Besides guidance from the Internal Revenue Service (IRS) regarding U.S. President Donald Trump’s executive order to allow deferral of the employee portion of Social Security payroll tax, Toby Mathis and Jeff Webb of Anderson Advisors provide further clarification. Do you have a tax question? Submit it to taxtuesday@andersonadvisors.
Highlights/Topics:
- If I sell a piece of land and keep the primary house, what is the 1031 valued at? Is it a $0 or 150k purchase price in 2012? Get each parcel of land appraised to identify value for the basis
- Can I write off an RV, if I use it for business travel? It is possible to write off the RV by using it 100% for business, not personal use as a second home
- How does a trust work in relationship to LLC in real estate? Provides anonymity for beneficiary and LLC
- Can you take depreciation on a rental condo? What do you use for the basis? Yes, you can take depreciation on a rental condo, if you own the condo, not as a renter
- Is there an option to give employees a bonus without being charged a luxury tax? You can give employees bonuses, but bonuses are subject to regular payroll taxes
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Resources:
The Tax Toolbox (only $495; regularly $1,500)
Memorandum on Deferring Payroll Tax Obligations in Light of the Ongoing COVID-19 Disaster
Internal Revenue Service (IRS)
Real Estate Professional Requirements
Small Business Administration (SBA)
Healthcare Reform (Affordable Care Act)
Individual Retirement Arrangements (IRAs)
Capital Gains Exclusion/Section 121
Hobby Loss/Safe Harbor Provision
California Assembly Bill 5 (AB5)
Unrelated Business Income Tax (UBIT)
Unrelated Debt-Financed Income (UDFI)
Anderson Advisors Tax and Asset Protection Event
Full Episode Transcript:
Toby: Hey, guys. You’re listening to Tax Tuesdays. This is Toby Mathis, with…
Jeff: Jeff Webb.
Toby: Hey, Jeff, who’s been running this thing for the last couple of whatever weeks. I remember the last Tax Tuesday I did; it seems years ago. Anyway, we have a lot to go over today. I understand you guys actually ended on time while I was gone.
Jeff: We did, but we didn’t answer a lot of the side questions.
Toby: You didn’t?
Jeff: No.
Toby: You let everybody else do it.
Jeff: Yup.
Toby: By the way, we do have others answering questions, so that’s half the fun here is we have Eliot, […], Patty answering questions in the background. As always, jump onto our social media; we’re always putting stuff out. We have a feeling it’s going to be an eventful fall.
Jeff: Absolutely.
Toby: There are going to be lots of action from the Treasury. You can ask your questions by all means. There are some from New York. Tell me where you guys are at right now. I would love to see that. I sometimes do that on the regular podcast, it’s going to fill up our Q&A real quick but just tell me where you guys are from all over.
Jeff: I want to do a poll sometime with that.
Toby: And see where everybody is. We’ve got […], Dallas, Kansas, Florida, Milwaukee, Wisconsin—you guys got some stuff going on—Texas, Pennsylvania—my hometown, grew up […]—San Francisco, California, Westminster, NAPA, Houston. Oh my goodness, Sacramento, Ocean City, Maryland, Anchorage, Alaska—just to give you guys an idea of how many people—Houston, Port Washington, Seattle, Round Rock—that’s great. Let’s see, Arkansas and a bunch of stuff in here. I’ll go through and answer a bunch of your questions. Louisiana, Gilbert, Lancaster, Denver. You guys are all over the place. Jiminy Christmas.
All right. It seems like we got representatives from all over the country. I hope you guys are doing well staying safe, getting through these lockouts. Hopefully, we get through it. I’m not going to give you guys too much. Woodlands, there we go. […] Village. Gosh, we got people literally from all over. Orlando, Michigan, […], Washington. Notice I said that right, Jeff?
Jeff: I saw that.
Toby: They all come down from Gig Harbor up there in Clint’s hometown, hanging out at Pompano beach, which is […], Fort Collins, fantastic. All right, let’s jump in. We’ll get to everybody. I love going through that stuff. Let’s go to the opening questions.
“I live in Maryland and I’m going to buy a vacation home, Airbnb in Florida. Do I need an LLC in Florida or in Maryland?”
“My company is an S Corp since 2015, but all business income has been paid to the owner’s name and not the business name. What can I do?”
“If I sell a piece of land and keep the primary house, what is the 1031 value add, $0 or $150,000 purchase price in 2012?”
“Can I write off an RV if I use it for business travel? If so, what are the consequences? What are the requirements?”
We’re going to answer all of these.
“What is the right way to move money in and out of an LLC? Do I move personal funds to the business account and then pay the expenses?”
“How does a trust work in relation to an LLC in real estate?”
“How do I add my LLC, my living trust, and other tax consequences?”
“Can you take depreciation on a rental condo? What do you use for the basis?” Fantastic questions.
“What are the main differences between an S Corp and a C Corp? What are the advantages of making my futures trading account an LLC?”
“Is family-owned in a partnership […] trust LLC better for small business?”
“Is it better to invest in oil and gas as an individual or your LLC?”
So just you guys know, I grabbed these off of the chats. Usually, we spot check them for spelling and things like that, but I try to keep your guys’ language for the most part.
“Is there an option to give employees a bonus without being charged a luxury tax?”
“I have an LLC for my real estate business. How should I be paying myself through the business if I plan on filing as an S Corp?”
First off, great questions. That is really good stuff. What we’re going to do is we’re going to jump into some of the Q&A. One of the first things was something that we were just talking about.
By the way, we have our folks there answering your questions but I’m still going to jump into this. There was the president’s executive order. I’m going to go all the way down. We already had about 200 questions and comments come in. I’m scrolling and scrolling and scrolling. “Any guidance on the executive order for payroll taxes?” What that is, Jeff, I’ll let you go do that.
Jeff: As everybody (I’m sure) has heard, there was an executive order about a month ago, that the president was going to allow people to defer the employee portion of social security. On Friday, the IRS came out with guidance on this. It was a pretty miserable guidance. It didn’t say a whole lot that we didn’t already know. What we do know is that it is optional for the employer to allow that deferral. Again, it is a deferral. It’s not forgiven. It’s not a tax holiday like back during the Obama administration.
Toby: And you just hit on a big one. I just wrote it up there so you guys are seeing it. This is the one that’s throwing everybody off. They’re saying it’s a deferral and that you’re going to pay it in the first four months of 2021.
Jeff: Now, the executive order if you read it wasn’t really that long. Actually said that the Treasury Department should seek a means to forgive this debt, this deferral, which means that Congress has to act upon it because the executive office can’t mess with the purse strings.
Toby: Right. Now, you guys here say that sometimes Congress passes laws and the bureaucrats do their best to screw it up so you don’t get any benefit out of it. This is a case where the president sat down and said, hey I’m trying to give it a holiday, and then the treasury came out not for guidance. They screwed it all up. They put a cap on it and they let us know that we’re going to have to pay for the employee.
An employee of ours that defers were responsible for collecting that tax, and it’s just deferred. We’re supposed to be paying it in the first part of 2021. Here’s the problem. What if somebody leaves your employ at the end of the year? What if they quit in December? Is it the employer that’s responsible for those taxes? Are you supposed to go after the employee? Who’s responsible? The Treasury is not going after the employees. It’s going to go after the employer.
What if I hire somebody in January, who had a deferral from the previous three or four months in 2020? Am I responsible as the employer of that individual? Now, am I responsible for their withholding of taxes from a previous employer?
Jeff: From what I gathered from the guidance is that the employer who defaulted is going to be the employer responsible.
Toby: But they don’t specifically say. What I think happened is we’re operating really fast. Everybody’s kind of if they don’t like something they do their best to screw it up. If they give it to a committee and the committee spews something out, then we just have a lot of stuff being thrown out there. My guidance to anybody is when there’s uncertainty, stand still. Don’t change. We have a deferral, I don’t want it deferred.
I know what your employees are going to say. They’re going to say I want the extra 6.2%. That’s what it is. That old age, disability, survivor’s benefits, and Medicare. It adds up to 6.2%. They’re going to want that. They’re going to say, I’d rather have that. Then, you’re going to say as the employer, I don’t even know. It’s just deferred. You’re going to have to pay for it.
Jeff: Right. For an employee making (say) $50,000 are going to defer about just over $1000 over that four-month period from September through December.
Toby: If you’re over the $4000 bi-weekly, you’re out.
Jeff: Right, which comes about $104,000 I think. If Congress forgives this deferral, that’s all great and well. However, if they don’t, then come your first payroll in January, you start having to pay the $1000 or however much your deferral is. You have to pay it ratably, so they’re going to take it out of every paycheck through the end of April. That’s what we end up with.
Toby: And you’re paying your ordinary payroll tax.
Jeff: Correct.
Toby: So in theory, you’re going to make less in 2021 than you did in 2022.
Jeff: The people that it could help the most are those who are making low wages and all. It’s going to hurt the most if they have to pay it back because people in the lower income levels are going to need that money and use that money.
Toby: I’m just calling out Congress. Get your act together. Pick a direction. This is really annoying.
Jeff: Yeah. If anything’s going to happen, it’s probably not going to happen this October, which is unfortunate. And if it doesn’t happen in October, it probably won’t happen. Period.
Toby: Yeah. I think that there’s a lot of politics going on. […] stuck in between.
All right. I’m going to answer one more question that somebody asked that’s still on. “For a 35-year old W-2 employee,” I’m just going to call it a high net income earner, “what is the best vehicle for syndication?” It really depends on how much income you have coming in, what your tax appetite is, and if you don’t want to pay tax on it, by all means, use a self-directed IRA if you’re not really getting any of the tax benefits.
The problem is in syndication. Usually, you don’t pay much in tax on the income that is generating. Usually, you have enough loss inside the syndication. Usually, they’re cost seging or they’re doing something like that.
Jeff: Yeah. From what I’ve been seeing with those syndications, while the syndication is an operation, they’re typically losing money. But maybe five years down the road, they’re selling the property and—
Toby: Its capital gains, though.
Jeff: Correct.
Toby: This is what I would say capital gains you’re going to be 0%, 15%, or 20% depending on your tax bracket. If you are married, filing jointly, making about $600,000 yearly, for that, 20%?
Jeff: Yes.
Toby: If you’re married, filing jointly below $80,000 you’re looking at 0%. It sounds like you’re probably closer to 20% than 0%. I’d say probably meant the 15%. That’s not horrible. That’s not horrible if you hold it for more than a year. Me, personally, I look at real estate, and depending on what kind of syndication it is, I’m assuming it’s real estate but it could be anything. It could be a syndication to a business. If I’m looking at long-term capital gains, I’m not scared of it as an individual.
Jeff: And keep in mind that if you do invest in (say) real estate syndication and you’re high net worth (which I usually require you to be to join the syndications), you’re probably not going to be able to deduct any losses currently. They’re going to be suspended until probably the property sells. Then, you can recognize the losses at that time.
Toby: Yup. All right. Somebody said on the deferral issue on the payroll, “You’ll pay double for the first four months 2021.”
Jeff: Correct.
Toby: Yeah, in essence. So, you’re still going to pay it back.
Jeff: Now, one thing to keep in mind is this is only the employee share of Social Security. It’s not the employer’s portion and it’s not Medicare, so it’s set to 6.2%.
Toby: Yes. let’s jump into some of the actual questions. “I live in Maryland and am going to buy a vacation home, Airbnb in Florida. Do I need an LLC in Florida and in Maryland?”
Jeff: What do you recommend in this?
Toby: Home state is Maryland and you’re getting a vacation home. It looks like a vacation on an Airbnb system where it gets questionable. Depending on how many days you’re doing it as a vacation home, it might be a second home. It could be partially an investment, partially a second house, which tells me that I don’t want to screw it up. I’ll probably just put this one right here into an LLC. That would be Florida. I wouldn’t necessarily need a Maryland entity.
Now, what scares me is Airbnb. The reason is because Airbnb, if it’s seven days or less…
Jeff: Average stay, right?
Toby: Yeah, average stay, it’s a hotel, which means it’s active income, which means you have self-employment tax and other things to worry about. Now, we just converted something that was a passive entity, passive asset into an active asset.
Here’s what I would do. Again, this is up to your situation. I know you guys are going to make fun of me; somebody already did because I said it depends. It really does depend on how much activity you’re going to do. I’m just going to say I’m going to have an LLC in Florida. Here’s what it looks like. Let’s say that I have my real estate and I want it to remain passive. This would be an LLC in Florida.
Now, I do Airbnb. I’m going to rent this, it’s going to be a lease, it’s going to be probably one-year leases, and I’m going to set up either an LLC or a corp. It’s going to be taxed as a corp also in Florida, and this is going to be the Airbnb business. I’m going to have a long-term lease to keep whatever comes to me, and I’m going to make sure that’s passive.
Depending on how much other activity you have, this guy may actually be holding a Wyoming entity that comes to me. Those of you who have been through asset protection understand why. Florida is actually one of those ‘home of the homestead’ case, so it depends on how many people are going to be owners in that thing.
The Airbnb is equal to active. You only have to do this if your average daily rental is seven days or less. That’s simply because we don’t want to have active income hitting us. So, you have a few little issues moving around in here, but at the end of the day the reason this is important is because your real estate is equal to depreciation which should keep your income really, really low. It should basically eliminate any of the tax consequences from the Airbnb.
The Airbnb, we’re just trying to keep that active income off of you, but this could be a $2000 a month lease. The Airbnb is making (let’s say) $3000 a month (I’m just picking numbers out of my head), we can write off that extra $1000, $2000, $3000 pretty easy with just regular business expenses going back to the individual corroborating. Anything else you put on that?
Jeff: The only thing I was going to ask since Florida does tax corporations, is there any point where this becomes maybe not a great idea?
Toby: Because, whether you’re making money, I’m just zeroing it out. Somebody asked, “What if you had an S Corp?” Yeah, Trevor. The S Corp works, too. What we care about is that it’s not you.
Somebody says, “Can we rent the Airbnb to ourselves?” Well, what you’re really doing is you’re renting it to the corporation. I wouldn’t do it to you because if you’re seven days or less you are an active business. It gets a little loose.
Jeff: And that goes back to if you’re running to your S Corp or corporation, you’re renting it out 365 days a year.
Toby: Now, the other thing is if we eliminate all of that and all we are looking at is having a second house, then you get a second house. You can just treat that as a second home. You get to write-off individually what you are ordinarily entitled to anyway. So, Maryland, they’re probably going over the SALT deduction. I’m thinking they’re not going to get the real estate tax, and they’re not getting a lot of it. But you could still have a second house as a vacation house. I would still put it in an LLC.
Somebody says, “I bought my first property and have three rooms rented out. I’m wondering ballpark, how much I have to pay in taxes if I bring in $20,000 a year in rent and pay about $18,000 in expenses, including mortgage, utilities, repairs, […]. I do not have the home. What would be the best way to mitigate my taxes?”
So, you’re bringing in $20,000 and paying out $18,000 just tells me that you’re not going to have a problem. The way that real estate work is land equals no depreciation. Depreciation is a fancy way of saying a deduction. The improvement equals depreciation, which equals deduct. When you have an improvement—let’s just say it’s residential property—how long are you writing that off?
Jeff: Twenty-seven-and-a-half years.
Toby: That’s the default, 27½ years. The way you look at it, Tyler, is you look at whatever the cost of the improvement on it, and you can divide that up by 27½ years. You may knock it out. Now, we can actually accelerate a big chunk of this, if you want to, and accelerate parts of it to 5, 7, 15 years, or take off that whole chunk in 1 year. You can get a whole bunch over that period of time. You can wipe out a lot of income.
If you have any other rentals maybe that works, or if you’re a real estate professional there may be a reason to do that, to take and create passive loss, that you’d be exempt from treating it as passive. You’d be able to treat it as active and you’d be able to get a big tax benefit.
Somebody said, “What about the building? Doesn’t that get depreciation?” Yes the building gets the depreciation. If it’s non-residential, it’s 39 years. If it’s residential, it’s 27½.
Jeff: We use the word ‘improvements’ in this form, that if you were to look at your tax bill they consider anything built on the land to be an improvement, so it’s going to be all that depreciable property.
Toby: Somebody says, “I was recommended to place a few new storage facilities and a family limited partnership for a family member that has a lower bracket than my LLC that I have.” They own it then. Since this is a limited partnership, it’s never going to be anything other than passive. I’m not saying you shouldn’t do it, but you also have a gift because you gave them that interest, so unless they did it.
There’s quite a bit going on there. I’m saying, I would never do that. That’s just me because there are too many consequences. If somebody’s just doing that out of the hack, then you need to have a really good plan. They might be doing the limited partnership because that way they don’t have control on your place.
You’ve got to be really careful. You have $15,000 a year per participant or per beneficiary that you can give a gift to without having to file a gift tax return. So, a husband and wife until he can get $30,000. Even if you have a bunch of other folks, how you can do it right.
Somebody says, “Can you guys cover the two qualifications for a real estate professional again?” All right, we’re going to do that and then we’ll jump into this question. The qualifications for a real estate professional. There’s part one and part two. Part one has two parts. I will call them A and B.
One spouse—I’m just writing these out—has to do 750 hours in real estate. Not your real estate, in real estate—development, construction, redevelopment, et cetera. It has to be more than 50% of their personal service. What’s the biggest issue you see in this?
Jeff: W-2s.
Toby: W-2s. Your full-time employ is someplace else and you say I’m a real estate professional. It was not 750 hours; it’s 750 hours plus. That’s more than 50% of anything else you do. Let’s say somebody is working and they work 1500 hours for an employer. How many hours would they need to do real estate?
Jeff: To meet this test, 1501 hours.
Toby: Fifteen hundred and one hours, exactly. That gets some people, but this is one spouse. I’ll put it this way. Either spouse can qualify for that. It’s just one of you and it’s not your properties. It’s any real estate. You could be a developer, you can be a real estate agent, and boom you’re going to qualify for part one.
Part two is you have to materially participate in your real estate, which means all of your real estate you’re going to have to make an aggregation election to treat it all as one activity. I need to say there are about nine different tests, and it could be a 100-hour test, there’s the 0-hour test, there’s a 500-hour test, there are all these different tests that will spin your head.
What you’re doing is you look at it saying are my passive activities and my sole involvement in real estate, that it’s no longer fair to treat it as passive? I should take those passive losses and use it to offset my W-2 income, all that fun stuff.
Then, somebody says, “If you qualify for a real estate professional, one to actually take a large deduction, can you carry that over to future years where you don’t qualify?” Yup. It matters what year you created the loss. What you are the next year doesn’t alter that loss. What you can do under this CARES Act, Jeff. what do you think?
Jeff: Well, we just had this conversation with Erik from Cost Seg, about carrying where we were going to cost segregation in a year. They were a real estate professional and actually carrying that loss back to prior years when he wasn’t a real estate professional. You can absolutely do that. It’s crazy as it sounds.
Toby: It’s an ordinary loss, so under the CARES Act they give us the ability to carry back five years, your losses for 2018, 2019, or 2020. For those of you who are on the cusp in 2020 and you paid a lot of taxes in 2019 or 2018, you need to get a little shot in the arm with some extra money. Maybe this is the year you do a cost seg, qualify as a real estate professional.
Somebody says, “Do you have to be a real estate professional that does cost segregation?” No, you do not. A lot of times we’re just looking to offset the income coming from cost seg. You want to make sure that you don’t pay tax, that you’re in a high bracket, if you’re getting rent. We can offset that pretty well.
I can take a property. This is what we get all the time. You have somebody who is on property for a long time. They have $50,000 or $60000 a year hitting them that’s coming through their Schedule E from the rental real estate. Everybody’s looking at like, hey, how do you make so much? Well, they got a bunch of real estate. They had it for a while, but they don’t have a depreciation to offset it. So, it’s going into their highest bracket.
That’s where somebody is really incentivized to go buy more real estate and then accelerate the depreciation. It wouldn’t take that much. Maybe a $300,000 or $400,000 property would get the job done and offset the tax every year. What ends up happening is you are greatly incentivized to continue to acquire real estate. When you die, everything steps up in basis and you get to re-depreciate it all over again.
Jeff: Isn’t life great or death, whatever?
Toby: It is fantastic. I was explaining that to a buddy of mine. This actually was on Friday. He had a financial planner having him gift a bunch of stuff. I was like, what are you doing? He owned those real estate for a long time. You’re going to give up all that step up. You’re going to give up so much because you’re worried about the estate tax. They were well underneath the max but again some financial planners read all books. I think it’s the best stretch. Here’s a lot of bills, right?
All right. “My company is an S Corp since 2015, but all business income has been paid to the owner’s name and not the business name. What can I do?” What say you, Jeff?
Jeff: This has been happening since 2015 It’s kind of hard to undo those old years. But if it’s currently happening, for example you’re getting 1099 […] issued to you personally instead of the S Corporation, we can nominate that income over to where it should have gone, assuming they just did it improperly. We see this fairly often, to be honest with you, but it can’t be something that occurs year after year after year. You have to do something to correct it.
Toby: We’ve dealt with this a lot with real estate agents where their state may say the broker cannot pay it into a company. So, the agent sets up an S Corp because it saves them some quite a bit of money intact, probably 10% of their take home pay is going to be increased, and they look at it and go, I can’t do it. It’s not true. The IRS has dealt with this issue.
Two things are required to make this happen. I’m just going to give you one of the options and I’ll give you two more. Option one, the cleanest way is to write a letter to the broker saying the agent is under the exclusive control and employment of the S Corp, and that all the monies are being deposited to the S Corp.
Number two, you enter into an employment agreement with the S Corp. I forget the case. It’s either Flannery or Fleming or something like it. It begins with an F. The IRS […] tax court, took the position that that’s sufficient. As long as all the parties know what’s going on, then you’re fine. Otherwise, you have an issue of assignment of income. You’re not allowed to assign income. They say this is really bad. You don’t have to pay tax on it.
That takes us to number two. Number two is the money goes to you, you file a Schedule C—this is a sole proprietorship—as an individual, and you pay all the money to your S Corp and your expenses. You’re going to zero out your Schedule C, which is fine. You’re at zero. You’re not going to put a big bullseye on yourself when you’re zeroing out a business. You put a huge bullseye in yourself when you lose money as a sole proprietor because you have a section of the code called the hobby loss, that says you do that three out of five years and they can be classified.
Jeff: What we typically do when we do that is we say pay to XYZ company—whatever the company name as—what their EIN is and all, so then they can match it up with the income reported to that company. We just like to be very clear about that. This is why we’re not reporting the income on the Schedule C.
Toby: You’ll do that?
Jeff: Yes.
Toby: What do you do?
Jeff: We file a Schedule C exactly as you said, report all the income that was reported to you, and then have one line say this money was nomineed and reported by such and such, an S Corporation.
Toby: That’s cool. Essentially, that was number three with me was you just report it to the S Corp and you say it was done in error. Is that essentially what you’re talking about?
Jeff: Yes.
Toby: That’s exactly right. There are three ways, guys. The cleanest, as always, is just to have a pay directly to the entity. If you can’t, there’s not one, not two, but three options to make sure that you’re not paying the tax on it. The reason this is big is because you get to pay Social Security, which is old age, disability, survivor’s insurance, plus Medicare on all of your money that you make.
I always joked that when I worked at McDonald’s they mail me on every dollar I ever made there. Whereas an S Corp does not. You pay a salary and then there is no Social Security on profit. And that’s flowing to you. So, you just have to take a reasonable salary, which, about one-third is always going to get you there.
Some of you accountants out there are like, no, we’ve got to go to salary.com and all the others. Just a rule of thumb subject to your professional. We’ve never had an issue with the third. If you’re making $150,000, pay yourself a $50,000 salary, there’s $100,000 that say it’s going to save you somewhere north of $10,000 a year. That’s a pretty good reason to have an S Corp in my book, plus you have an accountable plan, plus the accountable plan is going to give you a lot of better reimbursements, plus when you start taking a salary it is really easy to do deferral under 401(k), you’re going to have benefits there.
Just so I’m understanding correctly in my previous question, “Do I take the value I bought the home for under year one for depreciation, bring in 20. Let’s say the tax rate is $4800, so take in the $6000 off. Will the IRS be paying me any additional amount?” No. Tyler, here’s the deal. You’re not writing off the amount that you paid for the house. You’re only writing off the amount of the improvement. Technically, when you buy real estate you’re buying the land and whatever’s on it. What would you say is a good ratio?
Jeff: 20:80 is usually a good ratio.
Toby: So, 20:80. Your improvement’s going to be about 80%. Let’s just say 80% is $160,000 divided by 27½, and you’re looking at $33,000 a year, $4000 a year, $5000 a year?
Jeff: Probably around $5000 a year.
Toby: Lower or $5000. Let’s just say it’s $5000 a year and your total revenue (I think) is $20,000 a year. You’d subtract off the depreciation, you had your expenses which, I think if I remember his question, about $2000. You’re going to have a loss carry forward, which means you’re going to use it. Now, the IRS doesn’t give you that money unless you’re a real estate professional, in which case they’re going to allow you to take whatever losses you have and apply it towards your W-2 income.
Jeff: And then keep in mind that the IRS never gives you money (though they do, sometimes, like with the earned income credit), but normally you have to have paid the money before they give you a refund of any kind. We run into that question more often than not; that’s kind of surprising.
Toby: Well, in this case you’re not just going to pay any tax on the income you have. The worst case scenario, Tyler, is you’re just carrying that forward. What’s going to end up happening is you’re just not going to pay tax and then in future years as rents go up—rents have gone up considerably over the last 10 years; considerably—assuming that they keep coming up, then eventually you’re just going to sit there going, this is really cool. I’m getting all this money but I’m not having to pay tax on it.
The other thing is if you dispose of the property it releases all of your loss carry forwards (you’re passive losses) and they become active. So if you dump that property you’re going to get a little benefit.
Somebody says, “How best to shield capital gains on stock investment?” Here’s the thing. Schedule A deductions, miscellaneous itemized deductions are gone under the Tax Cut and Jobs Act. They got eliminated. For those of you guys who like to play in the stock market, not so great. Now, we don’t get to take our expenses.
The workaround on this is really simple. What you do is you create a partnership, and that’s usually an LLC taxed as a partnership. Some of you guys are big LP fans. The only time I’m using limited partnerships these days is in flips in California to avoid excess taxes on the transaction.
Let’s just say that we have our stocks and bonds, and the LLC is taxed as a partnership, which means you file a Federal 1065 each year. I’m going to have a corporation—usually a C Corp—sitting up here is a 1% or greater partner, maybe 20%, up to about 20%. I hate to say this, but it depends on your circumstances how much money you have in this account. If it’s $50,000 probably even go a higher percentage. If it’s $200,000, $300,000, $2 million I’m probably going to go into the lower. You can just gauge it.
What this allows us to do is do what’s called a guaranteed payment to partner, and that comes off the top. If we make $20,000 and you were just an individual, it will just flow down to you. If it’s short-term capital gain, you’re a trader, all of that hits you as ordinary income. If we are paying the corporation a guaranteed payment to cover your expenses, let’s say that ends up being $10,000 what ends up happening is the amount that flows down to you, take off that $10,000 and that gives us net income of $10,000. The corporation expensed all that so we already got that.
Let’s say it’s reimbursing me. Yay. Then, we only have $10,000 net. Let’s say that it’s 99:1. That means that 99% of this number is going to you and then the corporation gets to keep 1%. All they get is $100. That’s it. That’s how you do it. There’s no other fancy-schmancy way you could do that. What are the expenses you can write off? Anything associated with managing your portfolio, including doing other things inside that same entity.
Jeff: Our preference is to write-off those investment expenses in the corporation, not in the partnership.
Toby: You’re writing them off, the corporation is getting paid a guaranteed payment. Usually, you put in there something like $1000 a month and you pay it $1000 regardless of whether you’re making profit or not. You want to make sure that you’re paying for these expenses. It’s giving it back to you. If the partnership needs money, put more money in it. It’s just adjusted to your capital account; it’s not that big of a deal. It works really, really well.
And get this. These things are really, really simple. We’ve been doing the stock market stuff since the mid-90s and it hasn’t changed that much. If somebody’s going to try to get you to be a trader, don’t. Unless you love getting audited and losing. Just do this.
“Does the brokerage account need to be in the name of the corporation?” No. Just the LLC. Frankly, we can put your brokerage account in a personal trust. It acts just like a living trust and we just make the LLC a beneficiary. You don’t have to confuse your brokerage house.
Deductions, if I’m trading in my home, I’m going to do an administrative office in my house. Before you guys think that’s just a home office, no it’s not. There’s no depreciation recapture, and we’re not limited to the goofy square footage. There’s a bunch of different ways we can calculate that. It usually gets you 15%–20% of the value that you’re paying on an annual basis, including cleaners and things like this.
Again, there are many more benefits on the business side than there are the personal side. I don’t write the rules, I follow them, but if you’re not looking at that you just want to make sure.
Somebody says, “If I have a Wyoming entity and I want to have a C or an S Corporation there, do I have to reside there? No. An entity can live in any state. The most common—when you look at the Fortune 500s—have a Delaware address. They may just have an office there for the registry agent to be doing principal place of business in your home state. We’re using Wyoming because nobody can take away from you and it’s private. I would prefer that you use an administrative office there.
We actually have an address there in Wyoming that allows you to just accept your mail, do your record keeping there. We have personnel there, we have offices there, more than just a bare office, which the court test is always, I walk into what I think is a business. It has nothing to do with where you reside.
Now, if you take a salary, that business may have to be registered in your home state for purposes of payroll only. It might be registered for tax purposes. That doesn’t mean that you’re registering with the Secretary of State. It varies from jurisdiction, but maybe do that. You can use something called a professional employer organization to do that if you need to take payroll, or if it’s just you just do like Intuit or something like that. All they care about is you’re going to have to do payroll and do your withholding in that state. It ends up working out really good.
Sorry Jeff, I’m hobarting questions again. Here you go. You can do this one. “If I sell a piece of land and keep the primary house, what is the 1031 value, $0 or the $150,000 purchase price in 2012?
Jeff: The first thing you’re going to do is you’re going to have to parcel off this piece of land which I’m guessing you’ve already done, but it’s neither $0 or $150,000. Actually, what I would suggest you do is you get that piece of property appraised, each parcel. And that’s a good point. You can actually get them both appraised at same time, the parcel you’re keeping the parcel you’re getting rid of. Then, they will give you a value of the land that you’re parceling off. Your whole point of getting an appraisal on both is that you actually need to find the ratio between the two.
Toby: You need the basis, so when you 1031 it means you’re not going to pay. Let’s say they have the land and a primary house is not your personal house. This is an investment property. If this is your personal home you wouldn’t do it. If this was your personal home, you would have a 121 exclusion, anyway.
Let’s just say this is an investment property. You want to keep the house, but you’re going to sell the back acreage. When a 1031 is done, the new property gets the basis of the previous property. You have to know what that basis is. You’re going to need to be able to figure out what that $150,000 is allocated towards. Anyway, you can keep it.
1031 exchanges are wild. I’ve seen people sell their own LLC in interest to another member of the LLC and 1031 exchange it. I didn’t realize you could do that. Until you actually see some weird certain situations, your like, oh man.
Somebody keeps asking about the real estate professional hours, “What is counted towards real estate the hour requirements?” Mr. Webb?
Jeff: When you’re talking about the 750 hours, it’s going to be real estate activities. You list a couple. What they do not include is real estate financing, in particular, so you can’t include those. For the other tests for the individual property, that is going to be your actual activity, either spouse on that property.
Toby: If they’re doing webinars and things like that, will they be able to count it?
Jeff: That’s a good question.
Toby: I’m asking you. When you can, when you can.
Jeff: I think the webinars, like the real estate, webinars and all you could count towards the 750. I don’t think you could count towards the individual property.
Toby: A lot of times, they’ll allow you certain things. They’ll say you have to actually be doing activities with regards to the management of the properties. I think that would be the case for material participation. For the 750 hours, I think it’s anything in real estate that’s involving real estate anything in your business, so they don’t really care. But when you’re actually doing material participation, you’re going to actually have to be involved in the management of your entities.
Now, remember. If you’re self-managing you don’t have an hour requirement. If somebody else is managing your properties for you, you just have to do more than 100 hours and more than them. If you have a lot of properties (and often, people are exceeding 100 hours) you need to make sure you and your spouse equal 500 hours or more.
Jeff: Yeah, and if you have a bunch of properties that you’re aggregating together, this test actually becomes much easier. It’s just when you have one property when things are going smoothly, you may not find that you don’t have a whole lot to do with that property if you go collect the rent every month.
Toby: You just go get it. All right. This is going to answer somebody else’s questions because they’re asking about the RV. “Can I write off an RV if I use it for business travel? What are the requirements?”
Jeff: You can write off an RV in a couple of different ways. If you’re going to put it in your business—this is my personal opinion—it needs to be a 100% business.
Toby: You’re going to have some traps. You will try to use it as an entertainment facility and things like that. If you use it personally you destroy that. We never just put in there and say it’s 100% business. But an RV can be a second home. If you’re using it personally that’s not a bad thing because now we’re writing it off as sort of an investment or some of the interest and things like that.
Jeff: As an example, my son bought a camper. He’s got a loan on it, but it’s got a toilet, it’s got a place to cook, and it’s got a bed. So, it qualifies as a second home.
Toby: Boats qualify, too. Anything that Jeff just said is so important. It’s cooking, going to the bathroom, and sleeping quarters.
Jeff: Right, and why that’s important is if it has all three, it qualifies as a second home for mortgage interest. Any interest my son is paying on that camper gets counted towards Schedule A deductions.
Toby: Do you like to double dip?
Jeff: I like to double dip.
Toby: All right, this is where you double dip. You can do the 57½ cents (I think it’s 2020) mileage deduction if you’re using it for business. It’s not uncommon for someone to say I don’t want to fly. Or, I had a friend who was an attorney, who would bring in what he called his […] away and he would try it to his trials.
You can use your facility as travel. You can always use anything for travel. If you’re zipping around the country, let’s say you put 1000 miles on it, that’s worth $575. What I would suggest everybody to use is something called MileIQ so that you can do that. Now, that has nothing to do with your phone deduction as well. This is why I say you can get a little bit of double dip in there, which is fine because you can write-off any of the interest, plus you can get your reimbursement.
Now, I’m with you. I would not put it in a business and my reason is a little different. My reason is because anytime you’re personally using a business asset, there’s a potential for a tax hit. When you have vehicles then that tax hit is its lease value, fair market value. They put it on a sliding scale and RVs are pretty valuable.
You could be hit getting hit on an annual basis depending on how much percentage use you have. Let’s say you’re using an app for business. I could be seeing a $6000 inclusion of income that I happened to pay expenses on. Someone just hit it. Joyce, you’re absolutely right. You’re in the business, you have an accident, it’s in the business, plus the insurance is more expensive. Insurance is more expensive because you could do it.
Jeff: I get why you’d want to put it in the business because the deductions are very lucrative. You’re talking about a $100,000 RV that you can write off the entire thing in the first year.
Toby: You do the math. Maybe it’s beneficial for you, maybe on a really high tax bracket and you say, you know what, Toby? You know what, Jeff? Twist your arm, let’s buy it in the business. We’re going to use it for business. We’re going to have 30% that we’re going to use it for. You got to be more than 50% business, by the way.
Let’s just say I’m going to use it for my business a lot. I know I’m going to use it, maybe you’re going off to sites and you’re using it as your mobile office. Under that circumstance, let us run the numbers.
Somebody says, “Is it in a second location?” You don’t want to rent it because then you have income. Somebody said, “What if the RV is for a nonprofit?” Same situation. You still run it. It’s not uncommon. Again, there are plenty of places where they use RVs as mobile office places, especially in the nonprofit arena. You’re going to see a lot of blood drives, all these other things, but they’re not using it personally. They’re not driving around the bloodmobile going through Yosemite.
Jeff: Yeah. Nonprofit is even more problematic because, by its very nature, since it’s in the nonprofit you cannot use it for personal use at all.
Toby: Right. We want to make sure that if you did this it’s included. You have an income. So again you have the IRS charge. Somebody said, “A boat also qualifies?” Yes. Cabin, cruiser, yes. You can do 288 with these guys.
Jeff: I’ve had people come and say, hey can I use my boat as my administrative office? I’m like, does it ever leave the dock? No, no, no, no.
Toby: A 288 is going to get you (I think) if you’re having business meetings, so I would make sure. We have people that do this. I’m thinking of one in particular, Pat, who uses his boat almost exclusively for entertaining clients. He did get audited, he had to prove it. but that was a different test. He was trying to get the business write-off.
Somebody says, “Do you have to do the corporate meeting in the RV?” Yes, but bring other people. Make sure it’s not just you and a spouse. Bring some other investors along if you’re real estate. Make it a day. Get the real value out of it and that’s tax-free money.
Jeff: Going back to what you said, though, about using the boat or RV for entertainment purposes. Did TCJ knock that out?
Toby: For entertainment, yes.
Jeff: Okay.
Toby: No, wait. There’s one exception. No. If it’s solely for the benefit of the employees, then I believe you can still do it. If it’s entertainment, like entertaining clients you can’t do it. But a non-taxable benefit to the client, to your employees, yes.
“Can you corporate your home 14 days each of your […]?” No. Dennis, we take the position that you get 14 days as a taxpayer, even though it says it’s per resident. Technically, you should be at home, number one, 14 days on number two, but that’s not the way the courts interpret it. Pigs get fat, hogs get slaughtered.
Somebody’s asking, “I’ve done four flips over the last three years with mixed results, mostly lost money. I have put flips on hold for now.” We’re in a weird marketplace, Matt, so I don’t blame you. “My C Corp currently manages one of my own properties and runs at an operating loss. I am single. making W-2, making pretty good money, and I’ve been doing well with options trading.” I’m not going to go over with that. “I like to do a partnership LLC to distribute some of the profits to the C Corp. What percentage can I go, 75%, 25%?” Yes. “Can I add it to the LLC?” You could, but you don’t have to. Unless it’s going to contribute money, Matt, you could actually just have mom on the board and start covering some of her expenses.
You are in the exact scenario of why we like seeing multiple businesses being used in those corporations because you can have business one losing, business two profiting, and business two is deducting the money going into the business to cover the shortfalls in the others. That’s perfectly okay if you set it up right. Almost every Fortune 500 calls that research and development, they’re experimenting. All other divisions that they’re trying something new on are using the profits from the profitable divisions. And that’s not uncommon.
Jeff: They’re cash cows.
Toby: Yup. I think that was in Batman 2 where we had the one off the books that was losing all the money, and it was Morgan Freeman’s mad scientist section.
Jeff: Oh, yes I know […] that.
Toby: […] the Batmobile. All right. What do we got? “What is the right way to move money in and out of an LLC? Do I move personal funds to the business account and then pay the expenses?”
Jeff: Oh, can I say it this time? That’s going to depend.
Toby: You could be a lawyer.
Jeff: It’s going to depend on how that LLC is being taxed. If it’s a partnership or disregarded to you personally, you can move money in and out all day long. It’s just contributions and distributions. You can always contribute or loan money to the S Corps and C Corps, even if they’re LLCs. I prefer the lending money because that money can be pulled back out just as a loan repayment. But as far as pulling money out that may be profit or pulling out appreciated properties, stuff like that, that’s especially problematic in the S and C Corporations.
Toby: If you are a partnership or a disregarded LLC, it’s the same. The fact of the matter is if you open up your safe and you put cash on it, there’s no tax. If you open up the safe and pull the cash back out, there’s no tax.
The second you make it a taxpayer, now I’m paying somebody else. It’s like Jeff and I. If it’s just me, and I just have a safe, I don’t have to worry about taxes. The second I say, hey Jeff, I’m going to start paying you, then we have the classify it right. If I loan money to Jeff, he pays no tax on it unless I forgive it. If I pay Jeff, here’s a dollar for your services, that’s taxable. That’s the difference.
In an S Corp, it’s more of a hybrid. Again, anytime you’re buying shares in a company—I guess I would put it—then there could be zero tax application. We just want to be careful.
Let’s go to this real quick. Matt, yes, 25% ownership in the partnership LLC.
Somebody asked, “Does it matter whether it’s an S or a C Corp is the partner?” Only to the extent that I want to be able to zero out that corporation or if you’re a high-income earner, I want to keep that income from hitting you. A high-income earner in my book is somebody making probably $300,000 and above. Because we’re getting into the point where you’re in the 30%, depending on your state, you may be getting close to 40%–50% tax. I’d rather sit next to a C Corp, pay 21%, and he can have access to that money.
I’m still okay paying the tax, I’m going to pay half as much, which means I have more money at my disposal but it’s sitting in an entity. To be really technical, if you guys like this stuff, by the way, this is the year to do it. You can give 100% of your money away to a charity and have no tax. That charity can be yours. You’re taking it and putting it into something that you control, you don’t own (because nobody owns a charity), but you still have access to those funds.
Some people choose to do that. They look at it and say, look, if I kept this $200,000, I’m going to pay $100,000 of it to the tax man, either Federal or State, and I don’t want to do that. I’m going to take the $200,000, I’m going to give it to my own charity. I’m going to use it for good things.
Later on, maybe they’re going to take a salary out of it in the future, something like that, maybe they have kids, maybe they’re doing housing, maybe they’re doing a project that they really care about. I have two. One a sanctioned body in the State of Nevada for USMCA. The other one is the stewardship organization. Both of those, I could write a check for at any time. I can get it done.
Yeah, it’s only this year, Joyce, the 100%. Otherwise it’s 60%.
By the way, this is a good segue because we just completed and finished up and are ready to start shipping the Tax Toolbox. If you like the concepts, we put it together in 22 videos on all the different ways to structure and use the tax code to your benefit. There’s a whole bunch going to the individual tax. I’m the speaker, but we have a really great tax division here that Jeff oversees. How many tax professionals are you sitting on right now that are doing the taxes?
Jeff: I think we’re at 31 right now.
Toby: Yeah. Plus all the administrative staff and everything else. They do a bang-up job. Taxes are really tough right now because people aren’t coming into that profession. We’re losing more than we’re gaining in the profession. They’re becoming more and more worth their weight in gold, but it’s really tough to find good, creative tax people who really want to save money for their clients. We’re really lucky. Jeff does a great job.
If you do this, by the way—I will say this—you get a whole bunch of stuff that we bring for you. You’re going to be able to go through it. Here’s the thing, until you do it, until you hear all the differences, and you see all the different options, you don’t realize what you’ve been missing. That’s the hard part. You almost have to sit down and go through it.
The Tax Toolbox, I’ll give you guys the link. We’re going to do an initial offer and I’m going to pair it up with the Tax-Wise Workshop that’s coming up. I believe it’s going to be in the first week of December, December first, second, or something like that. I usually try to do them in November, but I’m all over the place in November, so they said, let’s do it right away in December. We want to do it towards the end of the year and I want it to be after the election. I want to see what’s going on. We’re going to give you the Tax-Wise Workshop which we’re more likely to 99.9% be virtual. And the Tax Toolbox for $495. This is an initial offer. If you guys know how this is, it’s hours and hours and hours.
“My daughter makes me many more times in real estate versus using her Master’s Degree in Taxation that she earned at Golden Gate.” She’s helping you more than you ever paid for it, because she’s sitting there saving you a bunch of money. It’s something you guys are talking about, Platinum, et cetera. This is going to be the lowest price, period. I like my Tax Tuesday group.
Yes, if you’re Platinum, you’re still going to get the same price, but this is the deal. This is the link to it, by the way. The $495 that’s going to be offered does not include Tax-Wise, except for the Tax Tuesday crowd, so we’re going to give you both. You’re going to get Tax-Wise, you’re going to get the videos, you’re going to get all of that—I’m not going to spend much more time on this—you’re going to get Tax-Wise and the total amount of $495.
I’m going to let Patty or somebody put the link up there. And guys, we don’t play around with ‘today only’ or anything. I’m just making this feed for the Tax Tuesday folks.
Jeff: This isn’t the next 20 callers in the next 10 minutes?
Toby: None of that. This is you guys. This is not included in Platinum. This is a very specific and unique product. There’s lots and lots of stuff in Platinum that helps you on taxes, but this is spanking brand new, working on it for two years, I’ve only got it out product. We want to make sure that you guys have something easy if you like it. Is it tax-deductible? Of course. You buy through your business.
As an individual, you don’t get to write off tax def anymore because there’s no more miscellaneous itemized deductions. When you watch the Tax Toolbox, you’ll get that drilled into your head. All that stuff that went away. Those are all the tax credits. It goes through all the tax credits and everything else. It’s individual tax, it’s personal tax, it’s how they work together, it’s business taxation, and it is nonprofit, all of it rolled into one.
What we’re doing is I’m trying to make sure that you see. You have a full, complete experience and you get an idea of all the different tax angles so that when you’re looking at it, you’re not missing pieces. It’s like doing a puzzle. You don’t have the piece, it’s really tough to do the puzzle.
“How does a trust work in relation to an LLC in real estate?”
Jeff: If we’re talking like land trust, the primary role here is to give you anonymity. Your name is not on the property. The LLC’s name is not on the property and the county records. That land trust name is on the county records. This is especially nice in California because California doesn’t charge that $800 LLC fee to LLCs that are owned by the beneficiaries of trust.
Toby: A land trust is a fancy way of saying a trust that owns land. It’s a revocable trust. This isn’t an irrevocable trust. This isn’t asset protection trust or things like that. Just land trust. And if you go back to Illinois where they started, they’re just doing two pieces. You have the title and you have beneficial ownership.
For example, let’s say that Jeff was on title, but Toby gets the right to rent it. And I get the right to all the rents. Which would you rather be?
Jeff: I want the right to rent.
Toby: I want the right to rent. We don’t care about being on title. That just means it’s nothing. When we do this, what Jeff is actually saying is you can keep your name off of it. If you don’t want to get your name off of it—you can put your name on it, so you could just say whatever—use an entity. What I really care about is getting the LLC, getting my beneficial ownership into the LLC. But I don’t have to let anybody know. The only state that requires the listing of the beneficiary is Arizona and there is no remedy if you don’t do it. The remedy is for the beneficiary. Unless you feel like suing yourself, there’s nothing.
What we can have is an LLC out there that’s owning real estate and it does not have to list the LLC on the real estate. Your name is not listed. I cannot overstate this enough. I’m sure that when Michael was on, he probably stressed this as well. The best tool in asset protection is people don’t know you have it. Period.
Jeff: They can’t take something from you that they don’t know you have.
Toby: Exactly. If they don’t know what it is, where it is or that you even have it, they’re not going to try. The reason I know this is because I’ve never seen a homeless person driving to court and subjected to after judgement, subsequent proceedings where they’re trying to figure out what they own.
All right, there’s a whole bunch of questions here. “Who goes to […] court? Who is the landlord?” The land trust might be, you may be the trustee, or you just put it on the lease. Usually, the landlord is entering into the lease so it’s going to be a landlord. It can be in the management company if you have a management company. I’m usually going to have a management company if I was structuring. I would have a corporation being the management company or I’d have an actual management company. That’s who’s going to court.
“Can you have a primary home exemption if property is owned in a land trust?” Yes, it’s the same as a living trust. The land trust would be owned by the LLC. Technically, trusts aren’t owned. The beneficial interest is going to be assigned to the LLC, depending on the trust agreement.
When we do these, we do Illinois style land trust. The reason we’re using that terminology is because most attorneys know what that means. We’re giving the beneficiaries the right to control the properties. Sometimes we could do the opposite where we give the trustee the right to control the property and that’s not the kind of trust we’re using.
“Can I build my personal residence under my LLC for liability protections?” You can. And it really depends on your state and how much it’s worth. Somebody says, “I have those. You guys set it up, I just need to connect the dots.” Absolutely. There’s about a two-year learning curve in anything. In fact, there are really good studies that show that a learning curve takes 20 hours to get really good at something. It doesn’t matter whether it’s guitar or any activity. That about 20 hours gets you decent at it where you can function. I don’t think that running a business is any different.
The big thing for us is just to get you asking questions and get you using it and then you get comfortable, and there’s a little bit of time. Sometimes it takes a year, two years. If you’ve already done it, you’re already comfortable, you’ve run other people’s businesses or you’ve been in other people’s business, then you’re fine.
Somebody says, “I’m in California. Is it true that the $800 franchise fee isn’t needed?” Yeah, Jeff, we’ve actually won that audit. Jeff loves it when I say this. What happens is California charges an $800 franchise fee—they don’t think it’s a tax, but the court says it’s tax—on any entity that’s doing business there for the privilege of doing business in California. When you use a trust, there is no $800.
What California does is they say, if you have an LLC that’s out of state, (let’s say it’s Wyoming) and it’s owned by a California resident, then they want to charge the $800 fee to the LLC because they say it’s been controlled by a Californian individual, it’s owned by a Californian individual. They try that nonsense. You just make sure that the trust goes like this and if there’s a piece of property that’s actually going this way, and then, the Wyoming entity is held by a living trust or another trust, not you.
We actually won that on audit. We don’t advertise that because we don’t want everybody trying to do it because we just know what the franchise tax court will do, which is just pass a new law that says any trust now is subject to the $800. They lost in court on grantor trust outside the state, but I wouldn’t put it past them. I don’t want to tempt fate.
“How do I add my LLC to my living trust or other tax consequences?”
Jeff: It seems like you were just talking about this. It’s actually very simple to add your LLC to your living trust. You just have to deed your interest in the LLC to your living trust.
Toby: Yeah. If we set up your living trust, we already included an assignment in there that you just complete. If you don’t, if you’re Platinum, we’re just going to give it to you. I have a very simple one where I sign all my businesses. Kimberly, what I would do is I’d have your LLC owned by your living trust. If you don’t want to pay California—I’m not going to say don’t pay California. I was going to say if you don’t want to—there’s a way to do it. It’s aggressive and they may bark at you if they ever see it.
If it’s a disregarded LLC, we don’t have to worry about it. If it’s a partnership, you’re probably going to pay the $800. I always say, pigs get fat, hogs get slaughtered. Pay it on one, give them a little piece.
Jeff: Going back to the second part of this question, are there tax consequences. A living trust is considered a revocable trust. Which means you can always undo it. The IRS ignores it.
Toby: There’s no tax consequences. When you have a revocable, you can get it done, you could potentially have a tax. If you have an irrevocable trust, you could have a problem. If you have a revocable trust, then you have no problem because you can always undo it.
There’s one state where I’ve seen a tax consequence and that’s Pennsylvania. That’s when you’re transferring properties. They have some really weird, goofy rules. They have a weird rule as far as the residual interest, the distribution. My partner Clint is really good on that. We’ve gone to battle with them. We’ve lost a couple, we’ve won a bunch.
What they do is they look at the document. When we do it ahead of time, we can make sure that you’re out of harm’s way. If somebody comes in and they’ve already done it and they’re trying to undo it, sometimes we go to unring the bell, sometimes we can’t. It just depends on the trust document. The exception is supposed to be for living trust. But they look at the language of the living trust. It’s kind of weird, but that’s the only place.
Somebody says, “Does a Platinum member living in Washington have to use a Washington attorney to update their trust, or could we use you guys?” We have Washington attorneys on staff, Clint. We have an office in Tacoma […]. Technically, we could do trust work anywhere. It depends on where you’re […]. Anyway, we could actually help you, Dennis. Patty can get you in touch with the appropriate parties.
What else do we get? “Can we take depreciation on a rental condo? What do you use for the basis?”
Jeff: Yes, you can take depreciation on a rental condo.
Toby: What if you’re renting it? This is what’s weird. You read things and I read things, we see them all the time, and I’m wondering whether they’re saying, if I rented a condo, can I depreciate it?
Jeff: If you’re the tenant, no. If you own the condo—to be clear, timeshares do not fall in this category—they cannot be depreciated because technically you don’t own it. Anyway, yes, you can depreciate a condo that you are renting out to others. The courts have gone back and forth on whether or not you own the land. IRS’ position is even if you live on the 20th floor of the condominium building, you still own a portion of the common areas. But I’ve seen it go both ways. We would generally say your basis is going to be whatever you pay for that rental property. Blowing you right and down there.
Toby: The owner, yes. You can still depreciate. Land equals no, you don’t depreciate the land. If it’s investment property then you can depreciate the improvement.
Jeff: Right. If you paid $100,000 for a condo, put a small portion, 5% of whatever the land and depreciate the rest. Just for safety’s sake.
Toby: Somebody says, “Can you depreciate a pre-construction condo?” No. It’s not in service yet. Got to put it on service.
Jeff: Yeah, that’s something we will never talk about. That depreciation starts once the item is placed in service.
Toby: Somebody’s helping us. They said, “Undivided portion of the land equals non-deductible.” Correct. You have condos on the water, by the way. Just because you say land and sea. Like Washington, I used to have a boat. I lived there. They had condos. In fact, a lot of places they do it. You get your boat wet and it’s cooperative. It’s condos.
Somebody says, “What if the appraised value is higher than the purchase price? Can you use the appraised value as basis?” No.
Jeff: Actually, the opposite happened. If you have a property that you bought 10 years ago and the value has gone down since then, you have to use that lower value.
Toby: Oh, yeah. When we put it into service?
Jeff: Correct.
Toby: This is a good one. “When you have a house and you want to increase your basis, you could sell it to your own S Corp.”
Jeff: That’s true.
Toby: All right. We’re running too far which is fun stuff. Let’s go out of that. “What are the main differences between an S Corp and a C Corp?”
Jeff: A C Corp is its own entity. I keep one just like an individual. It’s its own taxable entity, its own legal entity. S Corp is kind of a hybrid between the partnership and the C Corp. It has the benefits of both.
Toby: S Corp flows to shareholders. The reason I was going to draw it up is because you might go into the LLC side. It’s taxed on its own profits. C Corp pays taxes on its own profits at 21%. Flat tax. By the way this could be a corp or LLC taxed as a corp in either one of these situations. As you guys, if you bought in here before you know, an LLC does not exist to the IRS. You have to tell it what it is.
What are the big changes, the differences would you say from a tax standpoint?
Jeff: Between an S and a C, the S has got a passive thing coming directly to its owners. It doesn’t pay its own taxes.
Toby: And then medical benefits, if you’re in insurance, any medical, anybody that’s greater than 2% shareholders, it equals income.
Jeff: Yup. Typically, we just don’t deduct medical expenses. If you write off, reimburse medical expenses in the S Corporation, we’re not going to deduct this.
Toby: Yeah. On a C Corp you can expense medical, dental, and vision at 100%.
Jeff: Correct.
Toby: With an S Corp you cannot. And as an individual who owns an S Corp, you can only write off at self employed the insurance premiums you pay. If you have a whole bunch of deductibles, co-pays, things that aren’t covered, you can’t write them off.
Jeff: Correct. You get out of pocket expenses.
Toby: Those are some big ones. The other one is if you make a charitable donation to an S Corp it flows down to the shareholder and is carried on their level whereas a C Corp, you’re capped. This year it’s 25%. Normally it’s 10% in net profit.
Jeff: Before 2018 it was 5%. It was horribly low.
Toby: Really low. What a lot of C Corps would do is they would do sponsorships of charities because then you can write it off as advertising. It is still not uncommon for corporations to prefer that because they don’t want a charitable deduction.
Those are the big differences. Usually, when we’re looking at a business, a lot of times they say, should I be one or the other? The answer is actually I may use both. You may have, for example, in a professional service, let’s say this was a doctor, dentist, real estate agent, consultant, you may see that being an S Corp so that we don’t do any harm. Maybe it’s a whole bunch of money, but you may have it being managed by a C Corp. And that same C Corp may be managing a holding LLC and it may be managing a stock account in another LLC. You guys seeing how this works? So that you’re able to control. Here’s you down here and you’re sitting on all sides.
I have income that’s going to flow to me. It’s going to have income that’s going to flow to me. I have this income. All I’m doing is moving it off of me if I need to, and it works pretty well. It’s much easier to operate. That stuff sometimes makes people anxious the first time they see it. The whole idea is that it’s only uncomfortable because you’ve never done it. It’s like a golf swing the first time you do it. It’s a little uncomfortable, but there’s a right way to do it. That’s the right way to do it, and then over time it becomes very comfortable.
We have a few more questions. “If you buy a fix and flip under an LLC and your wife then decides to make it your main residence, can you use any of the expense as a write-off or does it all get out to basis?”
Jeff: Every bit of it to basis anything that went into that properly.
Toby: Yeah, but this is the thing. When you have an LLC and it’s just yours, then we don’t care. It all goes to basis. But if that’s an LLC taxed as a corporation, you really should buy it from the corporation, even on installment sale or something.
Jeff: Oh, I agree with that.
Toby: And then establish your own basis and allow some of that money to go to the corporation to cover its expenses, et cetera, just a way. There are some thank yous to our guys. Hopefully guys you’re getting your questions answered.
“I purchased two condos overseas. Can I depreciate it? And what do I have to report to the IRS for overseas purchase?”
Jeff: I don’t know of anything that will prevent you from treating those foreign rental properties as rental property. Period.
Toby: The IRS doesn’t care where it is.
Jeff: No. The only big thing I’m aware of is, those properties are not eligible for 1031 exchange for property in the US. Other than that, you just treat them like ordinary income.
Toby: Yeah. […] rental.
Jeff: As normal income is what I was going for and I said longer.
Toby: No self employment tax […], it’s still rental income. Just so you guys know, just for fun, just for giggles, if you ever get into a conversation with somebody, there’s really three types of income. I do this too, I’m guilty of it, but a lot of practitioners just look at it and say, there’s active and there’s passive. That’s technically not true. There’s active, passive, and portfolio.
The passive is when you own a business that you don’t do anything and that you don’t maturely participate in. You’re the hands-off owner. You’re the silent partner. You invest in something. The problem is that’s passive losses. If you have an S-Corp that you’re a shareholder in but you don’t do anything, you’d have passive losses and it kicks losses down to you. A lot of people will try to take those. No, that’s just real estate.
Real estate is the other passive activity. Active activity is anything that you do to generate income, meaning you do with your labor with your own energy. It’s being a sole proprietor, it’s getting W-2 wages, it’s all those things.
And then you have portfolio income which are royalties, dividends, interests in capital gains. Not subject to old age, death, and survivors but very different. Capital losses are treated differently than losses from other portfolio income. Wish it was way straightforward, but it’s not.
Somebody says, “How long is the promotion on the Tax Toolbox?” Don’t worry, it’s not going away. For you guys, you could use that anytime. That said, do it sooner than later.
“What are the advantages of making my futures trading accounts in LLC?” Futures, you’re going to have that 60% and 40%.
Jeff: Right. And he’s talking about 60% long-term, 40% short-term.
Toby: Whether you held it for a day, futures contracts substitutes short-term capital gains. If you don’t know the difference, this is 0%, 15%, 20%, this is your ordinary bracket. But you don’t get to write off any expenses. When you put an LLC around this guy, same situation. We have a C Corp or an S Corp—just say a C Corp—it has a percentage, and this is a 1065, this is a partnership, LLC, LP, then we have the corporation owner percentage. Now we can get our expenses out. Otherwise, you’re hosed.
“What are the advantages of putting a futures account?” You could actually write off your expenses. It also keeps it away from lawyers and snoops because you can keep your name off it. You can make it where nobody can take it from you.
Jeff: Going back to the Trading Places movie, say I sell orange juice at $50 whatever the size is, but it turns out to fulfill that order, I have to buy that orange juice at $100. By having an LLC, is that going to protect me personally?
Toby: It has. You’re talking about doing some kind of a margin. You’re putting yourself on an obligation. Actually, we had that precise scenario, not just on this but also on margin calls. When I first got into this business, we would set up the LPs (Limited Partnerships) because they didn’t accept LLCs in all states. You remember those days.
Jeff: I remember those days.
Toby: You would set it up and if they didn’t get a personal guarantee, they were toast. We had somebody with about a half a million dollar margin call when the tech bubble burst and they walked away from it because it was in an LLC. Now, is that a good thing? Me, personally, I don’t want to get into judgment on it, but it saved them from taking a major hit. That was the brokerage company giving the, unfettered access to margin and they give a lot of rope to hang themselves. Pretty interesting.
Jeff: I’m assuming the trading companies have learned something since then.
Toby: They know it’s you. They don’t generally like to do things that cost them a bunch of money. We have a lot of questions but we’re way over so I’m just going to zip on through here. “Is a family limited partnership, irrevocable trust, or LLC better for small business?”
Jeff: You could do it in an irrevocable trust, but I don’t think I would. The trust could be subject to UBIT?
Toby: It depends on how it’s taxed.
Jeff: Okay.
Toby: Typically, you have some business trust that floats around out there that operate, I would never do it like a traditional business for small business. You’re going to be an LLC and you’re there going to be taxed as an S Corp or a C Corp unless you are really, really, really small. When I say it’s small, I would say less than $30,000 a year. Just because the money is almost always between a sole proprietorship and an S Corp is not even close. The S Corp is generally going to save you more than whatever its costs are when you’re getting over $25,000, it’s right around $1500–$25,000. Just do the S Corp.
The limited partnerships are out of vogue. You still have some of the folks running around out there talking about them. It doesn’t make sense. The LLC does a better job, gives you better protection and doesn’t have the downside of having the passive income limitation. If I’m a limited partner, I can literally lose my real estate professional status by having a small portion of my income coming through a limited partnership. It’s actually 10% of gross rents. I want to be really careful with those. The only time I’m using this is for flips in California or if I’m dealing with Canadians.
“Is it better to invest in oil and gas as an individual or in an LLC?” What say you, Jeff?
Jeff: I’m not crazy about oil and gas. Right now, there’s a lot of companies including Halliburton, Occidental, and Williams Energy that are all in trouble. They have more debt than they know what to do with. Okay, off my soap box.
Toby: Right, what about the energy companies? They’re the worst sector this year. Just got tortilloed.
Jeff: Oh, they have. Even the big ones like ExxonMobil.
Toby: I’m shocked at Exxon.
Jeff: Yeah. They’re in trouble.
Toby: Chevron. Probably the best in all of them.
Jeff: There are several ways to own oil and gas. You can own it through a limited partnership like Occidental or Atlantic Oil. Williams Energy is another one. You can own a royalty interest in oil and gas where they basically send you a check every month. The third way is you own a working interest in that oil and gas company. If it’s a working interest, you definitely need to be an LLC.
Toby: The only problem is that you get this ordinary loss from the intangible drilling cost. This is why a lot of people invest in oil and gas is because they get an ordinary loss. If I put in $100,000 in investment, there’s a good chance I’m going to get $80,000 deduction in year one. But I have to be at risk and you have to be personally at risk.
If you’re doing an LLC for oil and gas, you need to put in a provision to make sure you are still at risk, which is weird because usually you use an LLC to not get risk. But you need to be at risk for the actual exposure from that oil endeavor. You’re not generally going to have anything that’s going to come get you, like something bad happens on the property and they come after you. But you still have to be at risk. If you cut off the risk, you’re going to really be put into a problem. Because if you have a loss, you’re not going to get to take it.
Jeff: The working interest are typically the most difficult to do because you’re receiving money from whoever is actually drilling oil. But you’re having to pay them back for their expenses. You’re actually switching checks between them. I know people who made lots of money not a few years back until the oil market tanked.
Toby: Some of you guys are saying that the oil field is hurting hard. The negative price a few weeks ago scooped. The others are a ton of bankruptcies and energy breakdown. Which doesn’t mean it’s going away. It just means they’re seeking protection.
Jeff: What they’re talking about with the negative price was there was such a glut of oil that there was no place to store it. You were having to pay people to take your oil off your hands.
Toby: Somebody’s asking some questions, so we’ll zip off. “Hey, I’m a dissolved flip LLC.” Which means that they flipped something and they want to cut off their liability. “Do I send share certificates to Anderson for storage?” You can and then you keep the deeds and the financial records. You have a requirement, I think seven years?
Jeff: Yeah.
Toby: Just scan them and put them in your box. You can put it in the box, forward with us and we’ll store them for you.
“Is there an option to give employees a bonus without being charged a luxury tax?”
Jeff: You’re talking about employees and the monopoly game.
Toby: What is a luxury tax?
Jeff: The only luxury tax I’m aware of in real life is the one they had on boats and cars. And that’s been at least 10 years ago.
Toby: You can give bonuses to your employees. You’re just going to be charged regular tax at it.
Jeff: Here’s a general rule. Any time you give your employees any kind of cash, whether it’s a bonus, a commission, or a gift, that is subject to regular, normal everyday payroll taxes.
Toby: Hey Eric, we answered the payment deferral starting today and now do you opt into it? it’s actually your employer. We went over in the beginning just because we don’t like it. If there’s a deferral you still owe it and they’re going to still owe it in the future. They’re still going to owe it in the beginning of next year which means you’re going to have double withholding. But if the employee leaves before the end of the year, the employer could still be on the hook for the deferred payment or the IRS is going to say to the employee owns it, how are they going to go after the employee. They’re going to after the employer which means the employer may have to go after the employee. It just is a stinky situation.
What we’re saying is, until they figured out, I wouldn’t do the deferral. It’s just a temporary deferral. Some of you guys may do it, but I understand why you wouldn’t and I understand why you would. I’m just going to say I’m going to take the conservative route.
Somebody says, “Question, for real estate professionals. Would a Schedule E loss reduce modified adjusted gross income or just adjust your gross income?”
Jeff: Simple answer is you take the loss so it’s going to lower your taxable income, your modified AGI.
Toby: All of it. It comes after your calculation of modified adjusted gross income, so yes. There we go. Sorry, whenever I read into these questions without even switching the slide. This is an easy yes. You don’t have to pay the luxury tax because it doesn’t exist.
This one. “I have an LLC for my real estate business. How should I be paying myself through the business if I plan on filing as S Corp?” This is somebody smart. He figured out that an LLC is not a tax designation. There are LLCs taxed in S Corp. How should you pay yourself? You’re going to want to pay a salary. Do any payroll. What would you use, Jeff?
Jeff: I like the 30%. That’s what I’m using on my S Corporation.
Toby: What do you use into it?
Jeff: You mean for payroll? I’m actually using ADP.
Toby: They’re pretty good. There’s a whole bunch. What are all the big ones?
Jeff: ADP, paychecks, and I’m sorry aside, miss your payroll company. QuickBooks has their own payroll, but there’s any number of them. Doing it by hand—I know some people still do it—is insane.
Toby: Somebody says, “Are the questions private?” Yes, because names are associated with it and we don’t want you on a video saying, “Hey, I didn’t pay taxes for six years.”
Jeff: Yeah. We don’t want to give your personal information out.
Toby: Plus, you should see the questions. If I went through this right now, I would guesstimate we’d probably have 700 questions today. And just I’m going through, I managed to get through and scroll down just pulling this thing. It’s ridiculous. We’re probably a few pages deep.
I’ll tell you where you can get your questions submitted and answered. You can always go in and listen to these, by the way, at our podcast, the recordings of them after the fact. It’s never a bad thing to go through and listen to the last couple. I didn’t get the chance to sit there and give 2¢ on Michael and Jeff, and Toni and Jeff. They’re just fantastic, though. It’s never a bad thing to go through and listen, just in general. Just even in the background. I like doing stuff like that. I’ll play them in the corner and just look for ideas.
I have so many podcasts that I signed up for, and I’m always looking for nuggets. It was pretty easy. When you hear something, it’s like hmm? Anyway, the Platinum folks, you have a Platinum portal, you can always go in and listen to replays for all of them. The iTunes, it’s sitting on there, Google Play, easy peasy. And then you can always go to our social media, just aba.link and then any of the major ones. If you have questions and we didn’t get your question today—I know you guys have a lot—you can email them on it to taxtuesday@andersonadvisors.com. We will more than likely download the questions to make sure that everybody got answered.
There’s lots of folks getting answers in the last couple of pages of questions. We have quite literally just hundreds of questions. I see Patty and let’s see how far back. There’s Eliot. He’s probably trying to answer bulks of questions.
Jeff: He likes some really long questions.
Toby: Here’s a good one. “My self-directed IRA owns a rental condo. Can I get depreciation benefits?” It’s really easy. No, because you have no basis in it. You took a deduction. Or if you didn’t take a deduction and it’s a Roth, it’s still […]. It doesn’t have a basis for depreciation.
Jeff: Any rental income that you have is not going to be taxable to the IRA.
Toby: What if some of it was? Let’s say that you’re using debt. Would you be able to use the depreciation to offset the UBIT or Unrelated Debt-Financed Income if it was an IRA?
Jeff: I don’t think so.
Toby: Yeah, I don’t think so either, but I was just wondering.
Jeff: But you’re right. Whether it’s UBIT or UDFI, it makes a difference.
Toby: Somebody says, “Can I have an LLC in California and in Massachusetts? I live in California. Will California come after my Massachusetts’ LLC?” It’s not like they come after. They just demand that you pay taxes. They want the $800 fee if they see it. Basically, that’s just you and it’s not on your tax return, we’re just not filing a partnership return or you’re not getting a K-1. They never see it. But if you are getting a K-1, then California will probably start saying it wants the 568 form.
Jeff: 568 for the LLCs.
Toby: They just always […].
Jeff: California’s position is if you’re anywhere in the United States, you’ve probably seen a commercial about California which means they have nexus to tax you for everything. The courts have tried to correct that mentality, but…
Toby: It’s getting a little […] here because I think they did pass the 10 year, where they want to follow you around and tax you even after you moved out of the state. There’s no tax that California doesn’t like and they don’t really seem to care about the constitution because they think that they did everybody a favor by allowing you to live there.
Jeff: It’s a little bit crazy because we always knew that California was tenacious for saying that you were resident if you ever lived there.
Toby: Now they want to say, if you’re ever resident here, then any of the income that you may have earned while you here, we want to make sure we tax it even after you move.
Jeff: And there’s a real concern that wealthy people or people with high incomes are going to move out of the state.
Toby: I would.
Jeff: Because I believe what they could earn from that tax is not near what they currently earn.
Toby: I hear you and it’s frustrating, isn’t it? For those of you guys, it’s going to keep getting worse. I’m not going to say anything bad about California. It’s just the state’s going to need more money. They’ve done some weird things. They have an interesting view on your property and their property, getting that your property is considered their property.
I’m going to go back and give you guys the link again to the Tax Toolbox. Shameless plugs just because so you guys can see it. This is the first time we let anybody know that we have it. We’re going to keep plugging away and see as many people as we can. We’re going to educate on tax and see if they could start keeping more money in their pocket.
I’m not saying don’t pay it to the government. The best thing you could do is make more money with the money that you’re keeping because it actually benefits the government to do that, unless they tax you. These types of circumstances (statistically speaking) are better off in the long run. And I believe that we’re much better off doing our charitable activities personally than giving it to the government. Or the government is not very efficient. That’s not a knock on the government. That’s just a knock government.
I know I’m not saying that they’re bad. It’s just more expensive. If you doubt me, go look at what SpaceX has done with NASA in the cost of launching a satellite and things have gone down significantly, considerably so that we’re able to do so much more. I think that’s really cool.
Somebody says, “Will Tax-Wise be updated going forward?” I always update it. I cannot remember a Tax-Wise where I didn’t go through that.
Jeff: It seems like every one is brand new.
Toby: There’s got to be a lot of new tweaks just because there were so many law changes this year. This reminds me of George Bush Jr. when he was passing on the legislation. This reminds me of the Tax Cut and Jobs Act which was so not that long ago, but still, where they’re just turning things on its ear.
We have a lot of provisions that are expiring, the CARES Act has a lot of provisions that expire at the end of the year. You have some that just expired, you have some that are just about to expire. I believe that you have September 14th or 17th to get the money out of your IRA or 401(k) to early distribution. I have to look at that, but it’s some time this month. You have quite a bit.
Somebody says, “The property owner […] tax. If people are talking about California, the exit tax.” I don’t think it’s passed yet, but AB5 was stupid.
Jeff: No. The exit tax is not passed and a part of that is a new tax bracket that would make their highest tax bracket 16.3%. But I believe that’s on income of over $30 million.
Toby: Yeah. This is still nuts. “[…] updated under the Tax-Wise?” Yes.
“401(k) long deadline 9/22.” Thank you, John. You get a star. You guys all seem really cool. I’m just glad that I’m back.
Jeff: I know you missed us.
Toby: I was going to do them from Puerto Rico, but the connectivity there is […]. They got hit by a hurricane when we went down there. Then they got hit right when we left. I regret ever walking into that bar in New Orleans saying, I’d like a Corona and two hurricanes. You asked for it.
Anyway, that’s enough guys. Have a good one. We will see you in two weeks. If you didn’t get your question answered, we’ll grab you, we’ll get to you, and if nothing else, by all means, taxtuesday@andersonadvisors.com. Just email us and we’ll make sure that we get your questions answered.
As always, take advantage of our free educational content and every other Tuesday we have Toby’s Tax Tuesday, another great educational series. Our Structure Implementation Series answers your questions about how to structure your business entities to protect you and your assets. One of my favorites as well is our Infinity Investing Workshop.
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