As they attend “The Executive Retreat” in Maui, Toby Mathis and Michael Bowman of Anderson Business Advisors help you watch out for sharks, especially when it comes to taxes. Do you have a tax question? Submit it to taxtuesday@andersonadvisors.
Highlights/Topics:
- Can I take advantage of business deductions, if I don’t directly own rental properties, but invest in real estate as a limited partner in syndications and funds that generate K-1s? No; have one entity for investments and one entity to manage investments entity
- Regarding the 280A Form, how do I get reimbursed? You don’t have to report the payment as income or pay taxes on it
- Can the Charitable Purpose Board’s activities take place in another country? Yes, approve it in the United States, but perform activities in another country
- If I purchase a property within an opportunity zone and start a business based from that building, do I still need to improve the property? Yes, substantially improve the property
- If a person uses cost segregation on rental home, isn’t depreciation recaptured upon sale of home? Can a 1031 Exchange be used? Cost segregation lets you write-off things and a 1031 Exchange can be used
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Resources:
U.S. Government Accountability Office (GAO)
Real Estate Professional Requirements
Capital Gains Exclusion/Section 121
Anderson Advisors’ Executive Retreat
Anderson Advisors Tax and Asset Protection Event
Tax-Wise 2019 3-in-1 Offer/2fer Tuesday Bulletproof
Full Episode Transcript
Toby: Hey, guys. This is Toby Mathis and I’m joined by Michael Bowman.
Michael: Aloha, guys.
Toby: Aloha, guys, and yeah we are in paradise, we are really lucky. We are going to sit here and we are going to have a fun one. A little different Tax Tuesday. We are going to go all over the questions that you guys ask and beautiful day for tax day in a beautiful area. If you are not in a beautiful area, then you could pretend.
Michael: We are doing the executive retreat here which has been a blast and a lot of mastermind going on, synergy, networking going on, and learning a ton from some great professionals.
Toby: This has been really cool. If you guys don’t know what the executive retreat is, we are not pimping it. We’re not telling you guys to come and do it, but if you ever get a chance to come out to one of these.
Michael: I think it’s absolutely imperative that they do.
Toby: Yeah. We are going to have a bunch of guys come on that are here. Guys and gals, obviously, that are going to come on and have a little fun with them. They have questions, they said because it’s tax day and Michael, you are supposed to watch out for sharks. We have a lot of things to go over and I picked a lot of really cool questions.
First one, it is tax day so this is the one day of the year where I disappoint the government as much as it disappoints me. I think that’s funny. It’s almost as good as, “I’m glad I only pay taxes on what I owe as opposed to what I tell people that I make.” That’s another problem.
Just remember that there’s always social media. You can always go to Youtube and Facebook pages of Anderson Advisors. We are always putting out content. Even while when we are here, we have lots of stuff in the can that’s constantly being put out. There were some changes that came up in the last week.
The government accountability office for exempt entities and we are going to talk about some of that. Somebody already asked questions about charities and why do you have your own as opposed to using somebody else’s? You could use somebody else’s, but you could then you lose control of the money. So a lot of times, what I care about with our clients is keeping control of it, keeping it in their family, which doesn’t mean they have to own it.
Michael: And they can assure it’s going to those causes and maximize the dollar for people who need it.
Toby: Yup, making sure that […] that. A lot of folks realize that when you are doing a 501(c)(3), it’s not owned by an individual. It’s just controlled by an individual or individuals and you can bequeath that control to somebody else, so it’s keeping it in your family quite often.
Charitable actions isn’t what you think. Low income housing is charitable. Residential-assisted living is charitable, education is charitable, scientific cause is charitable, ammature sports is charitable. All of those are charitable causes.
Michael: Look how broad they made it to really help us out.
Toby: Yup. Michael, have you ever done a Tax Tuesday?
Michael: No. This is the first time.
Toby: So, it’s Tax Tuesday, Michael’s first so it’s awesome. He’s one of the partners at Anderson Business Advisors. A lot of you guys have seen Michael out there. You could always say hi to him and for those of you guys that have seen him, he’s amazing, active, very energetic speaker, filled with knowledge, and a good dude.
I’ve known him for a lot of years, so we are lucky to have him here. As always, this is about being fast, fun, and educational. We want to get back and help educate. We want to make sure that we are bringing tax knowledge to the masses. If you want a detailed response, something specific on your situation, then email it in. You need to be a tax platinum or a tax client, but you can always just ask us on Tax Tuesday Anderson Advisors. We’re really good at just getting your response. You can ask your question via Tax Tuesdays. I always grab the questions, the preset questions, from that grouping so you’ll see a whole bunch.
Somebody says, “For an Airbnb business in California, should I set up a separate California LLC disregarded into my existing Wyoming Corp or can I directly use the Wyoming C Corp?” Tim, right off the gate, when you have a Airbnb business, it’s a hotel. If the average guest stays seven days or less. If you want all the benefits of passive real estate, then usually you are setting up actually two businesses. One is the host, so you have something that is usually as a corporation, it’s doing the short-term rentals. You’ll have an entity that an LLC or whatnot that has the rental, rent it to the corporation which will then do this sublet to all these different individuals.
Michael: The corporation is doing the active side of the business.
Toby: You got it. That keeps it from making all that income, active ordinary income to you, you’re allowed to have your passive income, and you still have your active. The idea is usually, when you really get down to do it, then it’s a nice divide between what you get on the passive side and what you get on the active side.
Michael: Not to get too technical, but I think the total number of bookings divided by the total number of days rented to give you the average nightly stay.
Toby: We have a ton of questions I’m going to go through. I’ve already got some others.
Michael: One thing on that, make sure that you have the insurance on the property.
Toby: Yup, good call. Whenever you are doing an Airbnb, you want to make sure that it’s not your ordinary homeowners policy. For example, if you’re doing this as a second home, then you are usually talking to your insurance guy and they are aware that they are renting it out to others, but if it’s your house and you are doing like a room, you’re not going to have coverage underneath an ordinary homeowners policy.
Michael: One last thing is, also. Make sure you’re keeping abreast with the state, county, and city regulations, any changes that are going on. […] fines can get quite severe and it seems like a lot of municipalities change them quite regularly. Just keep abreast with those changes because the fines can get out of hand quickly.
Toby: Again, we are getting blasted with questions. I’m going to hold off for just a second and we are going to go through the questions we are going to be asking today.
“I have several LLCs taxed as partnerships. I buy foreclosures. Recently, I acquired a property and decided to sell without improvements for about the price I foreclosed, 10% gain. Can I still maintain my passive status in that LLC for this year even though I flip to resold this one property in six months?” We’ll be answering that.
“I am closing on the sale of a property purchase with my LLC of my Solo 401(k). Is there a tax benefit by paying a JV Partner from the LLC bank account versus directly from escrow? Meaning, does paying out of escrow reduce profit that would be subjected to tax?” We’ll go over that, too.
“Can I take advantage of business deductions for travel, education, conferences if I do not directly own rental properties and instead invest in real estate as a limited partner in syndications and funds that generate K-1s?”
“I have created a management C Corp that manages all my different LLC in properties. I’m not taking any salary out of this corporation at this time. The C Corp has an employee welfare plan that pays my out-of-pocket medical expenses. My question is, from this plan, can I reimburse myself the employee contribution of my W-2 job healthcare plan?” I’ll explain what all that means in a little bit and my answer.
“If I purchase a property within an opportunity zone and start a business based from that building that passes the opportunity zone test, do I still need to improve the property as well?” We’ll go over that.
“I’m planning to having my Wyoming LLC become 100% shareholder by two C Corps. One corp for flipping homes and one corp for flipping raw land. Will my LLC have to file a tax return even if I zero out the revenue with expenses and salary to myself?” We’ll go over that.
“If a person uses cost segregation on a row home, isn’t the depreciation recapture upon the sale of the home? Can a 1031 exchange be used?” Somebody asked that question already today and a little question when I saw that.
“What’s the best entity structure for Airbnb, HomeAway, and Vrbo? My plan is to sign long-term leases, 12 months, and rent them out on these platforms.” It sounds like this person is renting from somebody long and then subletting short. That’s great.
Then we are going to have some special guests from the 2019 Executive Retreat Maui. It is gorgeous here, beautiful week, and what a great group. I can say that we are on our last little stretch of it. We usually meet until noon. Today’s going to go a little longer because everybody gets together and we do panels. It’s just a heck of a lot of fun and these are just really great folks, so we’ll get through all of these.
We’ll start off. “I have several LLCs taxed as partnerships. I buy foreclosures. Recently, I acquired a property and decided to sell without improvements for about the price I foreclosed on and I still maintain my passive status in that LLC for this year even though I flipped and resold this one for property in six months.” Michael, what do you think?
Michael: It could be an intent-based test. Dealer goes and there are factors, so they are going to look for the number of frequency in sales. It seems like you’re buying the properties, you are holding them long-term. I don’t think it’s going to take you over. They also look at the extent of the improvements, how the property was acquired, their sales efforts, and their holding period comparative to your other sources of income. So, I don’t think it’s going to kick you over, but we are dealing with the IRS. There’s a wildcard in there.
Toby: Again, what Michael says is actually right. It’s an intent-based test and they look at facts and circumstances. That’s why people say, “Hey, if you hold a property for a year and then sell it, you’ll never have to worry about being labeled a dealer.” Here’s the difference. If I buy a property with the intent to lease it out and receive long term appreciation, then I’m an investor. If I buy a property with the intent to sell it, it doesn’t matter how long I held on to it.
In fact, there’s a court case where the individual held on to it for 10 years. They sold it after 10 years and they are still considered a dealer. The IRS looks at these two things. If I buy it with the intent to sell it, then it’s inventory. Cheerios and the Minimart where they are selling Cheerios. It doesn’t matter how long the Cheerios sit on the shelf. I had the Cheerios sitting on the shelf and somebody buys it after a year-and-a-half, it doesn’t make it a long-term gain. It’s still inventory.
Michael: And looking at the marketing efforts, too.
Toby: Yeah, they look at everything. So you have several LLCs, you buy foreclosures. The question is, what do you do with those properties? If you’re buying those foreclosures, you fix them up, and you sell them, you’re a dealer. If you buy those properties and you fix them up and rent them, then you are an investor. If you accidentally sell one once in a while just because, “I bought it and I really don’t want to the improvements. I just want to dump it. I get my 10%,” it doesn’t change what you are. That one little one-off isn’t going to matter so much. I wish it was an easier answer.
Michael: I think it covered it.
Toby: “I formed C Corp in California. I’m thinking I was going to flip in wholesale in California, but I’m doing it all in Oklahoma. Is it recommended to close the C Corp if not used? I live in California and I just reincorporated in […].” Federally, you’re still a C Corp. State-wise, I would move it.
Michael: The tendency is to form and file it. You’re going to […] articles you seen form and file it, but then you are paying for two sources of state fees.
Toby: $800 a year in California. It sucks.
Michael: And it could be state income tax on both states where you get a little offset, but you also want to take a look at maybe some seasoning of the corporation, how long you’ve had it. It’s a good thing to take a look at, but we haven’t had it for a very long time. No expenses accrued in there. You close it down and open up in the state where you’re doing the business. Don’t pay two sources of state fees.
Toby: Absolutely. Unless you like paying extra fees, don’t do it.
The next one is, “Can you talk about tax deduction for having team meetings on my house for my S Corp and the annual, semi-annual meetings, et cetera? I need a refresher.” Evelyn, what you are talking about is 280A and your corporation can rent your house or any property that you use as residence dwelling.
Michael: Anybody can rent that actual property.
Toby: Yeah. You can rent it to your own corp. Your corp pays you. If it’s 14 days or less, the statute actually say less than 15 days for some reason.
Michael: I love how they word that, less than 15 days. Perfect.
Toby: I think they are drunk. It’s 14 days or less, really, and you don’t have to recognize it as income. It’s actually kind of nice. So, what you do is do your meetings for your corporation. The corporation get a deduction, you get to keep the cash tax-free. That’s a fancy way of saying, “Hey, I got money in my pocket without having to pay tax on it.”
By the way, we have one of the attendees from the Executive Retreat, Mr. Brent Mott. Welcome.
Mott: Thank you so much. It’s a pleasure to be here.
Toby: I’m going to move this a little closer to you so we can hear you. You spent almost a week with us.
Brent: Yeah. It’s been great. Amazing time out there at the retreat. I had a lot of fun. I was able to, before we even started through the networking, save about $30,000 on some equipment that I was about to buy by talking to one of the speakers. That was before the event even started and then today, I’m looking at buying a small portfolio from one of the speakers that I learned an hour ago from you that qualifies for the non-profit.
Toby: Nice.
Brent: Yeah. Picking up a ton of really useful information that’s going to help out my business.
Toby: We love it. First up, you are a real estate investor, right?
Brent: I am.
Toby: How long have you been investing in real estate?
Brent: I have been investing for about 10 years. I’ve been doing it full-time for six.
Toby: Nice. So you don’t do anything else. What do you do with your life? You come out to Hawaii.
Brent: We are going to be home for a total of nine days this month. Next week we’re going to Vegas and then we are driving the PCH from LA to Sonoma for a friend’s wedding.
Toby: I have to ask you a question. You need to ask us a tax question. Think of a tax question, any tax question that’s been on your mind because you are sitting here on Tax Tuesdays. You pay taxes yet, by the way? We’re watching, the IRS is.
Brent: It’s that day. I have a few questions about the non-profit, the 501(c)(3). I don’t have one set up. I’m only 34. I’ve taxed deferred investing so self-directed IRAs, the 401(k)s. I can’t touch those for 25 years. I want access to my capital, to my assets long before that, so that’s never been an attractive strategy. I’m still in the accumulation phase in my life, in my business, so thinking of ways to defer has never been a huge priority. Learning about the 501s, the nonprofit. That has huge implications. My active flipping business, wholesaling business supports my lifestyle. My rentals are all passive income for the future, so using the nonprofit to hold these military housing is going to be really beneficial for them.
Toby: Right, so anytime that you are doing something for the benefit of society. A lot of people don’t even realize almost all hospitals, almost all educational institutions, all universities, just about every single one of them is a non profit. The NFO was even a nonprofit up to a few years ago.
You have just about every residential-assisted living would qualify as a nonprofit. Low-to-moderate income housing to HUD housing would actually qualify as a nonprofit. The biggest thing to get your head around on a nonprofit is if you don’t own it. You just simply control it. In my world, I typically say control is worth a lot more than ownership.
Brent: I do have a question that I thought of while you were talking about that. Can I use any of the cost segregation if I held properties in a non profit? Can I use any of the cost segregation to offset any other income?
Michael: You are going to look where is the income going in? Where the most bang for the buck go?
Toby: When you have cost seg, if you are a real estate professional, you can offset all of your active income. Otherwise, your cost segregation, which is basically rapid depreciation, is just really going to offset your real estate. You would qualify as a real estate professional because that’s all you do.
It’s a two part test, 750 hours, half of your time plus you materially participate on your real estate. That’s the test. You’re going to hit that easy. But there’s a downside which is when you accelerate your depreciation, it does not count when you give the property to a charity. So if I give a property to a charity, but own less than a year, it’s the basis in the property. If I’ve owned it for more than a year, it’s fair market value. I don’t have to worry about straight line depreciation, the 27½ or 39 year, but if I accelerated my depreciation—I took that depreciation and I made it personal property, it’s like 5, 7, and 15 year property—I have to subtract that from the fair market value when I donate it.
It’s not a horrible thing, but it’s something I still want to consider. So if I accelerate the depreciation, I wrote off, let’s say, all my carpet, my wallpaper, my electrical system, I wrote off an extra $10,000 and I give a property that’s worth $200,000, I only get a $190,000 deduction. If you think about it, I already got my $10,000 deduction. That’s that. You asked a very good question, by the way. Not many people will think about that.
Michael: You think far ahead.
Toby: Yeah. Anyway, thanks for visiting with us.
Brent: Awesome. Thank you so much.
Toby: You can hang in here. We are going through a bunch of questions. “I’m closing on the sale of a property purchased with my LLC of my 401(k). Is there a tax benefit by paying a JV Partner from an LLC bank account versus from escrow? Meaning, does paying out of escrow reduce profit that would be subjected to tax?” Now, this is a great question. Michael, […]
Michael: I’m going to have you answer then I’m going to tailor it in the way I thought when I read this question before.
Toby: First off, it sounds like you had debt. If you have a JV partner, quite often there really a lender or they’re in equity. In either case, it’s not going to matter how you pay them, whether it’s from the bank account or directly out of S Corp.
If you have an LLC that’s holding real estate and you have a partner in it, then whatever the loss or whatever the gain is, if it’s proportionate, you can actually make it non-proportionate. That’s a hint. It’s going to flow back to the Solo 401(k) no matter where you pay out of it. It doesn’t matter, but that Solo 401(k) is really important.
If you have a JV partner who is a lender, now we don’t have to worry about debt-financed income. If this was an IRA, that Brent, this is something you and I discussed, or a Roth IRA, or a self-directed IRA, then when you have income that is based off of debt, you have a real estate property that has a loan on it, you have taxable income called debt-financed income for that IRA that you actually have to pay tax on, whether it’s a Roth or otherwise.
This is a really, really big distinction. You do not have debt-financed income when you have a Solo 401(k). So, the answer to the question, it doesn’t matter where it gets paid out of it, escrow or from an LLC, it’s immaterial. What we care about is, is it debt or is it profit and will it have an impact? No. But that Solo 401(k) makes all the difference in the world if it is debt.
Michael: One of the things that I looked from a different perspective is where should it be coming out off? If it’s a JV LLC, where are the agreements? Coming directly out from an escrow, it might be a little sloppy. You might want to bring it through the JV LLC and then out or just make sure whatever the agreements, there’s a proper flow. If anything gets questioned, you know it the right way.
Toby: Absolutely. Spoken like a true attorney.
Michael: I’m just big into corporate formalities. I just don’t like people getting a little sloppy and cutting corners. Not so much from a tax perspective, but from a partner perspective or a lawsuit perspective. Things are unraveling when you start getting lazy and cutting corners.
Toby: All right. I have a ton of questions that have come in. We’re just going to ignore them for now. We’re just going to go right to the next question.
Michael: We’ve got some good questions coming up.
Toby: I know, but trust me. If this thing goes back another page, then I’ll never see them. You guys don’t see it, but I get questions all day long on these things.
“Can I take advantage of business deductions if I do not directly own rental properties, and instead invest in real estate as a limited partner in syndications, and funds that generate K-1s?” Michael, what say you?
Michael: The first thing we need to establish is, are you personally investing as a limited partner or are you using an entity to invest into […]? Your C Corporation, if it’s managing the entity that’s making the contribution into the syndication, then it’s actually managing. What we need to do is to have a service agreement between the two and then we’re going to put money in the corporation and then expense it out to the corporation.
Toby: Right. I’m going to stepback just for a second because you jumped about three steps forward on this one. “Can you take any business deductions if you are a passive investor?” The answer is kind of a no. The reason being is, think of your real estate. You’re doing REITs, you’re doing stock market trading, and things like that. It used to be you could write off miscellaneous itemized deductions on your Schedule A. If you’re 1040 Schedule A, you’ve got to get […] 2% of your adjusted gross income and you can write it off. That went out the door with the Tax Cut and Jobs Act.
What you end up having to do is make sure that you always or either actively participating in something or you have an entity that is engaged in active management of something if it’s holding passive. Michael’s answer is actually giving you the strategy which is, instead of just being a limited partner in a syndication, you should have an LLC that is the partner in syndication. That LLC could then be managed by the corporation that covers all the deductions. Basically, you’d have one entity for your investments, and one entity managing the entity in my investments. It’s actually really cool. Then, you get to take all the deductions you want.
Michael: From a tax-wise standpoint, it makes sense, but then from an asset protection standpoint, it makes sense. It’s very complimentary.
Toby: Yes, that’s a good one. I’m going to answer some questions now. It says, “In regards to the 288 form, how do you get reimbursed?” If you guys don’t know what a 288 is, it’s reimbursement from a business to you. You can actually pay and rent your house up. People do it for Airbnb, too. They rent out their homes for 14 days or less and they don’t have to pay tax on it.
It’s not really reimbursed. It’s actually paying you. The corporation pays you. It could be by check, it could be electronic, it could be anything. As long as it gives you the cash, it’s a cash basis taxpayer, so are you. It takes the deduction when it pays you. Then, you are under an exception to the rule. You have to recognize the income. You, under 288(g)(2), you just don’t have to recognize income. You don’t have to pay any tax on it. You don’t have to even report it. It’s great.
Michael: Let’s make it reasonable, too.
Toby: Let’s see. “What do you do if you’ve taken the 27½ year depreciation? You held the property for more than 30 years.” First off, you celebrate because that’s great, but there’s no way to take more depreciation on it. What you can do though—this is kind of mean—is if you give it to charity, you get the fair market value written off. That would be a property that I’d keep my eye on as to whether I ever want a big tax deduction. You can always sell it, 1031 exchange it. You could sell it, not 1031 exchange it, and invest it into a qualified opportunity zone. There’s lots of stuff you could do.
In the meantime, you’re just having taxable income coming in from the rents. One easy thing that you could do is buy more real estate and offset the rents that’s coming off the properties that’s already been depreciated. By buying more real estate, you continue to take the depreciation off a bit. It’s always kind of a math puzzle.
“How much depreciation do I need? If I need more depreciation, can I accelerate my depreciation by doing a cost segregation? And if I still have a tax appetite, do I want to get that property out of my name by giving it to something else?” Yeah, fine.
We just had another executive retreat.
Michael: I felt great just walking.
Toby: Lane’s looking around. […] Lane […] is awesome.
Michael: Lane is here.
Toby: And does syndications over on Oahu. He happens to be here with us in Maui. Lane’s awesome. Earlier this year, in January, some of you guys know that I was over heere teaching at the Hawaii Convention Center with iHeartRadio and doing a really cool thing for the locals on investing. Lane was kind enough to come out and work with us. His wife’s a first grade school teacher, works with disadvantaged youths and is an amazing person in and of herself. Here’s Lane, comes to the executive retreat. Why don’t you give him a little update on who you are, what you do, and all that fun stuff?
Lane: Yeah. I used to be an engineer, left that day job six months ago because I started investing in real estate in 2009, bought 11 single family homes, realized that they weren’t quite scalable, and that’s a great way to start. Today, in over a couple of months, in a couple of dozen syndication deals as LP and general partner, also a little bit of syndication, too.
Toby: Where do you do with them all?
Lane: Mostly in the southeast.
Toby: You live in Hawaii and you invest in southeast.
Lane: Live where you want, invest where the numbers make sense.
Toby: Yup. A great example. A lot of people are geographically scared and here you are. You probably 2600 miles away from your investments?
Lane: Yeah. That’s the nice thing about being an LP. You’re making all your bet on the frontend. I’ll go out and if I see a deal, I’ll underwrite it, get the P&Ls and the referrals, […] analyzer, get to know the operators, then I fly out. I’ll spend a couple of hours, walk around the block, and then get my butt back here.
Toby: That’s pretty awesome. Somebody says, “Aloha,” by the way. You get to say, “Mahalo,” right? I am learning. So, you’re sitting here on a Tax Tuesday. First off, how’d you like the executive retreat?
Lane: Awesome.
Toby: What do you think of the people?
Lane: Great group of people.
Michael: What about some takeaways?
Lane: It’s nice meeting a bunch of other people. There’s always some kind of synergy with other people. What’s nice is that some people do different things. It’s very uncompetitive and you’re doing the same marketing tactics, like I need to hire an employee. That’s the takeaway from this. It’s just something that I’m not aware of. For other people, it’s just second nature to them. They’ve done it five years ago.
Michael: I’ve seen among the attendees is there’s no scarcity mentality to it. There’s enough pie for everybody and you guys are synergizing, getting together, and building from where you guys are at. It’s awesome.
Toby: Who’s your favorite that you’ve listened to as far as these figures?
Michael: Michael Bowman.
Lane: I like your talk on the Nevada Asset Protection and the bonus depreciation. We do it on all our deals. I didn’t know it was all…
Toby: Usually the good ones. What was your effective tax rate this year?
Lane: 4%. My AGI was $130,000 something and I paid $5000 in taxes, so 4%. It’s crazy.
Toby: What did you do? You guys have heard me talk about this stuff. He’s a real estate professional. There’s somebody asking questions who lives here. They live here in Hawaii. What Lane did is, because he’s a real estate professional, he did cost segregation on the properties that he’s acquiring. All it did is it lowered your tax. You made $135,000 and you paid $5000?
Lane: Yeah, but I also made $200,000 of capital gains for selling a bunch of properties.
Toby: So you made $300,000-something.
Lane: Yeah, and everybody […] 1031 and they tell you to delay taxes, but I just used the bonus depreciation from all these asset deals I wanted to do.
Toby: That’s how you do it. We tell people it’s perfectly legal. You get to choose whether or not you want to take the straight-line depreciation. From an accounting standpoint, it’s called 1250 property, the structural property, versus 1245 property which is the personal property attached to the real estate.
You always look at real estate. Real estate is nothing until you start pouring cement and stuff like that off. There’s always the improvement and then of that improvement, some of its structure and some of it is like the electrical system.
We have Jennifer who lives here in Hawaii and started learning about real estate investing. “There’s a local real estate investment that’s a group that only invests in mainland, in particular, in Indiana and Ohio.” That sounds like Paul Xavier. Is that what it is, Jennifer? “What do you think about the new short-term Airbnb regulations?” Jennifer knows Paul. Paul is a great guy, by the way.
Michael: He’s awesome. Fantastic.
Lane: Short-term rentals? I don’t know too much about it. I focus on the cash flow on the mainland. I don’t buy off pro forma. No development deals for me. I want cash flow only because I feel like there may be a recession coming up in the next couple of years.
Toby: That’s the key guys. One takeaway that I always give people if your holding period is forever when you have cash flow properties. You don’t care. You’re not in a hurry to sell. In fact, there’s a few questions here.
Somebody says, “I bought a few properties over 20 years ago and have no mortgages. Titled it to my individual name. What is the best exit strategy with the least tax consequences?” That’s a great situation to be in. I’ll tell you, your best exit is to die and let the basis step up or to give jit away. Take the deduction now or 1031 it in the […] like the old Monopoly. Buy houses and trade them into hotels. Don’t do hotels but do apartments. Do multifamily, things like that.
What Lane is talking about is cash flow is king. You have these investments. You have an exit on them or do you always just hold them and keep them?
Lane: We try to sell them in five years. We’re buying a lot of 1970s, 1980s products. We try to put a little lipstick on the pig, but at the end of the hold of five years, you want to dump these assets. You’re not going to be holding onto them. Sell and buy some of the better assets. B+ assets are 1980s, 1990s.
Toby: So, you’re playing the game. “Hey, there’s going to be some deferred maintenance. Do you want to get into the complete rehab and then trade them?” You guys ever 1031 exchange your investments or you guys just pay a little tax on it when you receive it?
Lane: Typically, not. Most of our investors are in multiple deals, […] passive investments. I just want to move on to the next venture.
Toby: It all works out and there’s a way to keep the taxes down to nil. Even on the situation, […] about the 20 year property. You can always carry back a note and receive the income over a long period of time. You’re going to have both dividend and recapture, and you’re going to have a long-term capital gains. I thought about a 1031 exchange but don’t want to deal with the tenants anymore.
Kitty, I hear you. What you can always do—let me give you an easy one—is just something where you can email me up, put you in touch with some folks. If you don’t like tenants, then what you do is you 1031 exchange into storage units. That’s something you could do. You could actually be a tenant in common on it or you could just go out and get your own and get rid of the tenants. If you want some turnkey opportunities, there’s some folks out there that do that, too.
Let’s go back to some more questions. Do you have any tax questions you want to ask? Since you’re sitting here, I could ask you.
Michael: There’s a few other ones here, too.
Toby: There’s a ton that have been coming.
Lane: You’ve got a lot of questions there.
Toby: I know. You see how it works? Everybody thinks I sit here and pick my nose when I’m doing this. Now, I’ve got to show Michael here just how many. Let’s see. “Can the charitable purpose or its activities take place in another country?” Yes. Somebody’s talking about human trafficking in Libya, absolutely. You can do that. You approve it in the US, but it can be an out of the country purpose.
“Can you do more clarification about the IRA owning real estate?” Amon, IRAs typically, it’s up to your custodian as to what you invest in. A lot of people think there’s restrictions on IRAs to buy real estate. There isn’t. It’s basically when you have a custodian, they have to buy it for you in an IRA, and you have something called debt-financed income when an IRA has debt. Let’s say that you financed half of the property, then half the income that comes in is taxable even though it’s in an IRA. You pay tax on that, that financed income.
If you do a 401(k), you don’t have to worry about that. Nor do you have a custodian. I tend to like 401(k)s over IRAs for that reason. Plus, you can dump a lot more money into it.
“Our platinum membership dues is deductible to a business?” Absolutely. To an individual, no.
Michael: Taking a look at it, businesses expenses, customer, ordinary, reasonable, and necessary.
Toby: Yup. “What are the tax implications of a Solo 401(k) owning more than $250,000 in assets?” There is no tax implication. You just have to file a form 5500. They’re simple, really basic if it’s $250,000 and more.
“When selling a rental property, do you report that on Schedule D?” No, it’s on Schedule E. You have it in your capital gains. I will have to take a peek at that. I don’t know the exact form. That would be a Jeff question.
“I created a management C Corp that manages all my different LLCs and properties. I’m not taking any salary out of this corporation at this time. The C Corporation has an employee welfare plan. It’s really 105 Plan via cafeteria plan or health reimbursement plan that pays my out-of-pocket medical expenses. My question is, from this plan, can I reimburse myself the employee contribution of my W-2 job healthcare plan?” Michael, do you care about this plan or do you want me to answer this one?
Michael: Section 105A Plan?
Toby: Yeah. “Can I reimburse myself for the employee contribution to the W-2?”
Michael: I think the role on this, you can’t just double dip.
Toby: Yeah, you can’t double dip. […]
Michael: No double dipping.
Toby: Yeah, so if your employer is paying for the plan and its pre-tax, meaning, you’re not being taxed on the money, the easiest way to look at this is, a lot of companies will cover the employee, and then if you have a family, kids and spouse that you want to add on to it, they’ll take it out of your paycheck. Your C Corp can reimburse you the portion that came post-tax not the portion that came pre-tax.
Michael: I think that’s for a lot of people that make the mistake of pre-tax versus post-tax.
Toby: One of the cool things is even your deductibles, even your copay is they can pay it, too.
I’m going to go back to another question here. “I was told to trade stock option via an LLC. We’re doing so as to lessen my capital gains burden.” No, Jeremy. Only if you have a corporation that is a partner in it. This is a big one. When you’re trading and you trade stock options, you have two choices. You either, kind of like what I would think of, everybody is really an investor.
There’s some people trying to get you via trader and that’s just a minefield. There’s so many court cases. You better be making your living off if you’re a trader. You got to be doing over 700 trades a year if you’re going to be a trader. Otherwise, use an LLC taxed as a partnership but the corporation as the partner. Then, you don’t have to worry about miscellaneous itemized deductions that no longer exist. You can actually write off against it. You don’t have to qualify as a trader.
Michael: The other thing about that is the business expense is going to business return as opposed to your personal return.
Toby: Another question somebody asked is, “Do I have to be a real estate professional to be able to deduct real estate investment-related expenses? For example, training, car mileage, et cetera. I do have rental income and have a lot of real estate investment activities, but we don’t have enough hours to surpass hours in my W-2 job. Should I use Schedule E or other form?”
You can write it off, Grace. It’s just going to offset your rental income and that’s not a situation we have to worry about hours. It’s just your losses are passive. If you have passive losses, you can’t offset your W-2 income. Where the real estate professional comes in, is it takes passive losses and makes them active. You still get to write off your expenses that are associated with that and Schedule E is the place.
Next one, we’re going to advance the slide.
Lane: I have a question that comes up from my folks […]. All my investors invest passively and they get really nice bonus depreciation that we talked about. One spouse might be a doctor who’s making $200,000 a year. The other spouse stays at home with the children. We’re trying to make them into a real estate professional. How can they just go out? Do they even need a real estate license? Can they just make some referrals or work in real estate? What are some easy ways to save […] on this one?
Toby: Great question. Here’s how it works. When you’re a real estate professional, there’s a first part test, which is a two part test and a second part test. The first part test is a 750 hours and greater than 50% of your professional time. One spouse has to qualify in the part one. The second test is the material participation with your activities. That’s a cumulative test for both spouses.
Let’s go back to your scenario. First professional makes $400,000 a year. Let’s say it’s husband and wife. You want to qualify as real estate professionals so that the real estate losses—you can do bonus depreciation—you can offset the income being made from spouse number one. Spouse number two has to be a real estate professional. Does she have to be a licensed real estate professional? No.
Michael: You also want to be able to log all those activities and keep a log just to find it.
Toby: You want to keep contemporaneous? No. It’s a […], but they would still have 750 hours. That’s the minimum. What accountants screw up on—I’ll just give you what I see—accountants would oftentimes not group all of your rental activities. The part one, it doesn’t matter what you’re doing. I could be a construction guys and I would meet the first part of that 750 hours.
The second part is material participation on my real estate. I have to make an election to group all of my real estate activities. If I have a bunch of rentals, I better be grouping them. Back to your scenario.
Lane: Follow up on that, what if these individuals don’t have any rentals? They just have six $50,000 private placement flip positions?
Toby: Then they have to be materially participating in that. There’s about nine different tests to qualify.
Lane: Let’s just say, they don’t want to get some C-class, D-class, properties out there in Ohio and create a couple of headaches in itself. What if they were to be a general partner on a […] deal? What is the least amount of work they need to do to get the ROP?
Toby: The least amount is really the two spouses together. They should spend 100 hours. I think 500 hours is the threshold that you don’t have to worry about anything. If they both spend cumulative 500 hours total, we don’t care about the 50% rule on that one. It’s just for general participation, both spouses are doing that, and we don’t have to worry.
Lane: And no grouping.
Toby: They would group them all together, all their real estate activities, all those K-1s would go on to one activity and they would group them all. But they would have to hit that 500 hours. If you want to do the 100 hours, then, nobody else can do more time on all of your real estate, on all of their real estate when we add it all up. You couldn’t have one manager.
For example, if they’re doing what you’re saying, you’re the general partner in all of them, and you exceed their time, then they better hit the 500 hours. Otherwise, the 100 hours is cumulative. That’s both spouses together, by the way.
Lane: That’s not hard.
Michael: It’s document, document, document.
Toby: Yeah. What Michael said is absolutely true. You’re in charge of that, by the way. We have another guest. We have a bunch that we’re going through. Did I actually look at this one? We haven’t answer the opportunity zone, the one that I’m looking at right now. Hold on for a second. I’m going to introduce you but we got to answer some of the slides once in a while.
“If I purchase a property within an opportunity zone and start a business based from that building that passes the opportunity zone test, do I still need to improve the property as well?” Michael, if you want to whack that one out of the park, you certainly can.
Michael: Yeah, you have to go ahead and substantially improve the property. Adjust the bases in the property.
Toby: Even if you have a business from it?
Michael: […].
Toby: I love messing with Michael. We have two things here. You have the business. You’re starting a business in the opportunity zone based out of that building. You’re looking at two different assets. You have the building, which Michael’s absolutely right, you have to substantially improve it or it has to be abandoned property that you took over. The thing have to be abandoned for five years. Or it has to be land. I’m assuming, this sounds like there’s improvement. You have to double the improvement is basically what it is, so $1,000,000 property, $800,000 in improvement, $200,000 land. You got to put $800,000 in 31 months, written plan. If there’s a business there, it just means 50% of its employees, payroll expense comes out of that opportunity zone.
Michael: Makes you carve out the land.
Toby: Carve out the land and on the actual business, it doesn’t convert the land. I’m not seeing anything. This is one of those areas where I would say, it sounds like you’re doing a lot more. Here’s what really gets into it. When you’re doing an active business, I believe it’s a 70% test if you own a subsidiary. This is going to sound a little bit disjointed because I’m using percentages. It’s 90% of the fund has to have opportunity zone property. That opportunity zone property can include both the business and the land. Depending on the value of the building and the land, I should say land, it’s the building, the real estate, depending on the value of that business, we may not have to worry about the value of the property.
We can just ignore it and say, “Yeah, it’s still part of the opportunity zone because we meet the threshold for all of our properties.” It has to be a pretty valuable business, but it’s not uncommon to have that business be worth 6–8 times what value of business the real estate is worth. It gets a little bit convoluted, but I would want to know more about the facts and circumstances.
Michael: Let’s introduce Jason. Jason just walked in. He’s one of the attendees here at the executive retreat. Jason, welcome.
Jason: Great to be here, guys.
Michael: Jason’s one of those lazy guys that really doesn’t do much. He keeps his feet up in a lazy boy all day. I was kidding. Jason makes me tired when I hear all the stuff he’s doing.
Toby: Jason is here at the executive retreat with us. What do you think?
Jason: I absolutely loved it.
Toby: You love Maui?
Jason: I love Maui. I love Maui better than the other.
Toby: You went on the cruise last year. You went to Alaska. How about all the people that are here?
Jason: That people that are here are great. All the Anderson people are great. Everybody’s joining your little fan club.
Toby: Little fan club.
Jason: It’s a very small group of people that roll in line, thinking the same way.
Toby: Jason, why don’t you give them a little bit on you? You’re a big construction guy. You’re a developer.
Jason: I’m in a construction company and a development firm. We build in five stage right now, about to expand in South Dakota.
Toby: Nice. You’re in Montana?
Jason: Montana, Alaska, Idaho, Washington, and Oregon.
Toby: And you do big projects.
Jason: I do a lot of big projects. A lot of grocery stores, a lot of financial institutions, inline retail, Starbucks.
Toby: Starbucks.
Michael: He loves Starbucks.
Toby: I’m not saying anything. We love the Starbucks. We love the mermaid. So, if anybody from Seattle, you get a thumbs up from Jason. Anything that you learned or any questions that you had…
Michael: Just give us some aha moment from last…
Toby: You do the aha and then you can stump us with questions.
Jason: The aha from this meeting?
Michael: Yeah.
Jason: The true aha moment was the paper subdivisions from […]. That was great education. These aren’t new. I mean, I do these everyday. I create that piece of paper on multiple clients. I’m basically subdividing land all the time and I create this piece of paper for a project. They’re building or building for somebody else and I never thought why don’t I just create the piece of paper, sell off half of it and create free land?
Michael: So, an expert learn from another expert.
Jason: Absolutely,
Michael: Isn’t that cool?
Jason: It was an aha moment like ice cream cone on the forehead.
Michael: I just love you do this and all of a sudden, someone gave you another way to look at […].
Male: Yes, absolutely.
Michael: Fantastic.
Toby: […] a stud. That’s Donny and Marie’s nephew, by the way, for those of your guys that’s on the outside. Super nice guy.
Michael: Awesome guy.
Toby: Does residential assisted living, has his own furniture stores, is a developer, builds buildings, just does an amazing job and…
Jason: Super creative.
Toby: Yup. Comes out here and hangs out with our sorry butts every year.
Michael: I guess that’s another thing is about thinking outside the box also.
Toby: Yup. Hey, a tax question. You got to stump us.
Jason: Okay. “Let’s say you’re building a federally mandated credit union in a state like Washington state that has state sales tax. How does the contractor get around the state sales and use tax? Because the credit union hand you a piece of paper and refuses to pay any of that.”
Toby: Michael?
Michael: That was an easy one. You know what? Just look at Section 123 of the IRS code and we’re good to go.
Toby: Yeah.
Michael: No. You got me. I don’t know.
Toby: Actually, I do know enough to be really dangerous in this. You have exempt organizations. Exempt organizations fall into many categories. Federally mandated organizations like federal credit unions in federal governments and things like that, every […] fall into this other category where they’re exempt from sales tax and federal taxes as a whole. Anybody’s who’s here who’s been on […] and nonprofits realize you got to be in that name to get the exclusion.
Thinking about your issue, you’re building for them, but you’re buying the materials. They’re going to stick you with the bill even though the organization is exempt. Here’s my advice to you. They should buy the materials that you’ll use. You will not be paying sales tax on. You have to have them buy it. They will not pay sales tax. If you buy it, you will.
Jason: Interesting.
Michael: Okay.
Toby: Is that worth the price of admission?
Jason: That is worth the price of admission.
Toby: Because then, what it is, it’s theirs. In fact, I know that this is specific now that it’s ringing so many bells. They have to be the one that acquires the asset. Otherwise, Washington State is going to say, “You owe us the sales tax.” If you don’t pay the sales tax, then they’re going to say, “Well, you used the material to build,” and they’re going to charge you the use tax. Am I getting close?
Jason: Yeah, absolutely close.
Michael: We’ve been paying it all along.
Toby: Yeah, so you can avoid that completely. What you do is you have the credit union itself buy all materials with its exemption and now you won’t have that issue. It will save you the sales tax.
Jason: Okay.
Michael: Sound great.
Toby: Isn’t that fun?
Jason: That was very fun.
Michael: I just learned something, too.
Toby: Yes. Stuff that you never wanted to know, right? I don’t even know why it’s spinning in my head. I thought it was gone.
Michael: I’m going to use it five years from now.
Toby: All right. Let’s take a look at this thing. “Toby, how can I find out more about storage units?” So, he’s talking about Ryan Gibson. What do you think of Ryan?
Jason: I think Ryan was a wealth of information. He really has all of ducks in a row. He’s got all the right team mates in his in-house team, which is a great way to trust who you’re dealing with.
Toby: He does storage units and make a syndication of storage units and they’re pretty cool. I love the automation of it. It just sits there, do that, basically you build these things.
Jason: I do.
Toby: How much does it cost per foot just to build a storage unit?
Jason: It depends on what kind of materials, what kind of project you want to have, but usually a basic, bare-bones storage unit you’re looking at about $10-$12 a foot.
Toby: $10–$12? Are you freaking kidding me?
Jason: The barrier to entry is so low on these.
Toby: $10–$12 a foot. You’ve got to be kidding me. Jiminy Christmas. I’m going to have you build some storage units.
Michael: More and more of our clients are getting into it just because of the automation, but you guys mentioned it’s really […].
Toby: Somebody talked about doing stuff at $40 a foot.
Jason: We’re talking just the storage unit itself. We got to add the concrete slab, and then if you want electrical, all these upgrades, but we’re talking just the building itself.
Toby: Just the building itself. That’s freakish. Well, if anybody wants to get a hold of you, all you got to do, guys, is send to Tax Tuesday. If anybody wants any information about any of this stuff that we’re talking about, because some of you guys are saying, “Hey, how do I find out?” Just email Tax Tuesday and they’ll forward it on.
“Do I allocate holding company expenses to rental properties?” […] understand that, but the rental properties all flow to a holding company that all ends up on your Schedule E. So, it’s all being allocated over.
“Is it okay to pay my personal travel to visit properties owned in the Solo 401(k)? That’s a weird one. I don’t think so.
Michael: No. He can’t because you’re here for personal travel and you’re improving the property. Is that why you’re going on travel […] you’re starting to dancing the line. That makes me uncomfortable.
Toby: Roger that. What I would do is I’d make sure you have two sides. You can have the 401(k) and you can still have a management entity and that Solo 401(k) could be sponsored by the corporation and then I would just have the expenses go as a business expense to the corporation. I wouldn’t be reimbursing yourself expenses out of the 401(k). I don’t think you can do that. I think it’s prohibited transaction.
Michael: Definitely not do it.
Toby: All right, we have a bunch of other questions to go through. You can hang out and think of other things to stump us with.
“I plan on having my Wyoming LLC become a 100% shareholder of my two C Corps. One C Corp for flipping homes and one C Corp for flipping the raw land. Should my LLC have to file a tax return even if I zero out the revenue with expenses and sell it to myself?”
Michael: First of all, you have to ask how is your LLC taxed? Is it disregarded down to you or is it taxed as a partnership? If it’s a partnership, you will have to file a tax return, but if there’s no income or loss, then you don’t have to pay taxes on it.
Toby: Yup, what Michael just said is absolutely 100%. The LLC doesn’t matter what it owns. It matters how we tax it or what we told the IRS it is.
Jason: Is that a 1065?
Toby: Yeah, that’s a partnership. But a lot of people will set-up an LLC and they’ll have it own a corporation. A C Corp is fine. It could not own an S Corp under this scenario you be doing some bad stuff and you violate it. A C Corp pays its own tax. Quick question, Jason. Do you know what the tax rate is for a C Corp?
Jason: 20%?
Toby: 21%. You’re not even an accountant but you kick butt. […] build stuff.
Michael: What is it going to change to in five or six years? What do you think it’s going to change to?
Jason: I think it’s 23% or 26%.
Michael: Who knows?
Toby: C Corp doesn’t phase out. We don’t have to phase out like all the…
Michael: Not sure. Not sure.
Toby: All right. Not a tax question but an interesting one. “Land, LLC, Wyoming. Tenant stops paying rent. We tried to evict them and they challenged. We’re not the owners of the property because we’re not in the title or any proof. How do we prove without losing anonymity?” Your trustee can hire whoever it wants to toss them out, and you’re still the owner. The owner in title is the land trust. You can act on its behalf or have somebody else act on its behalf.
“Does managing the property count towards those hours?” Yes, absolutely. Anything involved in real estate pretty much count towards those hours.
“For a stock trader, can you have the corporation be an outside non-partner management company? What is the benefit of having it be a general partner?” Ross, that’s a huge one. This is the biggest difference. If it’s outside, not a partner, your payment is a miscellaneous itemized expense and it doesn’t exist anymore because they did away with miscellaneous itemized expenses. You get no deduction for it. If it’s a partner, if it’s a guaranteed payment to partner, and that reduces the amount of profit.
Michael: It’s a partner that’s taking a push into the profit anyway.
Toby: Yup. “I would like to purchase property in Florida and use it in a land trust. I’m new to land trusts. How things are protected from fraud if nothing is recorded?” It’s not how it works. You want to give them a two-second on the…
Michael: Land trust is simply a title-holding vehicle. It’s going to be disregarded most of the time and the income or loss goes to the beneficial owner.
Toby: Yes. Florida has a statute, by the way, so really easy to use and you’re still on title. Think about a land trust. When they first came out in Illinois, the court case was when they’re building the Sears Tower, they were using land trust to acquire. The court put it out real simple. They said, “Legal title is held in the name of a trustee for the trust and that trustee could be anybody.” We use companies, sometimes, we don’t care. But the beneficial ownership is just not listed. It’s the beneficiary.
So, you have two things. Beneficial use of that real property and legal title. We can make the legal title be a different name and all it does is it keeps them from finding everything he owns. That’s what it’s really good for.
Michael: But you see, it’s also the trust agreement. Just think of a trust as a title holding vehicle and […] a trustee that’s running it. When people get confused about different states and whether or not land trust exists, it’s just a revocable trust, and that’s all it is, just like a living trust.
Toby: Somebody says, “To Jason. Yes, Jarod’s talk was great. What a free thinker and a nice guy.”
All right, next one. Let’s see. “So Toby, I want to be clear. If I manage my rental property on full-time basis but I’m not licensed, does that time still qualifies real estate activity for tax purposes?” Yes. “And can I deduct all expenses?” Yes. Your travel, training, phone, mileage, all that fun stuff, yes.
Somebody says, “Should I use an S Corp for a stock trading business if I need the income to live off?” It depends. A lot of times I’ve used the C Corp because I can get most of the money out tax-free.
Michael: We’re in rate, too, at 21%. It makes it really attractive.
Toby: But you need the money to live off. It depends on how much, so it’s all facts and circumstances.
Michael: Make yourself salary, make a contribution to a…
Toby: 401(k)?
Michael: Yeah […] I think create strategies using corporations.
Toby: Somebody says, “Does an LLC taxed as a C Corp have the same requirements as a regular C Corp, meaning records keeping to keep the liability protection?”
Michael: When you look at a business filing like a corporation or an LLC, you start off at the state level and you’re the state that you want to operate underneath the state statute for corporations or the state statute for the liability companies. That’s at the state level. When you get to the federal level, if you’re going to be a corporation, you could choose a C Corporation or an S Corporation or an LLC could choose a C Corporation, S Corporation, partnership, or disregarded.
From a record keeping standpoint, from a liability standpoint, you still have to go ahead and do the record keeping. From an IRS standpoint, they want you to do books and records. They want you to show where the expenses came in and justify your expenses and deductions. It’s the same for the IRS, whether it’s an LLC taxed as a C or if it’s just a straight C Corporation.
Toby: Yup, what Michael just said and you said it really well. I would like to look at it as there’s three things. There’s the state, there’s the feds, and then there’s judges or third parties, lenders, whatever. You have an LLC. To the state, that’s the only party that cares that it’s an LLC. The feds say, “I don’t even know what an LLC is, please tell me what it is.” You tell the feds how you want to be taxed. They literally don’t have a tax designation for an LLC, so you have to tell them. And then, for third parties, all they really care about is do you actually keep records, do you have a P&L or do you have a balance sheet, and are you keeping some written notations on your decision-making so that we should recognize it and give it respect. Those are all three areas.
Michael: I would say it’s funny when you hear a client saying, “I have an LLC,” then you ask them, “How is it taxed?” and they say, “The accountant says it’s taxed as an LLC.” There is no such thing as an LLC taxation.
Toby: Yup.
Michael: It’s all Federal.
Toby: That’s just the Federal, so we care about the state and we care about the third parties. We care about them equally, so we always care about it.
Somebody else says, “If a person uses cost segregation on a rental home, isn’t the depreciation recapture on the sale of the home? And can a 1031 exchange be used?”
Michael: I was really impressed by this question.
Toby: All right. You knock it out.
Michael: No, go ahead.
Toby: You don’t want to do it?
Michael: No, you take it. But this is a pretty advanced strategy that just came about with the tax act.
Toby: Right, so this is fun. You guys heard me talk about this before, but I’m just going to give you the two seconds. When you have a structure, any sort of building, its 1250 property is the structure. If you do nothing else, everything is structure. It’s 27½ years for residential property, 39 years for commercial. What that means is whatever that cement, wood, metal, whatever you built on it, it has a useful life and you get a deduction of 1/39th if its commercial or 1/27.5 if it’s residential. You get a deduction for that amount every year against its income.
When you do cost segregation, you say, “We know that there’s a bunch of stuff in there that’s not going to last 39 years or 27½ years. So, I am going to break it into pieces.” Carpeting is my favorite example. It’s a five-year property. You’re always going to replace it in five years. It sucks after a period of time or it’s not worth anything.
First off, your cost segregation is a fancy way of writing a bunch of stuff off. When it’s recaptured, it’s at ordinary income only to its fair market value. Let’s go back to our carpeting. It’s five year property, you sell the property. In 10 years, don’t you have to pay recapture on that? The answer is no. It’s actually considered capital gains.
This is really important because even in a 1031 exchange, you’re deferring recapture and capital gains. We do not have recapture on short-term assets. It’s not the same. It’s not that 25%. You either have ordinary income or long-term capital gains. It’s either worth something or it’s not. If it’s worth something, then you recognize whatever that is. It’s ordinary income and it’s usually when you’re selling something, a building after a period of time, all of the stuff that you’ve rapidly depreciated has no value or has minimal value, like what would you pay someone for their carpeting that they’ve been using the last seven years? You’re not going to pay them anything. It’s going to cost more to tear it out of there. It’s fair market value is zero, so you don’t have to worry about it.
The cost segregation is fantastic. What Michael was talking about under the new tax laws, the new Tax Cuts and Jobs Act says, “I can write off all short-term assets. Anything less than 20 years, in one year I have 100% bonus depreciation. It doesn’t have to be new property anymore. That was the old law. It has to be new and put into service this year. Now, I can do it on used property.
We’ve managed to save quite literally, with out clients, millions of dollars. I can say that unequivocally that the folks that I can add up in the top of my head, I just dealt with another one today that we saved about $80,000 to this year. Lane, $200,000 easy. So many people. Do you do cost seg?
Jason: I might as well. It’s the same thing as construction did.
Toby: Yup because when you’re doing construction, you already know what it is. As long as I’m going to own it, I may as well write it off anyway. In 1031 exchange we use, yes, but in exchange, you only worry about the gain. It’s actually the best of both worlds. In fact, there’s a lot of practitioners out there writing about how potent it is to do a cost seg with a 1031.
Jason: In conjunction, yup.
Toby: Yup, because when you sell that property, you’re not having to recapture ever. It’s actually really cool.
All right. “What’s the best entity structure for Airbnb, HomeAway, and Vrbo? My plan is to sign long-term leases, 12 months, and rent them out on these platforms?” What do you think?
Michael: We covered this one. We talked about a property owned by an LLC and the […] with a corporation. That corporation then runs that through Airbnb.
Toby: Yeah. What you end up doing, what Michael just said, is when you have about seven days or less of rentals. What I do is you take your total number of days you rented a property, divide it by the number of guests. Let’s say that I rented my property for 140 days and I had say, 30 guests.
Michael: Total bookings divided by the total number of days rented equals average length of stay.
Toby: That’s ordinary income. You still get depreciation and stuff, but it’s subject to self-employment tax, which you guys know what that is. Old age, death and survivors, and medicare at 15.3%. The actual tax hit is 14.1% to be technical up to that $137,000–$138,000 I think this year. We tend to want to stay away from that. The better route is what they’re doing, which is leasing it for 12 months. You do that through a corporation.
So, the best entity structure would be an LLC taxed as a corporation or a corporation, assuming that these are all short-term, seven days or less and renting them out on these platforms. Then, you have the ability to get that money out at least not subject to self-employment tax or at least a portion. If you have an S Corp, you have to pay yourself a small salary or a C Corp where you just let it be taxed at 21%. There’s lots of tax strategies. We’re using an accountable plan and some other things to get the money out.
Michael: Just make sure you read the lease and make sure you’re not violating the 12 month lease.
Toby: Who did that? I think it’s one of the Trump’s that leased the property in New York and Airbnb-ing it out.
Michael: Yeah. Just make sure there’s no new restrictions on it.
Toby: Somebody says, “You can defer depreciation recapture when doing a 1031 exchange. Can you defer depreciation recapture if doing reinvesting into a qualified opportunity zone?” Yes, Ross, you can. That is a great question. That was one that we needed the regs to give us the answer on. So, you can do both. For those of you who don’t know what that is, qualified opportunity zones is seg capital gains, but it also includes all 1231, including your recapture. Great question. Ross, you rock.
“What’s the tax form to specify C Corp or S Corp?” You do the C Corp on an SS4. The S Corp is the following additional 2553.
Michael: Within 75 days of the date of filing.
Toby: “And the shell C Corp that isn’t filing any tax exchange for the last five years, is there any major concern in filing these returns that have zero income and zero loss?” No. You still have a requirement to pay. When you file a return, you just have no tax and there’s no penalty. So, you want to make sure that you file those.
“Do I need to file a separate tax return for a land trust?” Mina, no. You don’t have to. It’s a […] trust 99.9% of the time. It’s the beneficiary who is going to report all that income.
“I’m starting an Amazon-based ecommerce business with some partners. What is the best entity for tax advantage and asset protection?”
Michael: It’s going to be […] but you guys want out of it if you don’t describe […] or bring forth income. Partnership return might be the best way if you want to do some active and do some retirement planning. You might want to do an S Corporation.
Toby: Yup. It always is it’s going to depend. So, as he said, the answer is always going to be is it going to make money? Lose money? What are they putting in?
Michael: What’s your long-term strategy also. Keep in mind you can always change the tax status later on, too.
Toby: Yup. We already had the special guest, so that’s all of our questions. There’s a couple of more. Two for Tuesdays always. We do the Tax Wise Workshop. We have one coming up in a couple of weeks. Still time to register, at least access live stream. I think it’s sold out for the live, but you get all access to all of our workshops as we did for Tax Wise, all the recordings. Plus, you can attend the live stream to one coming up in November and you get the Bulletproof Investor.
You have two tickets to our Tax and Asset Protection Workshop. That’s a live event, three days. You get Clint’s Tax and Asset Protection for Real Estate Investors. You get a three-part video series, and you get a strategy session. You get both of those things for a whopping $197. That’s crazy. You literally have five days of classes there that you get access to.
Michael: And the video series is pretty awesome, too.
Toby: That’s because Michael did one of the videos series.
Jason: It’s worth it. I’ve been to it several times. I’ve watched Tax Wise four times.
Toby: You rock. Jason’s a very large person, so when I say he rocks, I mean it. All right, what do we got? “Can I use the timeshare for Vrbo?” Yeah.
Michael: Make sure you don’t violate any of the regulations.
Toby: Yeah, and then, “Are there any advantages to holding the deed to the property versus standard time share?” I always want deed.
“Do you have a W-2 job? Do you still pay social security tax?” Yes. On every dollar you make, you’re getting hit with social security tax. That’s one of the best […]. You can defer depreciation. All right, we’re not getting into that. I think we’ve been doing good. I think we have just a couple of things to finish up on.
You know what’s really gorgeous? All the cool people we get to meet. You should honestly consider coming to our executive retreats. I never had one where somebody came back and said, “You know? That was horrible.” Partly because we always have them in really cool places. We do cruises. I think we’re going to do European cruise next year.
Michael: One of the things about executive retreat is that not only do we provide content, but I think equally important is the synergy that goes on with like-minded people. You find yourself investing in real estate. Sometimes you go through some valleys. People here are like-minded. We’re all in this together. Just watching everyone work together is fantastic.
Toby: Absolutely great group. Some of them have done quite literally. You’ve done millions of dollars with the 10 days from last year, right?
Jason: Yes.
Toby: We have a couple of them that done over $100 million worth of transactions […].
Michael: Mike and Kindle, I gave a contact to out of Georgia. I think they’re doing at least a million dollars through word-of-mouth.
Toby: Yup.
Michael: I handed them a golden egg.
Toby: See? This is the beautiful part is that you have people that are actually trying to help each other and not asking for something in return, which is what’s always cool. Last little thing, if you have questions, always shoot them into Tax Tuesday at Anderson Advisors or visit andersonadvisors.com.
Check us out on Google Play or iTunes. We quite literally get hundreds of questions and we make sure that you’re getting answers. Sometimes, people say, “Well I haven’t got an answer.” it might take more than a few days, guys, because we’re getting a ton of these in and we don’t charge for it. So, when you ask some little question, I don’t know of any other place. You’re going to get tax attorneys and accountants answering for free at our lovely Tax Tuesdays.
Thanks for joining us. I think we’re way out of time. Michael talks so dang much that he goes way over. Thanks for today’s […] and the guys next time, we’ll see you next time.
Michael: All right. That’s all guys.
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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