. I don’t see a lot of the maintenance versus remodeling stuff coming up anymore. It was big a few years back before the cost segregation. Actually, before the 168 bonus depreciation, which was under the Tax Cut and Jobs Act. Before 2017, it was a much bigger deal. You do have the safe harbor of a $2500 invoice that’s if you choose to treat it as a repair, it’s immediately deductible.
A betterment gets stretched out over the life of the asset. On a traditional single family residence, for example, the best example I can give you is if you went and you replaced your roof, that would be stretched out over a 27.5 year period. You’d retire the old roof, whatever value you hadn’t taken, you would take a deduction for that entire amount. If the roof was $20,000 and you depreciate it half a bit, you get a $10,000 deduction. You put the new roof up, let’s say $20,000, you take that $20,000, and you’d start stretching it out over 27.5 years again.
If I just repaired the roof, let’s say I did $2500 worth of repair and I said, hey, I don’t care what it is, I’m just going to expense it. You would just write off $2500 that year, which is going to lower your taxable income. Most people that have rentals have more depreciation than they have income. Just my experience because we can accelerate it. We could accelerate all of the 5-, 7-, and 15-year property into one year if we want to. The old rule is if you’re paying taxes and you have real estate, you just don’t own enough.
Jeff: We see a lot of people who will go in and, well, I had to update my kitchen and bathrooms. That seems like a great time to do that cost segregation on that renovation because there is a lot of short-term, five, seven in there.
Toby: All of the stuff you put in a bathroom is pretty much it because you put in the cabinets, the tile, the fixtures, the glass, the mirrors, and the light fixtures.
“What if the HVAC, how do you treat betterment?” Mina, a betterment is treated as that asset. If it’s nonresidential real estate, it’s 39-year property. If it’s residential real estate, it is 27.5 years. As a matter, of course, you could elect to change that treatment, and then they would say, what type of asset is it? Is it a 5-, 7-, or 15-year property, or is it part of the structure? So it depends.
Jeff: You put a new appliance into a rental that’s going to be 5-year property. You’re going to do that bonus depreciation and write it all off that year.
Toby: Yeah, 168 lets us write anything less than 20 years, we can write-off in one year if we want.
Jeff: Put in a pool, it’s a 15-year property.
Toby: You can write it all off in one year, right? You’d have to do the cost segregation, right?
Jeff: I think something like that that was so determinant that you were installing a pool, it could probably stand on its own.
Toby: You can probably do that. But if you’re buying a property, you’re going to have a little.
Jeff: You’re buying a property with a pool, you’re going to need to segregate all those costs.
Toby: Somebody says, “I have three different businesses, two of them are now making money.” Congratulations. “How would I pay myself? Should I have them all report to my S-corp and pay myself for my taxes from there.” Great question. A lot of times, what I do is I have a single parent that runs the different companies.
If I have three different active businesses, I’ll have one main parent, that’s usually an S-corp, and then it will own either disregarded entities or what’s called a QSub—which is a qualified S subsidiary. The reason that I do that is so I only have one tax return so that if two are making money and one’s losing, they offset each other. It’s treated as one activity.
“Do you recommend a resource on cost segregation company?” Yeah, Erik Oliver at Cost Segregation Authority is really good. We have some others too.
Jeff: We do a lot with Erik.
Toby: Yeah. Somebody says, “What about flooring?” Flooring will generally be, what? Five-year property?
Jeff: Yeah. That’s a good point, if it’s carpet or interior paint, that’s always deductible in the year of replacement.
Toby: Yup. “Can you use bonus depreciation for it?” Yeah.
Somebody says, “Sorry if you’d […]. I’m just saying that GP is in private placements, neglect to mention UDFI, so that then gets folks to invest?” Yes. You’re right, Charles.
Jeff: They notify you on your K-1.
Toby: We’re very much aware, let’s say that. Somebody says, “What if you have to realign your sewer to a rental, how would you handle that?” Partial cost in backyard would be about $6000, and front of city line would be about $8000. What would you do on that?
Jeff: I would probably treat it as an improvement, but I’d also probably treat it as 15-year property.
Toby: When you have sewer lines. I guess there are two types. There’s specialized plumbing and then there’s ordinary plumbing. Ordinary plumbing might be part of the foundational issue. Just sitting here, I wouldn’t know.
Jeff: I think once it gets inside their house it becomes structural and then it’s the 27.5-year property.
Toby: It sounds like on those, you might be able to accelerate it into one year if you want to take the big one.
“Does $2500 maintenance per year per repair?” Per repair, per items. You can’t have three roof repairs for $2500 each. You could have a roof repair for $2500, siding repair for $2500, sidewalk repair.
“What is bonus depreciation in the context of real estate bonus?” Bonus depreciation is 168(k), 26 USC 168(k). All it’s saying is anything that’s less than 20-year property, you could elect to treat it as one year, you can bonus it all into one year. It doesn’t have to be the year you put it into service.
In real estate, it means I look at a big structure. Jeff and I are in a studio here in a commercial building. This is a 39-year property. But the carpet underneath us, the tiles on the walls, the tiles in the ceiling, and the light fixtures are a combination of 5-, 7-, and 15-year property. What cost segregation is as you change your accounting treatment, so it’s 3115 that you follow with your 1040 or 1065, and you say, I’m going to treat this building as not just structural real estate, I’m going to break it down into something called 1250 and 1245 property. The 1245 property is personal property.
This carpet, we know this carpet is not going to make it 39 years, so we’re going to treat it as a five-year property, and then you can bonus that, boom. If this building here is probably about $15 million dollars, and the carpet in it might be worth $1 million. No, it’s not that. Maybe, gosh, $250,000 probably more along with the flooring. It just means that I could take a $250,000 deduction in year one.
Jeff: I did cost segregation a number of years ago for a structure that was a freezer warehouse for a food manufacturer. The cost was so much and we ended up segregating so much of the cost into the freezer capabilities that very little of the cost was left in the warehouse.
Toby: Do you know where we see that? We had a guy buy a mobile home park that had all the fixtures. I remember that because it was Erik at Cost Segregation and they thought it would be like $130,000 is what they were looking at it. When they actually went out, and the engineers went out, it was $1 million-plus on the personal property versus about $200,000 on the land. They got a massive, massive deduction. I’m sure I’m a little bit off on those numbers, but it’s pretty darn close. It’s pretty freakish.
All right. Everybody wants to know about Bitcoin. Okay, one quick question. “What is 15-year property, 20-year?” All property has a life span according to the IRS and they put it on a schedule. A car is a five-year property, an airplane is a seven-year property, carpet is five-year, appliances are, what are they? I don’t know.
Jeff: Five-year for a rental.
Toby: Five-year for a rental, cabinets are seven-year property, HVAC, God knows. What it just means is that I paid $1 for it and it’s five-year property, it means I write up $0.20 a year, unless there’s some other rule.
Somebody says, “I thought you could expense repairs up to $5000? Is it only $2500?” There are two safe harbors. You’re referring to a different safe harbor. I think Piao’s already answering, so I’ll let him do it. The easiest one for me to remember is $2500. There’s another one.
Jeff: There’s another one that I want to say is 10% of the property value up to $10,000.
Toby: Yeah. There are some funky ones.
Jeff: They might be confusing it with the old—before it was $2500, it used to be only $500.
Toby: $500, isn’t that fun?
Jeff: We’ll just keep guessing what you’re thinking.
Toby: All right. “If you mine Bitcoin, how is it taxed? Is it taxed at the coin of Bitcoin minus electricity then turned into U.S. dollars?” Do you want to do this one?
Jeff: Yeah, I’ll do this one. When you mine Bitcoin or any other currency that does mining or staking for some of the other coins. When you create a coin, whatever it is worth in the time you create it, that is your income in that coin. Right now, Bitcoin I think is trading about $56,000. If you did the work to create the Bitcoin, you’d have an income of $56,000.
Toby: Is that active income?
Jeff: That is ordinary income, that is not capital gain income.
Toby: That’s going to be taxed as?
Jeff: At your ordinary rates. If you’re in the top bracket, it’s going to be 37%.
Toby: It’s subject to self-employment tax?
Jeff: It is subject to self-employment tax.
Toby: All right. We haven’t sold it yet.
Jeff: No.
Toby: Let’s say that we create it, you created it at X dollars, and then you sell it a year later for X plus Y. Let’s just say this is $56,00 and we sell it for $100,000, that means that Y is $44,000? That would be taxed as how?
Jeff: Capital gains.
Toby: This would be long-term capital gains. Long-term capital gains mean it’s taxed at either 0%, 15%, or 20%, unless Biden at all changes that.
Jeff: In the second part of the question about deductions, yes, you can deduct your cost of goods sold or any other business expenses. We know electricity is a huge expense. I’ve heard that the electrical cost of virtual currency is greater than the electrical costs in some developed countries.
Toby: That’s the big problem. Creation minus expenses equal your total tax. The problem that we always have with miners is their mining coins all the time. Just to give you an idea, there are 5 billion Dogecoins mined every year. I don’t know the total number of Bitcoin right now.
Jeff: I know they’ve got a market cap in the trillions.
Toby: There’s going to be a total of 21 million Bitcoins total once it’s done in about another 100 years. What they do is they have a difficulty equation, so there’s less and less being mined every day. Every 10 minutes is like 6.25. I’d have to figure out what that adds up to.
Jeff: I think I saw the cost of electricity was about $5000–$10,000 per coin.
Toby: It’s kind of like oil and that is sometimes it’s not worth it. A lot of the mining operations are saying, hey, it’s getting too difficult. Okay, that’s good. That means that there’s more scarcity. Until it goes up in value, if Bitcoin was worth $560,000 a coin, they’d probably be doing it. Eventually, that difficulty equation is going to make it worth it.
The creation on a daily basis, and in some of these cases you have these little machines and they’re mining 20 or 30 coins a day of a different type of currency. From the accounting standpoint, I’m just telling you, it’s a pain in the katush because you have to figure out what those coins’ value was. Generally, would you use the close of business?
Jeff: You will probably do midday or something like that.
Toby: Isn’t that crazy? Just think about this. You make a coin and you’re going to have to go look and say, oh, what’s this one at?
Jeff: We hear people talk about investing in virtual currency or mine crypto, but they don’t talk about the ones that are using it for business expenses and stuff like that.
Toby: Well, this is a good thing. When I put sell, that equals sell or exchange. Which means I use Bitcoin to buy a Tesla because you can buy Tesla with Bitcoin now. Let’s say I take one of my coins and it’s worth $60,000, I mined it at $10,000. I have $10,000 of basis, it’s now worth $60,000, and I buy a Tesla with it.
What I really did is I sold my Bitcoin at $60,000. I would have capital gains for that difference between what I minded at and what I exchanged it at, and I would owe tax on that $50,000 of gain. Which would be either short-term or long-term depending on how long I held it.
Jeff: Going back to what you’re saying, though, I think one of the biggest difficulties we see with miners and even traders of crypto is really bad record keeping.
Toby: It’s really difficult. A lot of these guys are kind of off the beaten path anyway. They’re like, hey, how is anybody going to know? Until they start digging, nobody does.
Somebody says, “Why are you taxed on creation? Isn’t that your investment” Well, kind of. Think of it this way, if you bought a share of Microsoft for $100, you had to generate the $100. When you mine, let’s say you mined a share of Microsoft, they’re going to say, you mined $100. It’s not an investment because you never got taxed. On an investment I paid tax on the monies that I used, it was after-tax money is an investment.
Somebody asked whether you could do this in an IRA? You can own Bitcoin in IRA for the most part. But you can’t mine it because mining is an activity, which would be unrelated, they’re UBIT—Unrelated Business Taxable Income.
Jeff: I will agree that the way they’re taxing the creation, is a bit unusual. But crypto’s probably the most tested issue by the IRS. Actually, there is now, as of 2020, a question on the 1040 of, are you investing in crypto?
Toby: They have an information-sharing agreement with Coinbase, it just went public two weeks ago. That’s a public wallet. If you really want to get into crypto, join us at one of the Infinities. We’ll do a deep dive for you.
But in a real nutshell, you have public wallets and you have private. Public is where somebody else is holding your Bitcoin for you, it’s really not in your possession, that’s a Coinbase. Then you have the private wallet, like […] and some of these others where you could actually download it, you carry it around with you, and it has either a phrase code, has a password on it, or both. So that if you lose the device, you can still recover it. But if somebody has your device, they don’t own their coins, they’d have to be able to get into it.
Jeff: How much is the deductible if somebody steals your virtual currency?
Toby: You’d have a loss, a zero.
Jeff: A zero. If somebody steals your wallet and takes your coins, you’re out of luck.
Toby: What if you mine it and then it disappeared?
Jeff: I don’t know.
Toby: Don’t you have a business loss at that point?
Jeff: I could see you’re having a business loss at that point.
Toby: It seems like it would be a capital loss. I don’t know. It’s a brave-new-world out there.
Jeff: I have a Coinbase account, and I’m kind of finding it’s more akin to gambling than investing.
Toby: It’s not stock, and it’s not paying you anything. It is pure unadulterated hedging against the dollar because you’re ticked off at dollars. Mark Cuban and Elon Musk said, hey, we’re going to take Dogecoin. SpaceX is paying for the entire exhibition to the moon in Dogecoin. I think that’s pretty funny. They’re basically saying, hey, central banks, read between the lines.
All right. “Can an employer contribute to a profit-sharing retirement plan if there’s no profit for the year?”
Jeff: We’ve been looking forward to this one. We call them profit-sharing plans but there they go by other names too. It really has nothing to do with your profit. It’s just helpful if you have profits so you can pay these contributions.
Toby: You can create a loss with it.
Jeff: Yes, you can certainly create a loss, we have that happen.
Toby: It sounds like you have to have profit because you’re sharing the profit. But like I said, having money and taxable income, two very different things. I could have lots of taxable income and no cash. I could have lots of cash and no taxable income. In most businesses, we can make the numbers dance a little bit.
Jeff: The only requirement here is that your employee or employees have compensation that you can base that profit-sharing on.
Toby: We have so many questions coming up. Here’s one. “I am confused between bonus depreciation versus cost segregation versus the $2500 write-off. If I have a rental and want to cost segregate the appliance, can I write it off in the entire year in year one?” If it’s an appliance, can they just write it off?
Jeff: No, you can write it off under bonus depreciation. Bonus depreciation is a tool that is used along with cost segregation. If we didn’t have bonus depreciation, cost segregation might mean a whole lot. It might mean shorter depreciation lines, but not the big write-off that we’re typically seeing.
Toby: I guess the easiest way to look at it is the $2500 is pure repair, that has nothing to do with personal property. It has to do with, did I improve a piece of real estate structure? That’s always the 27.5 in 39-year. When you get into personal property, bonus depreciation is just a fancy way of saying, I don’t want to write it off on the normal schedule of 5, 7, or 15 years, I want to write it off right now.
“Can you effectuate a sale of property with Bitcoin? How does this affect taxes?” Yeah, you absolutely can. More and more like Bezos are now going to start allowing you to settle up with Bitcoin. There are NFL athletes being paid in Bitcoin or a portion of their salary is being paid in Bitcoin.
But remember, when I receive something of value, let’s say this remote here is worth $10. Jeff says, I will do services for you for this remote, $10 is taxable to Jeff because that’s what that value is. If this value is $100 and we just say I want the remote, $100 is taxable. How do we know what the value of this is? They have exchanges where they say what the value is on a daily basis. I could say, hey, I will do work for one Bitcoin and I work my tush off and the Bitcoin is worth $6. I have a taxable event of $6. If it’s $60,000, I have a taxable event of $60,000. Same thing with mining.
Somebody says, “How can you determine your basis if the untraceable date of mining assuming you put it in a private wallet?” It’s really tough for them to find out. It’s the same thing as if I took cash for services, how does the IRS? No, they don’t. It’s a crime. That’s all.
Jeff: The consequences are dire if they catch you.
Toby: Yes, they’re going to prosecute you. They’ll make a case at you.
Jeff: The special agents that carry guns will show up at your home.
Toby: Stop that, you’re just scaring everybody.
“What is the depreciation of solar panels?”
Jeff: Five-year property, right?
Toby: Yeah. Solar panels are weird in that you get a tax credit if you install solar panels on a property. If it’s a rental property, for example, you’re not the user, you get a 26% tax credit, and then you reduce the depreciable basis by 1/2 of the tax credit.
If I put a $10,000 solar array on a rental, I’d get a $2600 tax credit, not a deduction. I’d get a tax credit to apply dollar for dollar. Then I would take half of that $1300 and subtract it off to $10,000, and I would get a deduction for $8,700. I could choose to depreciate it in one year and take the whole $8,700, or I could stretch it out over five years. If you are putting a solar array on your personal home, different rules. It’s just a tax credit, you get a 26% tax credit.
Look, you can go onto social media and follow us. We got all these people going to the moon. The Doge people are out there. The little Shiba Inus. I like cats, but Shiba Inus are essentially dogs that act like cats, I think.
Jeff: I must have one of those.
Toby: You have a dog that acts like a cat? Does it meow?
Jeff: No, it just whines a lot.
Toby: Cats don’t whine. I have a fuzzy cat, they just look at you with big eyes. They don’t even meow. It’s kind of disconcerting. You wake up in the middle of the night and just got eyes. They’re waiting for you to die so they can eat your eyeballs or something like that. Morbid thoughts. Is it breathing?
If my business and house are in my revocable living trust when I die, what kind of tax will my kids, the beneficiaries, have to pay on getting the business or the house?”
Jeff: Let me take a page out of your book and explain how a revocable living trust works. When you have a revocable living trust, you can always change that until the day you die. You put assets in it and you can change those assets, you can take it back out whenever. But once you die, whatever the living trust says happens next, and usually, it’s going to go into an irrevocable trust. That might be the pourover trust with the spousal side.
Toby: There’s a portion of the assets that could end up in an irrevocable trust when somebody dies. Assume that both parents passed and it’s going to the kids.
Jeff: I’ve died and I have all these assets in my revocable trust, now I have an irrevocable trust. Everything gets dumped into there on the step-up basis, correct?
Toby: When somebody passes, you’re going to have a step-up in basis, it’s going to go to the trust. Taxable to the beneficiaries or taxable to trust if it doesn’t distribute the asset.
Jeff: The beneficiaries are never going to pay tax on inheritance, gifts, or anything like that. At worst, if you currently have $111.5 million worth of assets, your estate may pay tax.
Toby: There’s I think four or five states with an inheritance tax. They usually exclude biological children and spouses. Basically, there are three types of taxes that the individuals who receive could be looking at. They could be looking at inheritance tax, they could be looking at an estate tax, like in Oregon, there’s only a $1 million exclusion. On the federal side, there’s an $11.8 million exclusion, and then there’s the federal. We focus a lot on the federal because it’s the big hammer, it’s 40%.
As long as you’re below that people are like, oh, phew, but you could still get hit with 11% tax out of estate. You could still get hit with an inheritance tax. There are not too many states with an inheritance tax anymore because that’s kind of evil. I could see them coming back if they don’t mess with the estate tax exclusion. Right now, the proposal is to lower that estate tax exclusion at some point. I don’t think it’s in the American Families Act, but I believe that they’re looking at lowering it to $5 million or thereabouts so that we could get hit. But Jeff is absolutely right that the basis of the company, so there’s no gain.
Let’s say that I have a house, so they have a house. Let’s say it’s worth $5 million and Mom and Dad paid half a million dollars for it 30 years ago—it’s in the Bay Area. The type of things you have to worry about is number one, capital gains on that step up. They’re trying to limit it to $1 million dollars to step up, I believe, is what they’re trying to do. They’re trying to say, hey, if you have that scenario, half a million dollar basis, $5 million, you would only have $1.5 million of excludable basis from the tax. You’d end up with $3.5 million of taxable gain if you sold it.
You also have this state, in California for example, if they choose, well, even if they choose to live in it, I think they only have a million-dollar exclusion, you’d have the increase in the real estate taxes, you’d have the federal tax. You look at the entire estate and say, how much was transferred if it’s below 11 million per spouse? If it’s less than 22 million, you’re not going to have to worry about that. California mirrors the federal from a state estate tax so you don’t have to worry about that. There’s no inheritance tax. You’re kind of looking at those things as a checklist.
You move that same situation into another state. Let’s say it’s Washington. Washington is right around $2 million, state estate tax exclusion. Same scenario, 5 million dollars goes to kids, you’re still going to get hit with the real estate tax, you always have. Mom and Dad had increases too. The same situation where you’d have the capital gain exclusion. Right now, it’s unlimited. If the American Families that came in you’d have a million-dollar limitation. You have a state estate tax exclusion of around 2.1–2.2 million, I believe, although they may change that. I believe that there’s a possibility they’re going to mirror the federal. There’d be the state estate tax.
Then we got the federal again that we look at. Washington has no inheritance tax. Every little bit is different. We take that same scenario and put it in New Jersey, and you’re screwed. Just kidding. Again, you have different rules in every jurisdiction. I wish they were universal, so you’d know.
Somebody says, “Once it’s converted into a revocable or irrevocable trust, you have to file a 1041?”
Jeff: Good question. As long as the assets are in the trust that trust will have to pay, file 1041, file tax return, and pay taxes on any income that they’re not distributing directly to the beneficiaries. Once you’ve disbursed those assets to the beneficiary, then the trust shuts down and so forth. Now one thing with a trust, you may want to keep assets in there because you may have young beneficiaries or things of that nature. The trust tax brackets are very high.
Toby: You want to distribute the assets.
Jeff: Yes.
Toby: Somebody says, “I was told trust pays 35% tax. Could you explain that?” It’s actually 37%?
Jeff: Yes, it’s 37%.
Toby: After $11,000.
Jeff: No, it’s like $12,000 or some. They max out the bracket really quickly.
Toby: They have a standard deduction, a small amount.
Jeff: Hundred dollars.
Toby: Yes, it’s really low. Somebody says, “If the husband dies, does the wife have to file an estate tax form for him?” Husband dies, you have to do an estate tax
Jeff: If their estate has less than half a million dollars, you do not have to file it. A reason you may want to is to get them what they call portability. That is, if I have an estate of $6.5 million, my wife may want to file an estate tax return. Because that 5 million that I didn’t use, she can now use.
Toby: There’s actually a question that says, “My husband passed away,” sorry to hear that by the way, “and our properties were deeded 1/2 to his trust and 1/2 to my trust. Can his 1/2 be signed off to go into my trust?” Once somebody passes, their trust becomes irrevocable and you have to follow that trust. If there’s a mistake that was made in the beneficiaries, don’t object. You could potentially decant it into a new trust, to rewrite it. For the most part, usually, if it’s a husband or spouse, husband or wife, the spouse, the decedent we call, their trust is now for the benefit of the surviving spouse during that surviving spouse lifetime. They have the right to access the trust assuming that they don’t have enough in theirs.
The reason that we do this is let’s say that I’m married and I have three kids and my spouse has three kids, we get together and we have six kids together. Three from each marriage. I pass away. I don’t want my spouse to rewrite that and disinherit my three kids. On the same token, I don’t want my surviving spouse to use up mine to disinherit my three kids, and then leave hers to her three kids. To put it another way, let’s say that we had three kids together and I wanted my estate to go to my spouse and then to my kids, and my spouse gets remarried to a new person who has 16 kids, whatever. Let’s just make it one child? The golden child. They get remarried and that spouse starts saying, hey, the same scenario. Now, surviving spouse passes, the new spouse would be the beneficiary, and if they could change it they could just leave everything to their one child, and we disinherit our kids.
When there are two trusts, the whole idea that one becomes irrevocable and you have to follow it, and that’s so you don’t have shenanigans. If you don’t think they’re shenanigans, what was the girl that married the 90-year-old, The Playmate, Anna Nicole Smith. Just go Google Anna Nicole Smith, she married a guy at 90 years old when she was 28 as a playboy model.
Jeff: One more question about taxes. Let’s say my assets are $5 million. I die and my assets go to my kids. Are there going to be transfer taxes involved?
Toby: You die and the asset goes to your children. It depends on your county.
Jeff: On the jurisdiction.
Toby: Generally speaking, I would say there might be a small transfer tax with the new beneficiary, but I mean it just really depends county to county. I would believe so unless you have the property, let’s say it’s an LLC or something and then nobody’s going to know. If you have a greater than 50 percent change, there may be a requirement that you’re supposed to, but most people don’t notify the county.
All right, jump onto another because I know we’re a little bit over. “Has the IRS relaxed the 750-hour requirement for real estate professional status in 2020, in light of the difficulties of the COVID pandemic?”
Jeff: No. There’s been no change to these rules since I think it was created in ‘87.
Toby: Yeah. Just remember that the 750 hours, this rule comes out of 26 U.S. Code § 469 (c)(7), which is half of my time. 750 hours have to be on real estate activities, which can be construction development, the sale. Not just on mine, anything I do it’s where the majority of my personal services come from.
If COVID has affected you, you may actually qualify now for the 750 hours in greater than 1/2 because you’re spending more time looking at real estate and I’m not spending as much time at work. Because maybe I wasn’t working. I can be a real estate professional now, whereas ordinarily if I was working too much, I couldn’t.
Jeff: This would be very hard to justify because real estate is booming. People are going crazy in real estate, buying investment properties, and so forth. I don’t think there would be a good argument for this.
Toby: Yeah, for lowering it? All it does is it takes passive losses and makes them active or ordinary, to be more precise. “Buck, buck, go to Amazon. Infinity Investing came out on April 13th. It’s doing pretty well. Number one relation financial services, that does not mean that it’s selling millions of copies. It’s selling thousands and we’re on a second printing, which is good.
How The Rich Get Richer And How You Can Do The Same. We published this, it’s doing fantastic. If you feel like getting it, I would encourage you to do so and share it with somebody. It’s a lot of fun and it will help them not do bad things in the markets and actually be pretty reasonable about generating wealth. We just steal all of our really successful clients’ ideas and put them into a book form. So we say, hey, who’s making money? How do they do it? And they keep doing the same things over and over again, pop in there, get it on Amazon. If you do, please make sure that you leave a review even if you don’t like it. Well, okay, if you don’t like it, you don’t have to leave a review, but if you like it a lot, then you really have to leave. Just teasing.
Let’s see. There are a few questions rolling around out there. Somebody says, they want you to answer the washer-dryer question again. What’s the washer-dryer? “Can you write it off even if you don’t do a cost seg?” Yeah, if you buy it.
Jeff: You’re either going to write it off on another $2500 rule or you are going to write it off as bonus depreciation.
Toby: Matt says, “Is a real estate professional tax different from an active participant versus just filing as a passive investor?” Yes. Here’s how it works. If I have passive losses from real estate activity or businesses in which I do not materially participate. I’m a silent partner in a business, but I have bases and it kicks me losses. I can only use passive losses to offset passive income with two exceptions. If I am an active participant in real estate, I can write off up to $25,000 against my ordinary income or capital gains.
Here’s the big one. That phases out at $100,000–$150,000. You start to lose; for every $2, you lose $1. Otherwise, I need to be a real estate professional. And as a real estate professional, I don’t really want to dive into that when I’ve done it a million times on this show. I would encourage you to go to our YouTube and check out real estate professional status or come to our events.
But in a nutshell, at least one spouse is primary. Personal activity is real estate in construction, in development, and being a real estate agent, or being involved in the sale. The spousal group with all of your real estate is materially participating. There are about seven different tests that you could qualify under there. You meet those in your passive losses become ordinary. If one spouse runs a construction company as a realtor, fill in the blank, then your passive losses could end up being used to offset your W-2 income or your other income. It gets really, really important in how you prove your 750 hours.
Somebody says, “You just document it.” I use a phone. I’m not a real estate professional because I spend much more time doing tax and lawyer. But if I was running construction or something like that, I would just keep my schedule, and if the IRS gripes you say, here’s my schedule. Here are all my days. Here’s what I spent. It has to be 750 hours and more than 50% of your personal services. It has to be more than anything else you’re doing. If you have a part-time job and you’re doing 1000 hours as a chef, you have to do 1001 hours real estate and then you could qualify first prong. The second prong is materially participating in your real estate.
“I understand that I will owe income taxes on the amount of withdrawal from my traditional IRA. Can I use passive activity losses from rental real estate investments to offset this IRA withdrawal income to avoid income taxes?
Jeff: What a timely question.
Toby: Because we just answered this.
Jeff: We just answered this. IRA income is ordinary income. It is not passive. You cannot use your powells for passive activity losses to offset your traditional IRA income.
Toby: Repeat that.
Jeff: You cannot use your passive activity losses to offset your traditional IRA income.
Toby: Unless?
Jeff: Unless you made the $25,000 exception?
Toby: Or?
Jeff: Or you’re a real estate professional.
Toby: Yes. Isn’t that fun? We just answered this one. I’m not going to spend too much time on it. I’m reading all the questions. I get distracted. I see all these good questions. Let’s see, we’re getting close. Actually, we have two more. I’m thinking, we’re a little bit over.
Jeff: This might be the last one.
Toby: No, there’s one, there’s one. “Can I buy an investment property before selling a property in a 1031 Exchange?”
Jeff: Yes, you can. It’s called a Reverse 1031.
Toby: Big red lights. You cannot buy the new property yourself, you have to use a qualified intermediary to acquire it.
Jeff: Actually, there’s another person have to use, exchange something titleholder. I guess it could be the QI.
Toby: It’s the QI, but they’re taking the title in the name of the exchange in there on your behalf. And then you do the exchange when you sell the other property. As long as you don’t touch the money or the title, you’re good. Here’s the hint, make sure that you’re going to a 1031 Exchange facilitator to do it, but yes, you can. You could actually build a house. I believe you have 180 days. If I acquire a property, then I could sell mine, I have 180 days to get it done. There are ways to do it where I’m actually not just acquiring, but I’m doing construction and building it and then I’m doing it.
Jeff: In the reverse exchange, you just have to sell the other property within 180 days of your purchase, and that should take all of 45 minutes to sell that property.
Toby: Very good. For a W-2 employee, what do you recommend is the best way to save on taxes when stock market trading? What do you think, Jeff?
Jeff: The rules would kind of reapply no matter what you’re talking about, what kind of income you’re looking at. The best way to save on taxes when stock market trading, want to hold long-term in your trading, you’re going to have lower tax rates by holding long-term. If you have a lot of gains, you should consider harvesting losses to offset your gains.
Toby: Just in a regular world where you have these things and somehow you have a stock account or you’re an employee, you invest a little and maybe you’re going to have some capital gains. Just remember that long-term capital gains can be taxed at 0%, especially if you’re married filing jointly. If you make less than $80,000, your long-term capital gain rate is 0%. So what Jeff said about the holding period is pay attention to it, don’t just sell something at the end of the year and say, oh, I think I need to get rid of it. You may want to look at that and say, wait, if I wait a few weeks, I might not have to pay tax on this. Because if you sell it as short-term, it’s just added into your ordinary tax bracket.
You’re going to be paying in that case, 24% plus your state. If you have expenses then the big thing I would say is to make sure you’re not trading in your individual name. I would make sure that you are trading through a structure. Usually a partnership with a corporation in that partnership acting as a manager or a general partner. The reason that you’re doing that is so you can actually use the corporation as a mechanism to allow you to take some expenses.
If you are lower income than I would suggest that you do like a Roth IRA and you’ll never pay tax ever again on any of the gains in your stock market. You put the money in there as after-tax dollars and a really low tax bracket, and then hopefully you make $5 million. The guys that did PayPal, not Elon, but the other folks, one of them had done that through a self-directed IRA, and they had about $6 million made through the retirement plan, or some very large dollar amount. Which yes, was shielded from tax. Not a bad deal. Those are just a few ideas. I think we could sit around all day long and conjure more up, but it’s kind of fun.
Somebody else said, “Hey, what if you’re 49% owner and a partnership that sells 2 properties and the 51% owner doesn’t want a 1031 exchange. Can you do that separately?” The answer is it’s really hard because when you do a 1031 exchange or have to go from entity name to the entity name. If somebody wants out, the best thing you do is what’s called a swap and drp where you agree to be purchased and bought out after the 1031 exchange, and that’s how you do it.
And then after you 1031 exchange it, then you buy them out of the proceeds and you keep your 1031 exchange good with that entity, but then you buy them out of their interest. You’re going to have to probably refi the properties after. Somebody says, “I have two rental properties, A and B. A is suspended, passive losses carryover from 2019. In 2020 both A and B have profits. Can these profits offset A’s passive losses?” Yeah, it doesn’t matter where the passive income comes from, your passive losses can offset it. If you’re a silent owner in a pizza shop that makes money and you’re losing money in real estate, the real estate can offset the pizza shop.
People never get that one right because if you are a silent owner, you’re not materially participating, you’re just sitting back. I said, hey Jeff, you want to go to a pizza shop? Here’s some money. I don’t want to be involved. That’s perfect. And assuming Jeff lights up the world and sells lots, lots of pizza, then that’s a great mechanism for me to use up my passive losses.
A lot of investments are driven by that, guys. You often see somebody who says, I’m willing to participate but I don’t want to be involved but they’re saying is, I have passive losses that I need to use.
Hey, if you like this sort of stuff, you want to go listen to some of the previous Tax Tuesdays or some of our most popular events. It’s kind of interesting. People like to listen to this. I always think that they’re looking for mind food to see if they can save a few dollars or they just like listening to other people’s scenarios. By all means, go to andersonadvisors.com/podcast. The link is right there. You’ll see there’s a lot of different podcasts. We have all sorts of folks on. It’s always fun to have conversations with these people. Replays of the Tax Tuesdays are always in your platinum portal as well.
If you have questions, especially if you had a question that was not answered tonight that was maybe a longer question, by all means, send them on in to taxtuesday@andersonadvisors.com. We don’t charge for this. Never want to charge for this. This is more fun having conversations with you all. We always have 400, 500 people on. Sometimes 1000 just depending on what’s going on in the world. And then we have lots of thousands of people that download and listen to it. It’s just always fun to have these conversations and you guys always ask great questions. Christos, Pio, and company all do really great, Dana, I shouldn’t be mean, and Elliot, they all do a great job. And Patti answers questions. They’re always doing a whole bunch of stuff.
“Did I miss the application for borrowing against your crypto?” Email us and we’ll get you the folks that we’ve had people actually use. I never like talking about stuff that we don’t have experience with. I could just go look it up and say, here are people that say they do it. I’d much rather hear from my clients who said I’ve had a good experience and we have people that have borrowed. Let us get you that information so that you have a better chance at having success as opposed to somebody who says they could do some things.
Sweet, that’s it. Do you have anything else?
Jeff: I got nothing else.
Toby: I got nothing. We’ll stay on and answer the questions. These guys answered 187 questions in writing. There are about six that are still open. If you have a question, now is the time to ask it quickly and see if we can get you an answer, and these guys will help you. I hope you guys are all doing great. Stay safe and hopefully, you guys will have a prosperous next couple of weeks and we’ll see you at the next Tax Tuesday. Thanks, guys.
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