How do you calculate taxes for flipping houses? Toby Mathis and Jeff Webb of Anderson Advisors answer your tax questions. Submit your tax question to taxtuesday@andersonadvisors.
Highlights/Topics:
- Is there depreciation recapture on a business vehicle when it is sold or no longer used for the business? Depreciation recapture works differently for personal/tangible property than for real estate. So, anything that’s not real estate and intangible, such as a car.
- Inherited IRAs: Are distributions taxed no matter what or can you shelter them with cost seg and depreciation from short-term rentals? Can you shelter with long-term rentals? It doesn’t matter if the IRA is inherited, the distributions are taxable because you could have cost segs or short-term rentals from somewhere else that are offsetting that income. IRAs, unless it’s a Roth IRA, are always going to generate taxable income.
- I am a physician in a single-specialty practice under an LLP. I have set up my personal PLLC in the state. Do I need to set up payroll and give myself a W-2? It depends. Most states require that you’re an S-corp. You are going to have to take a reasonable salary that is about a third of all the net profit.
- We made $200,000 on our first flip, we closed in April 2022. How much should we put aside for IRS taxes? Would you happen to know how much we should put aside for state taxes as well? if you were set up as a business before you made the $200,000, then you just made the 200,000 and that’s it. Pay the tax.
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Resources:
Unrelated Business Income Tax (UBIT)
Full Episode Transcript:
Toby: Welcome to Tax Tuesday. Hopefully, you guys are having a great Tuesday out there. My name is Toby Mathis.
Jeff: And I’m Jeff Webb.
Toby: This is where you come to get annoyed by tax questions. Actually, Jeff, this is where you come to get annoyed by tax questions. Today, we’re going to have a lot of fun. We got a bunch of questions selected. We’ll go through them and we’ll answer all your other questions in the chat.
Here are the rules. In the Q&A is where you put a question that you want our people to answer for you. In the chat, you can comment, you can tell us where you’re from, and you could harass. People always harass Jeff. Nobody ever harasses me.
Jeff: They love you.
Toby: They’re so mean. We have two howdies, believe it or not, Howdy from Raleigh and Howdy from Texas. That is bizarre.
“Hey, I have been missing in action the last couple of calls.” Sherry, you haven’t been around. What’s going on? What have you been doing? You’re saying there are more important things than talking to us? “I’m traveling around.” All right.
You could email your questions during the week to taxtuesday@andersonadvisors.com. There’s no cost for this. You can just shoot them in there. We’ll get back to you somehow, some way. If you need a really detailed response like something specific to your situation that requires analysis and more than just a quick answer to a question, then you need to be Platinum. It’s included in your Platinum though. You could ask your questions. We ask you to do those to the Platinum portal which all you guys will know how to use.
We have a whole bunch of folks on to help you, by the way. We got Matthew, Patty, Troy, Piao, Dana, Eliot, Christos, Dutch, and Ian. What do we got, six accountants on? We have the head of bookkeeping. If you have a question, today is a good day to be on because you just have a lot of talent there. You can just ask your questions. We’re not going to send you a bill.
All right. It’s fast, fun, educational, and bringing drive-by tax knowledge to the masses. Here we go. Opening questions. We’ve got a lot of questions to go through.
“I am considering investing in a short-term rental and managing this myself so I can take immediate bonus depreciation and offset my W-2 income. If I do this in the second half of the year, how long do I have to manage it myself before I can turn it over to a property management firm?” Good thinking. “I’m investing in the property in December. Can I manage it for one month to recapture my bonus depreciation?” Very good question. A good one to start off on. We’ll get to that in a second.
“Can I offset stock capital gains with stock losses dollar for dollar? I have capital gains of $100,000 and losses of $100,000. Can the losses cancel out the gains?” We’ll answer that one.
“Is there a depreciation recapture on a business vehicle when it is sold or no longer used for the business? If so, is there a strategy to reduce or eliminate the amount of recapture?” Three really good questions right out. We’ll jump into all this.
“I want to set up a Wyoming LLC to be the trustee of a land trust. The LLC will have two members. How does that impact annual filings since it is not a single-member LLC? The purchase in the land trust will be cash and there is no income or loss for the LLC. It will simply act as a trustee.” There is something to go over there.
“Inherited IRAs—are distributions taxed no matter what or can you shelter them with cost seg and depreciation from short-term rentals? Can you shelter with long-term rentals?” We’ve had good questions already. I’m already excited to answer three of them maybe. Hopefully, Jeff could answer everything else.
“I am a physician in a single-specialty practice under an LLP.” Sounds like an East Coaster. “I have set up my personal PLLC in the state. Do I need to set up payroll and give myself a W-2?” Good question. We’ll get into that too.
“I am starting out in real estate investing.” Welcome to the real estate investing world. “I’m looking to start with short-term rentals. One property will be a joint venture and 2–3 will be individually owned by me. Will there be a difference in the way the taxes are paid on both?” I was just thinking, well, the joint venture when you have your lawsuits. I’m just kidding. In real estate, JVs, you’ll learn. You’re brand-new in real estate.
What is this? Why are people already trolling me? Somebody says I look tanned. I think they changed the lighting here because I’m about as pale and pasty as a cup.
Actually, I was going to ask a question in the middle of the opening questions, which we never do. We’re going to ask you guys real estate investors out there with some experience of more than 10 transactions. What do you think of joint ventures (JVs) with other people? Tell me in chat. I’ll read them in a second. It’ll be fun. We just want to see what you guys think of joint ventures.
“We made $200,000 on our first flip we closed in April 2022. How much should we put aside for IRS taxes? Would you happen to know how much we should put aside for state taxes as well?”
We’re already getting a good one. “Avoid, no, no capital, no joint.” Anybody who’s done a few might have some strong opinions. We’re not saying that you won’t be successful. I’ve heard that people have gotten married off of Tinder. I just don’t know if that’s where I would go looking for my spouse.
“I am a co-owner of a C-corp. The C-corp owns real estate which is the C-corp’s primary place of business since 2003. We would like to get the real estate out of the C-corp and into the LLC. Is this feasible? What steps need to be taken to minimize tax consequences?” Really good questions again.
Somebody says, “I’ve always invested by myself. I’m doing my first JV, but now I’m scared.” Again, it’s not a 100% guarantee. It’s just that everybody who’s been investing for a long period of time has their JV stories. There are some people that love joint ventures and they make money at it. One of those favorite things for real estate investors is to beguile their tales of woe of the guy that takes the money, doesn’t do anything, or says I’ll do this, and then stole all the sheetrock and sold it out the back. There are always these stories and you’re like, what? You knuckleheads. Make sure you’re in control. That’s all I got to say.
Jeff: And just because you deal with a family member doesn’t necessarily make it any better.
Toby: It makes it worse. There are no loans between family members. There are only gifts.
“There are conflicting opinions about this question. What say you? I set up a series LLC taxed as a corp with 84 cells.” Somebody’s really got some stuff going on. “Master Filing, Master OA, Master EIN with 84 individual filings and 84 agreements. Do I need 84 individual EINs or can I roll up under the Master EIN?” Really good question. We will absolutely talk about that a little bit.
“I am a real estate investor and have a full-time W-2 job. I’m in the market for a new SUV. Historically, I have just deducted the appropriate mileage from my real estate projects. I was wondering if I got a vehicle and rented it out a time or two during the month with Turo or a similar company how that would affect my situation.”
Really good questions today. I’m kind of jazzed. I don’t always get jazzed on the questions, guys. You guys usually ask really good ones, but every one of those is pretty interesting.
If you like bizarre tax questions or you want to go to a good YouTube channel and subscribe, by the way, you could live stream this. I think that’s what it’s called. Whatever they do live on YouTube.
Jeff: Oh, yes.
Toby: Hey, Andrew, what is that called? Whatever you’re doing on YouTube right now.
Andrew: We are live streaming to YouTube now.
Toby: So it is live streaming. All right. Patty has been home. She’s on here. I don’t know why. Stop being on here, Patty. You’re supposed to be resting. She can’t help herself.
Anyway, if you want to go to YouTube, you can come on. By the way, that’s not an accurate screenshot of what’s going on today. There are just a bunch of videos on there that we upload. That’s last week, I suppose, or two weeks ago, but we’re always putting up new videos. Maybe I’ll grab one from today and throw it up there, but there are always probably two or three a week that are coming up just because we really love putting out content. Also, the recordings of the Tax Tuesdays are on there too.
If you like these and want to listen to them during the week, you absolutely can. That doesn’t mean that you don’t attend live though because then we get really sad when people don’t attend live. We love you guys listening to the recordings. If you’re like some of my guys, they put it on 1.5X and they listen to it so that we sound like we’re chipmunks.
“I’m considering investing in a short-term rental and managing this myself so I can take immediate bonus depreciation and offset my W-2 income. If I do this in the second half of the year, how long do I have to manage it myself before I could turn it over to a property management firm? If I invested in the property in December, can I manage it for one month to capture my bonus depreciation?” Jeffery, what do you think?
Jeff: Managing it yourself as a short-term rental, good. Doing the cost segregation to do bonus depreciation, good. My one concern here is if he buys it in December, he can establish it as a short-term rental, but what about the material participation test? He’s not going to be able to meet the 100-hour test.
Toby: What Jeff is talking about is if you want an ordinary loss, there’s rental loss and then there’s ordinary loss, short-term loss from a trader business. The question is does a short-term rental count as passive rental or does it count as a trader business? The test is seven days or less, it is not a rental under the passive activity loss rules. It is just a trader business.
Once you check that, test number two is, did I materially participate in it? If I did not materially participate in the business, then it is still passive. It’s just in the second prong of a business that you did not materially participate in. It’s just like being a silent owner in Jeff’s pizza shop. We talk about that almost every month. If Jeff had a pizza shop and I’m just silent money, I don’t get an active loss. I don’t get a non-passive loss.
It’s really important that we establish that we materially participate in it so that we get the loss. What this individual is talking about is I know I can create a big deduction. Jeff just mentioned bonus depreciation, cost seg, and all that. What is that in a nutshell?
Jeff: Cost segregation—I can’t think of another term I’ve heard it called, but you’re actually taking a building and pulling out segments of it that are not actually part of the building like cabinetry, flooring, wallpaper, paint, light fixtures, and so on and so forth. They’re not needed to hold the building up. For that reason, they’re segregated. They’re put in shorter lives.
Toby: Tangible property
Jeff: Yeah, they’re shorter lives. Why that’s important is you can bonus depreciate any life that’s under 20 years.
Toby: Yup. In English, it just means that if we have a building, we can write off about 30% of the building itself, not the layout. You can’t depreciate land, but it’s no different than buying a computer. Because it’s short-term, I can write it all off—this year is the last year we can do this—100%. It’s a big loss.
If I bought a short-term rental and I bought it for (let’s say) $300,000, I might be looking at an $80,000 deduction in year one. That’s a big deal. The question is can I use it against my W-2 income?
We always get the doctors going and saying, hey, what do I do to lower my income? I’m getting killed here with W-2 income. How do I do all this stuff? They know about real estate professionals and all these things, but they’re like, that’s not attainable for me. How do I get it? This is one of the strategies.
The beautiful part about the one month—and I’m talking about at the end of the year—is that with tangible property, it doesn’t matter whether it’s in service for one day. You can take that bonus depreciation. It’s just like people buying the Range Rover at the end of the year for their business because it’s over £6000 and they’re like, oh, I get to write it all off for 100% business use.
We know it’s going to be short-term. As long as you go through a couple of guests. There’s really no set test for it, but as long as it’s in service during December, you’re good. What Jeff is pointing to is did you materially participate? Seven tests. What test might you be able to meet even if you only had a week?
Jeff: There is another test that said, I did substantially all the services in that activity.
Toby: And there’s no hourly requirement. That’s how you would have to do it. The top three tests—I’m going to do it like Inglorious Basterds. That’s a movie reference.
Let’s say that there are three. The ones that we see the most are I did everything substantially all, I did 100 hours and nobody else did more than 100 hours, and I did 500 hours. We count you and a spouse together if you’re filing a joint return. You’ll be able to hit this. This is what you guys should all be doing. This is actually really, really smart.
If you’re a high-income person, even if you might turn it into a long-term rental later, all we care about is this taxable year. In 2022 when you acquired that property, was it a short-term rental? If it is, it’s not a rental activity. It is a trader business. Did you materially participate? If you did, you’re good. You’re fine as wine. You take that big old deduction and you move on, which is great. They’re subsidizing the acquisition of your real estate. In fact, the government is telling you what to do. Please go out and buy more real estate.
Jeff: A quick word about cost segregation and bonus depreciation because you mentioned that this is the last year for 100%. Next year, it drops to 80%, but you should still be looking at that cost segregation.
Toby: Yeah. Bonus depreciation, it’s the last year for 100%. Cost seg, you could do any year. A cost seg is just saying, hey, my driveway is a 15-year property, so I’m running it up over 15 instead of 39-year. If this is a hotel, if this is a short-term rental, it’s a 39-year property. Instead of 39 years, I’m writing it up over 15. If I have a fence, it’s 15-year property. If I have a cabinet, it’s seven. If I have carpeting, it’s five. You’re just writing it off over a shorter period of time, so it’s going to be great either way.
Jeff: Yeah. Even in the worst-case scenario, if bonus depreciation was gone completely, you could still accelerate your depreciation into the first 5–7 years, a lot of it.
Toby: Somebody’s asking a really good question here, by the way. They said, “My San Francisco condo is 50% assessed on land and 50% improvement. Are there other methods to increase rental property basis?” In your case, Leanna, I would be going with an appraiser in saying, I need you to break down what the land value is versus the improvement value.
Jeff: Yeah. What we’re finding especially in San Francisco is they’re buying crap properties for millions-plus, tearing them down because the land is worth so much more than the buildings are. I think I’d asked an appraiser to see if you could get a revaluation.
Toby: You could use any method that’s in your best interest, so you won’t be putting yourself in a worse position. Like, oh, I wish I hadn’t done that. The worst thing is you’re getting an appraisal and you’re paying for the appraisal. The best thing is they come through and give you a much better basis for the improvement. Right now, improvements are valued really high because everything’s really costly to get done.
Somebody asks, “Question on that. If you’re buying a crappy, old short-term rental, should you do the cost seg and wait to remodel it until next year?” You could do it in the first year you buy it. You don’t even have to make an election to do a cost seg. You just got to know what the values are.
Jeff: Yeah. If I have time to get the improvements and the renovation done in that first year, I’m going to do that if I can still accomplish my short-term rental. I’ll get it written out.
Toby: Yup. But if I choose just to do a cost seg and then I do an improvement, it’s really easy to see what’s the value of the 5-year, 7-year, and 15-year property because you have invoices. You don’t even really need to do a test at that point because you have it really good. It’s like, hey, we got this thing.
I’m doing a cost seg. I’m saying here’s what’s what. You’re going to have an engineering study when you do the cost seg even if it’s a crappy, old short-term rental. They come in and say, here’s all this, and then you add to it. It just means that that’s a 5-year, 7-year, and 15-year property.
If you’re somebody and your tax appetite is like this, I make okay money, I would love it if I got a $20,000 deduction, but I don’t need a $100,000 deduction in year one or whatever the number is, I could use pieces, you might be better off doing the cost seg in year one and not doing the remodel until year two knowing that when you do the remodel in year two, you could spread that out over time. But you do have to do your bonus election in year one under that circumstance, right?
Jeff: I think you can still do a bonus on those component parts in year two if they were added in year two.
Toby: But you’d still do it by the 5, 7, and 15.
Jeff: Yeah.
Toby: All right. It would be one of those things where you sit down and you’re actually like, hey, what do I expect to make this year? What do I expect to make next year? If you’ve been pretty consistent, then if I’m in the $150,000 range, I’m like, I want to shave that down a little bit, but I don’t want to go to zero. I might just be okay with, hey, I just do a regular, old cost seg. I do my improvements whenever. I don’t want a huge chunk of deduction, but instead of $8000 a year, I would love it if I had a $25,000 a year deduction, that type of thing.
In that circumstance, by the way, you’re really close on those numbers to not even have to worry about real estate professionals or anything like that. All right. We spent a little bit of time on that one, sir. For this one, you could just do a one-word answer.
“Can I offset stock capital gains with stock losses dollar for dollar?” Just answer that one.
Jeff: Yes.
Toby: “I have capital gains of $100,000…” I’m assuming stock losses, but you know what they say about assuming, right? “…and losses of $100,000. Can the losses cancel out the gains?”
Jeff: Correct. Yes.
Toby: They can? What if the losses—because it doesn’t say capital losses—are passive losses?
Jeff: Passive losses, I’m not sure. Let’s just say no.
Toby: You can’t. This is just Toby being annoying to Jeff. We’re assuming that those are stock losses.
Jeff: Let’s say it’s a 1244 loss of $100,000.
Toby: Then you could use it. What if it’s just an ordinary loss from a trader business?
Jeff: Yeah, certainly.
Toby: What if it’s me trying to take $100,000 losses because you suck at running a pizza shop and I want to offset mine?
Jeff: That’s going to be a passive loss to you.
Toby: And then you wouldn’t be able to use it. That’s called geeking out. The $100,000 of stock loss, you can use against any type of capital gains. What if I have short-term capital gains but I have long-term capital losses?
Jeff: They still offset. Whichever number is bigger is what gets carried over.
Toby: And we want that, by the way, guys. Your gains would have been max taxed at 20% and your short-term gains would be max taxed at 37%, so you want to use that long-term loss against your short-term gains. That’s the trick. Don’t use your short-term capital losses against long-term capital gains because you’re getting half the horsepower out of it.
Anyway, we’re just playing games with it at this point, but stock losses offset stock gains. If we really want to get technical, I would say those losses, just make sure none of them are wash sale rules. Make sure that they’re actual realized losses.
“Is there depreciation recapture on a business vehicle when it is sold or no longer used in business? If so, is there a strategy to reduce or eliminate the amount of recapture?”
Jeff: Depreciation recapture works differently for personal tangible property than it does for real estate.
Toby: Is a car tangible property?
Jeff: Yes. Anything that’s not real estate and is not intangible is tangible personal property. We talked about real estate and depreciation recapture a lot where it may have a higher tax rate. That’s not the case here. What happens is if I totally depreciate my vehicle, sell it, or even trade it in for $10,000, I have $10,000 (we’ll call it) depreciation recapture, but it’s a gain. That’s all it is.
Toby: The worst thing that could happen is you depreciate. Let’s say that you’re Mr. or Ms. real estate agent and you’re talking to your accountant who says, let’s buy the Range Rover at the end of the year. We get the new Defender or whatever, or better yet, let’s do a Tesla X.
We’re going to spend $130,000 and we’re going to take that as a write-off because it’s over £6000. We have it as a 179 deduction. You do it right at the end of the year, so you have 100% business usage because otherwise, if you used it, whatever percentage is the amount of deduction you could actually use. They think they’re really smart.
Then, the following year, you use it about a third of the time for business and two-thirds of the time personally. What happens to the $130,000 you wrote off in the first year?
Jeff: It has to be recaptured immediately
Toby: A hundred percent of it?
Jeff: Well, not 100%. It’s going to be the difference between straight-line depreciation and what you previously deducted.
Toby: I think the max is around $16,000–$18,000 in the first year if you do some bonus. You would end up recognizing about $112,000-ish of that as ordinary income. Don’t do that. Jeff and I tend to go do the reimbursement until you know I’m using that thing at 80%, 90% for business because at any point you fall out during those five years, you have recapture and it’s ordinary.
Jeff: Businesses’ strategies to avoid the tax on this could be as simple as if it’s a company truck or something that’s worn out, you trade it in. You better have a gain on it. You’re going to have depreciation recapture. But if you’re replacing that vehicle, it’s going to get the first-year depreciation, not bonus depreciation, so you can pretty much offset the gain with any depreciation you take on the new vehicle.
Toby: Somebody just wrote in, “Hey, I use my car solely for my business.” You’re okay. You’re the exception to the rule. What the IRS asks is do you have a personal vehicle? When I have a business vehicle, they say, is this used by somebody who’s a 5% or greater owner, and do you have a personal vehicle? If you say, yes, yes, you better not be saying 100% business use because they’re going to say, no, there’s no way that’s all you did. They’re going to want to investigate that.
Jeff: It’s when you go out and buy a Ferrari for your real estate business and you say it’s 100% use, sir.
Toby: Yeah. “Is there a strategy to reduce or eliminate recapture?”
Jeff: Not really. Like I said, you could replace it with a vehicle and use depreciation from the new vehicle, but there’s really not a whole lot else you could do.
Toby: Let’s say I buy the Tesla X, I write it off, I use it solely for business, I’m feeling really good, I want another one, I sell that one for $40,000, and I buy another one for $130,000. You’re going to recognize the $40,000 and you’re going to get a $130,000 deduction, so you’d have a net deduction of about $90,000.
Jeff: Yeah. Keep in mind that this depreciation recapture will never be more than your gain on the vehicle. If you take it to the junkyard to be scrapped and you get $250 for it, your recapture is going to be $250.
Toby: Perfect. Don’t you love these? This one, I don’t know if I love. I didn’t put opening question on that. Maybe I shouldn’t have. Maybe I’m smart not to do that this time.
“I want to set up a Wyoming LLC to be a trustee of a land trust.” They’re doing that so that your name’s not on the trust and your name is out of the public record. “The LLC will have two members. How does that impact annual tax filings since it is not a single-member LLC? The purchase in the land trust will be cash and there are no income or losses for the LLC. It will simply act as a trustee.” Jeff?
Jeff: I had difficulties with this one because I have not seen an LLC used as a trustee.
Toby: We do hundreds of them.
Jeff: Really? I’ve seen them used as a beneficiary.
Toby: We’ve used them as the trustee because technically, there’s a violation there of the trust agreement, but who’s going to complain? It’s the beneficiary’s right to complain. Hey, I need an individual as a trustee.
You use them because we can use a Wyoming LLC and your name’s not on it. If you want your name at your house, you don’t want your name in a public record. Let’s say that you’re an actor, an artist, a doctor, a politician, or a judge on the Supreme Court and you don’t want anybody to know where you live, this is a way that you could own real estate without anybody knowing it’s you.
Jeff: We have this LLC. Let’s say it’s not between spouses. It’s not in a community property state.
Toby: You just hit an issue, you’ll explain that one.
Jeff: If the LLC is owned by spouses in a community property state, it is considered a single-member LLC.
Toby: You got it. It can be ignored, so it’s called disregarded for tax purposes. You don’t have to file a tax return for it.
Jeff: Here’s my question for you though. If this LLC is not transacting businesses and it’s only serving as trustee…
Toby: Why would you have two members? That’s exactly the issue. Why do you have two people on this? It’s not doing anything. The only reason you would do it is maybe you don’t trust your spouse and you think that they’ll convey the property someplace. But if you’re in a community property state, it doesn’t matter.
Even if you’re in a separate property state, you may want to consider doing something through your living trust or something like that, but realistically, if it’s just sitting there as a trustee, there’s really no reason to have two people.
Jeff: You’ve effectively formed a partnership by doing that, but I don’t think they’d have any filing requirements because they’re not transacting any business. They’re just sitting there.
Toby: Yes. The problem that you have is the 1065 if the IRS takes the position that you owed it. It’s the penalties on a monthly basis that get ridiculous. It’s $195 a month or something.
Jeff: Last I saw, it was up to $205 a month per partner.
Toby: So $400. It could cost you about $5000 a year to not file that if they decide you’re doing business. The IRS would just say, you’re a trustee of a land trust. We think you’re doing business.
Jeff: Real quickly on that, a partnership return is required if you have any items of income or expenses that can be deducted.
Toby: And you can deduct it because you’d have the fees for the LLC. It’s $100, $50, or whatever it is a year. It’s cheap, but it’s not free. I would say don’t have two people. How about that?
“Inherited IRAs—are distributions taxed no matter what or can you shelter them with cost seg and short-term rentals? Can you shelter with long-term rentals?”
Jeff: The inherited IRA, it doesn’t matter, it’s inherited. The distributions are taxable. I’m not going to say they’re taxed. They’re taxable because you could have cost segs or short-term rentals from somewhere else that are offsetting that income. But yes, IRAs, unless it’s a Roth IRA, are always going to generate taxable income.
Toby: When you have an inherited IRA, there are two types. If it’s a spouse, they could stretch it out over their life expectancy.
Jeff: Those rules are really funny too because one of the options for a spouse to do is to basically treat it as their own IRA. It gets really far more complicated than it ever should have been.
Toby: Yeah, absolutely. They keep messing with it. The SECURE Act messed with it some more. Whenever you have income, the punchline is there are a couple of different ways to offset the income. Number one is with the losses from your other activities. Number two is, I believe you could just make up to $100,000 a year straight into a charity and not have to recognize the income. You probably mentioned that. I’m reading questions here.
Jeff: That was a good idea. I just thought something else about this. I don’t think he’s talking about having short-term rentals in the IRA, but we would never want to have short-term rentals in the IRA, correct? Because that would be considered a trader business.
Toby: What kind of rental, short-term?
Jeff: If we had short-term rentals.
Toby: It hasn’t been decided whether you have UBIT, but you’d have a trader business, so you could have a problem. What you would do is you would never have the IRA involved in operating it, so that would be passive in its worst case.
Jeff: Have it rent long if they have properties.
Toby: Yeah. You just have to make sure that you have a property manager if you’re doing the short-term. You wouldn’t be able to use the good old-fashioned strategy of renting to your corporation to make it rental either because it would give you something.
All right, hold on for a second because there was a question about the vehicles. They were talking about making a vehicle available for executive compensation. You can make a car available to executives as part of their compensation, but you just said the magic word, available as part of a compensation package. It’s taxable personal use of a company vehicle.
Let’s say I have a Bentley. Bentleys are valuable nowadays. Let’s say it’s $300,000. The company buys it and says, Jeff, you get to drive that home every day. Jeff, you’re now required to track your miles. They would look at it and say, wow, what’s the lease value of that vehicle to Jeff?
If he used it for business, they would say, all right, you don’t have to pay tax on that. If he used it for personal, they would say, whatever proportion, you’re going to have to pay the lease value.
They actually put out the numbers every year. It’s a big old chart that says, here’s how much you have to add into. Jeff would have a big tax hit, and the business would have to withhold. It’s still taxable.
Jeff: The bad part of it is the business doesn’t have to withhold. They just add the income to your federal income, but you still owe tax on that amount.
Toby: They wouldn’t have a withholding requirement?
Jeff: No, because it’s usually done at year-end.
Toby: I stand corrected. You don’t have to do withholding, but that makes it worse because you’re going to owe the tax on it 100% and your business isn’t messing with it. Is it subject to self-employment tax or to old-age, disability, survivors, and Medicare?
Jeff: No. We had a doctor-client who bought company cars for all of his employees and we had to do the calculation every year on how much that adds to their W-2s.
Toby: They probably really loved that. What did I get you for Christmas this year? You owe $5000.
Jeff: They love the company cars, but still, they have to pay the taxes on them.
Toby: “I am a physician and a single-specialty private practice under an LLP. I have my personal PLLC in whatever state it is. Do I need to set up payroll and get myself a W-2?”
Jeff: Go ahead and say it.
Toby: It depends. Is that what you want me to say? It’s what we went to school for. We charge $100 an hour to say it depends all day long.
I’m a physician in a single-specialty practice—that’s telling me that you’re probably in the East Coast, probably New York, something around there—under an LLP which is a limited liability partnership where you’re setting that up so that there’s no individual that’s personally responsible for the activities of the partnership. There’s a practice group, more than likely. There’s a PLLC, which is a Professional Limited Liability Company for that individual’s medical license.
The question is, is that PLLC set up as a disregarded entity or as some sort of corporation? Most states are going to be requiring that you’re an S-corp. New York is kind of a funky state where they don’t even have S-corps unless you ask.
Jeff: Correct. New Jersey’s the same way.
Toby: I think you’re going to be an S-corp no matter what. Let’s just say you’re taking money out of it, then the answer is if I am taxed as an S-corp, I am going to have to take a reasonable salary, which rule of thumb is about a third of all the net profit. If I do not take money out of it and I just leave the money in there, technically, I don’t have to take a salary which is bizarre.
If that PLLC is disregarded just straight to me, I cannot take a salary. It’s all treated as an active ordinary income to me. You said personal PLLC, so I’m going to assume there are no other partners in it. If it was an LLC and your PLLC was a partnership, in that situation, you could not take a salary because partners in a partnership are not employees.
Do I need to set up payroll and give myself a W-2? The answer is yes if that PLLC is an S-corp. The limited liability partnership, because it’s a partnership, the answer would always be no. You can’t be an employee of it. It all comes down to that PLLC and how it’s taxed. Did I say that right?
Jeff: Yeah. The only thing I was wondering about is since this is a medical profession that is passing income from the medical profession to the PLLC, if it’s an S-corporation, do we need to look at possibly higher salaries than a third because of the source of income? We usually say, what’s generating the income?
Toby: Honestly, I’ve never seen a case. The one case that would be on point was the CPA that took all the distributions and didn’t pay any salary and they assessed him a third.
Jeff: I’ve been doing this for 30 years and I’ve never seen an audit on the salaries of S-corporations.
Toby: Yeah. As long as there is a salary. What you see is if there are distributions so nobody takes it out.
Jeff: If you’re doing a distribution of $1 million a year—
Toby: You’re going to take a salary of at least $333,000. You don’t dink around on that stuff, unless you have a written opinion from somebody. But again, your chances of getting scrutinized is about once every 500 years under the current threshold because it was 0.20 last year. About 0.10 is where it’s currently sitting for the last tax year.
My guess is that S-corps are going to continue to be a thing of the past. There’s just no money in it for anybody. As long as you’re paying yourself something, chances are you’re never going to get scrutinized. You can be a little aggressive on that one.
Jeff: But the IRS commissioner said they’re going to be all caught up and things will straighten out by the end of the year, which gave the Senate hearing a good laugh.
Toby: The IRS is so smooshed right now. They’re about a year behind on their paper returns. We can’t get through to them. If your individuals are dealing with these letters that come out of these guys even after you pay things, they’re a dumpster fire. Whenever you have a dumpster fire, get some marshmallows and some sticks and make some s’mores.
Jeff: I thought weenies.
Toby: You can make some weenies. I’m going to make s’more. But there’s an IRS fire. I can’t blame them. It’s tough. It used to be like, hey, all the numerical people were engineers and accountants. Then computer science came along and they said, hey, we’re going to pay this profession over here some ridiculous amount. A lot of the brain drain is going on over there in the computer sciences. The IRS can’t get people and they can’t get really good people.
Jeff: IRS is making every CPAs life in America difficult, but we really don’t blame the agents.
Toby: They’re doing the best they can. If you look at the audit rates—I do this every Tax & Asset Protection. By the way, I have it up on the screen. You could sign up and it’s free, the Tax & Asset Protection Workshop. The next one’s coming up on May 21st. We have another one after that on June 4th. Spend the day with us. We do not record and send that out. We record them and keep them internally, but we do not send those out. We want you there.
“Audit rates, right into the toilet, for everybody other than the poor.” For the poor, it’s kind of going like this because they are the low-lying fruit, they tend not to respond, and they tend to just pay it. This is cool. There are some neat comments there below. I didn’t even look at those.
“Amazing event. It was packed with so much knowledge and information. Just when you think you thought of every aspect of protection for your personal portfolio, you learn something new. I would highly recommend anyone the Anderson Advisors. The entire team was very kind, caring, and attentive.” Yes, it’s fun. I like that. Then it says, “2020 and beyond.”
Somebody says, “I heard today the IRS destroyed millions of paper-filed informational returns.” Did you hear anything about that? We’re going to have to look at that. It wouldn’t surprise me, but there were reports. There are little LISTSERVs of accountants. In their Fresno office, they had a whole bunch of semi-truck containers full of paper returns literally just sitting out there last year. More would just pull up and they’re not doing anything with them. They’re not opening them. Maybe they take the checks out, but that’s about it.
Somebody says, “IRS had sent three extensions to my rebuttal of their audit.” Long, dragged-out saga. It’s tough.
“Report: IRS destroyed 30 million paper tax documents.” I got to read that, oh my God.
Jeff: It could be that they’ve been scanned into the system and then destroyed.
Toby: This is good. “An audit by the Treasury Inspector General for Tax Administration has found that the Internal Revenue Service made an intentional decision to destroy an estimated 30 million paper-filed informational return documents in March of 2021.” Hopefully, they actually inputted that information first and then destroyed it. Maybe it’s somewhere on a computer.
Jeff: We got more questions?
Toby: Yes, you’re not over. It’s only 3:45 PM. You’re lagging, Jeff.
Jeff: I know.
Toby: “I’m just starting out in real estate investing and I’m looking to start with short-term rentals. One property will be a joint venture and 2–3 will be individually owned by me. Will there be a difference in the way the taxes are paid on both?”
Jeff: Yes and no. The joint venture is going to be a partnership return. The other short-term rentals will just be reported on your 1040. However, in that partnership return, you’re going to get a K-1 from that and that will also get reported on your 1040. It’s not the partnership that will pay the tax. It’s just the partnership reporting the income on your behalf.
Toby: They’re making fun of you because you said yes and no. They said, “Just be straight, Jeff. Just say it depends.”
“I’m starting out in real estate.” That’s great. “I’m looking to start short-term rentals.” We already discussed this. That might be rental, that might be trader business, and one property will be a joint venture. Forget that it’s a property and think of it like it’s a business. Jeff and I are opening up a pizza shop. The most important thing about a joint venture is to establish clearly who’s in charge. Do not joint venture with a contractor who says, I’ll do all the work, you put in the money.
We do these quite often or we have in the past. We’ll set up an LLC. You will be the manager. You will have the right to everything until that property is done. Once they do what they promised to do, then they get to be on equal footing. Otherwise, it’s all you. You’re the cash. Otherwise, expect it to disappear.
Jeff: One of the things I wanted to bring up that we talked about earlier is there are seven tests for material participation. If you’re joint venturing with somebody, it makes it very difficult for both of you to be materially participating. Basically, for both of you to materially participate, you have to each meet the 500-hour test.
Toby: Which is tough. You’re going to have to be really involved. By the way, 2–3 will be individually owned by you, and then you have the short-term rental. Again, if you’re managing everything, something good about this is that you might qualify as a real estate professional. What Jeff is pointing out is that it’s very unlikely that both of you guys could be material participants on the same property.
Jeff: One of you definitely could, but two of you, very doubtful.
Toby: “I just made $200,000 on our first flip.” Look at the camera and just give them a snarl. On your first flip? It took me a while before I figured out how to make money on a flip. I’m not a big fan. I like to buy and hold. We made some good money back in the day, but I wish I had every one of those properties back.
Jeff: And in 2022 when prices were already sky-high.
Toby: Oh, you do that here. It’s crazy, 20% growth. That’s in Summerlin? You’re talking about 50% growth year over year. Everything’s up like crazy.
They just made $200,000 on their first flip. “We closed in April of 2022.” First off, congratulations. “Would you happen to know how much we should put aside for taxes and state taxes?”
It’s ordinary income, right? If you did a flip, it’s trader business, so it’s no different than a pizza shop again. You’re not an investor. We don’t get other deductions other than the basis gets reduced out of the amount that you sold.
I assume you said you made $200,000 and that you have $200,000 of profit. It depends on the vehicle that it’s in. If you’re in an S-corp, there might be some things you can do, reimbursements, perhaps you have your kids working on, or you find some other people to shelter.
You could put a defined benefit plan in place if you’re a high-income person or a 401(k) for whoever worked on it. You could put up to $30,000 or $29,500 this year if you’re under 50. If you’re 50-year-old and above, you’d be higher. You get an extra $6500, plus you could do 25% of whatever it pays you.
There are some things you could do if you were set up as a business before you made the $200,000. If you just made the $200,000 and that’s it, what are their choices, Jeff?
Jeff: At this point, you don’t have a whole lot of choices.
Toby: You have until the end of the year to burn it up. Buy a big piece of equipment. What if they’re going to keep doing flips? Then maybe we put it into a business, make it (more likely) an S-corp or an LLC taxed as an S-corp. Couldn’t they maybe buy some equipment like the big Kubota or something?
Jeff: They can buy some equipment. Buying property is not going to do it for them.
Toby: You need expenses. You could do a SEP IRA because it’s going to be considered active income if you materially participated on the flip. I don’t see how you couldn’t in this situation, but let’s just assume they did it in their individual name.
Jeff: If you did it in your individual name, depending on your other income, the tax you might need to set aside could be quite high.
Toby: But we’re going to try to get it down. You have until the end of the year to try to whittle that down some ways, but otherwise, you’re adding it into your highest bracket, so it could be as high as 37% plus whatever your state is. It can be as high as 13% which means about half of it.
But let’s be real. Look at your situation. If you don’t have a ton of income or you’re used to making $100,000–$150,000 and you’re married, then you’re going to be in the 32% range on the top. Most of it is going to be at 24%, 12%, and 10%. You’re probably going to be around 15%. Maybe put aside 20%.
Jeff: At least, because you may be subject to self-employment taxes, too.
Toby: Yeah. When you flip and you materially participated. Again, it’s hard not to participate when you’re doing a flip in your name.
Jeff: One thing I probably wouldn’t be doing if this happened to me is I’d be opening up that SEP and putting in $50,000 into that SEP.
Toby: Here’s the deal though. Even though we made the money in April this year, you don’t actually have to fund the SEP until you file your tax return next year, or if this is an S-corp, until it files its tax return in 2023. You have a long time.
What do you put aside? If this was the first year and they didn’t anticipate this. Chances are they won’t have a penalty. You’re not going to have an obligation to do quarterly use yet. At least you’re not getting penalized. You could actually start putting aside money.
Actually, I’ll just make this simple. Talk to your accountant because he should be able to do a projection so that we’re not guessing. We’ll make it easy. Otherwise, we’ll go through 20 scenarios.
“I am a co-owner of a C-corp. The C-corp owns real estate…” Let’s just stop and have a moment. “…which is the C-corp’s primary place of business since 2003.” They grouped them but instead of having them separate, they decided to put them in the same business. “We would like to get the real estate out of the C-corp and into an LLC. Is this feasible? What steps need to be taken to minimize tax consequences?” Jeff, what are the tax consequences?
Jeff: My suggestion is you sleep in the bed you made because the tax consequences are you have to recognize the gain on the fair market value of the property in order to get it out of the corporation. You could always put an LLC inside the corporation, but to pull it out could have very large tax consequences.
Toby: All right. This is for David. Three issues here. Are we liquidating that C-corp? If we’re liquidating it and your portion of the real estate is not greater than your basis in the C-corp, then technically, we could get out of this without getting smooshed, but that’s not going to happen.
More than likely, what we’re going to have to do is perhaps we convert it to an S-corp, but then you have built-in gain. What the IRS does is that they tax you at 21%, keep the asset as though it’s held in the C-corp, and then if it pays out to you, then you’d have a dividend, so you’re going to get hit with about 36% tax if it’s a sizable amount.
Another option, which you may or may not like, is to buy it from the C-corp at its fair market value, get an appraisal, set up an LLC, have the LLC buy it as an installment sale over a period of years, acquire that property over time, and let the C-corp recognize that income over a longer period window. Is that right?
Jeff: Yup.
Toby: Can you think of anything else?
Jeff: Not really because with it having been in for so long, that’s a lot of depreciation and a lot of appreciation combined. We’ve had them where they put real estate into the corp and we’ve been able to pull them back through shareholder loans to offset what was going on, but I don’t see that happening here.
I really don’t like converting it to an S-corporation because we’re really not accomplishing anything. We’re not separating the real estate from the business.
Toby: Yeah. I know why most people do this. There’s a rule that says if I have real estate and I’m leasing it to my own business, I can group those two activities as a single economic enterprise. So if I’m making money in my business, but I’m losing money on the real estate because of depreciation, I can use that depreciation against my business income without even qualifying as a real estate professional. That’s why they did it.
Now, they’re going crap, which I get. Realistically, you may want to just continue down this path. Eventually, you’re going to sell the C-corp maybe. If you sell the C-corp, don’t take the property out of it. Just sell the C-corp and let somebody else deal with it.
Jeff: If we put an LLC inside the C-corp and shove the real estate down into the LLC, can we get any liability protection that way?
Toby: Yes. We’d get liability protection inside the property. Let’s say the property burns down and causes fatalities. They would be stuck in the LLC no matter what. At least we keep it out of business.
If the business, however, gets into financial peril, that LLC is an asset that’s available to the creditor of the business. Chances are we would isolate an LLC inside the C-corp unless there’s a good reason for just crunching the numbers. In which case, you may want to sell it to an outside LLC. Or if you have sufficient basis like you’ve dumped a bunch of money into the C-corp over the years—you and your other owners since you said co-owner—and you have enough basis, it’s just the gain on the property that you got to worry about. It might be that you look in saying, hey, let’s transfer it out to the shareholders. If you have enough basis, it may not be taxable.
You got to look at those things, but there are really three things. I wouldn’t switch to an S-corp. That’d be the one I would roll off the table right away unless there’s a real, compelling reason. I’d be looking at should I distribute it or should I buy it? If your company is going to wind up anytime soon, you might want to just wait there and do it at that point. If you’re going to keep the business going, you might want to do the sale.
Jeff: I agree with that.
Toby: All right. “There are conflicting opinions about this question. What say you? I set up a series LLC taxed as a court with 84 cells Master Filing (which is Master Series Filing), Master Operating Agreement, Master EIN with 84 individual filings and 84 agreements. Do I need 84 individual EINs, or can I roll them up under a master EIN?”
Jeff: I’m going to take the easy parts first. That is if any of the cells are doing anything that is not disregarded up to the master, they’re going to need their own EIN. Say you make this cell corporation, this one a partnership, those are going to need their own EIN. From what I’ve seen, it really depends on what state you’re in because different states recognize the entities and the cells in different ways whether they’re separate entities or not.
Toby: If it needs the bank, if it’s taxed with different ownership taxed differently, if it has payroll, and any of those things, it needs the EIN.
Jeff: We’ve seen issues with people having a cell, they go to the bank to try to get a loan or something, and they’re like, where’s your EIN? This isn’t matching up with the EIN.
Toby: A series is a fancy way of saying we have a master LLC. Then, it has these little series that are all treated as separate LLCs. They can have separate owners. Again, he or she is mentioning that they have operating agreements.
The only reason you’d have separate operating agreements is if you’re trying to isolate them. If you’re trying to isolate them, get the EIN. It’s silly not to do that. Even if they’re just disregarded, I’d have an EIN on it, but ignore it and tax it to the parent or ignore it and tax it to me. Whatever the case, I still have an EIN.
Jeff: It doesn’t hurt you to have the EIN.
Toby: A lawyer would poke at it if you didn’t. You may as well get the EIN. You went through all the trouble to set this thing up. You have 84 cells that sound like substantial assets. This could be a taxi company. This could be something that holds a bunch of real estate. It could be something that owns valuable assets, maybe a bunch of equipment, whatever.
If you went through that much trouble, don’t skip the last part just because. You just don’t want to give them an argument where they can poke a hole at you. I don’t think it’d be dispositive, meaning that it would just tank you, but I think it’d be an argument. Depending on whatever else they could find, it could be proved to be that proverbial straw that breaks the camel’s back. We don’t want to see somebody fall into that.
This is the last one, I think. “I am a real estate investor and have a full-time W-2 job. I’m in the market for a new SUV. Historically, I have just deducted the appropriate mileage for real estate projects. I was wondering, if I got a vehicle and rented it out a time or two during the month with Turo, would that affect my situation?”
Jeff: Let me start off by saying personally, I dislike mixed-use assets.
Toby: We just talked about this earlier. If you fall below 50% and your business has the car or vehicle, you have a taxable event back to you.
Jeff: Let’s say you’re getting a new SUV that you’re using for both business and for Turo, you could do that. Absolutely. I would continue due to the mileage reimbursement on the business side.
The Turo, you’re going to have to track mileage, particular expenses, and so forth. Depreciation is going to be almost nothing on this because the percentage is going to be so low if you’re using it a couple of times a month.
Toby: It depends. If you’re a real estate investor and you drive every day for your job, you’re not really an investor. You’re a developer, you’re in construction, or you’re something else.
Jeff: I’m just assuming that if they’re using Turo that they’re renting it out to other people.
Toby: They are. What it looks like is they have a full-time W-2 job. If they’re using the SUV to go back and forth home, those are personal use. But if you’re driving it just as much for investments, you just want to push it over the edge with the Turo, you’re going to have somebody put 200–300 miles on it every month with the Turo app, and you’re renting it out to somebody, that might be enough to keep you on the business side, but you still are only going to get a portion of the depreciation.
Jeff: I see what you’re going at.
Toby: Me personally, unless you’re going to make that a real business, I’m reimbursing myself the miles. Even if it’s Turo, I’m reimbursing myself the miles. Hey, you could use this. Just reimburse me whatever business miles you put on it.
Jeff: Absolutely. You could do that.
Toby: It’s easier. With Turo, just make sure you get the right type of insurance because a lot of insurance companies won’t cover you if you’re renting it. Otherwise, it’s so much cheaper to do it this way too. Instead of having the business, try to own where you’re doing commercial insurance. If it’s just one vehicle, it’s cheaper just to have your plain, old-fashion insurance, just reimburse yourself. It’s so much easier. And we don’t care about the vehicle value.
If you sell the vehicle, it doesn’t matter. You’re just getting $58.5 a mile this year. Use MileIQ. It’s a simple app that you could get on the App Store. If you have that, then you could just track whatever your business miles are, write yourself a check every quarter—whatever it is, every month, every quarter, or even once a year—and reimburse yourself for those miles. If you have 10,000 miles that you put on this thing, that’s not a small check. That’s $5850. That’s money you don’t have to report as tax or anything. You get to just keep that money.
If you like this sort of stuff and you haven’t had enough, we record these, put them on our YouTube channel, and we have a podcast channel where you could go look at all the different podcasts.
Clint’s been very active. If you like podcasts, he does a great job. I turn all the Tax Tuesdays with me and Jeff into our podcasts too, so you can go back and listen to those. There’s my channel again. Look, I’m actually wearing a suit. No, I’m not. That’s just a sports coat. I wasn’t even wearing pants in that video.
You can go onto YouTube and subscribe. We love it when you subscribe because it’s fun. It’s one of those things where if you get over 100,000, you’d be feeling special. If you subscribe, then whenever a new video comes out, you’re notified. That’s it. It doesn’t hit you and email you all the time. It just says, hey, we just put one out.
I think today is about audits. If you like learning about audits, go to the YouTube channel, subscribe, and watch the audit. If you want to learn how to keep your assets invisible, go to the YouTube channel, subscribe, and click on the Make Your Assets Invisible right there. If you want to learn the difference between a will and a living trust, the same thing. All sorts of great videos are up. Nonprofits—if you want to learn about 501(c)(3)s, there are tons of videos on there.
Not just mine, but Clint has a wonderful YouTube channel as well. Together, we’ve been doing this for more than 20-something years. Clint does a great job. He spends his time more on Asset Protection. I spend my time more on the tax, but together, we get a pretty comprehensive look.
Here’s a bunch of the videos you could see. What are some good ones out there? I do some of the passive investing stuff because I’m pretty adamant about that. There’s Avoid IRS Audits. We did the analysis between sole proprietors and S-corps, so if you have anybody who’s a sole proprietor, you can make fun of them by siting all the facts of how […] they are.
You could talk about combating inflation. You could say why is housing inventory so low? There’s a ton of fun stuff out there. There’s even asset protection for physicians, so if you’re a doctor and you’re annoyed at the idea of getting sued, we’ll show you some simple ways to minimize that heartburn.
We had a lot of fun today. Anything you want to add? I’ve been a Chatty Cathy.
Jeff: I know for all the chatting you did on that first question, we actually did pretty good for the time.
Toby: It’s 4:06 PM. We used to do this for 1 1/2 hours or 2 hours every time. We got razzed for it because we’d go about 20 questions.
If you have a tax question, taxtuesday@andersonadvisors.com. No cost, we’ll respond to you. Do not worry, we know how hard it is. It’s really tough. To see an accountant right now, good luck getting into an accountant. It’s brutal out there for those folks. Feel bad that they’re having to deal with the IRS. We don’t want to blame the IRS for everything. It’s not just them. Those poor agents are just getting smoked.
Here’s an easy way to get some answers. If you are an accountant, quit emailing us 10 of your questions for your clients. There are a few of you. We know who you are. We’re like, oh my God. We actually like going back and forth. We love all the tax professionals out there. We know how hard it is. It’s hard to find good folks to bounce things off with.
Come on back in two weeks, and we’ll do another Tax Tuesday. Hopefully, you have a lot of prosperity and you have a good time in the next two weeks. Don’t watch the news. It seems to be ugly. I actually watch the news, but put on your critical thinking glasses or earmuffs for some of it. Hopefully, we see you back here in two weeks and we’re through all this nastiness in the stock market.
Jeff: Don’t look at your 401(k) right now.
Toby: Here’s the lifehack for investing. This works great, by the way. Put all your stuff on auto-buy. Just continue to reinvest. Buy your favorite companies—about 10 of them—put them in a nice stock portfolio, have that account automatically funded, lose your password for about 20 years, and try not to worry about it. At the end of the 20 years, you’re going to have a big chunk of money sitting there waiting for you without all the heartburn. I’m just teasing on that, but I’m not really.
All right, guys, we will see you back here in two weeks. Thanks for joining us. Thanks, Jeff, for hanging out with this another one.
Jeff: Thank you.
