Spend a little bit of time and money to learn a lot about taxes and put more money in your pockets. What do you have to lose? Nothing. Toby Mathis and Jeff Webb of Anderson Advisors offer fun and educational tax discounts and freebies. Do you have a tax question? Submit it to taxtuesday@andersonadvisors.
Highlights/Topics:
- I may inherit a timeshare that I’m sure has fees with it that I don’t want. How do I figure out the details to get out of it? Disclaim/bequest your inheritance
- Is all the funding for legal costs to start a business tax-deductible? Organizational costs can be expensed up to $5,000 in the first year
- Which is the best way to fund an Airbnb; cash or mortgage, if money is no issue? Depends on the mortgage interest rate to get a better capital return, or invest the cash elsewhere
- Can you have both a private and public foundation? Yes, you can control both, but can’t own them
- What IRS requirements are necessary to qualify as a real estate professional? Refer to 26 U.S.C. 469C7 to change real estate losses from passive to active
For all questions/answers discussed, sign up to be a Platinum member to view the replay!
Go to iTunes to leave a review of the Tax Tuesday podcast.
Resources:
Real Estate Professional Requirements
Individual Retirement Arrangements (IRAs)
Capital Gains Exclusion/Section 121
Rollovers as Business Startups (ROBS)
Full Episode Transcript
Toby: Welcome. This is Toby Mathis.
Jeff: And Jeff Webb.
Toby: You’re listening to Tax Tuesdays. We’re bringing tax knowledge to the masses. Happy Tuesday. It’s another fantastic Tuesday. We’re already getting hit with a whole bunch of questions (which is always fun) and we get right in. I’ll get to those in a second. Send your questions to taxtuesday@andersonadvisors.com. That’s where we answer the questions.
During Tax Tuesdays, we grab questions. There are usually hundreds of them. We grab ones that are duplicative and you say, “Hey, here’s something that stomps us sometimes.” Sometimes it’s something that everybody needs to hear repetitively, so we’ll grab it and it’s asked in a different way. Whatever the case, we grab those and then we answer them. If it’s just general stuff, we just answer it. If you’re a platinum client, we’re going to answer it, if you’re not a platinum client and you ask very specific things to you, then you just need to become a platinum client.
It’s actually really easy. It’s a whopping $35 a month and you can ask all the legal and tax questions you want. This is fast, fun, and educational. We want to get back and help educate. We’ve been doing this, we’re well over 100 shows. I forget what exact number this is, but we’re well over 100 shows that we’ve done.
For those of you guys who have been on before know, we try to keep it around an hour. We’ve been saying that for years. Usually, it ends up being a little bit over like sometimes two hours sometimes an hour and a half. We’re going to try to keep close to the hour mark just because some people don’t appreciate going on long. We have a whole bunch of questions that have been asked already, but before we get to those, let’s go over the opening questions that we’re going to answer tonight.
“I may be inheriting a timeshare that I’m sure has fees associated with it that I do not want. If I end up getting this, how do I figure out the details to get out from underneath it?” Timeshare’s just really comes down to inheriting a timeshare. What if you don’t want it?
“How do I transfer ownership of a property used as a rental in my husband’s name to an LLC under my real estate C-Corp? Is it possible to refinance a rental property than transfer title?” We’ll get into that.
“If I purchase a Ram pickup with rear passenger seating, can I deduct the full amount to my taxes? I have two subchapter S-Corporations,” also known as S-Corporations. You don’t usually say this, it’s called an SS-Corp.
“Is all of the funding for legal costs to start the business tax-deductible? Do we get the full amount we put into starting this business refunded during tax time?” interesting question. I’ll dive into that. Jeff just lost another piece of his hair which is the best way to work. We’ll go over what a deduction is and how it works. Someone says, “Jeff, are you the whistleblower?” no. That’s not even me, that’s somebody else.
Jeff: I’m actually calling from Washington.
Toby: Why does your caller ID say […]?
“Which is the best way to find an Airbnb? Cash or mortgage if money is no object?” I love that. Money is no object.
“Which is the best way to find a new business that’s mainly based on one piece of equipment and needs just one staff?” We have to figure out what that equipment is.
“Is there a rule of thumb to follow when deciding whether to capitalize expenditures made to renovate a property? For instance, with new flooring, lighting, plumbing, built-in cabinets, et cetera be considered expenses or capital expenditures?” Interesting question.
“I am a resident of Oregon, carrying several notes on houses,” that just means loans, “that I’ve sold and I’m carrying the paper.” So, owner-financed. “I am considering changing my residency, but do I have to continue to pay Oregon state taxes on these notes?” Interesting question.
“Where should property management business be formed?” “Wyoming is where I reside, Corp, S-Corp, LLC, disregarded.” That’s interesting.
Good questions thus far, “Can you have both a private foundation and a public foundation? The private foundation’s 5% donation to go to the public?”
“Do distributions from state-specific disregarded LLCs to a Wyoming holding LLC cause a taxable event?” Good question. We will answer that one, too.
“Is it too late to rent out your house for 14 days under the tax code?” We’ll answer that one, too. We’ll get into what they’re actually referring to.
“Hi, I’ll be 70 in April of 2020. Since the new tax law or the new law allows us to take the first required minimum distribution at 72, that I don’t need to take RMD this year?” That RMD, by the way, is Required Minimum Distribution from a qualified account like an IRA, 401(k), defined benefit, or something not a Roth.
“What is the requirement by the IRS in order to qualify for a real estate professional?” We’ve gone over that a few times, but it never gets old and it is something we need to keep going over because people keep sending me stuff that’s wrong. I love accountants, but sometimes they’re wrong.
Jeff: They make you a little crazy?
Toby: Like the IRS, they actually had said, “Oops, we made a mistake on this one.” They’ve done some opinions and they’ve had some court cases where they actually did it wrong and they’re pretty good about saying we got it wrong, but there is still bad stuff floating around there. We’ll go over that.
“What is included in calculating a gain loss on the sale of a single-family home rental? Broker commissions, seller paid, closing costs, renovation…” We’ll go over all that. Jeff loves that type of stuff.
“Does all revenue in a partnership have to be declared as income by the partners even if some is left inside the company?” So you don’t distribute. Yeah, we’ll go over all that.
Before we get into this, we have at Anderson, basically, there are actually five levels of classes. Level five is an executive retreat. I just want to go over this with you guys because a lot of you folks aren’t already Anderson clients and haven’t been to our workshops. I want to invite you to a bunch of stuff and I’m going to give you free stuff because that’s how we roll and then I’ll show you some really cool stuff.
The first one is a tax and asset protection workshop. Quite often, we run this one as a special where we will give you an invitation where you can come. It’s a three-day class on tax and asset protection. We really focus on real estate because it’s a huge risk asset. They’re all over the country. You can go to our website at andersonadvisors.com and look at it. You’ll see that there’s pricing on there. If you reach out to us through the taxtuesday@andersonadvisors.com email, Susan and Kendall will grab these and we’ll absolutely comp you because I said so.
Level number one class also is an infinity investing workshop. My little favorite workshop that I love to teach because I love teaching it to younger people. It’s not sexy. It’s how to get rich slowly. In the infinity investing workshop, we’re going to be doing one on April 18th, I believe. You will all be invited to it for free as a courtesy and it is a live stream. It won’t be something where you have to fly out. You’ll be able to stay home and listen to the recording as well. It’s a one day class, I would encourage you to watch and also get your teenage, young adult kids, or friends involved. The reason that I say that is because in 20 something years of looking at tax returns, I know who makes money and who doesn’t and I know what consistently. You’ve been doing this a lot longer than me Jeff.
Jeff: Close to 30 years.
Toby: Close to 30 years and are there things that people that make money all the time pretty much do that those that like to blow themselves up do not?
Jeff: Yeah, there’s different things and it’s anything from really paying attention to where your money’s going, setting up your structure properly.
Toby: I’m going to make it really easy for you guys. We’re going to learn what an asset actually is and how to identify it, how to avoid buying liabilities with liabilities. You’re also going to learn to actually use mathematical equations when punching and we’ll be able to cut our costs. Just to give you an idea, if you have a stock account with $100,000 in it, chances are you’re paying about $4800 in fees that you may not even be aware of. We’ll show you how to eliminate those.
It’s absolutely a hoot. We use stats. We use the information that’s available in the public record. You can go out there and see who makes money, and how they make it, how you can avoid being the gambler in the casino, and you can learn how to be the casino. Infinity investing workshops, actually fun. It goes hand in hand with everything else you’re already learning.
We work with a lot of awesome affiliates, a lot of great real estate companies, and this will go hand in hand. We’ll just give you some mathematical equations on how to build passive income sources. The idea of infinity is you never have to work a job again, and how to figure out what that number is, and how to calculate. These are free, the tax and asset protection workshop and infinity workshop.
Structural limitation workshop for those of you who actually put a structure in place if you’ve gone through one of our courses, if you have corporations, LLCs, we’ll teach you how to run them correctly, bookkeeping, and all the compliance you need to do. I’ve been teaching this level three workshop, this TaxWise, and I’m going to give you guys an offer for these next two days, on Thursday and Friday. It has been sold out for quite some time, but are still available on the live stream and I’ll show you how to get that. If you want to watch it or watch the recording.
The nonprofit workshop, I’ll be doing (I think) in 2-3 weeks. That is also sold out, but there’s also a live stream on that one. If you like doing […], if you want to learn how to run a 501(c)(3), it’s a lot of fun, but I’m going to focus on the Tax-Wise, because you’re going to learn basically 30+ strategies on how you can save. I always tell people, walk away with three of them, and you’re going to pay yourself several thousand dollars a year. It really does come down to about $1000 an hour of planning and we’re going to give you the tools so you can do the planning, so you can save yourself a lot of money.
It is obviously the 6th and 7th are sold out here. We’re completely out of capacity. We have quite literally about 600 people on the live stream, and we have room for more because this is a live stream. What I’m going to do is just to kick-off 2020. If you want to have the Tax-Wise courses, we do it at the beginning of the year and the end of the year. What we’re going to do in 2020 is two. We’re going to do it at the beginning of the year and the end of the year planning. Both of those, to have both of the live streams and the recordings is $247.
You’re going to go to this little ABA link, TW2020. It’ll take you to a login page. It’s not on the portal. A lot of you guys realize that if you’re platinum, you can go to the live streams for $197 each. This is going to be cheaper, it’s $247. It’s going to take you to a little page where you just fill it out. It’s basically two for one, it’s 247, you’re going to get the live cast and the recordings, and you’re going to get access to both the beginning of the year and the end of the year.
Guys, I’m not going to blow smoke up your skirt. If you spend some time with us on taxes, you’ll absolutely put money in your pocket. I guarantee you. If you don’t save, I would just say at least $1000-$2000, even a basic person, I’ll give you your $247 back, how about that? The fact of the matter is, you wouldn’t be making any money. I could show pretty much anybody with a pulse how to save money and that’s just because there are so many little nuances that people don’t see that we’re able to do.
Absolutely join us. Instead of paying a lot of money, you’re going to pay a little bit of money. You’re going to pay $247, you’re going to have both recordings and then we’re going to get direct right on over. Let’s jump into the questions. Feel free to jump on then, that’s the last you’re going to hear that.
“I may be inheriting a timeshare that I’m sure has fees associated with it that I do not want. If I end up getting this, how do I figure out the details to get from underneath it?” Jeff?
Jeff: Many people have run across these timeshares that they’re cheap to get into, but expensive to keep, and they’re very hard to get out of. I know one way of doing this is to disclaim your bequest, your inheritance. By doing so, you’re saying, “I don’t want this.”
Toby: Yeah, it is fun. Whenever somebody passes, they have an estate. Unless you had something in joint tenants or thread of survivorship, or you had a paid on death, or you own something, it has to be joint tenants (I can’t think of another situation), it’s going to be part of a separate estate.
If I’m a joint tenant with the right of survivorship, we both own something together. If one of us has a liability, the other party is responsible for it and vice versa, but if I pass, let’s say, Jeff and I own something as joint tenants, then Jeff owns it and he’s on the hook.
If I am a child of somebody and I don’t own that as joint tenants, usually joint tenants with the right of survivorship are something between the parents or husband or wife. The big issue is don’t do this with your kids, because your kids’ liability can come up and take something away from you during your life.
I see in certain cultures, mom will put their son on their bank account and then son gets a divorce the next thing you know mom’s account’s getting hit by an ex-spouse, which is never good or son us something funky. We’ve actually seen this a few times in bankruptcy. It’s an available asset, the bankruptcy estate, so they’ll grab it. You don’t do that.
But let’s just say that it’s a situation where you don’t own a joint tenancy, it’s maybe a child, then there’s actually the estate, and before it’s transferred to you, you have the ability to disclaim it. If you disclaim it, then you’re out from under it, so to speak, but if you use it, you lose the right to disclaim in these situations especially with the timeshare.
Jeff: Yes and the time to disclaim is actually fairly short, isn’t it?
Toby: It depends, you usually have nine months after somebody passes to get everything done. If you probate it, then it’s an estate-by-estate, but it’s usually about 120 days that they would have to make a claim. You’re just saying, “I don’t want it,” because it’s too costly, “I don’t want to get this timeshare that’s just going to weigh me down.” Now, if it’s an asset, you should have it valued.
Let’s say that you don’t want to pay those costs but you could sell the timeshare, the estate should sell the timeshare, so now you’re under the clock, usually, you get about nine months, you might want to list it for sale and see if somebody will take it. If they take it then you’re off the hook, again. You just sell it and then that asset would be part of the estate, gets distributed to the beneficiaries, if you’re one of the beneficiaries then you would get the cash, but it’s tough.
Then you have these weird forced heirship laws that exist in Louisiana and Puerto Rico. This one may force you to take something and then you’re fighting off the liability. I actually saw this once in Puerto Rico where somebody was being forced to buy a house that was underwater with the mortgage and it took a little bit of paperwork to get out from underneath it.
Do not put your head in the sand and say, “I’m not going to do anything.” You still want to get rid of this. You still want to get rid of it and it usually is going to require a disclaimer. Let’s put it this way. If somebody leaves you as the primary beneficiary, and then it goes to another sibling, an uncle, or some of the relatives, then it goes to them and they have to disclaim, too. It’s not easy-peasy, I wish it was.
“How do I transfer ownership of a property used as a rental that was in my husband’s name to an LLC under my real estate C-Corp? Is it possible to refinance the property then transfer the title?” What say you, Jeff?
Jeff: Here’s how I would do it and you may have another idea, Toby, but I would actually transfer title to my spouse or gift it to my spouse. It’s a tax-free exchange and then she can just dump it into that LLC, she can contribute it to the LLC under the corporation.
Toby: If you are in a community property estate, and it may not matter. If you transfer it into an LLC, this is where it gets really important. An LLC is not a tax designation. There’s no such thing as an LLC to the IRS. They want you to tell them how it’s going to be taxed. An LLC could be taxed as disregarded, ignore it and tax the owner. It can be taxed as a partnership. It could be taxed as an S-Corp, it can be taxed a C-Corp, it could be taxed as a trust, it could be taxed as an individual. Again, you’re telling the IRS when you filing its SS-4, how it’s going to be taxed. When you say, “I’m taking a rental property. I’m putting it into an LLC,” first question is, “How is that LLC being taxed?” If it’s disregarded or a partnership, then we don’t really care. You’re not going to pay any tax on that transfer.
Yes, refinance the property before you transfer the title 99% of the time because they will not finance it in an LLC. They will not finance it in trust unless it’s a portfolio company. If it’s a traditional lender, they want to finance it in your name and then you’re going to put in the LLC. If you’re worried about a due-on-sale clause or you’re concerned, I would use a land trust may be as something to hold title and then make the LLC the beneficiary. When they say, “Under my C-Corp,” hopefully that’s just a management company because I would never put the rental property in the C-Corp.
Jeff: I was going to say a couple of things I saw was apparently this rental property is not being protected by an LLC right now, so I think it needs some kind of protection, but yeah, I putting it in a real estate C-Corp would not be my favorite place to put it by any means.
Toby: Yeah. Somebody says, “Hey, what’s an SS-4?” An SS-4 is a document that you file to get an employer identification number. Whenever you set up an entity or if you want to be a sole proprietor and you want to operate in a different name, then you ask the IRS to give you an employer identification number. It’s like a social security number, but it’s for a company.
You’re just going in and asking them, “Hey, so it’s an LLC,” for example. There is no such thing as an LLC, so if you fill out the SS-4, you might say partnership. If it’s going to be disregarded, you’d actually click other LLC disregarded. You just write disregarded and then you give the tax identification number of whoever’s return it’s going to go under.
If it’s disregarded, for example, here it’s the husband and wife filing jointly, you can give either person social security number and the IRS now expects to see the profit and loss from that rental on that individual’s 1040. That’s what they look for.
Again, I wouldn’t have the real property in a C-Corp, there’s a number of reasons why. You lose the long-term capital gains as an individual, you lose the ability to have flow-through losses, you lose the ability to have a real estate professional status for that LLC, the real estate is offsetting my other taxes, either as an active participant or a real estate professional. There are so many things.
If you take it out of the C-Corp, it’s a taxable event, so we want to make it really easy to refi again, I want to pop it back in my name, it’s not taxable if I have it in an LLC taxed as a partnership or as a disregarded entity.
To answer your question more clearly, assuming that LLC is really you and your husband, then more unlikely an LLC is disregarded or taxed as a partnership, then yes, you can refinance it, put it in a transfer title, there’s no taxable event, you could take it out. If you’re in California, for example, there’s no Prop 13, it doesn’t reassess the value as long as you’re the owner. We see that all the time and people that do real estate know that all the time.
“But what if kids want the timeshare then they keep it?” Then they have to pay for all the bad stuff. That was on the previous question.
“If I purchase a Ram pickup with rear passenger seat,” by the way Rams are awesome, Michael Bowman, my partner, you know Michael, he’s up in Salt Lake City where he lives now and we’re driving around. He’s got himself a Rebel 1500, so those things are awesome. “can I deduct the full amount of my taxes? I have two subchapter S.” Do you want to whack this one?
Jeff: Well, it’s funny that you mention the Ram because 1500 starts at just over 6000 pounds.
Toby: Hey, it worked. I think there’s only the club.
Jeff: I bet there’s something totally worthless welded on the bottom of that sucker to get that over the 6000 pounds.
Toby: Why is that 6000 pounds so important?
Jeff: If it’s over 6000 pounds, it’s considered a heavy truck, a heavy vehicle and at that point, it’s subject to section 179 expense. It’s not limited in how much you can depreciate each year and even though congress—
Toby: In English.
Jeff: English?
Toby: You can write the whole thing, though?
Jeff: Correct.
Toby: You got to bring along a CPA, you need an interpreter with the CPA.
Jeff: All right, but you got to keep in mind that if you’re going to write the whole thing off, you got to use it 100% for their business.
Toby: Otherwise, you’re going to pay tax on personal use and the IRS gives you a wonderful schedule that says, “Based on the value…” A cheap Ram right now, let’s say, you bought a new one, it’s $50,000…
Jeff: I was looking at the prices of the trucks. Wow.
Toby: […] cheap and that’s when that’s pimped out, you could probably get one for $35,000 if you really want to have one. But if you had personal use for that, they’re going to say, “What’s the lease value?” let’s say you used it 50% for business, 50% personal. Then, they may say the lease value is $10,000 a year and since you used 50% for business, even though your business wrote the whole thing off, you’re going to have to pay tax on 50% of the lease value which is half of that $10,000. You pay tax on the payroll of $5000. That’s how that works, but your company got a $35,000 deduction, so you have to balance those.
Somebody says, “Depreciation on a Ram makes it look a little more palatable.”
“Can a single-member LLC taxed as a C-Corp create […] 401(k) for passive investing?” It can sponsor the 401(k), but you are the investor, so it’s still your account. The business sponsors it and you are the participant, but yes it can.
Somebody asked an interesting question. “I’m looking to start an IT staffing firm. I want to leverage after-tax Roth retirement accounts like ROBS.” Well that’s not really […] you’d think about doing a ROBS transaction with the Roth or 401(k) to minimize the tax burden, you’re going to have to use a C-Corp. He says, “I’m trying to avoid double taxation with the C-Corp. What is the best strategy step?” DJ, I might be looking at an opportunity zone (first off) because you may never have to pay tax if you hold it for 10 years and you can defer tax for a good six years now on anything that was taxable.
For example, if I sold something, had some capital gains, I could push that straight in and I wouldn’t have to pay any tax this year. I pay tax in 2026 and never pay tax again as long as half of my staff is in an opportunity zone. Or if you did a ROBS transaction, you have to be a C-Corp and C-Corps aren’t so bad.
C-Corps are actually really good because you have a 21% tax bracket. If you take the money out, you pay tax at your long-term capital gains rate, which can be zero. It always depends on when you take it out. Long answer to a simple question, so that you have a bunch of options. What I would say is you need to talk to somebody. Just raise your hand to Susan and she’ll get you hooked up with a professional adviser who’ll give you your options.
“Is all of the funding for legal costs to start a business tax-deductible? Do we get the full amount we put into starting this business refunded during tax time?”
Jeff: For the first part of the question, we talk a lot about startup costs. Actually these legal costs to start your business are what we call organizational cost. You have startup cost, you have organizational cost and both of them allow you to deduct up to $5000 or expense up to $5000 in the first year.
Toby: In the first year. “If it’s over $5000, do I lose it?”
Jeff: No, you don’t lose that $5000, you can still amortize the rest of it over the next 15 years but once you have $50,000 on either of those categories, you lose that $5000 in your amortizing whole amount.
Toby: If you spent legal costs of $30,000, you take $5000 and then you take the $25,000 and divide it 15, you get to write that off.
Jeff: Correct.
Toby: If it’s $100,000 then you would just take $100,00 and divide it by 15.
Jeff: Now, the second part of this question, “Do we get our full mount to put into starting a business, free fund it during the tax time?” I hear this fairly often. You have to understand the IRS is not refunding any money that you have not paid directly to them. But I think what we talk about is, you can reimburse money that you paid for starting up the corporation to yourself. So, the corporation’s reimbursing you. It’s not the IRS or any other government authority that’s refunding you money or reimbursing your money. Also, you’re using these expenses, so if you generate income, then it’s going to lower your tax liability.
Toby: Yes. Here’s the big one. First off, can you get the full amount refunded? What you can get is, you can have it returned as a reimbursement from the company. Let’s say that I spent $10,000. Your company can give you $10,000. It’s going to get a deduction of $5000, plus the other $5000 is going to be divided by 15, and you’re going to $400 something a year. Your first year is going to have a $5400 something deduction, and if you make $5400, you paid zero tax. You got the money back in your pocket.
It’s not a refund. It’s like a tax credit. The tax credit is dollar for dollar. You could absolutely, potentially do that, too. I don’t know if there is another way to look at this, but no, you just get a deduction. So, we’re going to make it really easy. What Jeff said.
Jeff: What the accountant said.
Toby: What the accountant said. Actually it’s better, you don’t need an interpreter on that. You did a really great job on that. By the way Jeff, you said there are startup expenses, too. You get $5000 for a startup, which is the investigations into the business and $5000 for organizational cost, filing fees, lawyer, accountant cost, all of that. Startup fees can be just anything that you spent, get checking out your business, and getting ready to go into it. You can have both.
“Which is the best way to fund an AirBnb, cash, and mortgage if money is no object.”
Jeff: Here’s my way of looking at this question. Can I get a mortgage loan that I can invest my cash elsewhere to get a better return? I don’t see that so much as a tax question. You do have to figure out, you’re going to have some interest on your mortgage that you’re going to be able to deduct and that is going to go into the calculation, but I look at this more as a return on the capital question.
Toby: Everything does that. Here’s the thing. If my returns on my money, and it always reminds me of the Buffet. He said, “A bird in the hand is worth two in the bush,” and he goes, “No, that’s not right. It’s a bird in the hand might be worth two in the bush, depending on the length of ownership and the return,” or something like that, I just remember laughing. I think it was his last year’s conference, but it was.
What is the best way to use your money? If I am getting 10% consistently on my money and I can get a mortgage for 3%, then I am better off to borrow somebody else’s money at less. The problem is, that’s pretty hard to do like you have to have some consistency. If you’re sitting on cash, chances are, I’m not going tell you to get a mortgage, if you can go buy it for cash do it.
Here’s the thing with Airbnb, whenever we see Airbnb, it can either be a trade-in business or it could be a rental. What dictates that is whether the average rental period per guest is seven days or less. If it is, then it’s a business, you’re a hotel and it’s active income, which means you’re going to get hit with self-employment tax and your ordinary tax rate. If it is not, if it’s over that seven or eight days or more, then it’s going to be passive.
The reason is it’s important, is you should look and see whether if you borrowed money, whether that interest is going to keep you from having taxable income. If that interest is going to make you operate at a loss, then you don’t get to use it because it’s passive, then I probably wouldn’t do it. If it’s going to create an offset active income, then I might, because every dollar that I’m saving, if I’m paying that, not only is it the interest rate that perhaps I’m able to make a spread on it, but it’s lowering my tax bracket as well.
I might say, “Hey, I’ll take that action just for the tax savings.” It’s a little bit of a calculation we do. I’m not going to sit here and play with the numbers live. It’s a fact and circumstances. What I’ll be doing is looking at your situation saying, “Hey, here’s your option, here is the spread.” If you can get cheap money but that cheap money that you paid to somebody else is lowering for every dollar that I’m paying them (I’m getting 50 cents of tax benefit), then all of a sudden I have to factor that in to how much I’m actually paying.
If I have a nice dividend stock portfolio that’s paying me 3%, maybe I’m selling some options on it and I’m getting another 2% or 3%, so I’m making a very no sweat 5% or 6%, maybe I’m doing this. Maybe it’s going to make a much better situation because all of that money that I’m talking about by the way, while I’m doing the dividend, that’s long term capital gains too. That’s tax.
Even if it was a push, I may still be coming out ahead, because I may be paying three, but I make three, but my 3% that I’m paying is offsetting active income and saving me 50 cents on the 50%, but the money that I’m paying in dividend is being taxed at 20%. I make a little 30% spread there. We actually have to do the numbers.
Jeff: The one thing I would say on this, if you’re going to do the mortgaging, you need to make sure that you’re putting enough down on the property where you are not paying fees that you don’t need to be paying.
Toby: See, these guys are fun. There’s a whole bunch of stuff going on here. All right, I’m going to have to get to these questions a little bit. You guys asked a ton of them, but they’re not related to this. That happens once in a while.
All right. “Which is the best way to fund a new small business, it’s mainly based on one piece of equipment and needs just one staff?”
Jeff: I found this question interesting because first off, I was very curious as to what this one piece of equipment was. Also, if the staff was somebody that they were going to have to hire to work the equipment? What were they doing with the equipment? Are they renting it out or is it some type of manufacturing? A lot of questions.
Toby: Here is the deal. Whenever I have a new business venture and if I’m going to use the equipment, I’m going to be very, very tempted depending on what my outlook on it, because most people get one piece of equipment with the eye towards getting two, three, four, five. You want to establish business credit in that business.
If I’m going to fund a new business and I need to establish business credit, I’ll tell you exactly how I’ve done. I’m giving it money, I take that money, and I put money into a CD or very conservative account, and pledge that as security on a line of credit so that business starts to build up its own credit profile. That line of credit, I would use to buy that piece of equipment. If I do this right, I may either generate an active loss, which I can absolutely take depending on that piece of business or I may not be, if it happens to worry about paying any tax.
For example, if that piece of equipment is $100,000, I may start off at the gate taking $100,000 loss. If it’s $179, I’ll believe I can take that as a loss against my personal, I’ll carry it forward. But let’s say, I made $100,000 off that piece of equipment, I paid zero tax on it. The staff member just tells me I had to be careful about taking out, depending on how many hours a week they work. I may have to worry about discrimination rules. If I throw a 401(k) on this, or if I have a very aggressive Cafeteria Plan, or 105Plan, health, dental, things like that, I may have to allow them to participate, so I want to factor that in. I would actually be looking at funding it with cash with an outlook towards using that cash as security to start the credit profile in the company.
When it comes around time to buy new equipment, I now have a credit profile that’s going to take a couple of years. I’m just going to warn you, but I’ve literally done this in two different businesses and this is the way you do it. What you end up with is you have a credit history on that business. Eventually, they don’t require the security, the piece of equipment is security.
If you have really good credit, depending on the type of equipment, if this is heavy equipment for example, then you may be able to co-sign and allow the business to start building up its profile with it being the main lender or the debtor and you as a personal guarantor.
Jeff: One of the things we talked about is separating the equipment from the business. Let’s assume as you said, it’s a piece of heavy equipment. It might be a mobile crane or something of that nature. If we were to do that and rented the equipment back to the business, we have a company that only has equipment in it, where would you put the staff?
Toby: It depends because the staff, there’s a liability with having staff. If you really have an expensive piece of equipment, you probably don’t want the staff with the equipment. I have them in the operating business and I have the rental income coming over from the equipment. Usually, it’s going to be an LLC. Let’s call it an Equipment LLC leasing over to a management company and the staff would be employed by the management company. You have discrimination rules, regardless. The discrimination rules say, “Any companies that I own more than […] percent of is all going to be treated as one anyway,” for discrimination rule.
Jeff: So, for benefits, it’s not going to matter where you put it?
Toby: Right. Some people think, “Hey, I’ll have employees over at Company A and I’ll be the sole company employee in Company B. I’m going to give myself a whole bunch of reimbursement and a bunch of benefits, insurance, et cetera, and I’m not going to provide it for the other company where the employees are.” It doesn’t work that way. They’ll call your brother and sister corp and they are going to throw you in together. Or any organization. It doesn’t have to be a corp. That’s where they determine brother or sister organization.
Jeff: When you were talking about the lease, bill, credit, and all, does separating equipment from the business change how you would do that or will it work the same way?
Toby: No. You would use that particular business and you’d have to show it’s income. Let’s just say that this wasn’t only the business, that I actually had the main company. For example, I had a dental office, so I was buying equipment […]. If I was going to create a separate entity with its own credit, I would have to show an income stream.
I would have to figure out what the fair market value for that rental is, I would lease the equipment to my main company, and I would start documenting. In credit, you always say it’s cash, collateral, or credibility. The three Cs. I’ve been doing this for years, so that’s what you call it.
You either have to have a bunch of cash, so you put money into it, put it in a CD, and use it as a collateral. You have collateral, which is there’s a piece of the equipment. Sometimes you are using real estate, sometimes you cross-collateralize. Then, there’s credibility. The credibility is you until the company is old enough to stand on its own two feet. It’s like a teenager.
You’ll have to co-sign at the very beginning. Some people get really mad and they say, “I’ve set up a company. It’s got a […] done in Bradstreet. Why do I have to co-sign?” Because there’s no history, that’s it.
“I just got approved to borrow by having the LLC pledge the asset property, should I have applied as the corp who owns the LLC?” Not necessarily. This is the case in point. This is somebody asking online, you guys can’t see the question. He got approved to borrow by having an LLC pledge the asset to the property. So it’s cash, collateral, and credibility. Which area does that fall into? The collateral.
You are cross-collateralizing. The LLC may have got it. This is exactly what we are talking about. Or if I wanted another company to build it’s a credit because it’s the one I wanted to have access to funds or equipment, then I would build it in that particular entity, in which case then I would just have to pledge the other asset. You just have to say, “Hey, use this as security.” You can. It’s like being a co-signer. You always have to be direct which company is going to build the credit and why.
If I am going to have a leasing company, I want to have a whole bunch of equipment, I don’t want to worry about my employees filling a discrimination case or slip and fall happening. I put a bunch of water on the floor and somebody, let’s say it’s the dental office, they trip and fall or there’s a malpractice claim. I don’t want my equipment to be in the target field. I don’t want it to be there for someone to take. Then, I’d separate it out. Good question, though.
Somebody has asked, “Do discrimination laws apply for your 100% owner of a C-Corp Management Company and you get benefits then you are also 100% owner of an S-Corp that manages that may have employees?” Yes, it does. Again, they look at it if you and anybody else own more than 50%, I think it’s 50%. Then any of those entities are considered brother-sister.
Jeff: Right and a really good example of that is I can’t set up a defined benefit plan in that C-Corporation where I only am and exempt all of my other people who are over my S-Corporation. Whatever I contribute for myself I have to contribute to the S-Corporation employees.
Toby: Right. Somebody just answered and said, “Company A is a doc and has employees. Company B is owned by spouse and Company A is also employed by Company B. Company B has a 401(k) with only the doc and spouse. Best employees of Company A be covered.”
I’m just going to say real quick, husband and wife are considered one person. So yes, you are going to have to cover. That’s a great example and this is the prime example. When you do that, as much as we would love to be able to say no, you are going to have to say yes, but there are ways around it. You just have to be aware of it and you can put in there vesting requirements. You can put in there different classes of employees. Sometimes, for example, you would say only a certain level of employees are covered. Sometimes they are safe harbors for 401(k)s.
What you could do is make them available for them. You may have your own 401(k) and you may have to have a 401(k) for the other employees and you just need a safe harbor which maybe is a 3% match or something. You actually work with a 401(k) specialist and they put it together to make sure that you’re copacetic. You just don’t want to pretend it’s not there because you don’t want to lose your deduction.
Here’s a good one. I have certain questions that I see come in and I actually get excited for. When I saw this I was like, “Hey, this is pretty cool.” “Is there a rule of thumb to follow when deciding whether to capitalize or expense expenditures made to renovate a property? For instance, would new flooring, lighting, plumbing, built-in cabinets, et cetera be considered expenses or capitalized expenditures?” First, of Jeff, could you explain what they are asking?
Jeff: Okay. We have a rental property perhaps and we’re renovating, maybe tearing out the kitchen. This actually has several rules of thumb. The first and easiest one is if each item comes on an invoice that is less than $2500, you can expense that.
Toby: What’s the difference between an expense and a capitalize expenditure?
Jeff: A capital expenditure is going to typically be depreciated over the life of that asset. It might be a 5-year asset, 7, 15, as long as 39 years for commercial property. It may take a long time. We used to see typewriters for $35 get depreciated over a number of years. The first way to expense that is like I said, you get the invoice, it’s important to work with your contractor if that’s the case that he is building that countertop and a sink may be separate to keep it under that $2500 invoice. What you don’t want is a bunch of $2500 invoices that say “renovating kitchen” because the IRS is just going to accumulate those and disqualify it.
Toby: What Jeff is saying, paraphrased if it’s something that is an expense you get to write it off now. If it’s something that is a benefit over the useful life of whatever that is you are attaching it to, then it’s called capitalized. They spread it out over the useful life of that structure if it’s a piece of real estate. When you say renovate a property, I’m assuming it’s real estate. It’s not a bicycle, it’s not personal property.
If it’s commercial, it’s 39 years. If it’s residential, it’s 27½ years. That sucks. If I put in flooring, lighting, plumbing, built-in cabinets, et cetera, I’m spreading it out over the lifetime. Certain cabinets, by the way, are over a shorter period of time if it’s in the kitchen, but if it’s in the bathroom then it’s over… They have some funky rules.
Patricia, by the way, you are hitting it. There are people that are responding live to me and they are saying, “What about bonus depreciation?” We are getting to hit that. You are getting it right on.
Somebody says, “What about the de minimis safe harbor?” Aaron, you are absolutely right. You guys are hitting this before we even get there. You guys are smart. You guys are already hitting on this stuff.
If you don’t want to capitalize it, then it needs to be considered a repair, or you need to be in a safe harbor where even if it would be possibly something that is benefiting the useful life, it’s in an area where the IRS can’t contest it. What Jeff said is absolutely right. If it’s less than $2500, the IRS can’t contest it. You are in a safe harbor. They agree not to audit you on it because it is less than $2500 and you get to expense it. I get to write it off right now.
What about the stuff that I don’t get to write off right now? It’s over a long period of time. That’s the default. That is 39 and 27½ years. Somebody nailed this already, I think it was Patricia. You get a star. If it’s less than a 20-year property, you can write it all off all in year one. Twenty-year property means, flooring might be seven years, the lighting might be five. For plumbing, depending on the type of plumbing, it could be 15, 7, or 5. Built-in cabinets, I’ve seen those, again if it’s a bathroom they’ll probably say it’s part of the building. If it’s anything else, it’s probably a five- or seven-year property. I forget which one.
Jeff: One of the big changes was HVAC was made to be a shorter life.
Toby: HVAC I believe you can actually do in your 179.
Jeff: Correct.
Toby: There’s an equipment amount of $1 million a year, you can write off immediately. An HVAC, I think security systems, but these aren’t commercial properties. These are for residential properties. But everything else, you don’t need that because if it’s anything else and it’s less than a 20-year property, you can write it all of in year one.
You are looking at this going, “How do I get there?” Well, you actually have to break down the pieces. It’s easy if you are doing a renovation because you have the contractor. What Jeff said is actually 100% accurate, but you are going to do something called cost segregation and that’s a change of accounting election. It’s a Form 3115 that you file. It says, “By the way, I don’t want the default. I don’t want to write this off for over 27½ years. I want to break the pieces down into 5-, 7-, and 15-year property.” If you are wondering about an example, I grabbed a few examples. These are things you would have that would increase the value of the business, that these will be broken down into pieces.
For example, when we look there and you see additions, bedroom, bathroom (obviously), deck, garage, porch, patio, those are all additions. Those will probably be 27½ , 39-year property depending on what type of property it is. The porch and patio might be 15 years. The lawn and grounds are almost 15-year properties. Miscellaneous, those are probably going to be closer to the new roof, one of those 15-year properties now.
Jeff: The roof also got an exemption, but I think, again, that’s for commercial properties.
Toby: Yeah, but it also has a shortened life.
Jeff: It does have a shortened life.
Toby: It used to be whole but I think it’s going to be covered underneath your bonus. A central vacuum is probably going to be 5 years. Wiring upgrades, what is wiring usually going to sit in under?
Jeff: It actually depends on what it is for.
Toby: Yeah, it depends on whether it can be removed. I know there can be funkiness. It might be 5 or 7 years. Seven is probably going to be than 15, but either way you have the right to write the whole thing off. A satellite dish is probably five. A security system is probably five. All of this stuff, you are going to get to write off in the year if you break it out. Anything that is less than 20 years.
Jeff: Here’s one of my favorite categories is that lawn and grounds. Some of those items, the driveway, the swimming pool, the retaining wall can be very expensive and they are all 15-year property which means you can write it off in year one.
Toby: You change your accounting and you go to a cost seg, which I promise you the only people who know how to do that are people that do real estate. You need to make sure that you are working with those guys.
“Does bonus depreciation year one only apply after cost seg year one is done and form is filed?” You can go back to last year. We can actually do a cost seg and make that election for 2019 all the way up to October 15 of this year. Nine months in the future.
Jeff: And the whole reason for doing the 3115 (called a change of accounting method) is I was previously depreciating my whole house using this method, but now I want to do it this way.
Toby: The way it was explained to me that made sense is if I have a rental house, I buy it and it has carpeting, brand new carpeting. I know full well that that carpeting is not going to last 27½ years. If I go into the default rules, I’m writing that off under 27½ years and if I sell that house, that carpet is supposedly worth something.
When we all know that when somebody buys a rental property, the first thing they are doing is tearing out that carpet and painting all the walls, so why do we buy into that? Why do we let the IRS treat us that way? We have the option, we get to choose, and whether or not you want to write that stuff off really has to do with whether you have taxable income from the real estate.
If you’re getting into depreciation, it’s offsetting all your income. You’re just quitting a loss anyway, then who cares? As long as you’re not a real estate professional or an active participant, you’re not getting any benefit, so why care? But maybe, you have other income, maybe you have other rental income. I’ve seen, “You know what, this saves me a bunch of money in taxes, so I’m going to do a cost seg study and I’m going to take this now.” We’ve done webinars on cost segging. You can go to our website. Done a bunch of them. This is a great winner for people.
Somebody says, “If you put it in a driveway, do you still need to change your accounting or just write it off as a bonus in one year without 3115?” You have to do the 3115.
Jeff: Actually, you don’t. As of placing the current year, you’re not changing that.
Toby: I see what you’re saying. Walk somebody through this. I buy a rental property and I put in a new driveway. You would just separate it out and now it will be 15-year property.
Jeff: Right, but I would still want to do that cost seg.
Toby: But is it required?
Jeff: I think it’s an authoritative way to do it.
Toby: If I own a rental property, if I have already been depreciating that property, do I not have to do it 3115?
Jeff: Then you absolutely have to do a 3115 to change how you’re depreciating that.
Toby: All right. So I have to do it. Existing property that needs a new driveway in year five. It’s year five. You’re going to have to do a 3115 and you do a cost seg study even if it’s not that bad. This is fun stuff.
“If you cost seg property this year but it gets done before April, is it supposed to happen this week with cost seg authority?” I know those guys, […] kick butt. Each great place. “We plan on 1031 this summer, we do a $30,000 in rehab prior to sale, can we do another cost seg immediately prior to the sale? Should we?”
No, you only have to do one. When you rehab, it’s really easy. You’ve already chosen to change your accounting methodology and you have all your property broken out. When you do the rehab, you just want to make sure that it’s easy to classify the property and you’re in […] and you’re good.
“I’m a resident of Oregon. I am carrying several notes on houses that I’ve sold and I’m carrying the paper. I’m considering changing my residency. Would I have to continue to pay Oregon state taxes on these notes?” Let’s just say that all these properties are in Oregon, you have notes on all these properties, and you move to Washington where there’s no state income tax.
Jeff: It can work one of two ways. If you’re just writing the note for it and you’ve recognized all the gain when you sold the properties, the next is an interest. I think you can move to another state and no longer pay taxes to Oregon.
Toby: However that state treats certain activities, if you had a rental property, you’d be taxable in Oregon. If you have a note which is simply, it’s interstate commerce once you move to a different state, then I wouldn’t be paying Oregon state taxes.
Jeff: No, if I sold my Oregon rental on the installment sale, Oregon’s still going to continue to want their share of the capital gains from that property.
Toby: Chances are this individual sold that on an installment sale. Chances are, if you’re carrying back a note unless they decided to recognize it at all because they had a bunch of losses floating around up there, chances are this is somebody who’s doing an installment sale.
What that means, folks is let’s say I had a house that I bought at $10,000 and I sell it for $100,000. I have $90,000 of gain. I sold it to Jeff and I carried back a $100,000 note. That entire transaction is taxable right then in that year unless I elect an installment sale, in which case if I elect to have it treated as an installment sale—let’s just go this 10%, $10,000 basis—we have some depreciation we have to add back, we have long-term capital gains (let’s assume I’ve owned it for over a year), so I had $90,000 of long-term capital gains. and then I have an interest.
I have some money coming that I’m receiving at zero, some money that I’m receiving as depreciation recapture (which is capped at 25%), some of it would come back at my long-term capital gain’s rate which would be 0%, 15%, or 20%, and some of it’s going to be interest which is going to be my ordinary bracket, so hopefully, your brain didn’t just explode.
Jeff: So every time I make you a payment, it’s going to be divided up into different buckets.
Toby: Yeah. And then yours is saying, “Hey, the interest portion would probably be taxable in Oregon in the capital gain’s portion, would probably be taxable in Oregon.” With the dividend and recapture, that would be today’s state tax?
Jeff: I don’t think that would be subject to state tax. That would be wherever you’re at.
Toby: “Is the interest taxable to Oregon along with the capital gain on the installment sale?” If it’s an installment sale, I believe that you’re—
Jeff: Yeah, I agree with that. I think they’re going to say it’s directly attached to those long-term capital gains.
Toby: Hey, I just got a really interesting one. “For California rentals, can you use an irrevocable trust versus an LLC to own the property asset protection then file for the 1041 and do K-1s to do trust beneficiary?”
Maria, here’s the rule just because you’ve piqued my curiosity. What that means is that if you are filing as an irrevocable trust, it depends on where the trustee is, as to whether the funds that are paid are taxable. If the trustee is in a State like, let’s say in Nevada or Delaware, then the income would not be taxable but if you paid it out to the beneficiary, then it would be.
Jeff: Yeah, California even asks on their state trust return, “How many in-state beneficiaries? How many out-of-state beneficiaries? How many in-state residents?”
Toby: That’s actually a really good case. I was totally geeking out with a trust attorney. It was somebody famous and it was their error and they had it up $2 million in a trust that was making about $400,000 a year, but they weren’t distributing any to him. They had a California and a Nevada trustee. Half of that $400,000 was taxable because none of it was distributed to the beneficiary. But when it does get distributed to the beneficiary, they’ll have to pay tax on the other half. If both trustees had lived out of state, let’s just say you didn’t have a California trustee, then it would not have been taxable at all.
Jeff: That’s crazy.
Toby: That’s why people do these nings and dings and there’s a brand new entity we’ll be talking about called a statutory foundation in Wyoming which I think is really, really cool. We’re doing all of our due diligence. I’m talking to the drafters of the statute and we’re making sure it works for you folks in California. California doesn’t get to do the franchise tax on you all when you have a grantor trust.
An irrevocable trust filing, a 1041 is not what I would call a grantor trust. If you do an irrevocable trust but you make it a grantor trust, then you get the asset protection with no tax on the franchise tax board other than your individual tax. You pay your individual, any income whether it’s distributed or not. I’m not going to detail it anymore. I love that stuff.
Let’s go to the next one. “Where should property management business be formed? Wyoming where I reside, incorporation, S-Corp, LLC, disregarded?” Yes, you can have this one.
Jeff: A property manager is only managing the property. They don’t own it. They don’t have any employees there. You can form that just about anywhere. My preference is someplace like Wyoming, they don’t have a corporate tax., they have good liability protection. For a property manager, I would probably prefer it to be a corporation because we can do a few more things with a corporation.
Toby: So, yes. It’s facts and circumstances. I wish I could give you guys an answer but if you have a management company, if you are a property manager, it’s going to be wherever the property is located. We may set it up outside the state and register it to do business there or if I want anonymity, then I’ll probably set up, let’s say a Wyoming entity and I’ll have it own an LLC in the state if I don’t want to have my name on a public record, so I may have an LLC that’s member-managed by that Wyoming LLC that’s taxed as a Corp.
Sounds long-winded. Let’s say all rentals are outside Wyoming, rentals in Inkshire, Washington, so Arizona, Washington, it depends. You have two and it really depends where you’re collecting the funds, whether you have another property management doing it. You actually have some choices here.
If I’m dealing with the tenants and the properties are owned separately by the trust with an LLC, then I am probably wanting to keep my name off of that entity. I want to just act like I am the landlord, not the owner but I’m just the management company. Then you can actually talk smack about the owner. Nobody knows. It’s funny how tenants would treat you differently if they don’t think you own the property.
Anyway, and the private managers are collecting rent time, just the asset manager, then you can be in Wyoming. You don’t actually have to be there and that’s probably what I would do. The money just gets paid to the out-of-state entity. You’d still pay tax on the rental, the profit.
So Jeff, if I have a property manager and I’m heading it out and sending it to my LLC, I’d still be paying a little bit of tax in Phoenix and Washington, depending on what’s obligated in both those states. There’s some version of the tax. Washington has the BNO and Arizona has an estate. I’m paying a little bit of tax on it but I’m only on the net. The management company is going to take its piece out of both of those.
Jeff: In regards to what type of entity, I really feel like the corporation’s the only one that makes sense for catch purposes. Putting it in any pass-through, you’re just taking that on one pocket and putting it in the other.
Toby: Yup. There’s somebody’s actually asking consistently, “Rent would go to the LLC or go to the asset management company?” I would probably have it go to the asset management company. Take your management fee out of it then send the rest as though it was received by the LLC. Just like a regular property.
Jeff: Exactly.
Toby: That will not change the IT from rent. It would still be rent but it would only be the net rent, whatever you leave in it. If you need to pay more of the eQRP, you can actually turn around and write it a check.
Somebody says, “What entity is an eQRP? Is it the same as the 401(k)?” Yes. Somebody just put an “e” in front of it and marketed it that way. There’s no such thing as an e401(k).
Jeff: That’s not in the code?
Toby: Nope. There’s no such thing as an e nor a kceQRP, whoever invented that. I get that question every time, they’re a marketing genius. I’m going to make one called a QRP. It’s Toby Qualified Retirement Plan.
By the way, somebody said, “We were asking the brother-sister corporation question. One of the businesses was a 501(c)(3) and the other one is a company that they have employees in and they are owners.”
Yes. No brother-sister there because there’s no ownership in a 501(c)(3). It’s not owned so you can’t be discriminating. It actually works really, really well. Yes, they are absolutely correct. Somebody had said that. When it’s a corporation, we’re assuming a for-profit, S-corp, C-corp, where you’re an owner. If you have a 501(c)(3), that’s away from the discrimination rules because you are not an owner. You are merely a director. You’re an employee.
“Can you have both a private foundation and a public foundation when you don’t own either one but, yes, you can control both. The private foundation’s 5% donation to go to the public?” Yes.
Jeff: Yeah, and real briefly, talk about that 5% donation. The private foundation is required to contribute 5% of its funds to a charity. I’m going to say a private and a public charity, but I guess it would also work with an operating foundation, wouldn’t it?
Toby: Yeah. Really, you have two groups. You have a pseudo group which is a private operating foundation, but here’s the deal. Public charities are the most common. Those are the ones that are actually doing something. A private foundation is not doing anything except supporting public charities in order to get the tax benefit in the charitable donation which is restricted. It’s not as much as, I think it’s half of the public charities. A public charity can give up to 60% of your EGI. A private foundation, you’re going to be restricted to about 30%?
Jeff: 30%, yeah.
Toby: In order to keep that, you have to give up 5% of its assets to a qualified 501(c)(3). The question is, “Can I give it to my public charity?” Yes, if it qualifies as a 501(c)(3). Yes, if you’re not doing any conflict transaction, you’re not trying to get shareholder benefit or something like that, but if you’re running these things properly, then yes, you could do it. I just put the caveat, so you can’t just take the money and run with it. Somebody says, “Nice, thanks, that’s always good.”
Let’s see, QRP, by the way, is a proprietary QRP, by a guy named Damien, marketing genius, smart. Hey, I never knocked anybody that manages to coin a phrase and here’s the thing, in all seriousness, we need more people saving money in their own retirement funds.
Here’s the funny one. People are always asking me which is better a Roth versus an IRA or Roth 401(k) versus as a 401(k). The answer is, it’s a push if your tax bracket isn’t changing, but if your tax bracket is going to go down when you retire, it’s better to take the tax deduction now and do a traditional. If your tax bracket is going to go up when you retire, it’s better to do a Roth, but everybody’s knee jerk reactions say Roth. When you actually run the numbers, if my tax bracket is 25% now versus when I retire and I have 30 years of growth the same amount, it’s exactly the same.
Jeff: I don’t think people realize that just because they put it into a traditional this year if mine don’t have any income next year, there’s not enough to make a contribution, but if I’m on a lower tax bracket, there’s nothing to say I can’t start a Roth account and go back and forth as needed, or even putting both accounts if you want to do that up to the $6000 limit.
Toby: Yeah. Here’s the deal. When you are really in a low tax bracket, for example, I have clients that will qualify as a real estate professional, we’ll do something this year, maybe we’ll cost seg, maybe we’ll take a bunch of accelerated depreciation (if you guys know about all that stuff), maybe will make them get them down to the 0% tax bracket. Now, I’m looking at them going, “Hey, if we’re at 0% and let’s just say that you even have a negative $100,000 you can convert up to $178,000 tax-free from your traditional IRA into a Roth.
Now the question is, “Do you think you’re going to pay more than 0% when you retire?” If the answer is yes, do that transaction. The answer is yes, guys. Anyway, math is fun. Somebody says, “A times B equals B times A.” Yes, but try to convince somebody that’s been drinking the Kool-Aid of the Roth IRA.
“Is it too late to rent out your house for 14 days under the tax code?” No, you can always rent out your house for 14 days in the tax code.
Jeff: I had to think about this for a long time. If you mean for 2019, yeah it’s too late, the year is over.
Toby: Yes. If you actually rented your house, if you actually used your house, you’re a cash basis taxpayer, so unless you physically move the money in your account, you’re not going to get to write off. You could still do it this year, but that 14 days is a section called 26 USC 280A. What it says is you can rent your house for 14 days or less (it actually says less than 15 days, so it’s 14 days or less), and you don’t have to pay tax on it. That’s why Airbnb people love to rent out their houses and have people sleep in their beds. It’s weird.
This is going to sound horrible, but I went to school in Europe in the middle of summer, and sometimes it smelled. So, I always think of the most smelly friend that I had and he’s going to come over and sleep in your bed. I always say, “Think of the most stinky person, the guy that never bathe or whatever, and they’re going to come to sleep and roll around in your bed. That’s what you’re inviting if you’re doing the Airbnb in your house, don’t do that. See, I’m helping them.
Jeff: We’re really seeing this 14-day thing work is, I know there were people in Miami who were renting out their house for small fortunes that maybe they’re paying $1000 a month on the mortgage and they’re renting it out for $7000 or $8000.
Toby: Then I’m happy to have the stinky guy, but what I’m going to do is I’m going to put plastic sheets on to put over it, and I’m going to burn the sheets.
Jeff: And the mattress.
Toby: Yeah, anyway. Somebody says, “Wait, we need to write a check from the business to the homeowner?” Yeah, or if the money was already there, then you just need to reclassify it. Let’s say I put a bunch of money into the company and it was a shareholder contribution that I need to offset, some of that contribution as a return to the shareholder, there’s a way to do it on paper, but you’re supposed to be reimbursing yourself.
Jeff: You should really be documenting what these meetings are about rather than just renting for 14 days.
Toby: Somebody says, “Hey, I want to do this. Pay myself a $5000 dividend. Can I reclassify it?” Yeah, absolutely you can. In fact, we’d encourage it. You just have to make sure you document it. “Do I need to 1099 myself?” No, because this is actually a section of the code where you don’t have to report it. Isn’t that awesome? “Will that be the same for meeting rents?” Yes, 14 days or less.
This is what we usually see. You see people renting their house to their corporation for their corporate meetings or I have a lot of clients that do MLMs or real estate. We have clients over the place. We have several, by the way, before you think crazy MLMs, I have many, many clients. I want to say more than a handful making over $1 million a year and they’re some of the nicest people you ever want to meet. They’re passionate about something and maybe they’re passionate about their product, you name it. It’s being passionate about something that tends to rub off.
Yeah, you could actually have your meetings in your house, rent your house out, it’s the fair market value, and yeah, you don’t pay tax on it. I’ve seen it, it works great and once a month. “Can I do three in one month?” Yeah, it’s 14 days or less. It can be 14 consecutive days for all the court cares. All the IRS says is, “Hey, we have to follow the rules,” and rules say 14 days or less.
Jeff: Yeah, you just don’t want to have that 15th day or all it will become […].
Toby: Yup. We actually did this calculation with an Airbnb when people were doing this. When he had about 15 or 16 days, you go backwards and in order to make up you have to hit 22 days, so in English, 14 days is tax free, 15 days the entire amount becomes taxable. It’ll take you to about your 22nd day to make up all the tax you had to pay, so don’t do that. “Is it free of state taxes?” Well, it’s non-reported, it’s absolute deductions, so yes, state tax and everything.
You guys can look it up, it’s 26 USC 280A, I’ve been writing about it for 20 something years and just go knock yourself out. We have a really cool 280A kit and we’ve defended this one a couple times under audit, sometimes it pops up. It didn’t trigger anything because there’s no paper trail, but one was not even our client.
We inherited the CPA’s mess and we fixed it. That was one of the areas where we’re able to get some serious tax relief for the guy, $79,000 tax bill down to $2000 and it took about two weeks, just because if you know how to classify things appropriately, those laws are there for your benefit, if you don’t, then they’re done. You’re still there, you just don’t know how to take advantage of it.
“Hi, I will be 70 in April of 2020, since the new tax law allows to take the required minimum distribution at 72, then I don’t need to take an RMD this year?” The answer is correct, you do not have to and that’s because the SECURE Act (Setting Every Community Up for Retirement Enhancement) was passed on December 20th or 21st. It was the president who signed it into law at the very end of last year. This is one of the things that raised that required minimum distribution, that’s required of traditional IRAs, traditional 401(k)s and defined benefit plans. It raised the minimum age to 72.
Now here’s the rub. You have to be 70½ in 2020. If you’ll be 70 in April, then you’ll be 70½ (in theory) in October, so you qualify. You will not have to take a required minimum distribution until 2022.
Jeff: Translate from the attorney. If you were already 70½ at the end of 2019, then this does not apply to you. I’ll tell you what, they count to the very day.
Toby: Yeah, so if you turn 70½ in 2019, is that what you’re saying?
Jeff: Correct.
Toby: Yeah then, you’re toast.
Jeff: You don’t have to take your first RMD until you’re 72. Now, here’s the other side of the coin that’s really weird is they did away with the “you can’t contribute to an IRA when you’re over 70½.”
Toby: You can actually contribute to IRAs forever.
Jeff: Let’s say I’m 72, I may have a required minimum distribution where I’m having to distribute some of my IRA. I may have a required distribution which is taxable to me, but I can also put money back into my IRA.
Toby: Hey, let’s be twisted. Let’s put money in our IRA and give the money that was required minimum distribution to a charity.
Jeff: Yeah, you can still do that with the RMD.
Toby: I would actually end up with a tax deduction.
Jeff: Right.
Toby: That’s so much fun. This is like a tax crack.
Jeff: But there were a lot of new factors in the SECURE Act.
Toby: One of the things is you lost your stretch. Somebody asked this, “Are required minimum distribution still required for inheritances? Well Ruth, that’s an inherited IRA and the rules are a little bit funky for a spouse or somebody who is actually older than the party they’re inheriting from.
Jeff: I think it’s less than 10 years.
Toby: Less than 10 years and also if it’s a special needs child or somebody under 18, otherwise it’s 10 years.
Jeff: Yeah, which is much better than the old five-year rule.
Toby: The five-year rule, but there’s no stretch anymore, I used to get it taken over my lifetime, but no more, it’s 10 years unless you’re a spouse.
Jeff: Also, there’s now you’re allowed to take IRA distributions to pay for birth and adoption expenses, up to (I think) $5000. It’s still going to be taxable but […].
Toby: It’s like $14,000 for an adopted child. There’s some pretty big incentives there. Somebody says, “So if I take a required minimum distribution, can I turn around and reinvest it into the IRA?” Well, technically, that’s not active income, so you take the required minimum distribution, but you’ve also made a little bit of money so you put some of the money you made into the IRA, then yes, you actually can.
Jeff: If you’re over 70½, you’re still going to have to have that earned income, either from W2 or self-employment income or something.
Toby: Whenever I hear distribution being taxed, I’m so thankful that I have a very well universal life insurance policy that will distribute to me tax-free, absolutely. Hardworking folks, it’s a game changer. Yeah, we actually wrote a book on it. It’s called, The Private Vault. If you ever go to our website, you’ll see it there.
People sometimes look at us and go, “What are you guys talking about?” I’m like, “It’s protected, it’s tax-free. I have three policies,” I tell people all the time. I don’t use variable, I use index simply because I got killed at variable when the stock market corrected, index is the more conservative and ratchets up and you can’t lose money no matter what stock market does.
I happen to be a huge believer in them, I have three because I have one for buy-sell with my partners because my wife and daughter aren’t lawyers. They can’t be an owner of a firm and it’s just legally, the way we’re structured as a business, even though we do a lot of tax and everything else, it is still a professional limited liability company that requires ownership to be a lawyer, so they can’t. It cashes them out.
I have a key man policy, because I’m one of the partners here and to replace me, there’s money that dumps in so that they can go to hire somebody else and then I have a regular one. All of those I can borrow against if I need it. I can also use it if I need long-term care and it’s nontaxable, so if I want money, I do it. I used it for my daughter’s education and for her car as well as paying her out into her company. I always laugh. I didn’t hit any tax affected. It’s ridiculous. There’s some years I got refunds back, a lot as my daughter was going to college. Let’s keep going. How many more do we have to go?
Jeff: Three, I believe.
Toby: All right, “What is the requirement by the IRS in order to qualify as a real estate professional?” This is about a two-hour response, so I’m just going to give it to you guys in two seconds. You’re under 26 USC 469(c)(7). You can go read it if you want. All this is, is to qualify as a real estate professional, make sure real estate losses change from passive to active. In order to qualify, there is a two-part first test and there’s a second test. The two-part first test has to be satisfied by one spouse. If you’re a joint return, one spouse has to qualify. I’ll hit this in a second.
The first thing they have to do is they have to hit 750 hours. Second thing they have to hit is it has to be more than 50% service time. Whatever you do that’s professional services, if you spend 1000 hours being a waiter, then you have to hit 1001 hours in real estate. It doesn’t have to be your real estate. It could be your realtor, your broker. It could be your construction person, you’re involved in real estate, you’re a developer, it doesn’t matter. That’s test number one, 750 and 50% or greater.
Test number two is, I materially participate with my real estate and it’s a nine-factor test. If you hit any one of the nine factors, you qualify. When you’re doing this factor, the time requirement is for both spouses. One spouse could qualify as a real estate professional, and the other spouse could qualify for the material participation, and you qualify for your tax return.
Now, the ones I’m going to focus on, this is the absolute, drop dead, don’t have to worry about anything else, if you spend 500 hours cumulatively, you and your spouse on your real estate, your rentals, managing it, handling your real estate, you qualify for material participation.
Somebody says, “What if you’re not married?” then you both have to qualify. You would have to qualify. Each person would have to qualify on their tax return, but if this is a married filing jointly, then you add both spouses.
There are two other tests. If I manage my properties and I’m the only one who does it, then that I qualify. If I manage my properties and I spend more than 100 hours cumulatively, so 50 hours for each spouse, and nobody spends more than 100 hours, then I qualify. Then you have a five out of seven year and a bunch of facts and circumstances tests. There’s nine of them. I’m giving you the big ones.
If you hit 500 hours cumulatively, you don’t have to worry about anything else. If you don’t hit 500 hours and you’re more than 100 hours, and nobody else spends more than 100, then you’re good.
Here’s the last one. This is a per rental property test. Unless you elect to aggregate them together. If you elected to aggregate it, that’s something you do on your tax return, guys like Jeff love to make aggregation elections, so what? They make you check a box and write […] and you treat all of your activities together.
Somebody says, “What documentation?” any log will do. Which means you can do it on a phone, you could be keeping it in a log, just don’t make it up at the end. Where people get in trouble is when they…
Jeff: They like to use that contemporaneous word.
Toby: They weren’t contemporaneous, but it’s not, “I have to do it right now.” They just want it to be correct. The people that get themselves in trouble are the ones where the hours physically don’t add up, like they do 2000 hours of real estate profession and they have a job where they did 2200 hours, and the IRS says, “There’s no physical way you could have done that,” and the court throws you out, says, “You’re an idiot.” Or you have 300 hours documented for one month and nothing else on any others. They just look at you like you’re an idiot.
“I am retired. Real estate is all I do. Do I still need a log?” Yeah. Technically, if they audit you, you need a log to claim it.
Jeff: You need to be able to prove your time.
Toby: Here’s what I do, I tell people, keep track in your phone. Just keep a little Google calendar and just pop in there, “What did I do this week.” Easy.
“Can you take a course and pass a real estate exam and join as a real estate broker?” Yeah, but you still have to do the hours. Being a realtor doesn’t mean you’re a real estate professional. It means that that might be what you do and you have it really cool.
“How about being a capital raiser for a real estate fund?” I don’t know if that would qualify.
Jeff: Yeah, some of those will qualify you for the second test, but not for the first test.
Toby: Yeah. I don’t think it is ever going to be, unless you’re doing it […]. There are certain things that don’t qualify at all, but shoot us an email. It’s a fun one and we may throw that in as a question.
“What is included in calculating gain loss on the sale of a single family rental? Broker commission, seller paid closing costs, renovation?”
Jeff: Basically, what your cost, your basis is going to be what you pay for less any settlement fees on both ends. I should say plus in a settlement fee cost, plus any renovations anything you put into that property that you did not deduct elsewhere, and then whatever you sold it for.
Toby: This is where the rub is, is it at your house and you have a capital gains exclusion, then it just sucks because you don’t get to write any of those off even if you don’t have any capital gains. If you have capital gains, then it’s helpful, but it really isn’t that great because it’s capital gains. It’s probably the best tax treatment you’re ever going to get, so it’s offsetting some of that. It’s just stinky. The deductions that are out there just because some people would say, “Hey, is it lowering the capital gain or is it a deduction?” the deduction is when you’re doing a mortgage interest, that’s deduction. Real estate taxes that you pay on your house that’s deductible. That will offset your ordinary income at the highest bracket.
We like those. This other stuff, maybe not great. If you’re 1031 exchanging, you’re never going to get that benefit. If you own it until you die, you’re not going to pay any tax anyway. You got zero benefit from it, but still track it.
“Can you be a real estate pro not only own one property?” Yes, you could absolutely do that. If you take trips three times to manage, travel to your rental properties, I don’t think it’s going to be included in your time.
Jeff: I’m not sure about that.
Toby: “Can I claim myself on the 1040 occupation section as a real estate professional?” No. You wouldn’t say that necessarily. You could, but realistically, that’s not what we’re talking about here. We’re talking about making passive losses into active losses. It’s a special section.
Somebody was flipping and they’re wondering about the deductibility and whether something should be deducted as an expense. If you’re flipping it doesn’t really matter because technically, you’re probably flipping within a year. If you need a deduction, like if you have a flip that was really good and you’re in the middle of a second flip, you might want the capitalized expenses versus ordinary, just immediate expenses you may want to take the immediate expense now.
“Will you respond to questions that you do not get during the webinar?” Yeah. Send it in, we answer them all month long. Send it to taxtuesday@andersonadvisors.com we’ll still answer your question. That’s what we’re here for.
“Does all revenue and partnership have to be declared as income by the partners even if some is left inside the company?”
Jeff: In a pass-through like a partnership, all revenue, all income gets passed to the partners, whether they take that money out or not. The distribution really doesn’t have anything to do with how much income you’re going to have to report.
Toby: What Jeff said is actually right. These are safes that have money growing inside it and you’re being taxed on the growth inside the safe. Sometimes, you don’t even know what the growth is because somebody else is running it and you’re just a passive partner. In which case, probably in a couple of months, you’re going to get told what you made last year.
That’s when you better have a diaper on in some cases because some of these guys do really, really well but they didn’t distribute it and you’re like, “Well, how am I going to pay the tax,” so you better be […] hope that they have to distribute something because this is where it’s fun. If you’ve ever had a credit or become an assignee, interest holder, or an entity, you know how much fun it is to give them tax bills with no money. That’s the lawyer side of me just being annoying.
Jeff: No, I have been there.
Toby: I think it’s fun. All right, free stuff andersonadvisors.com podcast. If you want to listen to our Tax Tuesdays plus our other podcasts, by all means, it’s free. Go on to andersonadvisors.com and listen. You can also go to iTunes, it’s free. iTunes is free and Google play is free. You can see there’s lots and lots of different episodes. Those are from last year when I took a snapshot, we always have new content.
If you come and go to our YouTube page, for example, you have Coffee With Karl, you have Michael’s podcast and videos, Clint’s videos, my videos, everybody’s videos. We’re always sticking stuff up there we’re an education company. Somebody says, “You’re a lawyer?” No, I’m a teacher and I happen to love working with real estate investors and business owners. Frankly, I just look at myself as an advocate. Jeff and I love to do Tax Tuesday. I think Jeff likes it.
Jeff: I love it.
Toby: It’s so much fun to just answer questions. There’s always the accountants. They should see some of the stuff we get. They’re like, “Why are you answering stuff on a public forum? You shouldn’t answer stuff.” Stop it. Go back to your practice and make everybody else miserable. “I’m going to charge you for an answer.” Come on. Give some people some direction and we don’t have to be stuffy.
I think that the legal, and the tax, and the business professions changed a lot the last 20 years. It’s so much more fun to put information out. We try to be as accurate as you humanly possible. I’m sure we make mistakes periodically, but we’re trying to do the best we can with what we got. If you like, you can go to any of those, Instagram, LinkedIn, Twitter, and here’s another one taxtuesday@andersonadvisors.com or andersonadvisors.com. You can always visit us, ask us questions.
You guys are right, some people said, “Hey, can I ask questions?” absolutely. Shoot it on over and then just know that if you ask a really good question, I’ll probably take it and stick it on one of these and we’ll answer it live because other people benefit from it. “Can I be sent the info on where to find those links?” Absolutely. Susan will get that to you, Reuss, but I’m going to put it back up there for you guys.
It’s really easy. If you go to aba.link/facebook, /youtube, /linkedin, /instagram, /twitter, or if you go to our regular website at andersonadvisors.com/ and then just type in podcast or youtube, you’ll find that. We’re pretty much creatures of habit. Everything’s the same, but aba.link/ and then any of the places you want to get to. You can see that we’re easy to get a hold of.
If there’s nothing else, I know there’s a few questions that I may have missed, feel free to email them all in. We’re here to answer your questions and I wanted to say thank you for joining us. It was fun as always. Somebody just sent a bunch of links out there. I think Susan just sent it out there to you guys. That would be so much fun. We’ll see guys in two weeks and we’ll do another one. Maybe we’ll pick another topic. I think we did bookkeeping last week, which Troy did a great job. You guys have no idea but Troy is a superstar and he hates talking in public.
Jeff: He did a really good job.
Toby: He did a great job. I gave him a hard time. The next Tax Wise is on Thursday. I’m going to put this up just because somebody asked. You can do the live cast on for all of them this year. If you want to join me on Thursday and Friday, we’re doing over 30 tax strategies that’s $247. It gets you both workshops this year. We’ll do all that fun stuff.
“How about details combining C-Corps and LLCs for business?” Not for real estate, so we can do all that fun stuff. We’ll probably do a retirement planning one, a traditional business one, and a few others this year just to keep it fresh.
We made you guys up for some questions specific to some of those things. I think you guys are already sending them in. “When are you doing bookkeeping?” Bookkeeping we just did last week. Get that recording because it was really good and I had chickens and swords.
Jeff: Chicken and swords you did.
Toby: Chickens and swords, you guys never thought you’d see in a bookkeeping webinar, but you did.
All right guys, thank you so much and enjoy the rest of the week. We’ll send all that out Debbie. Infinity rocks. We’re doing one on April 18 and we’ll send that out. Let me give everybody a freebie. You guys can all come to that one on live stream. We’re not going to do it live-live, but we’re going to do that and we’ll absolutely give it to everybody on this Tax Tuesdays for free.
We’ll make sure that we get you guys a link. I’ll probably shoot it out in two weeks, but just remember April 18, I believe it’s a Saturday, and we’re going to do that. Bring everybody you can to that. We’re really revamping it. We’re really going to be knocking it out of the park just because for two years, we’ve been testing it to make sure everything’s working, and we have just about 100% success rate on people growing their assets inside of that. We’re going to keep spreading that word.
All right guys, have a great one. We’ll see you in two weeks.
As always, take advantage of our free educational content and every other Tuesday we have Toby’s Tax Tuesday, a great educational series. Our Structure Implementation Series answers your questions about how to structure your business entities to protect you and your assets.
Additional Resources:
- Claim your FREE Strategy Session, and learn how Anderson Advisors can protect your assets.
- Join our next Tax & Asset Protection event to learn more advanced tax minimization & entity structuring strategies
- For all things investing, check out the Infinity Investing YouTube channel
- Subscribe to our YouTube channel to make sure you never miss the latest strategies & updates
