Are you and your friends getting the runaround from accountants, attorneys, and others charging for tax advice? Toby Mathis and Jeff Webb of Anderson Advisors set you straight and answer your tax questions. Do you have a tax question? Submit it to taxtuesday@andersonadvisors.
Highlights/Topics:
- If somebody inherits property through a probate, how can you avoid capital gains? When someone dies, capital assets step up to fair market value and costs $0 in capital gains
- What are typical percentages of improvement value for the cost segregation of personal property for 5, 7, and 15 years? About 20%, if property is less than 20 years
- If someone sells inherited real estate for less than appraised value, can they take a tax loss? Depends, but usually not on personal use property
- What constitutes being a real estate professional? 750 hours of professional time in real estate and material participation in real estate activities
- If I move to a different state, does my LLC need to be registered in new home state? Depends, if LLC is separate entity/location, it doesn’t need to be registered in new state
- Does a home-based business help with lowering taxes and need to be incorporated? Does allow some deductions, if business is profitable; doesn’t need to be incorporated
- Can I change my LLC taxes from one year to the next? Yes, but some limitations exist
- Can an LLC be recategorized from a sole proprietorship to C or S Corp in mid-year? Yes, but there are rules to follow and tax forms to complete
- If you’re doing an online business, such as an app, does LLC need to be in your own home state? No, if only doing interstate commerce
- Is equity stripping a necessity in real estate asset protection? Yes, stops lender and others from getting entire equity from your property
- What is the 199A deduction? 20% deduction on qualified business income
- If I start private lending to individual investors, is it possible to take the 199A deduction? Yes, maybe; if designated as specified service
- What’s the definition of dealer? What are the ramifications? Depends on your intent when purchasing the property; dealer buys something to sell it, investor buys and holds it
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Resources
Using Cost Segregation in Residential Real Estate
1031 Exchanges: 10 Things to Know
As always, take advantage of our free educational content and every other Tuesday we have Toby’s Tax Tuesday, another great educational series. Our Structure Implementation Series answers your questions about how to structure your business entities to protect you and your assets. One of my favorites as well is our Infinity Investing Workshop.
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Full Episode Transcript
Toby: Hey guys, this is Toby Mathis.
Jeff: And Jeff Webb.
Toby: You’re listening to Tax Tuesday. Welcome back to another Tax Tuesday, we’re going to jump straight into this thing and it’s like always we have way more questions. I want to make sure we’re getting through as many as humanly possible in a reasonable period of time. We always say these are an hour, but I think we did an hour never. Let’s pretend it’s a fictional hour, it’s usually about an hour and a half. You don’t have to stay on for the whole thing, obviously. If you have to go do other stuff, just know that we record.
If you’re a platinum member, you’ll have access to all of them in your little platinum portal. We also put them into podcasts and other thing. If you want to go and listen to some of them, we’ll also be sending you out the link to the replay so you can actually listen to things if you get time crunched, there’s a whole bunch of people saying hello, let’s go into this.
Ask live and we’ll answer the question before the end of the webinar, send in questions at taxtuesday@andersonadvisers.com, it’s where we grab the questions that we answer every other week. We grab the ones that are not books, some of you guys like to really write. If it’s also not too personal, then what we’ll do is we’ll grab it, we make it one of the questions. If you need a detailed response, you’ll need to become a platinum or tax client. In other words, if you’re asking lots and lots of specific things, as much as we love you and we’d love to do it for free, we’re not a nonprofit, we still have to make a little bit of dollars to keep the lights on.
This is fast, fun, and educational. We want you to come back and we want to get back and help educate, we always want you guys to share with each other. Bring it to your friends as well, if you know anybody that maybe they’re just tired of getting kicked around from the tax standpoint or they get run around from their accountant or their attorneys or whoever they’re getting tax advice from, maybe the guy down the street, maybe it’s a brother in law, whatever. Bring them all on, it’s free. They can get answers and they can verify some things to make sure that you’re getting good advice.
Things that you can do, here’s a freebie. You can always follow us on social media, go on to YouTube andersonadvisers.com/youtube. Sign up and become part of our community there, I think it’s called a subscription, subscribe to our YouTube channel. There’s a little widget next to the subscription button that you’ll click on and it’ll always let you know when we’re posting up new content. It doesn’t text you or email you and stuff like that, when you log on it’ll say, “Here’s the new ones.”
That way you can keep up to date on all these wonderful tax law changes. Believe it or not, they’re still going to keep making changes because that’s what Congress does, is they write laws, rewrite laws. I just wish they wouldn’t hire drunk elementary school children with their crayons to write the laws, it would be helpful if they actually…
Jeff: It’s obvious that they’re not reading the laws that they’re signing.
Toby: Somebody’s doing it, it’s done in a backroom.
Jeff: You’re at the mercy of the cheapest senator they have.
Toby: Somebody’s writing these things there, they’re just not always checking to see what the ramifications of their writing will be and whether it’s perhaps inconsistent with some other provisions, or they’ll just get rid of provisions and forget that there’s a bunch of laws that rely on them. It’s always fun, kicks and giggles.
Opening questions, what are the challenges of putting a California property into a Nevada trust, will you be protected after two years? We’ll answer that. When is a cost segregation study beneficial to a real estate investor? We will definitely go over that. If I moved to a different state, does my LLC need to now be registered in my new home state? Does a home based business help with lowering taxes and does it have to be incorporated? Where is the best state to set up an LLC? If I start private lending to individual investors, is it possible to take the 199A deduction? That’s the 20% deduction, we’ll go over that.
What are the tax ramifications or other issues with purchasing my personal property through my corporation? What is the best business setup for a family building or purchasing a multifamily unit LLC or C Corp? We’ll certainly answer that. What’s the definition of dealer and how can I avoid being considered a dealer? What are the ramifications of being a dealer? There’s the good, the bad, and the ugly, we’ll go over that too.
Under our corporation, is it better to lease a vehicle or buy? Last but not the least, a question we get quite often is can I deduct my real estate training cost? Frankly, can I just deduct any training cost? Which will be simple because we will get through it.
Let’s just jump into these. This is always fun stuff, what are the challenges of putting a California property into a Nevada trust and will you be protected after two years? This is a tax webinar that we’re going over Tax Tuesday. I don’t think that you’re asking just a tax question, you’re not talking about avoiding tax here. You’re probably talking about Nevada Asset Protection Trust.
First thing to know, in any trust you have three parties, the grantor, trustee, and the beneficiary. There’s two types of trust, revocable and irrevocable. Revocable trust, the most common example is a living trust. Irrevocable trust, the most common example is irrevocable life insurance trust. Nevada has a statute that’s called a spendthrift trust where if you put an asset into it and you have an existing creditor, that after two years they cannot make claims against that trust anymore.
There are some conditions to be met and you have to be aware that California has its own interest to protect. Whenever you’re going across the state line and you’re grabbing an asset, California could say, “We have a fundamental interest to protect so we’re not going to follow Nevada law, we’re just going to ignore it because we have a fundamental state interest that we believe is really important. We’re not going to follow it.”
What are the challenges to putting California property into it? If you wanted to effective, you’re going to have to make sure that you understand exactly what it is that you can protect and what you cannot protect. The first thing is you want to make sure that if you have a California piece of real estate, it might be wise to get that California real estate into a vehicle and convert it from just real estate into something that is something different like personal property. The way you do that is by using an entity, it may actually be a land trust.
I would more than likely have that land trust to have a beneficiary that is in a different state like Nevada or Wyoming, it really doesn’t matter as long as it’s not California. What we’ve done is we converted that piece of property from real estate in California to being broken into three pieces. Now you have a grantor, you have the trustee who is on title, and the beneficiary who use the enjoyment of that piece of real estate is now transferred out of the state.
I would then, this is going to sound weird, but when you’re dealing with asset protection trust, you want them to actually be enforceable. Usually, we would be stopping there and saying, “Maybe we’ll have a holding company on top.” Since you asked about the asset protection trust, we do a year and it’s usually for your higher end folks. Here’s why, it’s because you would actually have that LLC partially owned by the Nevada asset protection trust and partially owned by probably your living trust. We wouldn’t want you as an individual to own it just because California would say, “Great doing business here for purposes of the franchise tax.” They’d want to hit you for that $800 a year. If it’s sold by a trust, we can get around that, especially if it’s an irrevocable trust like Nevada asset protection trust. Most people are saying it’s my birthday last week. Got a little older and now I’m 30.
Jeff: A little older for the…
Toby: Yeah, I keep having anniversaries after a certain point. The anniversary of your 30th birthday is what I like to have.
Let’s go back to the asset protection trust. There are actually wonderful vehicles, when used correctly, you just want to make sure that a California court can’t ignore it. The way to do that is you got to get that real estate in California from you being the true owner of it to something else being the true owner it. The only way you’re really going to accomplish that with a Nevada asset protection trust is to make sure that the California real estate is owned in a trust and that trust is owned by an LLC that’s out of the state and that LLC is owned by the asset protection trust.
This sounds weird, I wish it was easier but that’s really the way if you want to use this. Sometimes it’s like bringing a bazooka to a gunfight. The asset protection trust that’s already been determined, you cannot break into those unless when you transferred it, you did something nasty like you did a fraudulent conveyance or you were doing bankruptcy planning or you’re making yourself insolvent. Again, I said, the LLC isn’t even owned 100% by the Nevada asset protection trust, we’ll have you own it and we’ll make sure that the asset protection trust owns it. The reason you do that is so there’s never a question as to whether you’re solvent or not.
It gives us lots of tools if you’re ever being attacked. If something happens to that California property, there’s not much you can do. They’re going to be inside the land trust going after the beneficial interest which is now inside of an LLC, it’s going to be stuck inside that LLC. They’ll get that property. This is really potent if somebody’s ever coming after you. Nevada is one of the only states, actually this is the only state that alimony is not an exception. If you have an ex-wife or ex-spouse, ex-husband or whatever coming after you all the time, asset protection trust is pretty strong.
Just know that you need to make sure that the property is not sitting in your state that you’re trying to go after because that court, whenever you’re in court, you’re in that judge’s forum. They could choose to do some pretty bizarre stuff, you want to make sure that they don’t have the ability to undo what you put in place.
Jeff: When we’re talking about the trustee and the beneficiary, the grantor is obviously the person turning over the property. Ideally, do you not have the trustee and the grantor be in the same person?
Toby: Ideally. I’ll tell you what I like to do, some of you guys might not like this answer, but I don’t really care what the statutes say, I’ll just stick an LLC in there. I don’t really want my name sitting on it or I’ll borrow somebody, have an attorney or somebody serving it. Just if I want to make sure my name is not floating around.
Let’s use the example of I have rabid ex-spouse that likes to sue me all the time and try to get assets. I don’t want them to know what I own, where it is or anything like that, I don’t want my name on it. The beneficial interest isn’t a public record, except in Arizona.
If you’re in any place else, then I’m just going to put it in a land trust and I’ll probably use somebody else’s name or I’ll use a Wyoming LLC to be the trustee. The way it works is this, the easiest way to think of a land trust, by the way, this isn’t even getting into the asset protection trust, just a land trust in itself. What we’re doing is we’re making the legal owner different from the beneficial owner, the party that gets to occupy it is the beneficial owner. The party that gets to rent it is the beneficial owner. The party on legal title is a trustee who has no liability for it and really nothing to do with it other than they’re holding title.
This came out at Illinois, that’s what they call Illinois style trust. There’s about 14 states with statutes, the rest of it is common law. The Illinois was great, that’s something about the Sears tower. If somebody had known that they were acquiring all these parcels and it was the same party, they would’ve jacked up the rates or somebody would’ve tried to block it. All they did is made sure that it was a bunch of blind trusts out there with different names on it and nobody knew that they were acquiring the properties.
Disney World too, that’s how they acquired most of that land. All it is is a fancy way of saying, “I don’t want everybody to know what I own.” If you love people knowing what you own, go for it, put your name all over it. If you don’t think that it’s anybody’s business, you don’t have to have your name on things. There’s a ramification, if I’m running a business, it might be tough if my name is not on the business. Bankers don’t necessarily like it, you got to be a little careful who you deal with.
For a lot of people, it’s worth a little complexity because if they can’t see it, they can’t take it. You’re asking for problems if everybody knows what you own, that’s my opinion because I’ve seen more law students come out of the fact that somebody thinks there’s something to get than the reality of it. I just don’t want to temp that.
Somebody says, can I use this setup? Yeah, absolutely. There are a few other questions. Let’s see if any of them have to do with what we were just talking about. I don’t see anything that’s right on point, we’re just going to keep going. What I do with all the live questions, we get a ton of them. Last time, I think we had over 400 questions. I’m looking for the ones that are relevant to what we’re hitting now. If we have time, we go back and grab everybody else. You’ll see that sometimes I’m answering stuff as it pops in. Let’s keep going after it.
That two years, by the way, is what the statute says is if you transfer an asset that somebody would’ve been entitled to to an existing creditor. This is where it really gets interesting, you don’t have to wait two years. If they’re not an existing creditor, then unless it’s a fraudulent conveyance, they’re not going after anything, anyway. You could set up an asset protection trust in Nevada and it’s effective right away. It’s just if you have known creditors right now, they only have two years to make the claim or six months from actual knowledge of the transfer, whichever is later.
If I’m ever worried about it, I’m just putting it and filing it with the county that I’m transferring an asset in the trust, that’s deemed notice. That is just two years. If they’re not a creditor of yours, you got immediate protection. They’re pretty potent. We use them with some of the higher end folks, it’s not that you shouldn’t use it. I hope that helps and makes sense. From a cost standpoint, by the way, let’s go back to that. From a tax standpoint, these are grantor and trust, there are no tax ramifications. Literally, that structure I just gave you has zero tax returns.
The land trust, to the LLC, to the asset protection trust, I make the asset protection trust, the way I like to do them is as intentionally defective grantor trust treated as a grantor trust for California purposes, there’s no franchise tax on it and there’s no federal tax return too, it just goes onto your Schedule E. That whole structure has zero tax compliance, just to fill that in for you.
Fun question, we love cost segregation. Do you want to jump on this? I don’t want to talk this whole show.
Jeff: Here’s my opinion for the cost segregation, these are almost always beneficial, except what I see in certain cases. If you’re going to be selling this property shortly, I see no reason to do cost segregation on it. Also, you’re going to get a deduction now but you’re going to be paying back in the next year. If you are not a real estate professional and you’re already incurring losses on your rental properties, this may not be a terrific idea because all it’s going to do is create passive losses that gets suspended while you hold the property.
If you’re a real estate professional cost segs, I believe are even better ideas. Being a real estate professional allows you to take losses that you might not be able to take as just a regular real estate investor. That’s my two areas to stand away from your rental properties are suffering losses and planning on turning the property over.
Toby: Jeff, I feel like geeking out right now, let’s geek out.
Jeff: Are you going to be an accountant?
Toby: Yes. When you buy real estate, there’s really important things. The value of the land or whatever you bought it for, Jeff’s going to use the word basis and stuff, but let’s just say you buy it $350,000. Your land value, let’s say it was $75,000, which means the improvement value is $275,000.
Jeff: I don’t know why you used $275,000.
Toby: Because if it’s residential, the IRS has these things called the modified accelerated cost recovery system, MACRS. That means that under the standard, you can have 27 ½ years to depreciate this, which means you take 127.5. You just divide this by 27.5 which means you’re taking $10,000 of deduction every year. If your rents for the year are $10,000, you pay zero tax. That’s all. The IRS basically says, “You’re going to have to replace that building every 27 ½ years. If this was commercial, it’s 39 years.
All cost segregation is saying, a study is saying is rather than take it all over 27.5, that’s considered 1250 property. 1245 property is everything else, that’s personal property. We’re getting geeky now, you guys are going to learn something. That personal property, this could be 5-year property, 7-year property, 15, anything below 20, you could do something called bonus depreciation this year. You can ignore all of these and you can take them all on year one.
What you’re doing is you’re having somebody break the building down, that $275,000 and they might say $200,000 of it is this 1250 property which gives this 27 ½. The personal property would be $75,000 which means you can take that in year one. I’m going to get one or you take your $200,000 and you divide it by 27.5, which is going to equal X, you can actually do that. You’re also going to get $75,000 in loss as well. You’re going to get something like $7272. You’re going to get the sum of that as a deduction this year, that would be $82,000, whatever it is.
Jeff: That’s right, $82,272.
Toby: You’re going to get an $82,272 deduction. That sounds neat and dandy, but you’re not allowed to take your passive losses and offset your active gain. There’s a passive activity loss. If you have $82,000 of loss, I’m just carrying that forward. I’m getting really no benefit. There’s really not a big reason to do the cost segregation. What if I have a bunch of other properties that have positive rents? What if I have $30,000 a year coming in from other properties? That $82,000 is my best friend and it’s going to wipe out $30,000 a year until we use it up, it just carries forward.
The other thing is what if I am a real estate professional? That’s how I make my living. One of the spouses needs to spend at least 750 hours in the field of real estate, the buying and selling of real estate, not just being a janitor in a real estate company or whatever. You actually have to be involved and then you have to maturely participate in your real estate, that’s the trip up, by the way. Over and over and over again, we see people that forget that you have to also maturely participate with your properties, you have to do an aggregation election which you do by filing it.
Jeff: It’s just an election you file over the year combining all your properties.
Toby: Is that a special form?
Jeff: It’s an election, it’s a statement that goes with the return.
Toby: You just have to remember to do it, if you don’t you’d be sorry because that $82,000 could offset your W2 wages. If you’re a real estate professional and you have one spouse making half a million and the other spouse is doing nothing, you just lowered your tax bills substantially, you just got an $82,000 deduction.
How do you calculate what the cost segregation will be? Do you need to hire a professional? The answer is yes. I could tell you the general rule of thumb is it’s going to be somewhere in the 20% to 30% range depending on the type of property. You actually have to have somebody go out and do the study, the studies have gotten significantly cheaper over the last few years. There is now a software that’ll do it. For single family residences, that runs about $400 per study but you don’t have somebody going through the property. If you were contested, you may have a little bit of an issue. Is there a place to see an example of a real estate professional statement? When you’re a real estate professional, where are you putting it?
Jeff: It goes in the return usually after the return itself.
Toby: All you’re doing is you’re making an affirmative statement as part of the return, it’s not even a form.
Jeff: It’s a statement, it’s an election that basically says, “I am under this IRC code, I’m electing to aggregate all my real estate activities.”
Toby: Joshua, if you email us at taxtuesday@andersonadvisers, we’ll kick you that. We’ll give you what the language is, the magic language. The language isn’t what’s important, what’s really important is that you actually document your hours. Your hours, it’s a two part test. It’s 750 hours plus you have to maturely participate with your real estate. The 750 hours has nothing to do with your real estate, it has to do with you. One of the spouses being in the field of real estate, the number one use of that spouse is time.
Jeff: If you have four properties and you spend 200 hours on each of them, if you don’t aggregate those, then you failed the test on all four properties.
Toby: Actually, not necessarily. Let’s go through this. Number one, I have to spend 750 hours on real estate. It’s only one spouse that has to do it, I don’t combine time between spouses. In your example, I had four pieces of properties, I spent 200 hours each. I just hit the real estate professional as long as that’s one spouse doing it or if you’re single, you’re doing it.
You have 800 hours, is there any other use of your time professionally that exceeded 800 hours? Let’s say you’re a full time bookkeeper, you’re toast, you’re not going to qualify because you spent more than 800 hours. Let’s say that you’re not, let’s just say you don’t do anything else as a profession, then you qualify in the 750 hours.
Now we go to the second test, mature participation. There’s literally three levels of testing. There’s 500 hours cumulative or there’s 100 hours and you’re the number one provider of time to those properties. Under the example Jeff gave, there are four pieces of properties. It’s so much easier to say, “They’re all one enterprise.” Otherwise you have to qualify for each property, but under the facts Jeff gave us, you would qualify for each property. You’re over 100 hours unless there’s a property manager, you’re doing more than 200 hours which I couldn’t imagine, then you are maturely participating.
To answer your question, Michelle, what does maturely participating mean? That’s what it means, it’s literally they just say you are doing some activity, you’re either managing the manager or you’re spending time on those properties. The IRS says it’s per property unless you elect to treat them all as one property, you’re making an aggregation election. Please treat all these properties as the exact same thing. It’s actually really potent but tough to hit.
The most extreme example is actually a friend of mine who made about $3 million in his legal profession one year and his wife qualified as a real estate professional. He went and he bought so many properties, he had all of his doctor buddies, they were buying up all of these commercial pieces of property and he was depreciating the heck out of them. His wife qualified as a real estate professional and he paid no tax. The IRS did not like that, they came in to audit him and he’s sadistic. He decided to represent himself because he thought it’d be fun, he is one of those people. He beat them, he’s actually pretty hilarious.
Jeff: Usually when I see per se on a tax case I know it’s going to end badly.
Toby: Yeah. I’m just going to make your life muy bien today. Here’s the question, this isn’t one of the questions that we have but this is a question just asked and the answer is so potent. Somebody says that was not Scott Aston. No, that was actually an attorney buddy of mine by the name of Howard Spier. He’ll tell you the story himself, I’m not breaching anything. He actually sued Savannah into bankruptcy a few years back. If you ever Google him, it’s for kicks and giggles, you can go in there and Google Howard Spier, very cool lawyer. He’s been our buddy for about 20 years. He actually represented a gal that had a tree fall in Savannah and Savannah said we’re not responsible, and he ended up winning, they didn’t have enough. Yes, Scott is actually smart enough to do it.
We’re going to go through this thing. Somebody inherits property through a probate, how do you avoid the capital gains? Here’s the beautiful part, when somebody passes, meaning they passed away or they died, all of their assets, their capital assets, step up in value to the fair market value on the day of passing. If Jeff owns a piece of property and he passes away and gives it to me, thanks Jeff, I could sell it the next day and pay zero in capital gains because my basis stepped up. That’s pretty amazing, it’s pretty cool.
Jeff: Pretty amazing that I die?
Toby: Yeah, it’s pretty amazing that you don’t have to pay tax on it. Here’s the kick, if you’re in a community property state and one spouse passes, the entire basis steps up. If you’re ever going to, “Hey, I really need to sell a property. I don’t want to pay tax.” All you got to do is go to the Grand Canyon. Give them a little nudge over the edge.
Jeff: The basis stepped up! Thanks. Taking one for the team.
Toby: What are the typical percentages of improvement value with the cost segregation personal property for 5, 7, or 15 years? Truly, it doesn’t matter whether it’s 5, 7, or 15. We just care that it’s less than 20 because the bonus depreciation will say, “Yay, we can do it.” The typical percentage is right around 20% from what I see. But again, it’s going to vary depending on your property and what you have in it. If I have a lot of carpeting and I have lots of stuff on the walls, lots of fixtures, and I spend a lot of money on a bunch of countertops, all this stuff and spend a lot of money, that means I’m going to have a whole bunch of value because those items aren’t going to make it 27 ½ years, or if it’s in a commercial building, they’re not going to make it 39 years.
Jeff: No. We’ll say that the bonus depreciation only applies to 18 and 19. You can do cost segs going backwards and do a change of accounting.
Toby: Yes. The bonus depreciation was in the Tax Cuts and Jobs Act. Before that it was 50%.
Jeff: It was 50%.
Toby: Yeah, and it’s going to go back down again. Let’s see, if the person sells a piece of real estate for less than the appraised value upon death, can the person take a tax loss?
Jeff: No.
Toby: Yeah.
Jeff: No, you can’t take a loss on personal used property. Well, it depends. Going back to our standard, it depends on what you are doing to a property. I guess it could be considered investment property.
Toby: Yeah. If it’s investment property, then the basis steps up, don’t you start your depreciation.
Jeff: Well, I’m thinking about even property that you’re just holding, that you inherit and you’re holding, when are you going to sell it. I don’t know if there would be a period you will need to hold it to.
Toby: It’s interesting. Bobby asked a very interesting question. If it sells for less than the appraised, the IRS would argue that the appraised value is what they really care about. The value is whatever you sold it for. But if you held it for a year, which was in 2008 then there’s a chance that you’ll actually take a loss putting that type of property. You don’t get losses when you sell your house.
Jeff: Right. You can take losses on any personal use.
Toby: Right, it has to be investment property so you’d want to make sure that you have a renter in there. I suppose you could. I’m not sure. I don’t recall any exceptions. Do you recall any exceptions?
Jeff: No.
Toby: Alright. You got us stumped on that. We may look at that. Maybe email that one because that would be a fun one to do. I think you’d actually get the loss… Email it in, Bob, so we can dig into it because that sounds like a fun one.
On the cost segregation, there’s another question “Do you have to be an actual spouse, or can business partners still qualify?” Spouses, has to be one tax return. You can’t do it with daughters and mothers. By the way, that material participation, that’s cumulative hours between the spouses.
Jeff: Right.
Toby: One spouse has to qualify under 750 but both spouses can be added up together to meet the material participation.
Going back to our questions. “If I move to a different state, does my LLC need to now be registered in my new home state?” the answer is you know what it’s going to be, it depends. Here’s the deal, your LLC is a separate person if it has a different home than you, then it doesn’t register when you move. What that means is it has its own location. This is why when you use Nevada, or Wyoming, you actually have to have an office.
If you live in a state, let’s say that you have a Dairy Queen, and you have that Dairy Queen at LLC, and you move. The LLC doesn’t have to move with you. Now let’s say that you have an LLC and you’re selling essential oils out of your house, and you have an LLC that’s only address is your home, and you move. Will that need to be registered? More than likely, yes. Now, unless you have a place for it to stay, you’ll have to have another home for it in your home state.
Jeff: Yeah. You’re going to lose liability protection aren’t you? If you don’t move it to your new state.
Toby: Yeah, you’d want to make sure that it’s there.
Jeff: I’m assuming you’re doing business out of your new home.
Toby: Right. If somebody says, “If I live in Ohio and business is in Ohio but thinking of moving to Florida, where does it go?” You’re living in Ohio, you can keep your LLC, it doesn’t have to go with you. It’s separate. It’s an artificial person. You can always leave it in the state. That’s why you’re going to see us use Nevada in Wyoming a lot and we’re not bringing it to your state because we don’t want to.
It’s kind of like this, if Jeff lived in California and I lived in Nevada, and Jeff gets sued, I don’t want it to have anything to do with me. If I’m Jeff’s LLC, the judges in California can’t do anything with me but if my bank account is in California, now those judges can do something with it. I always want to make sure to keep my LLC that’s not my state separate from me, make sure it has its own address, its bank account is not in my state. No judges can touch it. Anonymity. We can make it where they don’t see it too. They don’t even know it’s there.
That’s kind of the real secret sauce in my experience in 27 years of doing this. People can’t take what they can’t find. They can’t see it if it’s not in your name. There’s not a real place that they can go to see it. Every year we have somebody saying something about tax returns “Are those all your tax returns?” and I go, “Yeah, how’s that working for congress right now? They’ve been chasing after Trump’s.” I’m sorry. They may be able to get it solely because he’s the president but nobody else, I can’t go pull your tax returns for you. As much as we’d like to, unless you give them to us.
By the way, that’s my queue. There’s no such thing as a phone call from the IRS to start an inquiry. It’s always a letter. They do not call you and threaten you. If anybody calls and threatens you, this is actually a huge deal. It’s costing taxpayers millions of dollars. Hang it up. Block it especially if it’s a cellphone, know enough to tie it to any other numbers that are used in that group so that you don’t get those phone calls. It’s not real. Hang up and block it. Get rid of it. There’s no such thing as IRS calling and harrassing you. I get this because the clients call, “What did you do? The IRS is calling me and telling me I screwed everything up.” It’s not the IRS.
Jeff: You can always call them. Their number is 800-829-1040, say, “This is me. Did you send me anything? I’m just verifying.” They’d be happy to deal with that. They had a lot of trouble with identity theft and fraud and stuff.
Toby: It is bad and if somebody sends you something, don’t log into it either. They don’t email you as well.
Let’s see, regarding anonymity, […] as for all assets under your control. It depends, Dominic, on whether it has anything to do with your case. If I’m being accused of speeding and running into somebody, what does my financial situation have to do with whether I was being negligent when I was driving? The answer is it has nothing to do with it. I would contest that all day long. They’re not going to see my financial condition. Usually, what you do is you hand them your insurance and say, “Please read it.” They can’t find anything else, they’re just going to try to get your insurance and they’re going to leave it at that.
Jeff: Deep pockets.
Toby: We’ve seen this over and over and over and over. You always got some lawyer that says no, I’d get it. Yeah, if you have a rollover, pushover, sure. But we’re talking about $30 million cases that they’ve gotten out of. Not because they’re doing anything wrong but it’s because we’re able to settle it without putting all themselves at risk.
Jeff: Right.
Toby: We got first hand experience with this during that downfall where you had four and five partners in properties, and when the property project failed, they would look for the guy with the money. Our clients are often times the one with the money so we got to see how they were able to get out of these things. Whether it’s a $30 million dollar liability that they didn’t cause and they just happened to be the only one that has anything left when the whole thing blew up.
I’ll tell you what, we saw literally a son and his father go through the exact same suit. The son got released after two weeks, the dad had to fight it for two years. The only difference between them was the son’s assets weren’t in the son’s name, and the dad was old school and had everything in his name. Probably some lawyer telling him, “You don’t need to do that.” It cost him millions of dollars. We saw this over and over again.
Somebody that says, “Hey, I got four calls from a computer.” Probably a computer saying that they are the IRS or a risk going to jail. That is absolutely a scam, guys. Please share that with all your mothers, brothers, sisters, and fathers. Anybody, especially old folks. My mom calls me up always freaked out because somebody’s calling her, usually with a really horrible accent saying she’s going to be jailed for something she didn’t pay. It’s absolutely predatory. Get out and then report it.
Let’s see what else we got. Somebody says, “Big question, I plan on using RBA loan to buy properties; one in North Carolina, one in Florida, one in Ohio. Can we file a business name in each state?” You file an LLC. First thing you got to have those and an LLC in each state. That’s what you’re going to do. More likely, your ownership’s going to be through a Wyoming holding company. I would actually talk to one of our reps.
Somebody says I keep telling Allan not to make those calls. Oh my goodness, I know who you’re talking about. Alright.
Next one, “Does a home-based business help with lowering taxes and does it have to be incorporated?” Going back, I’ll jump on that. Somebody says, “Does each LLC need a checking account?” it does not. Under that circumstance, it does not. As long as you have a property manager collecting the money that can forward it to the holding. It is a factor as to whether or not they’re going to honor that LLC. In your case, you’re not trying to dodge liability. The liability will stay inside the LLC, there’s an asset for them to get. If there was a death on a property, a fire, a horrible environmental claim, or something popped up that was wrong with the property. We keep on saying, “If we’re on the East Coast, lead still is an issue. I got to see that first hand.” You just want to have that LLC wrapped around it so that they’re stuck in it. That’s not going to hurt you. You don’t have to go too crazy on it. You just have one account where the money would go.
“Does a home-based business help with lowering taxes and does it have to be incorporated?” Jeff, what do you say?
Jeff: I’m going to go with the second question first and say no, it does not have to be incorporated. You can be a Schedule C, preferably if you’re an LLC. It can be an S-Corporation. It can be a corporation.
Toby: But it does not have to be any of those.
Jeff: It does not have to be any of those in particular. You kind of want to have that entity that does this whatever your home-based business is. Now as far as does it help lower taxes, hopefully your home-based business is generating tons of income and making you pay more taxes but I understand what you’re saying. You’re going to be able to deduct the home-office, there’s going to be some other expenses that you’re going to be able to deduct. Your phone lines, your internet, and certain other expenses.
Toby: A portion of it.
Jeff: A portion of it.
Toby: By having a home-based business, period, you’re going to get to write off things that you’re not getting to write off as an individual. For example, if I am in my house and I’m using a room in my house, the IRS gives you a safe harbor of saying, “Hey, you can write off $5 per square foot for a year, for your home office.”
Jeff: Right.
Toby: That’s what they’re giving you and you’re done. It’s not so great. If you are a little more savvy, I would actually have something that is incorporated from a tax standpoint. Either an LLC taxed as an S-Corp, LLC taxed as a corp, an S-Corp, or a Corp and I would have an accountable plan, I would just go around that rule and I would just have it reimbursed you for the business use of your personal property. Now you’re not reporting that anyway, you’re just writing it off on the company. In any case, you’re getting to write something off that you wouldn’t have otherwise been able to. It will absolutely lower your taxes.
The big thing for us is because we look at asset protection and tax kind of on the same level, if you don’t have a box around your business, there’s no stopping the liability. That goes in and out. If something happens in your business, now they’re taking your personal assets. If something happens in your personal life, now they’re taking your business. We like to see a box put around the business for that reason, so they can’t take it away from you at least you make it very, very difficult for them to take your business away. On the same token, you’re not responsible personally if anything happens in the business. Yeah, there’s a bunch of tax reasons to do that, it will absolutely lower your taxes. On average, we’re trying to get the exact number but it’s between $20,000 and $30,000 of extra deductions per year. I think that’s what we are looking at.
Jeff: Right.
Toby: I know we are trying to grab a bunch of returns and give you the actual calculation but just by incorporating. If you have that much revenue then it’s a good chance that it will go away. What’s that worth to you, depends on what your tax bracket is. If that’s the only money you have coming in, not that great. If it’s additional money on top of a high paying job, then it’s fantastic. It always depends on your situation.
Jeff: Here’s a difference between having an S Corporation and a Schedule C. If you’re not profitable with your Schedule C, then that home office deduction is suspended until you are profitable. If you’re reimbursing that expense through an S Corporation, it’s a dented deduction. It creates a loss.
Toby: Yeah, and a lot of people. Again, accountable plans, that’s when a business reimbursing the business use of personal assets. They only exist for you, the owner, and S Corporations and C Corporations. You can’t do that out of a sole proprietorship or out of a partnership.
Jeff: Yeah.
Toby: That’s just life, unfortunately. The answer to your question is yes. Home Based businesses absolutely lower your taxes and it does not have to be incorporated although we strongly suggest that you look at that because it’s better for tax and better for asset protection. And just to throw it in there for state planning because you can’t give away something that you. If you pass and your sole proprietor settle your business or if you have an LLC or something, then it’s separate than you that can be perpetual.
“Can I change my LLC taxes from one year to the next?” You can, 70% limitations but absolutely. Somebody else is asking, “Can I own an Arizona property in a Florida LLC?” You can but you may be registering that Florida LLC in Arizona. Usually what we will do there is to have a land trust at the beneficial entrance held by the out of state LLC. That’s currently living and having an LLC in California. Have a bank and credit card attached to it. I run the C Corporation and Holding in Wyoming, of course, absolutely you can. Just know that California likes to try to bring in anything. If you ever ask them, “Hey, do I have to pay taxes here? The franchise tax?” The answer is always yes.
I have some bad examples but their answer is, “Yes, pay us money.” Every single time, it freaks people out. “Can an LLC be re-categorized from a sole prop to a C Corp or S Corp in midyear?”
Jeff: Yeah.
Toby: Yeah, absolutely. Yes, you can but you have to follow the rules. An S Corp, if it’s an LLC that’s disregarded, wouldn’t you just file a 2553, couldn’t you do it at the end of the year?
Jeff: Yeah, if it’s an LLC, you just file the 2553. You don’t have to do the check the box form.
Toby: Yeah. The other one you are doing an 8832 is the C Corp and you might be getting a different AIN, right?
Jeff: Right.
Toby: Somebody is having trouble seeing it on the same two weeks ago of things. Look, you are probably having some issues with GoToMeeting which is a GoToWebinar that’s probably the software that’s giving you fits, something’s just going funky.
Toby: Alright. Where is the best state to set up an LLC?
Jeff: Does it depend?
Toby: It’s going to depend, absolutely. Hey, somebody’s in Bogota. Hey, yes that’s so cool. Any time I see Bogota, I think everything just depends. Where is the best state to set up an LLC? If you are an active business, then you’re going to have to be registered in your home state.
Jeff: Yep.
Toby: Then I look at the inside liability and outside liability in that state and I say, “Hey, could we be an LLC in that home state and will that get us where we need to go?” You can actually set up an LLC in your home state and have it owned by an out of state LLC. If we’re looking at isolating the liability of the business in an LLC, it doesn’t really matter, we’ll have it in our home state. If we’re trying to keep somebody from being able to take that LLC away from you, you are probably using Wyoming, to be straight with you, nobody can take it away. That’s the truth. You guys are being mean to me today, this is horrible.
Jeff: Hey, he just had a birthday. Give the guy a break.
Toby: I’m getting older. I’m being like Jeff. These people are ganging up on us here.
Jeff: Walter.
Toby: What? Here’s the other one. If you have a business that has other partners in it than those partners, especially if you have an angel investor, they’re going to want you be in Delaware because they are self-serving. They want to be in and take that business from you. They also want to use what’s called an Objective Standard of Care. They want you to have to be a reasonable business owner. Whereas if you go to Wyoming, Nevada, it’s a subjective standard of care that I can pretty much do whatever I think and I don’t have to worry about getting sued by these guys.
You’ll see this and if you ever done a commercial loan, you will find yourself having to go to Delaware more likely. What they’ll often times do is they’ll have—the reason I know this is because I’ve done a bunch of these. They’ll have a holding company that is going to own the entity that’s getting the loan and that holding entity is going to be in Delaware. It will be the sole owner of the entity that’s actually going to hold the real estate. It’s a very interesting setup.
What they’re doing is they’re making sure that they can pierce through and take that company away from you in the event you don’t pay. That’s if you’re dealing with commercial lenders and that’s what you’re probably going to be doing. Then you would have the actual property held in an LLC in that state. If you do not need to do that, if you don’t have an angel investor or a hard money investor, if you are not doing a commercial loan–I’m not doing an asset based lending–then more likely I’m going to have your state LLC be wherever the real estate is or wherever the actual business is. But I’m probably going to have it held in a Wyoming entity at some point.
The reason being is that in Wyoming, the only thing that you are allowed to get under law is the lien against your LLC. They can’t take it away from you with the exception if you’re doing fraud or criminal activity. If you’re doing your best and you’re being an honest person, they can’t take it away. What it does is it forces an early settlement because their win is a lien, it’s all they can get. They don’t get any money, so you think about yourself. If you’re going to sue somebody and your win is basically to put a lien on their business, but they’ll still run. You’re not even in control, you have no say in it, whatsoever.
There’s some really good questions people are saying, “What if you are doing an online business like an app, does the LLC need to be in your home state?” The answer is no. If you’re doing interstate commerce only, then you can have it be in Wyoming, Delaware or Nevada. Is equity stripping a necessity in real estate assets protection? So, equity stripping. Jack, that’s a great question. I think it’s one of the best things you can do.
Let’s just goes back to this idea of inside and outside liability and pardon my drawing. Let’s say that I have a piece of real estate, here’s my real estate and here’s my LLC. If I have a fire or something happens to this piece of real estate. I want it to remain in there. What they can get is the equity in that real estate. If I own this piece of real estate and it’s $200,000, and I own it for cash, they’re going to get my 200,000. They would get whatever the equity is.
Here’s another way. If I don’t want to have equity in there, the chances of them really pursuing it super aggressively are reduced. I may have an entity out here, my little lending entity. Loan it money and take back and have a deed of trust or lien against that property, and that’s called equity stripping. You can use a bank, you could use your own entity, you could use your buddy’s entity, you could use your buddy’s IRA, pay him a little interest or whatever. But all you’re trying to do is say rather than have 200,000, maybe I’d take a 160,000 on a loan. Now, my exposure is the $40,000 of equity.
What that does is I happen to know that the average cost of a foreclosure is right around $40,000. It tells them that if they win, they’re going to get nothing. The chances of them pursuing you aggressively for $40,000 is greatly diminished. You’re probably settling that thing for $10,000. It’s not trying to get out of things you owe or escape liability, its forcing the privilege cases to go away, the legitimate cases hopefully have decent insurance, and if the insurance company is being goobers and they’re not paying for something, it doesn’t put you in the cross hairs. They’ll probably kicking something out to make it go away as well. In any event you’re limited at what your total loss could be, it went down from $200,000 to $40,000.
Somebody says, “If you already have solid asset protection setup with regards to rentals, do you still need landlord insurance?” Absolutely, positively. There’s a huge difference between a regular personal property and a D3 and some of these others. You want to make sure that you have a landlord insurance as well and you want to make sure that your tenants are carrying renter’s insurance and that they’re making that the primary. Unfortunately, in this day and age, make sure you have umbrella insurance as well. It’s really good lawsuit protection because even if your landlord says, “No, we’re not going to cover you.” The secondary insurance will come in, at least cover the lawyers so that you can negotiate this thing and get rid of it.
What happens if there’s a lien against your LLC in the example and you’re selling a property, you get a payoff. In my example, I’ll go back to it, let’s say there’s a deed of trust for $160,000 and you go to sell it. When you sell it for $200,000, the deed of trust gets paid off so you get the cash up here if it’s you. If it’s a bank, they get paid back just like anything else.
“What is beneficial to put your name on the title or people’s property? If total is five properties, do you use five LLC name or just one LLC?” I’m not sure I understand the question but I think you are saying if you are using a land trust, use an LLC. And you can use one.
“Does the SBA put any special requirement in the setup?” Of course they do. They want you to be a personal guarantor and they want there to be one entity holding an asset so that they know they can get it and there’s nobody else making a claim against that asset because that might be how they get paid. I’ve negotiated many in SBA loan when the crisis hit here in Vegas. I got way too involved that a whole bunch of SBA loans and clients where their business were failing or their bank pulled their lines of credit and all of a sudden you just had one here, a huge restaurant. It seems like everybody was doing their best job to put them out of business. It was like are you kidding me? These bank are just being goobers and you had all this stuff going on.
The SBA was actually the easiest company to deal with, the easiest organization to deal with. Nobody’s really in the business, they really don’t want the assets back. No bank is in the business of running your business, they just want to know that they’re secured. Going back to the same example, we’ll get back to this stuff, guys. We’ll go through all these questions.
Somebody is asking, “Are you saying that the outside entity borrows $160,000?” No. This guy is loaning it so this guy up here, this guy is loaning the money down here. This guy is loaning so the money is going this way to buy the property and that’s the lien. That’s the deed against that guy. If there is a non-friendly judgment and they can’t take your LLC, what happens when you’re selling the property held in the name of the LLC? Nothing. Do you sell this property? Hey, I sell this property inside the LLC, nothing. LLC owns it.
Nobody can come outside and take it. If you’re out here, let’s say I’m out here, here’s Toby smiling, who owns that property? The LLC does. This little LLC down here owns it. If they ever come after me, then they have to try get here and there’s not much equity.
I know what you’re saying. If somebody is going after me and you sell the asset inside it, you’re still getting $160,000 up here. Problem is if you own that one too, you better hope that is in Wyoming, because you don’t want them to be able to take it. We have a whole bunch more questions to go through.
“If I start private lending the individual investors, is it possible to take the 199A deduction?” Jeff, what do you say?
Jeff: Well, the answer is kind of, sort of yes.
Toby: Kind of, sort of?
Jeff: Maybe. We’re still not sure about this. We’re pretty sure that individual private lenders are not going to be able to take the 199A. They’re considering whether hedge funds or private equity funds may be able to take them because they’re usually considered trade or businesses in themselves.
Toby: Yeah.
Jeff: But for an individual doing private lending, you’re probably going to be consider what’s called a specified…
Toby: Specified Service.
Jeff: Specified Service, yeah.
Toby: Here’s where it gets fun. Clayton says, “What is a 199A deduction?” 199A deduction is a fancy way of saying the 20% deduction on qualified business income. I’m going to unpack this for you real quick. 199A equals 20% deduction versus QBI.
There’s a few other tests and some of you guys that are savvy on this stuff knows that there’s some other things you have to meet, but it just means that if I make $10,000, I only have to pay tax on $8000, or if I make $100,000, I only have to pay tax on $80,000. It’s a nice big deduction. It’s what they gave the pass-through businesses when they gave the C Corps that 21% flat tax rate. It’s pretty potent.
Now here’s the thing. You have to go to QBI and say, “What qualifies as qualified business income? It’s trade or business income?” Then you have to look and say, “What is not considered trade or business income?” First off, wages are not considered a trade or business income. Capital gains are not considered a trade or business income. Interest is not considered trade or business income.
Now I look at it and say, “Hey, wait a second. I am doing private lending. Does that even fall underneath the category of QBI?” The answer is no, unless it’s your business; in which case, now we’re going to say, “Do you meet the definition of a dealer?” You’re buying it to sell it. If I’m buying notes and selling notes, then I might qualify. But if I’m just writing notes, probably not.
Then we look at it and say, “All right, maybe you’re rising to the level of a trader business where that’s really what you do is you’re just doing a whole bunch of lending,” and I don’t know the threshold, guys, nobody does. But let’s just say that’s what you’re doing in this business. Now you’re going to fall into an exception, what they call the specified service business where it’s in financer or brokerage—if you’re brokering loans especially—in which case, you’re going to phase out if you make over $157,000 as an individual or $315,000 if you’re married filing jointly, you’re going to lose this deduction.
To say the least, it’s complicated. To reiterate what Jeff said is really what he’s trying to do. He doesn’t want to say it depends just because he doesn’t want to have people make fun of him but it depends. If you’re lending to individual investors, my position would be that that’s interest income and it’s passive if you’re doing anything else. If you’re primarily a gap lender, would you be eligible? Probably not. If you are doing other activities, then the answer is a big fat maybe.
What I would be doing is saying, “Hey, maybe I should just try to make sure I don’t have any of that income. Maybe I’m paying it up to a corporation. Maybe I have an LLC that’s doing the lending.” Or better yet, you have the lending going to a corporation, in that way, the corporation has less exposures like it’s keeping the exposure off of you and you’re just getting interest income that’s not subject to Social Security taxes, so yeah, I would take that too and all of that stuff.
Here’s another one. “I’m borrowing money from the LLC and the LLC sends off a 1099 for the interest they made. Is there any other paperwork I have to do from the IRS?” Wouldn’t that be a 1098 or is that a 1099?
Jeff: No, the 1099 would be fine.
Toby: INT.
Jeff: Yeah.
Toby: Then you’d be good. What about lending through an IRA? Then you don’t have to worry about the 199A deduction because it’s not a trade or business. Lending from an IRA is fantastic.
Jeff: And you don’t have to do a 1099.
Toby: Yeah, because it’s not taxable. Yay. We like it. If you have an IRA, really consider lending to people that you know that aren’t related to you. That’s called a gift, it’s not a loan when it’s to family members.
Jeff: You will never see that money again.
Toby: “What are the tax ramifications or other issues with purchasing my personal property through my corporation?” This is an interesting one and that’s because it doesn’t make any sense if they’re buying personal property through a business, but you can hammer this one.
Jeff: If we’re talking personal property, meaning, property that was personal to you, don’t do it to the corporation, please. If you’re talking personal property as intangible personal property like equipment, which is when I consider personal property.
Toby: Here’s the thing, they said “my.” Whenever you say “my,” that implies that you’re using it personally. When you say personal property, then I’m thinking that you’re using it personal and you’re just buying it through the corporation. What’s the tax ramification? If you don’t have an exclusion for it like it’s not something that’s being used by the business and it’s just buying it, then that’s considered wages.
Jeff: Yeah. If you’re buying your personal residence through your corporation, please don’t do that.
Toby: If I buy you a car and I give you a car, that’s wages. If I buy a car in the corp, even if it’s 50% used by the business that I can write it off through the business, whatever portion that I’m using is still taxable to me as wages and they use the least value. They put a new schedule every year. Nobody does that. They roast people on it so it’s like you see 100% business, you should buy the family car.
Jeff: Yeah. For example, we did have a doctor who bought cars for everybody on the staff and we had to compute every year what the personal use was so they can put it on their W-2s.
Toby: Yeah, tax ramification. What if it’s a computer or your phone or other things? Then the company can write it off and you don’t have to.
Jeff: Yeah, I think of the corporation’s buying you a cell phone because you’re required to have a cell phone for your corporate job. I think that’s a legitimate expense. It’s got to have a business use.
Toby: Absolutely. “What is the best business setup for a family building or purchasing a multifamily unit, LLC or C Corp?” I’ll be really easy on this. If you are buying a property that you are going to sell immediately, then you are a dealer, then you could go ahead and use a C Corp or an S Corp, probably an S Corp. An LLC is not a tax designation, an LLC is only for state so it depends on how we would have it taxed.
If I was flipping a property, then I could have an LLC taxed as a C Corp and an LLC taxed as an S Corp. LLC or C Corp, it would not matter if I am a dealer. If I am buying a building or I’m at multifamily and I plan on renting it out and I’m keeping it, then I am not doing a C Corp because there’s adverse tax consequences to having appreciating assets in a C Corp. If I ever take it out, it’s going to nail me as wages, the whole appreciated value of the business and that goes for an S or a C Corp.
If I am an LLC, I could be taxed as a disregarded or as a partnership. That’s fine for a family building. If I’m buying a building that I’m going to lease to my business or, “Hey, I want to have an apartment unit or an eight plex, it’s going to be an LLC-taxed. It’s either a disregarded entity which means it goes right under my Schedule E or as a partnership. In either case, it’s going to flow through to me. I’m not going to have it being taxed as a corporation.
Jeff: You’ve got to have that LLC though.
Toby: Yeah. No bueno. “If I’m buying a duplex and living in half,” you’re house hacking. AJ, I know what you’re doing, “and renting half, should I purchase or hold the home under an LLC, by current C Corp or just under me personally?” AJ, it’s kind of funky. If it’s me and I have a tenant in that house, I’m isolating my liability, I’m putting it in an LLC. But I’m making it a disregarded LLC. The reason I do that is because half of that property is my personal home, my personal residence, and I qualify for something called a 121 exclusion.
A 121 exclusion is when I can sell a house and not pay capital gains if I lived in it as my primary residence for two or the last five years. If I’m single, it’s $250,000, if I’m married, it’s $500,000. I want to make sure that I don’t ruin that. I’m not going to use a C Corp, but it’s going to be an LLC.
I wouldn’t do this just as me personally because there’s no stopping the liability. If somebody falls down the building or the steps on their half of the building and sues me for something, says I was negligent or whatever, there’s literally no cap on the amount of damages I could get hit with and they could follow me around the rest of my life so I don’t want that. I want to be able to cut it. I guess I could go bankrupt at some point but it depends on what you nailed for.
I actually, on behalf of a client, garnished a tenant in a piece of property for over 11 years at her job. Just because somebody says, “Oh, I’d just go bankrupt,” well she tried to. There’s exceptions under the Bankruptcy Code, too, so there’s a good chance that you don’t even get to bankrupt away the liability. Anybody who says differently doesn’t know the exceptions.
Jeff: Even though the duplex is one undividable property, you’re still putting that rental portion in that LLC.
Toby: I’m putting the whole thing in the LLC.
Jeff: Oh, really?
Toby: Yes. I still have a homestead in many states, I should say. In some you’d lose it. Being in Texas, in Florida where they have an unlimited homestead, it stinks but there’s nothing you can do about it. You have a home property that’s a non-divisible piece of property that is both personal use and investment use so you ruined your homestead anyway. The way I look at it is I would just be putting that in an LLC. It’s more important to me that I don’t lose the rest of my assets that I have and I don’t subject myself to adverse tax consequences. Those are the big things for me.
Somebody says, “Any ways to minimize the franchise fee for multiple LLCs in California?” Yeah. You could have a local property management company, you have a single holding, and it’s [01:01:29] out of the state. That holding entity really should be held by a trust so you’re not bringing it right back into California and then you would make sure that the California properties are held in individual land trust and either with LLCs out of the state or something along those lines. That’s how you do that, Daniel.
Now if you ask the Franchise Tax Board, they’re going to say, “Great. Pay us $800 on every LLC you have that’s not nailed down.” You want to make sure that you don’t own it, that it’s in a trust that owns the LLC and that LLC is the one that owns the other LLC. You want to try to pre-keep yourself twice removed. What we oftentimes do is we put different trust between each layer so you may have a personal property trust owning the interest in the various LLCs and again all we’re trying to do is get out ahead of this thing.
We actually won that on an audit. We had two highway patrol people that won against the Franchise Tax Board simply because they didn’t own it, it was their living trust that own the LLC. How often does that happen? We don’t get audited. We try not to allow that to occur but it does. It’s nice to have your argument.
“What’s the definition of dealer and how can I avoid being considered a dealer? What are the ramifications of being a dealer?” Want to hit this one?
Jeff: A dealer depends on what your intent was when you purchased the property. If you were intending to sell this property when you purchase the property, you’re going to be classified as a dealer.
Toby: A dealer is buying something to sell it. An investor buys it to hold it and make long-term appreciation and rents.
Jeff: The consequences of this is the income is considered ordinary income, not capital gain income when you’re a dealer. I think there’s some danger that if you have other sales of property, they may consider all of them dealer transactions.
Toby: Yes. One of the journals of accountants had a pretty nasty case where a gal developed some properties when she was a developer. A dealer and a developer are considered the same thing from a tax standpoint. They’re taxed as ordinary income and they reclassified everything she had saying, “Oh, it’s all part of one enterprise,” which is really bad because you lose long-term capital gains, everything is active ordinary income in a [01:03:32] self-employment tax. You lose the tax benefits of an installment sale and you can’t 1031 exchange, so you lose a lot of the benefits of a dealer and you can’t appreciate. You lose your depreciation, you lose your 1031 exchange, you lose your long-term capital gains, and you lose installment sale benefits.
What are the ramifications of being a dealer? It’s pretty miserable. If you get caught doing this, and as for the time frame, anybody who tells you that, “Hey, if you hold the property longer than a year, you’re not a dealer,” hasn’t read their cases. There’s cases where people have held the same property for 10 years and are still considered a dealer. They look at your intent when you bought it. If they can see your intent when you bought it, that’s what you are. If you bought it to sell it, even if you didn’t sell it but they could see that that’s what you’ve been trying to do the whole time, you’re just waiting for the opportunity to get out of that thing, you’re a dealer. If you fix and flip, you’re definitely a dealer.
Jeff: If you look at previous cases to determine the holding period, what they paid the [01:04:42] basically says that it’s going to depend on that person sitting on that bench.
Toby: Yeah. Somebody said, I think it’s going back one, “If you have the property deed in LLC for liability purposes while using as a personal residence, do you have to do that for the personal residence exemption?” No. What they do is they ignore that LLC. Usually when we’re doing the LLC, we’re filing it as disregarded, so you don’t have to worry.
“If you sell your home and get more than owed on the mortgage, is that capital gains tax?” No. Capital gains is your basis minus what you sold it for.
Jeff: Let’s give you a really ugly scenario. Your cost in a property is $100,000. Over the years, you’ve refinanced and the loan amounts have gone up. You now owe $400,000 on this house if you sell for $500,000. Under the loan scenario, you would think your gain was only $100,000 when in fact, your gain is $400,000.
Toby: Plus you have to recapture the depreciation you took. How many years did you hold it for?
Jeff: Let’s say 10 years.
Toby: Ten years?
Jeff: Let’s make it to nine years. So, a third of the value.
Toby: A third of the value. Whatever the [01:15:37]
Jeff: About $170,000.
Toby: So if it’s $100,000 and your land value is $30,000, then you’d have $70,000 and you take a third of that is probably what you wrote off.
Jeff: Yeah. We sometimes see this on sales of property, especially if it’s residence that people have borrowed against their home and what they get out of the proceeds of the sale after paying off their debt is way less than the gain.
Toby: And you’re like a lot of people. You think, “Oh, shoot, but I didn’t get any of the money. I gave it all to the lender.” It doesn’t matter. You got that money at some point. You’d still want to 1031 exchange that and you’d want to get another loan, got to have to, or you have to buy equal or greater value regardless of the debt.
“Under our corporation, is it better to lease a vehicle or buy?” We get this question quite often and the answer is always going to be depending on what you’re buying, like how much is going to be used by the business. I’m always going to say you’re better off to not own it in the corporation nine times out of ten. There’s people that think you’re a goober for doing that, but the ramifications of doing this wrong are so draconian that I’d just rather do MileIQ and reimburse myself and not have to think about it. Pay less in insurance and it’s my car and I don’t have to worry about which car is, all my mileage logs, I just have one app on my phone. But if I am a corporation, which one’s better? You’re writing both off. It depends on whether you have a bunch of income. If you’re making a whole bunch of money, then I might buy a vehicle. If I’m not, then I’m probably leasing it.
Jeff: Let me throw this in. Let’s say you’re buying an expensive car, not an SUV, or a van, or a truck, but an expensive car and say your company needs of that Corvette, your depreciation deduction is going to be limited to, what is it this year, around $20,000, the depreciation?
Toby: It’s like $16,000.
Jeff: If you lease the vehicle, you’re going to get a much higher deduction over time. I don’t know if a lot of companies lease vehicles to small corporations.
Toby: You’re going to be a personal guarantor no matter, they will. Somebody said, going back to the previous question, “I was told by my accountant that in order to claim a personal residence exemption, you must hold it in your name, not an LLC.” That’s just an accountant not knowing the tax laws. But if you’re worried, you just put it in a land trust so that way they don’t have to know that there’s an LLC involved. The LLC is disregarded for tax purposes, period. If you’re owning it and it’s you, not you and a spouse in a separate property state, but it’s you or you and a spouse in a community property state, then there’s not even a tax form, nobody even knows. Again, I’m pretty sure that the code has that specific provision, I know for the living trust.
Jeff: I know it has for the living trust.
Toby: Yeah, but I’m 99% certain, I know what the IRS does too. It’s disregarded for tax purposes, therefore you still get your personal exemptions as long as you’re personal residence.
“Can I deduct my real estate training cost?” is the last question we have today. “Can I deduct to my personal training cost?” Yes. The question is, “Can I write them off right now? Do I have to spread them out over a number of years? Can I write them off personally or do I need to put them inside of a corporation?” The answer, Jeff, you like doing this stuff. It’s always going to be fact-specific.
Jeff: Yeah, because I know it’s going to [01:09:12] or say it depends, but it’s going to depend on where you want to deduct these and how it relates to the business that you’re currently in. I’m going to disregard the real estate portion and just say training costs by itself because we do have this. We can sometimes have a personal training, mentorship, and coaching. If this is an existing business that’s doing business, it’s easy. We’re assuming the training relates to the business that you’re at. It’s a deduction.
If it’s a Schedule C and it’s a new Schedule C business, you’re probably not going to be able to deduct the real estate training. Say you’re flipping in a Schedule C, which we don’t really advise, but if it’s a corporation and you’re flipping, we go back to that depends on when the actual training took place and when the corporation reimbursed you for those training costs. Any real estate training that took place before incorporating, you’re probably going to have to amortize those costs over 15 years. Any of those trainings that were reimbursed back to you after you incorporate it, we’re assuming that you are in business and those are training costs for your business.
Toby: Yes, it gets complicated.
Jeff: It gets complicated.
Toby: If you already have real estate, it’s easy. If you don’t have any real estate, then you’d better make sure you’re incorporating. That’s where it really boils down to. Then when you actually go through the training or mentorships, will dictate whether or not it’s something that’s a startup cost or whether it’s an ordinary necessary expenses while your business is going on that you’re just reimbursing. If it’s before your business doesn’t account as a startup, the answer is yes, unless you haven’t done it.
I’ll give you an example. Let’s say there’s this guy, Jeff, who goes through a real estate training and mentorship and he hires a coach. He pays $20,000 for coaching and that’s really his real estate training cost. His coaching, it’s going to be for the next six months and he incorporates, that’s not a startup expense. His corporation is now in existence. He hasn’t done any of the coaching. The coaching all goes to the benefit of the corporation. That’s an ordinary necessary expense. Even though Jeff individually had purchased it before he transferred it over to the corp, corp got the benefit, corp doesn’t have to worry about a start-up expense.
Now flip that around. Jeff does $20,000 of coaching, sets up his business, says, “Hey, I really like this, I’m going to really make it work now,” that’s a startup expense. That startup expense, still deductible, but you’re only able to write off $5000 in the first year, you’re taking the remaining $15,000 and you’re spreading it out over 15 years so you’re taking $1000 a year for the next 15 years. You don’t lose it, you’re just spreading it out. It’s obviously better to, if you can, make sure you’re in business and it’s a lot more fun.
“I paid for a live stream and I’m a full-time real estate investor, what type of expense is that?” I would put down there as continuing education. Depending on your licensing, you actually get credit for that.
“Is a disregarded LLC simply an LLC with one member?” Not necessarily. The IRS looks at it and says, “Yeah, it’s one member,” but it could be a husband and wife in a community property state, they’re considered one member, and it’s just disregarded. We just ignore it for tax purposes so it flows right down to the owner.
“If it’s before the business, is that a kind of a startup?” Again, it kind of depends.
“If I owned a non-profit and put a property in the nonprofit, can it charge rent?” Yes, of course. Let’s say that I donate a piece of property to my nonprofit, I get to write off the value of that piece of property. If I’ve owned it for over a year, it’s the fair market value. If it’s less than a year, then it’s my basis. In either case I’m going to be limited to 30% of my adjusted gross income for the deduction and I can carry forward the additional for five more years. But that nonprofit now can rent it, yeah, it generates income with it.
“Do you have to be taxed in the C Corp to get the benefits of education costs?” Not necessarily. An S Corp could do it too, a C Corp locks it in stone. If you’re an S Corp, then I guess there’s a little bit of a worry that it’s not in the business unless it’s actually owned by real estate, too. It’s much cleaner if you do a C Corp but I don’t want to say that it’s just for a C Corp.
“Are ABA workshops considered continuing education expenses?” Yes. A lot of them are actually qualified for continuing real estate education depending on your state, a lot of them get your continuing legal education, some of them even get the continuing accounting, what do they call that?
Jeff: Continuing professional education.
Toby: Yeah. You check with your state and then we have a member of our staff that can help you with that, Valerie, that’s what she kind of works on so we’ve gotten some, the three days, I forgot how many hours those things, it was like 20 hours or some ridiculous amount. I know because we get them for teaching them.
Let’s keep going through the Tax Wise Workshop. We’re getting pretty close to an hour-and-a-half so I want to wind this thing down. June 13th and 14th, this week we have next Tax Wise Workshop. If you want to attend that live stream, we don’t have any more room in our office. It’s andersonadvisers.com three-for-one. You can get the live stream for $197 plus you’d get access to the recording from January, you get the live stream for November, and you’ll get recordings on all three. It’s just basically, “Hey, you get all the Tax Wise for the entire year.” Go over about 30 different tax deductions. I change it up every event just to keep it interesting and because we’re focusing on different things, beginning of the year versus the end of the year, planning is a little different. You can do that.
Jeff: We get a live workshop coming up on Thursday and Friday this week.
Toby: Yup. This June 13th–14th is right there. You can do the live stream. There’s not going to be ability to come live but you can stream it, which means you can sit there, watch it, and you’ll get the recording.
Jeff: And be that much smarter than everybody else.
Toby: Hey, it only takes one. I get the benefit, I get the emails afterwards. What’s always fun is that you’ll have one strategy and I tell people to try to learn three every time they go through, just find three that you’re going to apply. You don’t need to know them all and do nothing. You need to know one and actually do it. You’re much better off.
You find three that pique your interest and those are the three. You could have one. I had one couple that ended up with $177,000 deduction that they wouldn’t have had otherwise, offsetting some pretty sizeable income. The benefit of the class—just one of them, they were chuckling about it—was about $80,000 in their pocket and that’s not completely uncommon.
Jeff: Unfortunately there’s not usually room for me to send my tax people but I do have lessons at the Tax Wise.
Toby: Yeah, it’s fun stuff.
Jeff: It’s fun stuff, it’s stuff to sharpen your skills even for us tax people.
Toby: If you can’t tell, there’s a lot that changes and there’s constantly things being put out there in the tax world. They have regulations being entered, you have things being phased out, phased in, and of course Congress likes to change the laws. You just have to keep your finger on that pulse, otherwise you risk losing a ton because usually they will pull things to where you think that you’ve got it under A, they’ll make it into B, and B has an adverse consequence to you. You just want to your keep your nose to the tax grindstone a little bit. You don’t have to know it all but you’re just listening for things that are relevant too.
iTunes, you can go in and listen to our podcast. You’re going to see a whole bunch of Tax Tuesday. Jeff and I do these every other week so you can always come in and check with the Tax Tuesday. You can get the podcast with iTunes. Myself and Clint, and sometimes, Michael Bowman and other folks do interviews with folks. For example, residential-assisted living, everything from cost segregation, qualified opportunity zones, insurance. We grab people that we work with, that we know, or that are experts in the field, have them enlighten us on certain rules and how people use these things.
You can do the same thing on Google Play. Just because you guys have been so good, I’m going to throw this one at you. If you really thought out how to compute and actually make money without getting reamed and without spending obscene amounts of money to make mistakes, then do the Infinity Investing Workshop. You go there to the infinityinvestingworkshop.com to sign up there and that little code there gets you everything for free. There’s 11-part series plus 4-part bonus series on everything from financial stewardship to how to create an infinity investing income stream. It’s fun and you can use that little free tax.
If you’re super, super smart, you’re really good at making money, and you already know how passive income works, then don’t do it for yourself. If you know of anybody that’s tired of they seem like they’re running it so fast, they can’t get ahead, they’re probably trying to build the wrong type of income and they’re being sold liabilities in the guise that it’s actually an asset, go through this, share this with them so that they don’t make those mistakes. You’ll see that it’s pretty easy, pretty fun and you’ll learn how to make some money on some things you probably didn’t realize you can make money at.
Replays of this Tax Tuesday, you can always go to your platinum portal and you can see it in there. Of course, you’ll get a link to this one if you’re registered for the event. Feel free to share it with anybody. We don’t charge for these things. All it is, is getting the information out there; helps everybody.
Then please follow us on YouTube and Facebook. If you’re willing to, please rate what you see here. We’re big education junkies and we believe that you should teach the topics that you’re constantly working with. It keeps you sharp. If you can’t tell, Jeff and I sit here. In between us we have quite literally many, many decades of experience and we’re still having to think very hard. We don’t always know the answer. There’s a lot of ‘it depends’ just because there’s facts and circumstances. If you want to know more and save more, like I’m looking at this one how to legally write off your cell phone that’s pretty on an accountable plan, you don’t have to pay any tax on it, like literally reimburse the whole thing, but it has to be an S corp or a C Corp from a tax standpoint.
Jeff: I reimbursed my phone.
Toby: Yeah, got to do it. Go to andersonadvisors.com/facebook, andersonadvisors.com/youtube, and of course if you have any questions, email them in, guys. No cost to it. Email them on in. We’ll either have somebody answer if it’s really long and drawn-out, or we’ll get it back to you, or just visit Anderson Advisors. We probably have 200 videos on our site. If you can’t find the answer to your question there, by all means, become platinum and just ask us and we’ll get somebody write on it, unlimited Q&A, whopping $35 a month.
If you want to find out more about that, just go to our website or email us in taxtuesday@andersonadvisors. You talk to a lawyer. Ask any tax question you want. It doesn’t go up. It doesn’t go down. It’s been the same price for more than a decade and we’re not planning on raising at any time. We have a really great group of folks. We have a great group of advisers. We got awesome clients all over the country and we’re always thankful.
That’s it, Jeff, unless you have anything.
Jeff: No I’m good to go. I’m glad you all could stay with us perfect today.
Toby: The coupon code is freetax but you can grab that and by all means, share that with kids before they go too crazy. Where am I located? We are in Las Vegas. We have three offices here. We have offices in 45 states as well as our main office is up in Tacoma, Washington. I and Jeff are sitting here in our rainbow office on the second floor; we have three floors here. There’s about 250 of us here [01:33:24] Oh my God. You guys are crazy. Love it. Thanks guys. Until next time, this is Toby and…
Jeff: Jeff.
Toby: Thanks again for spending some time with us on Tax Tuesday. Until next time.
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.
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