What’s the answer to all tax questions? Calculate, calculate, calculate. Fortunately, Toby Mathis and Jeff Webb of Anderson Advisors provide additional information to help you determine what makes sense from a tax standpoint. Do you have a tax question? Submit it to taxtuesday@andersonadvisors.
Highlights/Topics:
- What do you have to file when you have an S Corp and take a salary? Payroll tax forms, possible registration with state, county, and/or city for withholding
- I’m a small business owner who didn’t make any income last year. Do I have to file? Depends on type of small business, but filing is recommended, especially for losses
- How much of my remodel can I claim on my taxes as expenses vs. improvements? Remodel tends to mean improvements; separate improvements from repairs
- Can you claim both the home office deduction and the Section 280A for the same C Corp? No, for technical reasons; reimburse yourself for home office costs and corporate use of house for meetings
- How do you report real estate rental income for properties in a trust? Depends on type of trust and how it’s taxed; may be taxable to grantor
- What determines your state residency when you live in a non-fixed location (RV, boat, etc.)? States typically follow the 183-day primary rule, so depends on where you spent most of your nights, as well as where you’re registered to vote and your driver’s license
- I have a family limited partnership that is going to get a large sum of money. I plan to put it all into a nonprofit. Any taxes owed? A large sum of money is typically a source of adjusted gross income (AGI), which is only 60% deductible
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Resources:
Employer Identification Number (EIN)
Individual Retirement Arrangements (IRAs)
Real Estate Professional Requirements
Capital Gains Exclusion/Section 121
Professional Employer Organization (PEO)
Rollovers as Business Startups (ROBS)
Full Episode Transcript
Toby: Hey, guys. You are listening to Tax Tuesday. This is Toby and…
Jeff: Jeff.
Toby: There you go. Hey, Welcome to Tax Tuesday. First off, happy Tuesday Jeff.
Jeff: Thank you.
Toby: Send your questions at taxtuesday@andersonadvisors.com. We will put you into a queue of the questions that we pull into these, and we’ll also make sure you get your question answered. If you need a very detailed response, like you are asking stuff that is very specific to you and it is actually tax advice on yours, then we’re going to say become a platinum tax client, because it’s going to be more than just a simple little answer on the actual rules.
This is fast, fun, and educational. We want to get back and help educate. If this is your first Tax Tuesday, hopefully you are in for a treat. If you’ve been through these, you know that half the fun is listening to what everybody else asks.
Let’s jump into the questions that we are going to be answering today. There’s already a couple of questions that are out there. Let’s just do one that they sent from last year. “Do distributions from state-specific disregarded LLCs to a Wyoming holding cause a taxable event?” It’s not the distribution that actually causes a taxable event. I’m assuming that you are talking about LLCs that are owning real estate in local areas. You are going to end up paying tax on it because it’s sourced from a different state, so you are going to pay the state tax on it. That’s all that’s going to happen. I’m trying to think of a state that has a tax. I always think of Tennessee. I don’t know why I always go to Tennessee.
Jeff: Let’s go a little bit north. If you are in Kentucky and you have a distribution from your LLC—
Toby: Does it even matter if there’s a distribution? You are going to be paying the state tax regardless, right?
Jeff: Right. I said distribution, I said exactly what the questioner said. If you make $100,000 in that passive entity, whether you take out money out or not, you are going to pay tax on it.
Toby: Yup. It always passes through, unless it’s an LLC going to holding LLC that is a Corporation.
Somebody says, “Do you need a tax license besides an EIN for rental property?” Not necessarily. Some states, you are going to have to register with the city and the landlord. Use a good property manager and they’ll let you know, but the entity itself, if it’s in the state then you are easy. If you are out of the state, then technically it needs to register to do business in the state that’s going to hold the property, or you use a land trust and have the land trust take it’s beneficial interest. We are going to take that beneficial interest and we are going to assign that out to a different LLC.
Here we go. “What do you have to file when you have an S Corporation and you take a salary?” We’ll go over that.
“I’m a small business owner who last year didn’t make any income, do I have to file?” We’ll go over all of that.
“How much of my remodel can I claim on my taxes as expenses versus improvements?” Hint, when you say remodel, Jeff and I had the same comment on that.
“When rolling over a traditional IRA to a Roth IRA, is this then counted as regular income in the year the rollover? How does this impact social security payments?” We’ll go over that. That’s an interesting one.
“I am 74 years old, and I have had my Roth IRA since December 10th 2009. I usually do a conversion of my Rollover IRA (established in 2002) to my Roth IRA each year. I thought earnings on the Roth IRA are/were tax free, but I understand the government implemented new rules, the Trio of 5-year Rules,” actually, it’s always been there. “Can you explain how this affects me and what is my plan of action?” We’ll go over that.
“Can you claim both the home office deduction and the Section 280A for the same C Corp?”
“How do you report real estate rental income for properties in a trust?” Those are good questions today.
Jeff: Yes, they are.
Toby: They keep going on, Jeff. There’s people blasting us with questions online and then we have all these questions too, and I want to be done in an hour.
Jeff: We’ll talk fast.
Toby: “My question is, I have someone who is based abroad and is willing to provide funds for gap funding in house flipping. How do I go about it?” Good question.
“My husband and I filed separately, but my husband didn’t have any income in 2019 and I did. Can I claim him as a dependent on my return with the married filing separately status?” Interesting question.
“What determines your state residency when you live in a non-fixed location like an RV or a boat?” Interesting.
“I am starting an LLC. What is the best entity to lend it money for a startup?” These are intriguing questions.
“Tax liability as a dual citizen in Canada/USA and recently received an inheritance from my Canadian parents?”
“Is an SDIRA (self-directed IRA) subject to UDFI (Unrelated Debt-Financed Income) when invested in a syndication that uses debt financing? If so, what’s the alternative?”
“Will UBIT (Unrelated Business Income Tax) or UDIF (Unrelated Debt Income Financing), occur in my SDIRA (self-directed IRA)? I’m investing passively in syndications where there is a non-recourse loan?” UDIF is the same thing as UDFI, or are we looking at different things?
Jeff: No, they are the same.
Toby: Here’s an interesting one. This one caught my mind. “I lost my property to foreclosure. My CPA treated it as investment property since it was a rental property before I lived in it. However, I lived in that property for two years of the last five years. Was my CPA correct, or should I amend that tax year return?” Really weird question. There are so many issues there.
“So my question today is, if I have a Roth IRA, do I have to pay capital gains tax on money that the Roth produces, or is that growth tax deferred?”
Somebody says, “I transitioned to real estate professional this year, looking on how to write off expenses on my husband’s W-2 income.” We’ll go over that.
Last question. “I have a family limited partnership that is going to get a large sum of money. I plan to put it all into a non-profit. Any taxes owed?”
Jeff: Good question, but we’ll talk.
Toby: Yeah, good question. I love this. There’s a whole bunch of questions that came in, by the way. Somebody paid some tuition for seminars. They went through some classes and they wanted to be able to deduct tuition on those classes.
Here’s the issue. If you don’t have a business that is going to be when you are actually in business, you are going to want to make sure that you have a company set up and that it’s reimbursing you or using this as a startup expense. As an individual, unless you are already in that activity, it’s really hard to deduct education expenses.
It’s really easy to deduct education expenses as a startup if it’s shown that it’s in the investigation of creating the business. But a lot of folks, they do it backwards. There’s actually a case that involves somebody that actually went to a class. His accountant convinced them to do the opposite of what we are recommending, and he ended up being a tax court case and lost.
We were right. That really stinks because we would rather be wrong for the guy because he got hit with a pretty big tax, but it really came down to when did he get into real estate. In that particular case, he didn’t buy a property until December and he had done the classes prior. You can’t write those off. If you are a stock market person, you can never write them off as an investor. You always have to use an entity.
“In California, if I lend to a flipper with a shared appreciation note, does the borrower need to issue me a K-1?” Claudius, no. If it’s a shared appreciation, it means it’s a loan with a contingent interest and that is interest, so they are going to give you a 1099-INT.
Anyway, we got to jump. Guys, I’m not going to go over this very long. You know that we have classes out there. If you like Tax Tuesday, by all means, we will invite you to come to a Tax Asset Protection Workshop Class or in any investing workshop class. Reach out to us at taxtuesday@andersonadvisors.com. Let us know if you are interested in classes. We’ll have somebody reach out to you and give you your options.
For the most part, the Level 1 Classes, we will comp you in if you are a part of Tax Tuesday. The Tax and Asset Protection Workshop is a three-day workshop all over the country, and the Infinity Investing Workshops are one day workshops. We are going to start having them on April 18th is the next class. Saturday, all day, but it’s a class that is livestream so you don’t have to leave your house.
Let’s jump into the questions. “What do you have to file when you have an S corporation and take a salary?” Jeff?
Jeff: There’s all kinds of forms that you have to file. Payroll tax forms. You may have to register with a state for withholding if you are in a taxable state. They have to register with a city or county if you are in Kentucky or Ohio.
What I strongly recommend—it’s not exactly cheap, but it can save you a lot of trouble—is that you sign-up with the payroll company.
Toby: Payroll company may cause you $50 a month if you are doing consistent payrolls. Or you just go online and it may cost you $100 or $200 for the year. They do all the tax […]. It’s so much easier than trying to do it yourself. Somebody says, “And it’s worth it.”
Jeff: Yeah. They can tell you if you need an employment or not, workman’s comp or not. This is one of those areas where you think you have yourself covered and you don’t.
Toby: I’m going to give you guys something else. If you are somebody and if you have between 5 and 20 employees […], there’s something else you should know that exists out there, that’s going to make life easier for you. It’s called a PEO (Professional Employee Organization). For those of you guys who are in California, for example, this is a big one because if you have contractors in your business, it’s a good chance AB 5 just made them into employees.
It’s so much easier not to deal with the non-sets. No more 1099; that’s correct. What you want to do is instead of you becoming an HR and developing your own, if you are between 5 and 20 employees, it’s not going to be worth it. Use an outside company. It’s better for you because you’ll end up paying about the identicals if you do it yourself. They will save you money because of their rating or things like workman’s comp and unemployment because they have all of the employees. And they get full benefits, so they get a master group plan.
I wish you can do this as one person. I think the minimum is three family members. A husband, wife, and a child, or another friend, parent, brother, sister, you name it. Then you get access to things that only groups get available to.
PEO is something that you should look at if you are a small mom-and-pop, one-person, two-person, husband and wife, then you might want to go ahead and just use a payroll company. There’s some easy ones, ABP out there and paychecks, there’s a ton online, Patriot.
Jeff: And some of these companies, if you are taking payroll and you want to set up a retirement plan, you can actually work with a payroll company to help you with that out, too, so you are not messing up those plan requirements.
Toby: Here’s another one. “Would it make sense as a one self-employed person to pay yourself a salary?” This is where it gets really interesting, and it depends on how much you are making because you have to look at it. There’s two calculations that we have to do now.
First of all, if you’re self-employed and an individual, you are going on a Schedule C. You will be paying social security—they call self-employment tax but it’s old age, death and survivors, and Medicaid—up to $137,000 on every dollar. When you add those things up, it’s actually 15.3%, but you get small deductions for half. It’s 14.1% is the way to look at it. If you set yourself other than an S Corp, you avoid that on about ⅔ of that money. It ends up saving about $10,000 a year on that scenario.
But on the flip side, if you are at $30,000 it might not make much of a difference at all and you are using a corporation. The answer to all tax questions is always calculate, calculate, calculate. Get your pencil out and determine whether it makes sense from a tax standpoint, but don’t forget about asset protection. Don’t forget about estate planning and business planning. Make sure that everything falls in line and works.
There are other fun stuff like an S Corp gets audited .02% of the time versus a $100,000 sole proprietor is 2.4%. Sole proprietors lose 94% of the time. S Corps lose about 60% of the time, so when you are looking at it, it’s like S Corps starts looking better and better. That’s how we like them. That’s the answer to that question.
There’s a few others. “It’s not specifically required by the state. Is there a reason to notify the separate state that an LLC has sold their interest to another party?” If somebody sells an entity, it’s the same thing as if you sold the underlying asset, so if it’s real estate and you change more than 50% ownership, almost always you are going to have to report that to the county as though you sold the underlying real estate.
Here’s another one. “I’m a small business owner who last year didn’t make any income. Do I have to file?” Jeff?
Jeff: It depends on what kind of small business owner you are. If you are a corporation or an S Corporation, yes you have to file. If you are a partnership and have no income or expenses, you don’t necessarily have to file, especially if it’s your initial year, but I recommend it.
If you have losses, and I know you said you didn’t make any income, but if you have losses, then absolutely file that because that can lower your income if you have other income.
Toby: You just nailed it. It gets kind of weird. As an individual, technically we don’t have to file if we don’t make any money, but most businesses you don’t have that exemption. So, if you have an S Corp, you could file an 1120S or a partnership, 1065. If you don’t file even if you don’t make any money, you’ll have some pretty heinous penalties. What is it? $195 a month now?
Jeff: It’s $205, I believe.
Toby: $205. Geeze, they keep raising it. It could be really ugly. I would always tell people to just make sure that you file your taxes on time. By on time, that doesn’t mean April 15th for individuals and for S Corps it’s March 15th. It means add-in the absolute, positive, guaranteed extension. We are really talking about filling your taxes by September and October.
Pay your taxes if you owe any, but if you don’t owe any, still do the return. Like Jeff said, there might be some tax reasons why we want to do it because we can capture some of the losses, even if we are just carrying them forward. By the way, take that loss and offset your other income.
Jeff: Yeah. Even if you are not required to file, you may go carry that loss over the next year.
Toby: Yeah. If you as an individual, you can just still keep carrying that forward.
“How much of my remodel can I claim on my taxes as expenses versus improvements?”
Jeff: What we were talking about earlier was once you call a remodel, you’re almost saying that it’s all improvements. You have to separate out what is an improvement from a repair. One of the other things where I see this maybe the only time I can bring it up, but this may be a time for cost segregation if it’s substantial.
Toby: Yeah. You’re just sitting on something that’s really important; actually a couple of things that are really important. Number one is when you do something on a property, it’s going to fall in one of two categories. It’s either a betterment to the property that’s going to make it worth more, or it’s fixing something that’s already there. The repair is deductible, the betterment is depreciable. The level of depreciation depends on whether or not you’ve done a cost segregation, you’re choosing the default matters, or the straight line depreciation.
In English. If I have a property, and it’s a residential property like rental property, it’s going to be 27½ years. If I have a commercial property, it’s 39 years, unless I do an engineering study and/or a cost segregation study and break off the pieces. It’s really easy when you do a remodel because now you have the invoices directly, in which case, you may have some of those things where you’re writing off over 5, 7, 15 years. All of a sudden, that remodel doesn’t look so bad. You may not want to write them all off in one year. You may want to let them just offset your income for the next five or six years at the top bracket.
The other thing that’s really important is there’s a safe harbor for repairs of $2500, which means if you do something for $2500 on a property, you call it a repair whether it’s a betterment or not. You’re allowed to do that and the IRS can’t audit it, so that’s really good.
Jeff: Something we will talk about a lot, but I got the question the other day is making improvements or remodeling my personal residence, and actually we want the offset to happen. You want those to be improvements. They’re not deductible, you can’t expense them anywhere, but it does increase your cost basis in that property. So, the more improvements you have, the more your cost basis is going to be.
Toby: Very good. Flippers. That’s always the question we get. They’re fighting like crazy to call something a repair, like you’re selling the house.
Toby: Yeah. In the case of flippers, everything goes into your cost basis.
Toby: All right. Somebody else asked, “I purchased a Wyoming LLC that is over 2 years old and I’m applying for an EIN. EIN has gotten so detailed, the use of the LLC is being considered for several different functions. What is the best selection to make EIN simple? Use someone else to apply?”
Casey it’s just an EIN. It depends on whether you wanted the LLC to be taxed as disregarded, as a corporation, or as a partnership. That’s all you’re doing with your EIN. They might be thinking of something else; the type of business. I would just decide whether you want it to flow onto your return or it be somebody else’s.
Jeff: Yeah. The form to get the EIN is fairly simple. Some of your answers aren’t even binding as far as what year end do you want, what type of entity it is.
Toby: Elijah just asked a question. “Can taxpayers who don’t actively participate in real estate activities but own a rental still qualify for the rental real estate loss allowance?” There is no such thing. No. Passive passive losses offset passive gains with two exceptions: active participation or being a real estate professional. If you have a rental property, that is (per se) passive unless you meet one of those exceptions.
Jeff: Now, do you think he might be talking about that $25,000 rule?
Toby: That’s active participation. It says you don’t actively participate.
Jeff: Oh, sorry. Never mind.
Toby: So, I’m just saying that the two exceptions are active participation or a real estate professional. But great question, Elijah. And that’s how hard it is. People always get rental properties confused with capital gains and capital losses. The capital loss, you can use $3000 a year and offset your active income. With rental losses, you can’t use it at all unless you dispose of the asset, in which case you can take all those losses that you didn’t get to take before, and take them all on your…
All right. “I waited until 70 to receive social security and I’m getting a salary. Should I ask ATP to stop taking out social security?”
Jeff: I don’t think that’s a choice.
Toby: Yeah, I don’t think it’s a choice, so you still have to. It stinks.
Somebody says, “Hey, to write off a class, do you have to have the corporation set up? The LLC already set up?” No. What you want to do, what’s the best situation is before you go to the class, make sure the business is set up because after you go to the class, you’re going to be amortizing a lot of it.
Somebody just said, “Is it right I can write off anything over $2500 as an expense on your primary home? No. Jeff, you can’t write off anything with your primary home. You can only write off things that are income-producing properties, so it must be a rental property. Your home when you do stuff, you just add it to your basis.
Jeff: Yeah. You just want to keep track of all those expenses and improvements.
Toby: Yeah. The exception is if you’re fixing up your house to sell it, then you can write it off right away (I think). In the recesses of my head, it says if you fix up your house to sell it, it’s not even something you have to do on basis. You actually take it as a deduction measure. But for the most part, no, you can’t do that on your personal house.
“I am 74 years old, and I have had my Roth IRA since December 10th, 2009. I usually do a conversion of my rollover IRAs (established March 8th) to my Roth each year.” What they’re doing is they’re taking a piece of it every year and they convert it, so maybe it’s $5000, $6000, however many thousands of dollars. Maybe it’s $10,000, maybe it’s $20,000. “I thought earnings on the Roth IRA were tax free.” They are, but I understand the government implemented new rules; the trio of five-year rules.
Your conversion is never the issue. It’s the earnings once you convert. Once you convert your traditional to your Roth, you’re going to pay tax on that conversion. As long as you hold it for five years after the conversion and every year you’re having a new conversion, you have to wait five years or the gains on that money will to have a penalty imposed. Is it a penalty or is it a tax?
Jeff: It will be subject to the tax.
Toby: Subject to tax. So, you have five years from conversion, five years from contribution, what was the other five years?
Jeff: Own an inheritance.
Toby: Inheritance, right. All it’s saying is you have to let it stew for a little while. I think because you’re doing all these conversions, you’re going to have a little bit of accounting to track, but you basically pull it out, you’re going to take it out of the money that’s already met the conversion requirement. You’re not going to take the whole thing out. The way it would affect you is just be careful not to start pulling all the money out.
What you may want to do is if you’re really looking at this conversion is make sure it makes sense. A lot of times, people that are converting their IRAs don’t make any sense because their taxes are going to drop after. If you’re converting because your income tax is really low, you’re moving it over there, and then you start growing out this money, then I say, “Bless you. That’s perfect.” Just make sure that you’re aware and you don’t dip into the earnings of one of those conversions, which would be really hard for you to do.
If you’re doing this all the time, my guess is you have some sizable amount. I wouldn’t really be worried about it. Just mark it and just be careful if you go above this dollar amount, maybe that’s taxed. You could actually calculate it.
Somebody asks, “I saw an old YouTube video from Clint, saying best to avoid real estate deals done by your Roth self-directed IRA. Once Anderson has set up my LLC for my […] a new JV, between it and Roth holdings used by a Solo 401(k) to purchase and flip properties (both parties are JV) coming from Roth accounts.” This is going to drive me crazy; this is a long one. “Are there any taxes involved? Will the IRS give a flip a dealer status? Thanks in advance.”
What’s going on here is you have two self-directed IRAs doing a joint venture together, and they’re going to flip a property. Technically, there’s no guidance on whether that’s UBIT is what you’d really be looking out there. Dealer status is you and me, and we don’t want to be a dealer. That dealer status doesn’t really get nailed onto an IRA. It’s going to be UBIT, and there’s no cases on it.
They always say, “The rule of thumb is anything less than six I’m not going to worry about.” That’s just other people. I’m just to say that there’s no guidance on it. But if you’re buying a house, then technically they’re looking at it saying, “As long as you don’t do it too often, we’re not going to yell at you.”
“If you have an S Corp and a sep IRA, do you have to take out those distributions at a W-2 box on wages on a sep? You’re making a contribution of 25% of the amount that you’re taking.” I don’t think you can defer.
Jeff: The only thing you take out of the box one would be employee contributions, which you normally wouldn’t have on a sep.
Toby: And get a refund on the payroll taxes previously paid. Actually, you’re still paying self-employed.
Jeff: If you did, it would only come out of box one. It wouldn’t affect social security or medicare. There would be no change. It would actually be the employees’ money and they would get the recovery.
Toby: Yeah. What you’re asking is in your situation if you’re doing the sep, the S Corp’s contributing 25% of the businesses. I’m usually going to go to a 401(k) anyway because I do want to do what your accountant’s playing, which is the deferral (which is much better). You can do both, by the way. Solo 401(k) actually has the deferral and the 25%, whereas the sep is just the 25%. But you’re not paying the payroll taxes on that.
Jeff: Yeah. The employer contributions are never going to reduce your payroll taxes.
Toby: “If you change ownership from a California LLC to a trust, then Wyoming LLC is the beneficiary. Can someone follow the chain?” No. It’s almost impossible.
“Does a trust instead of a corporation, better for sole proprietorship in California?” No. The trust doesn’t give you any protection. Realistically, if you’re going to set up a business, you want to have a wall around you. You don’t want to be subject to having somebody take all your stuff because the business fails.
Let’s jump back into these ones where Jeff can actually see them. All right, Jeff, can you claim both the home office deduction and the Section 288 for the same C Corp?
Jeff: I’m going to say no, but for technical reasons. Typically, if it’s a home office deduction we’re only seeing that on a sole proprietor. A sole proprietor cannot claim Section 288 deduction. They’re not going to have corporate expenses. Since they said it was a C Corporation, what we actually want a C Corporation do is not do a home office deduction. We want the C Corporation to be reimbursing the homeowners for that home office.
Toby: You are such an accountant.
Jeff: What’s that mean in English, Toby?
Toby: It means that you can reimburse yourself for the cost of the home office, and you can reimburse yourself for the corporate use of the house for your meetings, and yes you can do it at the same corporation.
So, Jeff’s cool. He and I both want the same thing. When you say home office deduction, that’s a phrase that you use with the sole proprietorship. When you say business use of the home reimbursement, that something different. It’s not reportable by the individual. It’s not calculated for depreciation recapture. It’s basically a bunch of free money out of the company.
If you haven’t heard of these concepts, you need to go to a Tax-Wise. I’ll just make it simple. You need to come a Tax and Asset Protection or come to a Tax-Wise because we go over those. Those two together probably a good $20,000 a year of money in your pocket that the company can reimburse you, capped in write-off.
“How do you report real estate rental income for properties in a trust?”
Jeff: It’s going to really depend on what kind of trust it is. If it’s an irrevocable trust… Did I say that right?
Toby: Yeah. If it’s irrevocable and when it files its own tax return.
Jeff: Right. If it’s a revocable trust, like a grant, trust, living trust, they go by about 100 different names, it’s going to be taxable to the grantor, which is you.
Toby: Somebody just asked me whether we intentionally skipped over one rolling over to a traditional IRA to a Roth IRA. We went over that?
Jeff: We went over that.
Toby: Benny? You need to go back. We did that one.
“How do you report rental real estate income for properties in a trust?” The answer is it depends on how that trust is taxed. If the trust is irrevocable and pays its own tax, it’s reported on the 1041. If it’s irrevocable and passes it to the beneficiaries, it’s going to go via K-1 to those beneficiaries. Where is that going to go? Page two of Schedule E?
Jeff: Actually, page one of Schedule E.
Toby: Page one? That’s going to go straight on the front?
Jeff: Right.
Toby: A grantor trust is a fancy way of saying, “We ignore the trust.” So, if it’s a grantor trust, then it’s going on whoever the grantor was. The due is going to go on your individual tax return. If it’s another irrevocable trust that sets it up, then technically you’d be on that.
All right. I’m going to answer a question that somebody just asked. “With the new AB 5,” this is somebody in California, “are contractor’s or subcontractor’s work should be classified as employees?” The answer is no because there’s an exception for those folks. I believe that there is an exception for those folks. I’m 99.9% and you just have to be careful. They need to have their own license (I believe) and be true subs. There is an exception, so I would take a look at it.
Somebody says, “I wanted to register as an S Corp, probably because I’m a single member LLC. I’m being told to file as a sole proprietorship. Why?” Because whoever is advising you, Derrick, is incorrect. Your LLC can choose however it wants to be taxed. If you want the LLC to be taxed as an S Corp, you’re one document away, and you need to do it now.
You would file a 2553 before March 15. It’s Form 2553. It’s all of two pages. You fill out a bit of information, you sign it, and then magically your LLC will become an S Corp. The IRS will confirm receipt of that. They’ll make sure it’s […]. So barring any surprises, you’re going to be treated as an S Corp. Whoever told you that just doesn’t understand it.
Somebody else says, “Can I change my tax year from LLC taxed as a C Corp last August?” Yeah, you can actually file your tax return, in 12 months?
Jeff: Yeah. For your initial return, you can make your year-end whatever you want to be within 12 months. After that, you have to get permission from the IRS. That’s a long form, I want to say 1128. Anyway, you just request permission to change your fiscal year.
Toby: So Rick, it really comes down to it is if you just set it up, then you can just file your tax return. If it’s August, that means that you’d be due in what?
Jeff: If it’s due in August?
Toby: No. His tax year ends this August. The end of August, August 30th. So then is it the 15th day of the 4th month or is it the 3rd?
Jeff: 15th day of the 4th month after the year end.
Toby: So, September, October, November, December.
Jeff: December 15th.
Toby: December 15th. So as long as you file by December 15th of this year, you’ll be fine.
“I sold a rental property this year without an exchange. Can I chip away the capital gains taxes with the write-offs they may not be thinking of?” You need to actually do a Qualified Opportunity Zone. Potentially, as long as you set up a fund before (I think it’s) June 28th, you could defer the whole thing. And yeah, you could still chip away at capital gains. If you have any losses on capital losses, they’d automatically be used to offset. There’s plenty of things.
Lots of questions going in. Here we go. Let’s jump on to some more. “My question is, I have someone who is based abroad, and he’s willing to provide funds for gap funding in house flipping. How do I go about it?”
First off, let me just set the table, Jeff, then I will ask for your opinion. A gap funder is a lender. They’re a lender in the house and if it’s flipping, it means you’re buying the house to sell it. I don’t know if they’re foreign or they just live abroad, and whether they’re a US citizen or a non-US citizen, but let’s just assume it’s a non-US citizen whose loaning money to you so you can flip houses. How would you go about it, Jeff?
Jeff: The getting of money is very simple. There’s no forms to file, there’s no returns filed just for getting the loan from the gap funder. I would suggest if you’re getting money from offshore, you’re not giving them your banking information.
Toby: You don’t want your account to disappear?
Jeff: Yeah.
Toby: Let’s assume this to somebody you know.
Jeff: Oh, okay. So this is a reputable gap funder. Everything’s hunky-dory, you develop the house, you build the house, or reflip it. You’re going to have to get money back to that person to repay the loan and give him his share of the interest or how you decide to divide up the income. That income portion is going to be subject to withholding. Usually, it’s a 30% rate depending on where they’re at. If you borrowed $50,000, you give them back $60,000, that $10,000 is going to be subject to about $3000 of withholding.
Toby: And they’re going to have to file what’s called a 1040-NR. That’s 1040 Non-Resident for US-based income. Hopefully we have a treaty with the country, and the treaty may say you don’t have to do the same amount of withholding. Sometimes they go down to 15%, sometimes they don’t require any withholding at all. It just depends.
As far as the mechanics of it, though, just do a note, and then we’ll worry about the tax later. You want to make money and then worry about it. You want to go in knowing how it’s going to be taxed. It’s going to be taxed as interest, most likely in the United States. Then, if they pay US tax, they’ll get a credit and apply it towards their foreign tax most likely. That’s the easiest way to look at it. If they’re a US citizen, then it’s even easier. They’re just going to pay tax on the interest, even though they’re abroad.
Somebody says, “Hey, does the home office work with and LLC in reimbursements?” Yeah, as long as it’s taxed as an S Corp or a C Corp, technically even as a partnership you could do it.
Jeff: And you don’t even have to own your own home. In any case, for that you can be running an apartment and that’s still subject to reimbursement.
Toby: Yeah. Somebody else says, “If you reimburse yourself for business use of the home, do you still have to depreciate the home?” No. You’re not depreciating it, but you’re reimbursing yourself as though you are, and you don’t have any recapture in the section of it. I can actually give you the publication, Robin, if you shoot me a…
Jeff: And that’s one of the big differences between a home office deduction and reimbursing for home office expenses. If you do the deduction, then yes you do have to depreciate.
Toby: Yeah, you can go 26 Code of Federal Regulations (CFR) 1.62-2 is the section for reimbursement plans where it says you don’t report it. That’s CFR 1-162-2 and any of the actual expenses, 26 USC 161, that lies in ordinary necessary business expense, so it’s not 162. Those are your two sections. 280A is where you’re going to find the ability to not have to report tax. It’s G2 if you want a specific site. Otherwise, just shoot me an email and I’ll point you to a bunch of other stuff.
Let’s see. “Can you backtrack to have the S Corp reimburse you? Can you go reimburse for something that the S Corp as employee expense?” I actually can answer this one. If you have an accountable plan, you’re supposed to do them quarterly. If you go back, just know that if contested, you could potentially lose it. But I just don’t see it being contested if you incurred the expense and the company reimburses you. Frankly, I’ve seen people reimburse stuff that was incurred two and three years ago. You either document it as it belongs to the company or its contribution. They can always return that money to you at some point tax-free.
This is fun. This is Jeff’s favorite one. “My husband and I filed separately, but my husband didn’t have any income in 2019 and I did. Can I claim him as a dependent on my return with the married filing separately status?”
Jeff: Unfortunately, the answer is no because if you’re married, you can only claim yourself your own exemption. Nobody else can claim that exemption. If you want to claim the husband’s exemption, you have to file married filing jointly.
Toby: So, you’re going to have to file jointly if you’re going to claim him as a dependent. Otherwise, he is his own, right?
Jeff: Right.
Toby: Head of the household?
Jeff: No. If you’re married, you can’t claim as head of the household. I know there’s reasons that people file separately, but just from a tax viewpoint, it normally doesn’t work out better.
Toby: Somebody’s saying, “Can a business reimburse you for percentage use of your house?” Yes. Whenever you’re an employee of a company, and the business gets a benefit from something of yours, it can reimburse you for the business use of that, or in some cases 100% of it, regardless of how much it’s used for the business. On a cell phone, they don’t care how much is used for business. It could be 5%, but they can reimburse you the entire amount of your cell phone bill in your cell phone. Same thing with equipment.
Now, your house, what it reimburses you is reimbursing you for the right to use your home as an administrative office. It doesn’t even have to be the principal place of business. It’s where you do your administrative activities, so long as you’re not doing them elsewhere. You could even have another office that you visit on a daily basis, and as long as you’re not doing the P&L, the books and things like that in that office, just make sure you’re doing it from home, the company can still reimburse you.
Most people (if they are a client), their management company is probably located out of state. That’s one of the reasons to do that, not the least of which is complete anonymity, making something that’s going to last a really long time, making it so nobody can take it from you. But one of the side benefits is you need a house. I mean you need a home office, and you need to have meetings statutorily. You’re really creating a nice scenario for yourself to justify expenses. It can reimburse you under any reasonable methodology for calculating what that value is.
The IRS gives you the schedule on reimbursing yourself for the depreciation on the house, for the utilities, even cleaners, and it’s going to be a percentage. Some of the court cases, they’re going up 70%, which blows me away because I’m always nervous when you get in a 25%–30%, unless they’re on the high end.
There is a case where they just got trashed, and they got 42%. It was because they’re using the garage to store products. I just look at it and say as long as you’re creating a nice of situation, like you’re actually doing the calculation—I have a calculator to get my clients—as long as you’re doing the calculation and you’re justifying it, you can literally have a company reimburse you for that portion of your house.
We just did one where we did the calculation, and the client receives $34,000 a year. That’s an actual portion of the expense. They live in the Bay Area. It was an expensive house with lots of real estate taxes and all that fun stuff. It’s not a small amount. Then, you have some of the other houses where it’s $5000 and $6000 a year. That’s tax free, so that’s something that you should never… How do you determine what is a reasonable home office write-off? You do the test. You do the calculator.
“If you reimburse yourself for business use, do you have to depreciate it?” Nope. They already answered that. You do not. You reimburse yourself the portion of the reimbursement because the business is getting the benefit of using the home.
“How does the home office work with an LLC reimbursement?” Either assuming that it’s an S or a C Corp, it literally just reimburses you out of its income.
All right, let’s keep going on through these questions. “What […] is your state residency when you live in a non-fixed location?” So, Jeff is going to go ride around the country for the next five years in an RV. So, tell me where do you reside?
Jeff: The primary rule that the state looks at is the 183-day rule, which means where did you spend most of your nights? If you’re traveling between 3 or 4 locations, and you have more than 183 nights in one state, that’s what’s going to be your residence is. Now, since I like to move around a lot from state-to-state-to-state, let’s say I’m going around in my RV, and I’m not staying 183 days in any particular state. They’re going to look at where’s my driver’s license, what else Toby?
Toby: They’re going to look at where you actually vote, sometimes actually look and see, like if you’re Californian, you’re going to count how many lumens or whatever it is you’re using, whatever your bits of electricity… They’re adding everything up. They’re looking at where your kids are going to school, they’re looking at things that are normal. So, for you in your RV, they’re probably going to look and see where you’re registered to vote, where your driver’s license is at, where is your insurance, what’s your address, things like that.
Jeff: That tag on your RV could be an indicator of what state you’re in because that’s usually supposed to be where that vehicle is garaged.
Toby: Now, there are whole groups out there that do this stuff, and I know they’re going to say like The Dakotas, Texas, Florida, or great states because they don’t tax you and they’re pretty easy going. But if you’re not living there, like you’re literally just showing up there for one day, it’s not going to work. If a state wanted to come get you, like let’s say you’re in California a lot, they’re pretty aggressive. They’re going to say, “Where do you actually spend your time?” and they’re going to try to backtrack to figure out where it is that you’re ultimately located.
Somebody else says, “Can a Solo 401(k) be a joint venture partner to buy real estate? The partner is the owner of the Solo 401(k).” That’s awesome. Technically yes, but you’ve got to be really careful. But you can partner with your own Solo 401(k). What you can do is enter into transactions after, so you can’t lift up a hammer. You can’t benefit in any way.
The better route (usually) is to borrow money from your own 401(k), then use it for your real estate, pay it interest and all that fun stuff. Technically, there’s something called a ROBS (Rollovers for Business Start-up) transaction and you could use your qualified retirement account to start up a corporation that then runs a regular business. People do that all the time when they have a bunch of money in their retirement account. They want to buy a franchise or something that’s their second career, and they go do that.
The only thing that I don’t like about ROBS transaction is that about 1 in 13 are successful according to the stats I’ve seen, which means I wouldn’t drain your retirement account to go into business. It usually doesn’t end well.
“I have a revocable trust. At your end, does K-1 for my multi family investment in my name on my social security number or in the name of the trust of my social security number?” Kim, I would make sure that it’s going to your living trust, just to make sure it’s out of your estate. It’s not going to matter from a tax standpoint, though, at all.
Anyway, somebody else says, “How do you tax a basement rental in a primary home?” In other words, they have a basement that they’re renting out, that they’re going to break their house into two pieces. They’re going to call one of them their personal residence, and then a portion of it they’re going to call a rental. How do you protect yourself under those circumstances? I’ve tried stuff, Meg. I’ve tried putting that in, that portion of the home into an LLC. You can do that. You’re going to have to use a trust to do it, and take just a beneficial interest, that small portion. I’ve never seen that tested. I’ve never seen somebody go to logger heads on that.
What you really don’t want to do is make sure that you have the right type of insurance and get yourself an umbrella policy because you’re opening yourself up to a ton of liability by bringing people into your home. Just make sure (depending on the state) that you have a good homestead. If you don’t have a good homestead, make sure there’s a big loan against the house, so someone doesn’t get any bright ideas. It’s usually a lawyer that gives them these bright ideas of attacking you for stupid stuff, and when you say basement, they immediately think mold even though it maybe a great basement, and that’s just because you see so many cases.
Somebody asked, “When does the book come out?” It’s already gone to print, Cherry. The print house that we used has had some sort of an equipment malfunction and it’s supposed to be out literally in the next few weeks and we’re going to send it out to everybody. I think we have electronic versions for everybody in the meantime. We fully expect it to have it done and printed out by now. Issues we’ve run into the print problems, and where if anything, we’re too loyal, so we stick with companies. But we’ll get it out to you.
All right, next question. “If I’m starting an LLC, what is the best entity to lend it money for startup?”
Jeff: This is my personal opinion. You lend the money yourself. You don’t startup another entity to lend money to your LLC. Just my opinion.
Toby: Okay. It didn’t really matter. I actually had this question yesterday from a dentist. Here’s what I would suggest. If you are lending it money personally, like you want to protect it, it gets interesting. Sometimes, what’s more fun to do is to go ahead and buy a CD, go to the same bank where that LLC is banking, and get a line of credit using that LLC as its security.
What that does is it gives the LLC access to a line of credit, you still have your asset, and it starts building up credit for that LLC, so that eventually you don’t need to keep that CD anymore. It takes about two years to do that. I’ve actually done that transaction on a couple of different occasions for different startups, and it works like a charm because the bank’s super happy. They always have an asset. They used to charge me $50 a year for the line of credit, and then you only pay interest if you actually use it. If you do that, you’re still making some interest on your CD.
The other route is you just put it directly into the company as a loan, buy a CD, have the line of credit there, and then yourself interest to get more interest out of it. You can do that, too, and you can actually work some money out. But it actually works really, really well because in the credit world, whenever you say lending, its cash, collateral, or credibility. It always comes down to those 3 things. Your credibility cannot be established without getting some credit. Here’s an easy way to start a relationship with the bank and they tend to like that.
A couple of more questions that came in online. “What’s the best way to send contributions for senior investors if they want monthly versus yearly?” To send contributions for seniors, I’m not sure I follow that. I think you’re saying, what’s the best way to return it, to pay them on a monthly or yearly basis? You can always return somebody’s contribution to them tax-free and anything above that would be taxable. You have the K-1 that’s going to go out to them, if I’m hearing that quick question.
“If a Solo 401(k) puts up earnest money deposit on a real estate purchase within an assignable contract, does 100% of the assignment fee go back to the Solo 401(k)? Must it go back?” Yeah, unless there’s more than one party on that contract. Is there somebody else that you had to pay in the middle? Then, no. You have to put the net.
“Can Form 2553 convert the LLC back 3 years and 75 days?” No. You can sometimes go back to a late election. There’s a revenue procedure that allows you to change an LLC to an S Corp for tax purposes. In addition to changing the LLC to an S Corp, it’s changing it from whatever if it’s a sole proprietorship, it’s disregard, to an S Corp. You can do that for the previous year up to where you file the tax return, so long as you follow the revenue procedure.
Jeff: You can go back 3 years and 75 days. You can elect that far back, but the IRS doesn’t have to approve it. You can do a later election.
Toby: You can go back 3 years and—
Jeff: Three years and 75 days.
Toby: Wow, okay. So Jess, strike my no and change that to a yes, according to jeff. You can go back 3 years and 75 days.
Jeff: And there’s no guarantees.
Toby: There’s no guarantees you’re going to get it. The rev procedure’s almost a guarantee. It’s not a guarantee, but have you ever had one rejected?
Jeff: Usually it’s for technical issues with the form or with the entity.
Toby: All right. Let’s keep going on. Oh, this is crazy. Tax liability. “Is a dual citizen in Canada and USA. Recently receiving inheritance from my Canadian parents.”
Jeff: The problem with being a dual citizen is you’re subject to tax in dual countries. We’ll start by answering the inheritance question first. In the US, when you’re getting an inheritance, there’s no tax to you on that. I’m assuming it works similar in Canada.
Toby: When somebody passes that’s Canadian, they treat it as though everything was sold on the date of the passing. You end up paying 50% of the capital gains, which is ordinary tax. They treat it as though you sold half the assets, is what you end up paying tax on half the assets as though they were sold. There’s going to be a tax hit on the Canadian side, and then the rest of it depends on where you live.
Jeff: Now, as far as the dual tax between Canada and the USA, you really don’t pay dual tax. You usually get some kind of credit for the tax paid to the other country.
Toby: This is one of those situations where Canada could hose them. Here’s the thing. In the US, you have a huge exclusion. It’s $11 million plus; $11.4 million per person. You’re probably not going to have any USA tax. If you’re above that, then you probably could. And you have the Canadian tax. The USA taxes you based on your citizenship, where Canada taxes you based on residence.
They’re going to say, “Where were the Canadian parents? We’re going to tax that.” You’re a citizen there. If so, then it comes down to where you live. They’re still going to tax it because the parents were there, and the USA is going to tax you because you’re a citizen of the US. Even if you’re a green card holder, you have residence here. You’re going to get taxed worldwide. This is something where you really do want to have somebody take a look at it, to make sure you’re doing it right. I have some pretty good Canadian accountants I can send you to. There’s some good folks up in Vancouver. They’re pretty familiar with all the provinces, so they tend to be pretty good with the CRA.
Moving on. “Clarification. I have a commercial building on a California disregard LLC. I want to assign it to a land trust, and then assign the land trust to a new Wyoming LLC with partnership tax status. Can this be done and then cancel the existing California LLC?” Not really. When you talk about an assignment, you’re not changing titles. It’s already in the California LLCs.
What you can always do is have that LLC held by a trust that’s assigned to a Wyoming LLC that you tax as a partnership. What that would do is end up making that the end party that’s ultimately responsible for the tax, is going to be that Wyoming LLC and it would pass it down to you. That’s what you can do.
“I sold my rental property in 2019. Is there anything I can do now to avoid the capital gains that I’m going to have to pay, or did I miss the boat on this one?” Rene, you know there’s always something you can do. You can actually still do a cost seg on that. Until you file your tax return, there’s always something you can do. If you have the capital gains, you actually have some things you can do this year also to avoid those capital gains, or at least push them out of there six years, which is a Qualified Opportunity Zone.
Somebody said, “Are fully depreciated rental improvements subject to unrecapture gain on sale of the property?” It’s recapture, so it’s basically depreciation recapture, and the answer is yes. Everything that you depreciated over those 27½ years is going to be recaptured. Your ordinary bracket capped to 25%, unless you do a 1031 exchange or pass away and somebody inherits it.
Look at this one. “Is a self-directed IRA subject to UDFI when invested in a syndication that uses debt financing? If so, what’s an alternative?”
Jeff: The UDFI that’s been passed from the syndication to the self-directed IRA, they are going to have to recognize it.
Toby: Yup. On your K-1, it’s going to say non-recourse financing or recourse financing, unless your syndicator just doesn’t. I’ll tell you right now, there’s a lot of indicators that don’t, in which case you’re supposed to report it to 990-T. But most people don’t ask for it, they don’t push it, and they don’t pay it. So, the IRS came in you, you’ll be in hot water.
Yes, this is still subject to UDFI. If you want to avoid it, the easiest way is to roll that into a 401(k). 401(k)s are not subject to UDFI. It goes away. See how easy that was? You cannot be an IRA with debt. You cannot use debt in an IRA without paying tax on it. You do not have to pay tax on debt in a 401(k), therefore you have a very good reason to roll that self-directed IRA into a self-directed 401(k) to avoid that tax.
Same type of issue here. “Will UBIT or UDFI occur in my self directed IRA if I’m passively in syndication where there’s non-recourse loan?” It doesn’t matter about the recourse/non-recourse. You cannot sign on to a loan, you cannot have a recourse loan (for example) in your own self-directed IRA. You just violated it. Or 401(k), for that matter. If you have a non-recourse loan, then the self-directed IRA pays on the loan on the income produced by that loan. It’s called Unrelated Debt-Financed Income. It’s debt-financed income that’s making half the money is because of that debt, you pay tax on half the money.
UBIT is another thing completely. It’s Unrelated Business Income Tax. If you’re passive, you don’t have to worry about that. If you’re in a syndication and it runs active businesses like McDonalds and a bunch of other stuff, you don’t have to care because your ownership is passive. You don’t have UBIT.
If you’re ran a McDonald’s in your self-directed IRA, you’re going to have problems, and you’re going to have UBIT because it’s not going to let you have a leg up on the competition by not paying tax for the exempt organization. That’s where you have a 401(k) or an IRA, both are going to be subject to UBIT. Only IRAs are subject to UDFI. Don’t you love that stuff?
Jeff: Interesting stuff.
Toby: Speaking of interesting, There’s a whole bunch of other questions. “If you have a meeting at home, what’s a reasonable reimbursement for home use?” You call around and get and answers or get quotes. That’s the best thing.
“If I sell inherited property in Guatemala, what are the tax liabilities in the US if I bring the proceeds back to the US for investment?” You’re going to have a Mexican tax. If you live here, if you’re a resident of the United States, then going to have capital gains tax. You’re going to get a credit if there are taxes paid in Guatemala. I believe that we have a treaty with Guatemala. It’s something where, I believe that you’re going to get a credit for, but you paid in Guatemala and then you most likely get a credit subject to reviewing the treaty to make sure that it’s giving us that credit.
“When doing the CFR 1-6-2 reimbursement, do I need to have an accountable plan in place?” Yes. You still do it. An accountable plan is all on one page. Again, if you go through some of our classes, you’re going to see them all over the place. If you’re Platinum, you already have access to all those. If you’re not Platinum, then you should be, or you should go on to Tax-Wise because I give out the accountable plans at that, too. All of those are really easy, and by the way, you can go to the tax A&P event and I’ll comped you in. It’s not going to be a big deal.
Somebody asked, “If you’re recently divorced and choose to live in the same house. Can you claim the husband is the head of the household or head of the household as your dependent?” This is going back to the married couple where the husband didn’t make any money. If they get divorced and they live in the same house, now can the wife claim the head of the household?
Jeff: No for a couple of reasons. One, he’s not a qualified dependent.
Toby: Why not?
Jeff: Because they’re not related.
Toby: They’re not related?
Jeff: He’s not qualifying as a child. He’s not a qualifying relative. He’s not a dependent at all.
Toby: If you care for any adult that’s not related, you can’t qualify as a dependent?
Jeff: No.
Toby: He has to be related?
Jeff: The other issue is who actually owns the home? How are they dividing expenses and so forth?
Toby: Well that stinks.
“Does S Corp profit and loss on an 1120 flow directly to each of the 2 officers’ 1040?” It actually goes to the shareholders, and yeah, it goes to their 1040 on page 2 of their Schedule E.
“I lost my property to foreclosure.” I’m so sorry to hear that. “My CPA treated it as an investment property since it was a rental property before I lived there. However, I lived in that property for two years the last five years. Was my CPA correct? Or should I amend that year’s tax return?”
Jeff, let me just point one thing out before I hand this to you. If you made a mistake on your return and it was in all good faith, and then you find out that you’re wrong, you’re not under legal obligation to fix the return. That’s number one. There’s nothing that says you’re supposed to go back in, read the tea leaves and go, “Oh my gosh. I think I made a mistake. Now I have to amend,” because otherwise, holy cannoli.
What they care about is at the time you signed it, was it in good faith? Now, if you’re wrong, they could possibly go back and hit you with accuracy-related penalties and stuff like that. But don’t think that you’re going to be like, “Oh my goodness. I’m going to have to go back and do all this stuff.”
Jeff: This is really a facts and circumstance issue because there’s a couple of calculations that go on here. One is how much COD (cancellation of debt) income do you need to recognize? This was obviously a mortgage property. How much debt were you relieved of, that exceeded the cost of the fair market value of your home? Now, that COD income, the five year rule about excluding income never applies to COD income. It’s always treated as ordinary income.
Toby: So COD, there are some things on your personal property. I think they just added more under the SECURE Act. I might be mistaken, but I believe they just extended retroactively COD income on your personal residence per million or $2 million. All that means is that if I loan Jeff $1 million for him to buy a house, I secure it with the house, the house is worth $1 million when I do it, and the house becomes worth $500,000, I say, “All right, Jeff. You don’t have to pay me back the $1 million. I’ll take the house.” The house is worth $500,000. I just cancelled debt to Jeff for $1 million. He doesn’t have to pay me back. I’m going to say I got back $500,000.
We used to have this issue and they would do the 990 or the 1099 cancellation of debt, the D or the A; we’ll get into all that. Let’s just say that there’s $500,000 that Jeff is relieved of. That’s taxable to Jeff, unless there’s an exception. Congress created an exception because so many people are losing their houses to foreclosure.
Jeff: There is a principal residence exclusion. Unfortunately, it doesn’t apply here because he was renting that at the time.
Toby: Well, here’s the thing. He says that he lived in it, but it was two of the last five years. At the time he sold it, it could very easily be an investment property.
Jeff: Okay, so it was a rental property before he lived in it.
Toby: Here’s how it works. In order for me to take an investment property and make it into a residence, all I have to do is spend in one tax year more than 14 days there, or more than 10% of the days that it was actually occupied. Then it’s a residence, and I’m going to apportion some of my depreciation as that and the others. It’s not going to be a principal residence.
If I make it my principal residence, then I qualify for that two out of that five year capital gain exclusion (Section 121) on capital gains. But when you have capital losses, you can’t write those off as an individual. But the property, when it was sold, was actually investment property.
You get into this weird thing because it was an investment property, then it was your primary residence, and then it goes back to an investment property. You get into this weird thing where you have to calculate different times what it was worth.
Jeff: Correct. We’re calculating this COD income. We’re calculating how much recapture there might be because you depreciate those properties as rental.
Toby: And you’re capturing how much loss you receive because when you dispose of a business properly, hence 165, right?
Jeff: Right, and I think that’s when it then catches people by surprise. They think there’s just that COD income. You could also have additional loss or gain based on just giving up the house.
Toby: Somebody said, “So you say you can’t pick up a hammer in a Solo 401(k)?” Yes. If you have a piece of property, you can’t use your personal labor to improve it or you disqualify that property. An IRA you just qualify the whole IRA, and a 401(k) you just qualify that portion of an asset.
“What if you have both an S and a C Corp? Can you get reimbursed for the office for both?” A portion of the office. If you have two offices, then yes, you could do it. If you have an office that’s used for both, then you can apportion half-to-half.
Jeff: You can’t double your expense.
Toby: Cannot double them. All right, let’s keep going. “My question today is, if I have a Roth IRA, do I pay capital gains tax on the monies that the Roth produces, or is that grow, tax-deferred?”
Jeff: Everything in that Roth IRA after you’ve held it for five years is going to be taxed. Not tax-deferred. That’s not going to be taxed.
Toby: Yup. You don’t have to pay tax on it, as long as you meet the five-year rule, the trio of fives. Wait five years, then you can do whatever.
“I have transitioned to real estate professional this year, looking on how to write off expenses on my husband’s W-2 income.” So, if you are a real estate professional, and you meet the test under 469(c)(7), which is that two-part test, which is the 750 hours half your time plus material participation in your rental real estate, then your real estate losses that would ordinarily be considered passive become non-passive. You literally just check a box on your return, on your Schedule E that says it’s non-passive. That will offset your spouse’s W-2 income, assuming you’re filing jointly.
Jeff: Yeah. Also a real estate professional allows you to take your rental loss, your passive losses in real estate. You’re not really running expenses off against the husband’s W-2. You have the husband’s W-2 on a line. On another line, there will be these big losses from all your rental losses. That’s how that works.
Toby: You just nailed it. This person’s actually ahead of the game.
All it means is that if you have active, ordinary income and you have rental losses, and the rental losses doesn’t mean you actually lost money, it means you could rapidly depreciate a section of the building or of the rentals and it creates a paper loss, it’s just going to offset your W-2 income at the highest bracket. It actually is usually pretty tasty when you do that.
“I had a family limited partnership that is going to get a large sum of money. I plan to put it all into a non-profit. Any tax?” he said.
Jeff: I’m assuming that this large sum of money is going to be some kind of income, which is great, but if this is your only source of income and you put it all into non-profit, you’re only going to get to deduct 60% of that.
Toby: Of adjusted gross income.
Jeff: All of this is going to go to your tax return as income and then you’re going to take an itemized deduction of up to 60% of your HEI.
Toby: Let’s say you have a family living in a partnership, and it’s going to get a large sum of money. I have no idea. You know the prints, you got it on an email and it says you’re going to be. I always think that’s what’s going to happen. Let’s say you have capital gains, it’s gone up, you’re going to sell, and you’re going to have all this money. You’re going to distribute it out to the partners and you say, “You know what, I don’t want to pay tax on that.”
You can actually give your partnership interest to the non-profit and you would avoid all tax on that. Now it could sell and a taxable event occurs, now it flows into the non-profit. That would avoid all taxes.
If it exceeds 60% of my adjusted gross income, in that particular case, it’s a capital asset. It should be capped at 30% of your adjusted gross income. Assuming you held it for more than a year, you just carry that forward for five years. It’s going to be able to offset for the next five years.
There’s two things going on here. It’s, “Hey, it hasn’t made the money yet. Should I give it to the non-profit now on a lower valuation?” Maybe, if you think you’re going to have a big hit. Before you guys think this stuff’s all crazy, PayPal is partially funded through a Roth IRA. They made millions of millions of dollars in a tax-deferred account. The rules of the IRA’s 401(k) are the same for a non-profit. It’s still an exempt entity, so you could take that and put it anywhere.
Jeff: Also, in your example, I could sell a property and my family partnership for (say) $500,000, but my gain may only be a small portion of that, so I may be contributing. That’s what you’re talking about, I’m just contributing to LLC in.
Toby: Yeah, put the limited partnership getting here.
Jeff: Yeah, the limited partner.
Toby: It goes like this. If I have stock that’s worth $1000 and my basis is $100, I’m going to have $900 of gain. I could sell it, pay tax on the $900 gain, and then give all that money to charity. I’m going to have a taxable event for $900. Assuming it’s long-term capital gain, it could be taxed as low as 0% and as high as 23.8%. I give that money away and I’m going to get to write off that asset because I gave cash. I get to write off against 60% of my adjusted gross income.
Assuming that’s all the money I have, I’m only going to get a partial deduction this year, I’m going to carry it forward next year. Or I could just give the entire $1000 of stock away and sell it. I get $1000 deduction and $0 income. I have $0 income. I just carry that forward but I don’t have any tax hit.
“Can a holistic medicine be deducted in a C Corp?”
Jeff: If it’s by a medical practitioner, yeah.
Toby: Or if a doctor tells you that you need it, yes. When you say holistic medicine, if you’re using vitamins and things like that, the answer’s no, unless it’s prescribed for a specific illness.
“To fully fund my family trust, does that mean changing the beneficiary by employee pension plan as well?” Kevin, you want to make it a contingent beneficiary. And yes, it’s not your primary beneficiary, necessarily, maybe make that a spouse, but otherwise, you would just make it a contingent. You would be the secondary.
“I ran a portion of my house as a vacation rental. Can I claim the same house as my personal residence?” Yes but you’re going to have a portion that if you exceed 14 days on, and this is what’s weird, the VRBO is about whether it’s taxable. We know that you’re using VRBO. If you go above 14 days in that room or that portion of the house, then you just treat that portion of the house as an investment property. It makes your house into two pieces. One of it’s an investment property and the other portion’s primary residence.
“Which type of HELOC should be used as a second lien to pay off your mortgage much quicker? Is there a strategy that you are knowledgeable about?” Which type of HELOC should be used as a second line, I don’t know. A HELOC is a home equity line of credit. I don’t know what type you’re thinking of.
“Can the CD as collateral for the line of credit to the LLC be used for the asset protection as well?” Yes. Absolutely, depending on whether you’re keeping it in there or outside.
“What if the LLC is undesignated […] for a checking account? How is the LLC defined for tax records?” LLC is by default. You’re going to be ignored for tax purposes to their owner. If you have more than one owner, then by default they’re a partnership. Hope that helps.
“For the line of credit, we should have a contract with the LLC?” Yes, absolutely. You would actually have a loan or you’re contributing that money. In either way, you’re documenting it. “What is a Solo K?” That’s a 401(k).
Jeff: With one member.
Toby: Yeah. with one member, husband and wife count as one member or if a partner counts as a member.
“What are the implications of a C Corp of an accountable plan that reimburses 2019 expenses in 2020?” So, you’re reimbursing things from last year, you can’t write it off until it pays you back.
Jeff: Correct.
Toby: “5-, 7-, 15-year property does not need to be recaptured. If the life of the property has passed and the approval has been fully depreciated. What about 27½-year property?” Correct, Ross. You don’t have to recapture. It’s all capital gains if you exceed the 15 years.
Let’s say you had 5-, 7-, and 15-year property, you held the house for 15 years then you sold it 15 years in, all that 5-, 7-, and 15-year property has no value. It’s all going to be treated as long-term capital gains. The 15 years of depreciation under the 27½ years is going to be recaptured. A portion of that is the structure. You’re going to have a little bit of a recapture, not much, and it’s way better. Sometimes, we do cost segs before we sell a building for that precise reason. We actually have a great example. About $80,000 savings on a $3 million sale.
“Does the rental income from a trust need to be reported on Schedule E or can it be reported directly on line one of the 1040?” If it’s a 1041, it’s going on.
Jeff: It’s going on Schedule E, page two.
Toby: Yeah, going on E.
“I live in Nevada, New York. Can I write off a red light ticket?”
Jeff: No.
Toby: No.
Jeff: Fines and penalties are never deductible.
Toby: Yeah, you’re toast.
“I had withdrawn about $78,000 from the IRA last year. I know I have to pay tax plus penalty. I had W-2 and I am thinking, is there any way to save tax on the mess?” Yes. Give us a call on that one. Email us so we can actually have you talk to somebody to see if there’s a way we can either undo it or minimize the tax.
Jeff: Yeah, there’s some penalty exemptions. There’s too many to list right now, but…
Toby: There are exemptions and it’s just a matter of running the letters, so you can have one on […]. You’re not going to want to write those letters yourself though. Never deal with the IRS on your own.
“If my self-directed 401(k) passively invests in a real estate syndication that is doing ground-up development, will I be subject to UBIT?” No, you’re never going to be because of syndication. You’re passive.
Somebody asked about a real estate professional. It’s 469(c)(7). You’d find this all over the place in previous Tax Tuesdays. They’re all over the place, the real estate professional, plus on our website.
“Can I include my HSA out of pocket expense in the C Corporation?” The HSA would be a deductible expense, but if you have a non-reimbursed expense can you reimburse it out of a C Corporation? Yes.
Jeff: Yes, but your HSA is not going to be able to go through there.
Toby: “Question on a Roth IRA five-year rule for multiple conversions. If Roth account opened 2017 made first conversion in 2018 and second in 2019, does each conversion have its own five-year clock?”
Jeff: That is correct.
Toby: Yes.
Jeff: Now, when you’re just talking about Roth contributions, once that clock starts, it runs for every contribution after that but not the conversions.
Toby: “If the loan is non-recourse debt and you lost the property to foreclosures, is the 1099 COD income non-taxable?” So, it’s a non-recourse debt. If it’s not theirs, it’s just the property then would they have COD income?
Jeff: Yes.
Toby: On the property, maybe.
Jeff: On the property. They can’t go beyond.
Toby: But it’s non-recourse, right? You can’t go after them for it?
Jeff: No. The non-recourse debt was with.
Toby: So, it sounds like it was an asset loan. They foreclosed on the property, and somebody still gave them a 1099 COD.
Jeff: They could go after them up to the amount of their security.
Toby: Up to the amount of the security, that’s it. Would it be non-taxable? It could still be taxable to you up to probably the amount of the security. Is that what you’re thinking?
Jeff: Well, the only place I’ve ever seen where it makes a difference between non-recourse and recourse is with recourse debt, after they take your house, they can keep going after you, whereas nonrecourse, their hands are tied.
Toby: You’re still a guarantor. I’m just thinking of this differently. So yes, it depends on whether it’s a personal residence or a business property. As business property, you get the loss on the property against that income, too.
“What are the advantages and disadvantages of making a donation to a donor-advised funds through a provider?” I know the Daffies well […]. The advantages are you get the tax reduction now and then you can allocate those funds over a period of years. The other downside is they don’t have to give it to the charity that you designate, and some of the funds have religious restrictions or restrictions on certain activities, like they won’t give it to a religious organization. So some of the funds won’t let you give it to your church, for example. You would just check with the provider, but just know that that provider could change their mind. Not that I’ve ever seen one do it, just know that legally, they could.
“If I purchase a single family home and rent it out until I can afford to buy it, is it better to buy it under an LLC instead of as a lease option?” It sounds like you buy it and then you rent it to somebody and you want them to buy it in the future, then a lease option is your best bet. Buy it under an LLC, yes, then do a lease option for some folks. There’s some states that don’t allow it like Texas. They have a little bit of a weird rule on these options so just make sure that you could do it.
“Can we claim American home shield monthly fees for a rental property?”
Jeff: Yeah, I think so.
Toby: Yeah. That sounds like a reasonable expense. I think we got through most of the questions. There’s a lot of questions out there.
“Can a COD from a margin call be used to offset the capital loss? Can a COD cause margin calls sound like options to be used to offset the capital loss in Schedule D?” COD?
Jeff: I’ve never seen a margin call where it exceeded the amount of the securities.
Toby: Yeah, that’s kind of weird. Marie, we have to see a little bit more on that. If anybody has purchased the new Tax-Wise, it’s been done for a couple of months, but it’s been languishing in the printer. The printing press broke, but it’s Bookmasters. They’re a big one and they always get us our books, so they should be here anytime, hopefully, sooner than later. We’ll get you the physical book.
By all means, shoot in your questions to taxtuesday@andersonadvisors.com or visit us at Anderson Advisors. Those of you sending your Tax Tuesday questions, it goes through, and if it’s very specific, they’re doling them off to folks. We get hundreds of them, by the way, guys. We take them and we make them into these Tax Tuesdays. We could see a few people looking for the books, so I’ll get it.
“I sent a question in an email hours ago, resent during the webinar.” I’m not seeing them, Carol. They’re all going through the Tax Tuesday group. So if you sent it just before, understand, there’s hundreds of questions. They’re going through them. We’re not getting them right before. If you’re going to have a question that’s going to go on a Tax Tuesday, that’s probably sent in two or three weeks ago.
If you want something that could get answered right away, ask it during the live event or send it with an urgent request and they’ll make sure that they get it. We’ll go look for it and make sure that we’re getting you a response, Carol.
That is it. Thanks, guys, for joining us and I hope you enjoyed it. We always do. Jeff?
Jeff: Thanks for spending an hour with us.
Toby: Yes, that long hour. We’ll see you next time.
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