Tax season is in full swing, and in this Tax Tuesday episode, Anderson Advisors attorneys Amanda Wynalda, Esq., and Eliot Thomas, Esq., tackle numerous listener tax questions with practical advice. They discuss the Section 121 exclusion for primary residences, explaining how married couples filing separately can each qualify for the $250,000 capital gains exclusion. They outline strategies for converting personal residences to rental properties using S-corporations and installment sales to maximize tax benefits. Amanda and Eliot clarify 401(k) withdrawal rules, explaining when penalties apply and options like the Rule of 55 and hardship withdrawals. You’ll hear recommendations on optimal entity structures for real estate syndications, explanations of the short-term rental “loophole” for active income classification, and when to use trading partnerships versus simple LLCs for investment accounts. The episode concludes with a breakdown of key Tax Cuts and Jobs Act provisions set to expire in 2025, including individual tax brackets, standard deduction changes, child tax credits, and bonus depreciation, highlighting potential impacts for taxpayers.
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Highlights/Topics:
- “I understand that you can sell your primary residence and receive an exclusion from capital gains taxes on the first $250,000 if you’re single and $500,000 if you’re married filing jointly. However, I can’t find any rules regarding if you’re married filing separately. Could you please confirm if married filing separate also qualifies for the exclusion? Also, could you talk about how making improvements adds to the basis?” – Yes, both spouses filing separately can each get the $250,000 exclusion. Only one spouse needs to be on the title, but both must use it as a primary residence for 2 of the last 5 years. Improvements (new floors, additions, HVAC systems) add to your basis, which reduces taxable gain when you sell.
- “Can I use both cost segregation and bonus depreciation from an S-corp you sell your personal residence to for the Section 121 exemption? Also, what is the accounting treatment if you sold your personal residence to an S-corp using an installment sale?” – Yes to cost seg, no to bonus depreciation (not allowed for related-party transactions). For accounting, record the property as an asset on the S-corp with a liability for the note owed to you personally. You’ll recognize all gain in year of sale (which is actually beneficial to utilize the Section 121 exclusion), and interest payments will be recorded as interest income.
- “Do I have to officially quit my job and be retired to take disbursements from my 401k? At what age can I take disbursements from my 401k? Are there any negative tax implications from taking early disbursements?” – You don’t need to quit your job to take distributions if you’re 59½ or older, though your specific plan may have different rules. Early withdrawals before 59½ incur a 10% penalty plus ordinary income tax, unless you qualify for exceptions like the Rule of 55 (if you leave your job at 55+) or hardship withdrawals for specific situations.
- “What is the best entity for tax purposes to invest in real estate syndications?” – A Wyoming LLC (disregarded) or partnership is typically best. This gives liability protection while letting income/losses flow directly to your personal return (important for using passive losses). Avoid S-Corps (reasonable wage requirements) and C-Corps (trap gains/losses on corporate return).
- “Regarding bonus depreciation and the short-term rental loophole, are either the 500 hours or 100 hours and, more than anyone else, material participation tests prorated for the year? For example, if a property is purchased and put into service in November, those hours would be difficult to achieve.” – No, these hours are not prorated. You must meet the full hour requirements between purchase and December 31st. Consider using the “substantially all participation” test if you personally perform nearly all work needed, even if under 100 hours.
- “If I purchased an investment apartment and repaired windows, floors and incurred other miscellaneous expenses to make it ready for renters, can I write the expense off on my Schedule E? I didn’t receive any income for that apartment as of yet.” – You can only deduct expenses after the property is “placed in service” (available for rent). If not in service yet, these costs must be added to the property’s basis and depreciated. The $2,500 de minimis rule lets you expense (not capitalize) individual purchases under $2,500, but only after the property is in service.
- “I’m starting to do wholesale investments. I’m still a W-2 employee, yet I will resign soon. Is it recommended that I start my LLC now, and why?” – Yes, start your LLC now for liability protection when entering contracts. Begin with a disregarded LLC in the state where you’re wholesaling. Once established and generating consistent income, consider making an S-Corporation election to save on self-employment taxes.
- “I have a trading account, but I do not actively trade in it. Should I set up a trading partnership for it?” – If you’re not actively trading, a simple Wyoming LLC for asset protection is sufficient. For active traders with significant expenses, consider the limited partnership structure with a C-Corporation general partner to shift some income and deduct expenses that aren’t allowed on personal returns.
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Full Episode Transcript:
Amanda: Welcome into Tax Tuesday, everyone. It is April 8th, 2025. The year’s going crazy. My name’s Amanda Wynalda.
Eliot: Eliot Thomas.
Amanda: Which you already know because you could hear him if he wasn’t on mute. All right, we’ve got everyone coming in and we’ve got Maui, Tijuana. Nice. Huntington Beach, California. Detroit, Michigan. Texas. Sometimes we get someone from overseas. We get a lot of questions from overseas on YouTube. So today we have a ton of tax professionals. Why don’t you tell them who’s joining us?
Eliot: We got Patty running the show. We got Arash, Dutch, Jared, Jeffrey, Jennifer, Marie, Rachel, Ross, Tanya, and Troy.
Amanda: Troy’s going to be answering your questions on YouTube live in the chat there. That’s pretty much where the wild ones are. Those of you who join us through Zoom, not quite as wild.
Eliot: Definitely.
Amanda: But moving forward, we’ve got some preset questions, so we’ll be going over those Q&A style. If you have questions about what we’re talking about or if they’re completely unrelated, go ahead and put that into the Q&A. The Q&A that’s going to allow our team in the back to provide you with an answer. That’s going to be marked private so that nobody knows what you’ve asked or any of your details.
If you’re having any issues with sound or things like that, such as when I was on mute earlier, that’s going to go into the chat. So just two different things there. If you’ve got a question you want featured on Tax Tuesday, just email [email protected]. And if you need a more detailed response, then you can become a Platinum or a tax client.
Anderson has this really great program called Platinum Membership. It is a for-a-monthly fee, way less than it would cost to hire a CPA or an attorney to be at your beck and call. You can submit questions to our team and they can give you much more detailed answers. But if you’d like to be featured here, that’s going to be [email protected].
This is supposed to be fun.
Eliot: It is. We have fun.
Amanda: Educational. We do have fun. Taxes can be fun, everyone. Who knew?
Eliot: It is possible.
Amanda: We’re going to go over just our questions and just read through them. Elliot, why don’t you take the first one?
Eliot: Sure. “I understand that you can sell all your primary residence and receive an exclusion from capital gains taxes on the first $250,000 if you’re single, and $500,000 if you’re married filing jointly. However, I can’t find any rules regarding if you’re married filing separately.
I file separately because I don’t want to add my husband’s income as my student loans are calculated based on my AGI.” Run into that quite a bit in tax prep, so you’re certainly not the only one who does that. “Well, could you please confirm if married filing separately also qualifies for the exclusion? Also, could you talk about how making improvements adds to the basis?”
Amanda: It’s actually very common to married filing separately, as we know because we both paid a lot of money to go to law school.
“Can I use both cost segregation and bonus depreciation from an S-Corp you sell your personal residence to for the Section 121 exemption? Also, what is the accounting treatment if you sold your personal residence to an S-Corp using an installment sale?” We got a lot to dig into there. If none of that sounds familiar to you, don’t worry. We will be explaining that strategy. Your turn.
Eliot: “Do I have to officially quit my job and be retired to take disbursements from my 401(k)? At what age can I take disbursements from my 401(k)? Are there any negative tax implications from taking early disbursements?”
Amanda: You got to do this. That’s in the question.
Eliot: Got to get the quotes in there.
Amanda: Some retirement plan question. “What is the best entity for tax purposes to invest in real estate syndications?” This question, we’re actually going to get into the legal side as well because we’re Anderson advisors. We do tax and legal. So we’re not just going to leave you hanging on one versus the other.
Eliot: The two walk together.
Amanda: They do.
Eliot: So we’ll do that.
Amanda: They hold hands.
Eliot: “Regarding bonus depreciation and a short-term rental loophole,” that’s STR for short, “are either the 500 hours or 100 hours and more than anyone else material participation tests prorated for the year? For example, if a property is purchased and put into service in November, are those hours difficult to achieve?” We’ll get into that more depth.
Amanda: They sure would be. I think that might be the point though, Elliot.
“If I purchased an investment apartment and repaired windows, floors, and incurred other miscellaneous expenses to make it ready for renters, can I write the expense off on my Schedule E? I didn’t receive any income for that apartment as of yet.” Some details in that question that are going to change the answer a little.
Eliot: “I’m starting to do wholesale investments.” Don’t know what that is; we’ll find out. “I’m still a W-2 employee, yet I will resign soon. Is it recommended that I start my LLC now and why?”
Amanda: Again, a tax and legal question.
“I have a trading account but I do not actively trade in it. Should I set up a trading partnership for it?”
Eliot: And then we’re going to review some of the expiring Tax Cuts and Jobs Act items for 2025. As you may know, that was put into place approximately September of 2017. Some of them are starting to come to an end. The whole thing comes to an end at the end of 2026, but we have quite a few that are going to expire at the end of 2025, so we’re just going to hit some of those.
Amanda: Yeah, we are. And then in a few months, we may be reversing what we say. Congress can always reinstate them, extend them. We’ve gotten so used to talking about the way things are.
Eliot: I think they’re a little busy right now, but…
Amanda: I think they have to keep us on our toes. It’s fine, though. That’s why we have jobs.
All right, this is our founding partner, Toby Mathis. He’s the reason you’re here. If you’re watching this on YouTube, then it’s going to be on his channel. Smash that subscribe button and like. You’ll get a notification whenever we go live for these Tax Tuesdays or when he uploads a new video.
Eliot: And he has over 1000 already.
Amanda: I know. A lot of great stuff. He’s got those cool YouTube awards. Are they cool? I think they’re cool. Putting a lot of information out there.
Eliot: Cool because he is our boss.
Amanda: Yeah. He literally pays us to say stuff like that.
All right. This guy is also our boss, Clint Coons, often known as the most handsome man in asset protection. We’re not laughing at that. It’s true, Ken. Stop. Also, a huge educator, really big in the space. If you follow him as well.
Clint and Toby were our founding partners and they have similar videos. But Clint tends to go more on the legal side, Toby more on the tax side. Watching both of them is really going to give you a lot of what you need.
This is our Tax & Asset Protection Workshop, or TAP as we call it. You can come to a full Saturday webinar that gives you all of the basics on tax asset protection. We usually have some pretty sweet deals on some services. Usually the lowest prices that you can get out there. Register, go to our website. You can register.
We also are doing a live event that’s going to be in Las Vegas, so if you want to have a deductible business expense for your next trip to Vegas, come and join us. That’s going to be at the end of June.
All right. “I understand that you can sell your primary residence and receive an exclusion from capital gains on the first $250,000 if you’re single, $500,000 if married filing jointly. However, I can’t find any rules regarding if you are married filing separately.”
This person filed separately because they don’t want to add their husband’s income to their student loans, which are based on AGI. “Can you please confirm if married filing separately also qualifies for the exclusion? Also, could you talk about how to make improvements on the basis?”
Let’s back up. For those people who have never heard of the Section 121 exclusion, why don’t you tell us what that is, Elliot?
Eliot: (Section) 121 is just that. It’s an exclusion from capital gains from the sale of your primary residence. Like anything in the code, it has some parameters, some guardrails.
Amanda: Requirements.
Eliot: Exactly. Typically, it’s $250,000 if you’re filing separately, but if you’re married filing jointly, you get $500,000. What we’re asking here is, well, I don’t do either. We both file separately, both spouses. Do we both get $250,000? Is really what’s going on, or would just one get $250,000? I think that’s the nature of the question here.
We do have an answer for that. Yes, we can do that. Both spouses can get that $250,000. But let’s go back to the actual requirements of 121 to begin with. Typically you have to own it and use it as your primary residence for two of the last five years. They don’t have to be consecutive years or anything like that, but it does have to be two of the last five years. Once we have that, if you sell it, then you’re entitled to the exclusion, if you have some gains.
Now, if you had capital gains over the amount, let’s say you’re married filing joint, it was $500,000, and the sale is $550,000 capital gains, you’d still pay capital gains on $50,000 in that instance.
However, here we are filing separately, and you pointed out something earlier. If we’re filing separately, just one spouse has to have, is it the ownership or is it the use?
Amanda: The ownership. You would think that each spouse, if you’re filing separately, separate tax returns, as long as each spouse qualifies on the two tests (the ownership and the use test), then they each get their $250,000.
They actually make it even easier for married couples filing separately, that only one spouse needs to own the property. So if you took title under only one spouse’s name for maybe lending purposes—maybe one person’s income was really good and another person’s credit was really poor, so they’re like, actually we don’t want you on the loan; that is very, very common—you’re still going to qualify each of you for that $250,000, even though only one spouse’s name is on title.
The same is true if you’re filing jointly. Only one spouse needs to be on title. But you both need to use the residence as your primary residence. We have clients where the husband lives in one state and the wife lives in another state. That’s the example I can think of, which obviously isn’t normal but you wouldn’t be able to qualify that way. You both have to use the property two of the last five years, unconsecutive.
Eliot: Correct. Yes, we can use it in order to take advantage of the exclusion. What about the improvements? If we’re making improvements, I guess we got to know what an improvement is?
Amanda: We do need to know what an improvement is. What is it?
Eliot: An improvement is just that, you improve the property. Now, it is very—
Amanda: Done. Next question.
Eliot: Right. I think you want to look at it as maybe a little bit more being put into it, like you put a new addition onto the house. Maybe you put a new flooring in or new cabinets or something like that. Now, in the US tax code there are definitions that vary and get in the gray areas, but it’s usually going to be something like that.
Let’s say you broke a window and you just replaced the window paint itself, probably not an improvement necessarily. Maybe that’s more of a repair. But these improvements, things like, again a new floor, new addition, new roof, things like that, that’s going to add up. We’re going to take that cost and add it onto your basis.
What’s your basis? It’s what you originally purchased it for, plus improvements. And that number, what we call the adjusted basis, is what you’re going to subtract from your sales price. That sales price minus adjusted basis gives us our gain, and that’s what we’re going to use this exclusion against.
Amanda: Do you want to give an example? You throw out the numbers, I’ll write them down.
Eliot: Let’s say that we bought for $200,000 and we made $50,000 improvements. We added some new flooring, some new cabinets, et cetera.
Amanda New HVAC. We just put in an alkaline reverse osmosis system, because my teenager’s like the water tastes bad.
Eliot: Go figure in Vegas. What?
Amanda: So that came from Lake Mead.
Eliot: All the atomic bombs we let off. All right, that gives us an adjusted basis of $250,000. And let’s say we sold for $800,000.
Amanda: Okay, that’s a good one.
Eliot: So right now, Amanda’s going to take the $250,000 away from the $800,000. That’s going to give us, how’s your math today?
Amanda: Tell me. I knew what it was.
Eliot: You sure about that?
Amanda: That’s your gain.
Eliot: So that’s our gain right now. If these taxpayers are married filing jointly, they’ve lived there, and used it two the last five years, then they would be able to subtract that $500,000, and we end up with just $50,000 of capital gains. We didn’t have to pay tax on $500,000.
So it’s a big benefit to have home ownership. It’s one that we try and really protect using that strategy a lot with our clients, depending on how we’re going to set up an entity maybe for a home or if they’re trying to do some funky stuff with a home, we want to make sure that we preserve that if at all possible because it is a great tax advantage.
Amanda: It’s funny because we work with a lot of real estate investors, and they’re trying to do the opposite with repairs versus improvements. They’re trying to classify everything into the repair category so they can deduct it against the rental income. But in this case, you’re going to want to try to classify as much as you can as an improvement. Maybe you break one window, maybe you just go ahead and put in…
Eliot: A whole new one.
Amanda: A whole new set. And there are a lot of tax credits and things out there for energy efficient–type stuff, so a great thing to look into as well.
All right. “Can I use both cost segregation and bonus depreciation from an S-Corp you sell to your personal residence for the Section 121 exemption? Also, what is the accounting treatment of that installment sale?”
We’ve just gone over Section 121, so I think we’re good on that. What is this whole situation with selling your personal residence to an S-Corp? Why would I do that?
Eliot: Just as you pointed out, some people have a lot of rental properties out there. A lot of our clients certainly do. Maybe they’ve been living in their primary residence and they’re not ready to sell it. They don’t really want to give it up. They want to use it as a rental.
Is there any way we can take advantage of that golden opportunity, the 121, and still keep it as a rental? Yes, there is. We can sell to an S-Corporation that we own. When we do that, we’re going to incur that same capital gains calculation that Amanda just went through on the previous question. We had, what was it, $800,000 minus $250,000?
Amanda: Did we do $850,000?
Eliot: Yeah.
Amanda: No, we don’t know. No, we don’t remember. It was five seconds ago, Elliot. It was 250.
Eliot: Two hundred fifty basis, yeah.
Amanda: We had $50,000 in capital gains. But when we sell it over to the S-Corp, what are we doing? We’re selling it for fair market value, so this $800,000 amount. When the property’s in the S-Corp, what’s the basis now?
Eliot: It’s going to be that new fair market value.
Amanda: That new fair market value, because it is going to be an actual sale, so you do need enough money in this S-Corp to put a 10% down, and then we’re going to do what’s called an installment sale, which for most investors you’ll recognize it really as seller financing. Then what’s the important piece to making sure it works out for you on the tax side? You need to recognize.
Eliot: Right. We can do an installment. However, because it’s to a related party, which our S-Corp is, we have to recognize all the gain in the year sale. But that works well into our plan because we were able to wipe out $500,000 of that gain using 121.
Therefore, this works really well. Just to step back, if we didn’t do this and you just turned it into a rental, didn’t sell it, didn’t put it into an S-Corp or anything like that, the basis you’d be taking your depreciation from is at $250,000. But by selling it to the S-Corp, Amanda was able to raise it all the way up to $800,000 for a new basis. your depreciation’s going to be a lot larger.
Amanda: So what’s depreciation? Depreciation on a single family rental means you take your basis, you back out the land because land doesn’t lose value, then you spread that out over 27½ years. It’s 39 years for commercial property. So if your basis is 250, let’s back out the land, just call it 200, you spread that over 27½ years. Do that math, Elliot.
Now with the cost segregation study, you have a specialized accounting firm come out. They can physically come out, you can do this over FaceTime or Zoom. They take a lot of info from the public record and they basically go, okay, you have an HVAC, you have windows, you have carpet, you have wood flooring. They separate it out into a report that separates out each individual thing—the plumbing, the fixtures—into 5, 7, 15, and 27½ year property.
Then you can take those on a shorter schedule. So if you paid $1000 for new flooring, you’re depreciating that $1000 only over five years instead of over the whole 27½. You’re getting a larger depreciation there. Now how does bonus depreciation work into that?
Eliot: Bonus depreciation is going to take whatever amount you have, anything under class under 20 years. That’s going to be the 15, the 7, and the 5 year property that Amanda was mentioning. Of that amount, you will have the current year annual depreciation—which is 5 years or 7 or 15—then you’ll be able to take an additional 40% here in 2025. It becomes a much larger deduction.
You already sped it up by taking the cost seg, so we’re doing it over 5 years instead of 27 like Amanda was talking about. But now we’re adding on something called bonus depreciation, which is going to take 40% of all those categories—the 5, 7, and 15—and we’re just adding on that extra expense. It becomes quite a large expense, and that can help us out a lot from our tax planning.
Amanda: It’s a deduction. It’s a paper deduction because it’s not money actually coming out of your pocket, but it’s reducing that taxable rental income that’s coming in 40%. It used to be better.
Eliot: Yes. It was 100%, and then slowly each year we’re losing 20% of that. We’re all waiting to see what the next tax bill will be. A lot of talk of it maybe being reinstalled. We don’t know yet.
Amanda: It has bipartisan support.
Eliot: Now an important aspect to this, though, because here we gave you all these definitions, gave you some calcs here, but we’re selling to a related party, the S-Corp that this individual owns. In that situation we can do the cost segregation, we can speed that up, but we cannot do the bonus. That’s a big—
Amanda: Yes to the cost seg. No. We just told them all of the benefits of bonus depreciation.
Eliot: Yes, we did.
Amanda: They were like, you can’t have it.
Eliot: They took it away.
Amanda: So you can do cost seg. You’re still accelerating the 5, 7, 15 year property, but you’re not going to take the bonus depreciation.
Eliot: Exactly.
Amanda: Now, what is the accounting treatment if you sold your personal residence to an S-Corp?
Eliot: Let’s call a friend.
Amanda: We’re not bookkeepers, so we’re going to phone our friend, Troy Butler. He’s on our YouTube channel answering questions for you all. But Troy was our head of bookkeeping for a very long time. He’s one of our tax supervisors, so he reviews a lot of returns. Troy, are you out there?
Troy: I’m here.
Amanda: Troy, can you walk us through the accounting treatment for this type of strategy?
Troy: Just so we’re clear, I was answering questions on YouTube so I wasn’t 100% paying attention, but the installment sale if you sold your house to your S-Corp essentially, right?
Amanda: Correct.
Eliot: Yes, sir.
Troy: Okay. What you would do is you would record on the S-Corp that is purchasing the home. You would record that as an asset. Then it would also have a liability, like a mortgage for the note that’s due to the original owner, you personally.
That’s going to be an asset, your building and your land. Then you’ll have a note for the installment sale, but you’re not going to defer the gains. You’re going to have to recognize the gains all at once, so we don’t have to worry about that, which makes it easy.
Then every month when you receive interest, that’s going to be interest income. Then you’re going to reduce the note by the principal payment that you receive each month. Each payment you’re going to have an interest portion, a principal portion, and then cash. Your debit would be cash, and then your credits would be interest, income, and interest expense.
Amanda: Perfect. Did you get that?
Eliot: I did.
Amanda: At least one of us did. Thank you, Troy, as always. Great. That’s how you do the accounting. You said you have to recognize the gain. You actually want to recognize the gain because that’s how you combine that 121 exclusion, so you’re getting that double benefit there. Don’t tell the IRS because they don’t really like double benefits, but we found a way in this situation,
All right. “Do I have to officially quit my job and be retired to take disbursements from my 401(k)? At what age can I take disbursements, and are there any negative tax implications from taking early disbursements?”
Let’s start with the second one. At what age can you take disbursements from your 401(k)?
Eliot: Under the rules it would be 59½ typically, is where you’re going to be able to take out without any penalty. The penalty would be 10% of the amount that we’re taking out. Like anything in the code, there are a lot of different exceptions, this and that and the other. But that’s what the code says.
Now often, we have within what the code says one can do, and then there’s what the plan itself says. So you always have to check your respective 401(k) plan to see what it allows and what it doesn’t. But the code will allow you to start taking that 59½ without incurring the penalties.
Amanda: No penalty, but you will pay income tax on non-Roth withdrawals.
Eliot: Correct, if you take your traditional. Exactly right.
Amanda: Now, there is a way to take it out if you’re 55?
Eliot: Yeah. We have something called a rule of 55. There are certain things that are special occasions (if you will) that the IRS lets you go ahead and take it out earlier. Typically if (say) you left your job or you lost your job in the year you turned 55, then you can start taking disbursements without paying the penalty. There are some other ones like education.
Amanda: There are hardship withdrawals. I have a whole list here. It needs to be an immediate and heavy financial need, those are the terms. So certain medical expenses are in, if you’re going to buy a home for you to live in. Again, homesteads, where you live, get pretty special treatment in the tax code, usually.
Education expenses, costs and fees to prevent eviction or foreclosure. It can even apply if you’re renting your home. A funeral and other burial expenses. And then loss due or repairs needed due to federally-declared disasters, so things like hurricanes, earthquakes, fires, things like that. It can’t just be something bad that happened.
We had a client who lived in a rural area. Their only source of water was a well on their property, and that well, something happened that they needed to dig a new well. We scoured the code to see if it could fall within this, because the only way they could get the cash was to do a withdrawal from their 401(k).
Even though it was a repair to their primary residence, it didn’t fall within a federally-declared disaster area. We ultimately determined that they wouldn’t be able to qualify under a hardship deduction. But there are ways to get money out of a 401(k) even if you’re not 59½, even if you don’t qualify for a hardship. What are some of those?
Eliot: Again, we have to look at your particular plan. But the code allows us to take a loan. You can take up to the lesser of 50%. Or was it 50% or…?
Amanda: Of your vested shares.
Eliot: Of your vested amount.
Amanda: Or $50,000.
Eliot: Or $50,000, whichever is lower. You got a plan, let’s say you have $100,000 in there that’s vested. You can take up to $50,000 as a loan, provided the plan allows it. In this case, that individual could have taken out the loan up to $50,000. You do have to pay back obviously with interest. I think it’s a five year period, I believe.
Amanda: I believe so. It is a five year period.
Eliot: And they’re pretty tight on that, so you will start making payments right away.
Amanda: But otherwise, you have to be retired to start taking distributions?
Eliot: Don’t have to necessarily be retired. Again, the code allows you to go ahead. If you’re 59½, you can start taking from the plan, the job you’re at right now. But if you had a plan from a previous employer that’s still over there, you technically should not be taking. Maybe some people do, but you’re not supposed to. But you could take it at your present employer’s plan if you’re 59½, if their plan allows it.
Amanda: There’s what the code allows and there’s what your plan allows. You got to look at your particular plan. What’s the tax consequences of taking these early? It says early disbursement, so we’re going to assume this person’s less than 59½.
Eliot: Certainly we’re going to pay if this just was a regular 401(k). In other words, it wasn’t a Roth. Then we’re going to pay income tax, ordinary rates on whatever that dollar amount we pull out. If we don’t meet the age requirements, if we don’t have these special conditions that Amanda went over, we’re going to hit an extra 10% penalty on that, and that’s going to be your tax consequence.
Amanda: What about the Roth portion?
Eliot: If it’s a Roth, well then typically you don’t have any taxable gain. That’s the whole purpose behind the Roth. You may still get hit with the penalty if we don’t meet one of these conditions, but we wouldn’t have the tax on ordinary income because it grows tax-free.
Amanda: And the same is true for the amounts you contribute that you’ve already paid tax on.
Eliot: Yeah, and usually (I think) you have to wait five years to let it settle (so to speak) is what they call on a Roth. But after that, then yeah your contribution amounts are yours and you can take those out.
Amanda: All right. Very thorough, Elliot. Thank you.
“What is the best entity for tax purposes to invest in real estate syndication?” We’re going to start off with the legal implications. With a real estate syndication, you are typically investing as a limited partner. The limited partnership owns the asset. You as a limited partner have limited liability. That’s what it means to be a limited partner.
From a legal side, you really don’t have a ton of risk out there. Your risk is up to the amount of your investment. If that limited partnership, if that syndication is sued, you put in $100,000, you could potentially lose that $100,000, but you’re not going to have any other type of personal liability there.
That being said, we do still generally recommend that you hold limited partnership interest through a Wyoming holding company. It just gives you a little more anonymity there. If that limited partnership sued, that gives them a list of all the limited partners you’re seeing an anonymous LLC there.
That’s going to be either your main holding company, or often clients will set up a separate holding company called a Safe Assets LLC. That’s going to hold things like your syndication interests, your cash, your brokerage accounts that you’re not actively trading in. All of those things that don’t have a lot of liability coming to them.
On the tax side, Eliot, what is the best type of entity for this investment?
Eliot: We do really work hand-in-hand with the law here. As Amanda pointed out, we’re going to look at those types of maybe a disregard LLC to put it in because that’s going to flow directly to our 1040, which we like.
This is real estate. For those that don’t know what a real estate syndication is, it’s just a large group of investors typically getting into the investment. You may have a general partner out there, but most of the investors are all limited partners, as we pointed out earlier.
We want all that activity hitting our personal return, usually, because they’re going to do some of those things that we talked about—cost segregation, bonus depreciation—can create a lot of losses that might be in our favor. You like to have that hit your 1040 return for various reasons.
We’re typically going to see it in that type of maybe a disregarded LLC, maybe a partnership if you’re married and you and your spouse are in the partnership. We could put in there too.
Amanda: If you have other passive income coming through from other rentals, then those losses are going to typically offset that, so you’re paying less tax overall. What about holding it in an S-Corp? Why would we not do that?
Eliot: I don’t know that there’s any reason that you couldn’t, but first of all, an S-Corporation will be an additional return. You do have different concerns with an S-Corporation. Perhaps you might have run into a reasonable wage requirement if you have a lot of income coming in there. And there, we’ve gone the wrong direction.
If we have to pay a reasonable wage, we’re adding to our tax burden because it’s not just going to be ordinary tax. There’s going to be additional employment tax on that. There are quite a few reasons why we typically would shy away from an S-Corporation. We don’t like to put any real estate in there unless we’re flipping or something like that, which is not what we’re doing here. Usually, you’re disregarded or your partnership.
Amanda: I like S-Corps more for active businesses where you’re working it. What about a C-Corp? Why would I not put my syndication in my C-Corp?
Eliot: Again, I don’t know there’s any. There’s no rule out there that you can’t, but maybe we won’t want to because eventually if let’s say you were going to use those losses, that is from the cost segregation, bonus depreciation that we talked about that often these cost segs do, that’s going to be stuck off on a different island. It’s going to be on a different tax return.
Amanda: The C-Corp island.
Eliot: Exactly. It’s never going to hit 1040 island, which we needed. Then when they ever sell it, all the benefits will stay in the C-Corporation.
Let’s say you have a large gain there, how are you going to get it out? There are things to get some of it out, but if we’re talking about a large amount of money, in a sense it could be trapped there. How are you going to reinvest it? You have a lot of different considerations if we’re going to use that C-Corporation.
Amanda: So best entity for tax purposes, it’s going to be a disregarded LLC, typically going to be set up in Wyoming or another anonymous state, or partnership if you’re married.
Eliot: And we talked about the passive aspect. A lot of our clients are beyond that. They are what we call real estate professionals.
Amanda: That’s true.
Eliot: It’s no longer passive, and now it’s active. All the more reason you’d want something that’s going to hit your 1040, typically not get it messed up in a corporation.
Amanda: We want those active losses.
All right. “Regarding bonus depreciation,” which we talked a little bit about already, “and the short-term rental loophole,” STR, short-term rental, “are either the 500 hours or 100 hours and more than anyone else, material participation tests prorated for the year, for example if a property is purchased and put into service in November, those hours would be difficult to achieve?” Yes, they would, and that’s the point.
Eliot: That’s the point, right?
Amanda: So let’s talk about what is the short-term rental loophole first of all, because if you haven’t heard of it, you may not understand any of the other words in that sentence.
Eliot: The STR, it stands for short-term rental. What we’re saying here is we got a different type of rental. We all are familiar with why I rented out an apartment or something like that for a year-long lease. That’s long-term. That’s the normal condition you usually see.
But they’re things such as Airbnb where we have a shorter period of time, usually seven days or less average stay. That has a totally different type of tax treatment if we do something like that. There it becomes a trade or business. It’s like a hotel you’re operating, not classified as long-term rental property. We have two different categories going on there.
What the short-term rental loophole is, is that it’s theoretically at least easier to not make it or to get it out of the passive realm. Any business out there, any trade or business that you get into, you have to materially participate in if you’re going to have it as non-passive income or losses.
Here, short-term rental loophole, we refer to it as a loophole because you can have a rental type property even though it’s short-term, Airbnb. It’s a lot easier to meet that standard of material participation for the short-term rental, which is going to make it non-passive or what we call active losses. You’ll be able to offset any income on your return with those losses. That’s why they call it the loophole.
But we have to meet a material participation status. There are seven different ones, but there are two or three that we typically deal with more frequently. The 500 hours or 100 hours or more than anyone else. That just says you’re putting more time in than anyone else. Those are the two that we primarily see.
There is another one that fits into play here. We’re in November. First of all, answer the question I guess. Do we prorate? No we don’t. You have to get that 500 hours or meet the 100 hours or more than anybody else between November and December 31st.
There is the other test, test number two and that is your activity substantially constituted all participation. In other words, Amanda did everything. She ran the thing, she marketed the thing, she cleaned.
Amanda: Maybe I didn’t do 100 hours, but I did most of it.
Eliot: Yeah, she did substantially everything. She’s going to get material participation under that test, which we don’t have listed here. That would be my guess that that’s the test they want to try and go for in November. But remember they got to be the one doing everything. You can’t really have other people coming in and cleaning or anything like that.
Amanda: And that’s really the big chink in this strategy. If you don’t live close to the property and you’ve got to hire someone to come in and clean, you have to really rotate those cleaners in. Because remember, if you’re going to meet the 100 hours and more than anyone else, nobody else can do more than you. If they’re different cleaning crews from one company, that’s going to be considered one place. you may have to rotate through different companies.
A lot of our clients will actually wait until the third quarter of the year to implement that strategy. You’d be surprised how quickly you rack up 100 hours when self-managing a rental, especially a short-term rental, and because they don’t want to give another third party the opportunity to rack up as many hours. Maybe they’re only having the property available for rent a quarter or half of the year. Then there’s no danger of that.
What type of hours actually qualify as material participation? Obviously anything that’s day-to-day management, which is pretty, I don’t want to say it’s easy. The whole idea is that you’re putting in enough work that the code is now treating you as active in that activity.
When you’re generating losses, which is the point of this strategy through cost seg, bonus depreciation, those active losses now offset your W-2 salary, so lowering your overall taxable income.
You do have to put in a lot of hours. It’s fairly easy to do once you’ve got it set up with all of the apps, the automations and things like that. You do still have to communicate with the renters who sometimes always have problems. You know the type. But does looking for the property, furnishing the property, do those hours count as well, Eliot?
Eliot: They do, but we don’t want to abuse it. The example we were batting around, well what if you went and looked at 20 properties in one weekend? Are you going to take all that time? And let’s say it took 20 hours. Are you going to use all that time? No.
And how are you going to really show that that time was dedicated to that one property? That’s going to be very difficult. It’s not Amanda and Eliot you have to convince. It’s the IRS.
Amanda: It’s not us.
Eliot: Exactly. So if you can isolate. “I went back to that property the next weekend, the time I spent doing that to acquire that property, get it purchased,” then I think you have a very strong argument for using those hours. Then any renovation that you did hands-on will typically count. It gets a little bit messier if you’re just observing and overseeing it.
Amanda: You can’t count the hours where you’re scheduling contractors, things like that. But the IRS is fairly savvy. The material participation types—rep tests, rep status, short-term rental loophole—are pretty highly litigated compared to topics in tax, so there are quite a few cases out there.
There’s one in particular, Hairston. It was a couple who very clearly needed 40 more hours to hit that material participation test and they didn’t have it. So they just threw down at the bottom of their log 40 hours supervising the painters.
The court got a little bit cheeky and said, we understand Mr. Hairston, having recently retired, had a lot of time on his hands, but we simply don’t believe he spent 40 hours watching paint dry. The court knows when you’re just trying to pad your log and they know when you’ve really been doing it.
So definitely list the hours that you are doing something, but if you are not actually painting, you don’t want to list the entire time the painters are there. Even if you do just sit there in a lawn chair with the margarita watching them work, if it’s in a nice resort area, that could be a good use of your time, but you’re not going to count all those hours. So log everything, and then put the onus on the IRS, if in the small chance of an event that you got audited to disprove your hours.
Eliot: Those are again, hours outside of just the direct management of it. Again, acquisition, renovation, time spent, hands-on type stuff is certainly time that we could probably throw on there. But you really want to get the bulk of it in your management because it’s very difficult for them to argue against that.
Amanda: Yeah. We turned our old personal residence, not into a short-term rental, but a furnished, 30-plus day rental, because that’s what you’re allowed to do in Vegas without a permit. It took my mom, my dad, me, my sister-in-law, and my brother an entire three days to clean it, get it set, and do all the shopping to furnish, all new.
We needed a few extra appliances because obviously we were taking our appliances with us to our new house, furnish it. If you’re building the furniture, you can count that, but if you’re really doing the work, that 100 hours is easier to hit than you would think.
All right. “If I purchased an investment apartment and repaired windows, floors, and incurred other miscellaneous expenses to make it ready for renters, can I write off the expense on my Schedule E? I didn’t receive any income for the apartment as of yet.”
This goes back to our question earlier, the reverse of improvements and expenses for your personal residence on a rental property. What can we write off in the year and what do we have to add to basis?
Eliot: Repairs are going to be something where you’re just trying to bring it back to its original condition. Eliot broke a door handle on something and you put a new door on there, that’s a repair. You’re going to be typically able to go ahead and deduct that in full.
Gosh, again, broken window. That’s always a popular one in my neighborhood. New carpet or something like that, new floors, certainly you can. Yes, those are expenses that you’ll get to deduct in some form. And yeah, just new light bulbs.
Amanda: What is the $2500 safe harbor rule?
Eliot: We do have another provision. Those were repairs. We have other things that are more significant, like you added on a whole new addition. We call those improvements, which we’re going to have to depreciate typically and not expense.
What’s the de minimis rule that you’re referring to? If you buy something that would typically be depreciated over time, if it’s under $2500 and you got the receipt for that one purchase there, you can go ahead and expense it. The IRS doesn’t care.
You could get a washer and dryer set for under $2500. You get a new refrigerator. If you have separate receipts for them showing the purchase, and those respective purchases were under $2500, go ahead and expense it right away.
Amanda: So basically anything $2500 or less, we can classify as a repair. Anything above, we really have to look at whether it’s a repair or a capital improvement. Repairs we’re deducting in this tax year, so we’re getting the tax benefit now. Capital improvements we’re depreciating over time, so we’re getting a smaller benefit over time.
Now, the nuance in this question is these are all expenses incurred to make it ready for renters, meaning that there were no renters in that. We have to look at the rules for can you take expenses before it’s actually even a rental property?
Eliot: You can’t until you place it into service.
Amanda: What does placing it into service mean, Eliot?
Eliot: It just begs that question. Generally it just means that it’s available for rent. Again, you ask what that is. Well, if you just happen to have a property and you’re ready to rent, if someone comes up to it, well then it’s technically available for rent. But usually, evidence that by going ahead and putting it out there on the market in some advertising venue that would usually be the day that you call it available for rent.
Amanda: What if you listed it but nobody could actually move in because the floors were pulled up.
Eliot: Well then you got possible legal problems if someone goes in there and they trip or fall. You definitely want your asset protection. If it’s going to be condemned, you have all kinds of problems. You could still be making repairs, have it available for rent people out there, and you could get by with that.
I think at some point though, the balance tips a little bit where it’s not practical that it’s actually available for rent, it’s not safe. But if it’s a minor repair, we’re doing maybe a gutter or something like that, I think then we’re okay.
Amanda: So you can’t really get around the put into service requirement by simply just throwing an ad up on Craigslist or Zillow. It has to really be available to rent. if it’s not in service, you can’t take those expenses. Even if they are smaller repairs. You add those in the basis there.
Eliot: That’s right. Then we’ll depreciate it.
Amanda: You add that doorknob into the basis.
Eliot: Exactly. And the window.
Amanda: And the window.
Eliot: And the dead plants.
Amanda: So secondarily, let’s say the apartment was available to rent and you’ve made these repairs, but you didn’t make any income because for whatever reason, no one rented it. Can you still take those expenses then?
Eliot: Absolutely. There’s no income requirement. You don’t have to be making money for it to be a trade or business. And yes, you’d be able to take the expenses.
Amanda: And that would just show up as a loss on your Schedule E. Passive loss if you don’t materially participate, which would offset any other passive gain you had. So if you had extra income from another rental property, those two things would offset each other. If not, that loss accumulates as a passive activity loss (PAL).
Eliot: Yes, it does.
Amanda: Until when?
Eliot: Until we either substantially sell the unit that’s creating the losses—typically that will—or if you sold some other property, it could suck up those passive losses as well. But it’s going to be the selling, typically, of the structure.
Amanda: Even if you can’t use those losses, you get to still keep them. That’s going to help you in the sale of property (eventually).
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All right. “I’m starting to do wholesale investments. I’m still a W-2 employee, yet I will resign soon.” That is the spirit. “It is recommended that I start my LLC now. Why?” What’s wholesaling for those of our audience who are not real estate investors?
Eliot: Wholesaling is when you go out, you find a property, you get it under contract, but you haven’t really closed yet, so you don’t really own it yet, and you’re really just trying to unload that contract as quickly as you got it.
You can do that by assigning the contract or maybe doing a double closing; a little bit more dicey there, but certainly it’s something that can be done. What we’ve done now is basically moved it from the seller over to the new buyer, and you acted as the middleman, as the wholesaler.
Amanda: And you’re usually charging a fee for that. You’re doing the legwork for the investor who is eventually going to turn it into a rental, maybe flip it, things like that. If you’ve heard the term ‘driving for dollars’ when you just pop in your favorite CD and you drive around looking for those properties that look a little wear and tear, like they haven’t been taken cared of, walk up to the door, knock, and saying hey, would you be willing to sell your property? Typically for a reduced rate so that every person along the line is getting a good deal.
Wholesaling, if we’re talking about active versus passive income, it’s going to be active income, just like 1099, just like W-2. Active is by the sweat of your brow. If you’re driving for dollars and marching up to people’s doors, you’re definitely sweating. In some localities.
Eliot: Definitely in Vegas in the summertime. But it’s going to be ordinary income. You’re going to get hit with extra employment tax. So yeah, we’re adding on the taxes. There’s no question about it. And when we do the whole selling type investment strategy, I think that leads into our next part about the LLC. Any thoughts on that? What are you thinking?
Amanda: From the legal side, you definitely want to do this in an LLC. If you think about it, you’re entering into contractual agreements with the seller, also with the end buyer. And if something goes wrong with that, maybe the end buyer defaults, then you’re stuck holding the bag. You don’t want to be personally holding that bag. You want your LLC to be holding that bag.
Worst case scenario, the LLC is sued for it to enforce the contract. It has no assets to enforce that contract under. So you definitely want to be doing wholesaling through an LLC.
You typically do a state-specific LLC. if you’re doing it in Nevada, Nevada LLC. You are the manager, the member of that. You’re still signing everything but adding your capacity as the manager, not as the actual person doing the wholesale. That’s going to give you some legal liability protection.
Then on the tax side, disregarded, probably to start? I would start just disregarded.
Eliot: Yes, because if you don’t know if you’re going to hold it or not. Sometimes what happens is we get into these situations and they want to hold the property. I’m with Amanda. I wouldn’t be opposed to having it disregarded until you knew that you knew that you’re going to do that double closing, or that you were able to assign that contract over to the new buyer.
But once we know that that’s going to happen, we probably want to go into a corporate structure, S-Corp or C-Corp, make that election on that disregard LLC. Why? Because it can help us save. We got time then to get reimbursements and deductions against that income, get a lot of money back to you tax-free.
If it’s an S-Corporation, we might be able to save on more employment tax. So a lot of tax goodies happen there. But every now and then you do end up renting that property instead of getting rid of it, so we don’t really like to have those incorporations.
Amanda: Definitely. Wholesaling is just like any active service-based business to me. You start out as a disregarded LLC until you know how much you’re going to make. If you’re making maybe $30,000–$50,000 that’s when you make the S election.
If you get a property under contract and you end up having to close on it yourself, you can always assign that contract to your other LLC that’s going to hold the passive rental property. You don’t want to hold long-term capital assets in that S-Corporation. You’d want to eventually close if you’re keeping it in a separate entity.
Eliot: And if we’d started out, which isn’t the worst, and then you held the property, well then it is the worst because it’s very difficult to ever get back out. I’m with Amanda if you can hold off, buy some time, and keep it disregarded until you know that you’re ready to close, then make that election.
Amanda: What point in the tax year do you have to make that election?
Eliot: For an S-Corporation, what the code will tell you is you if you’re starting at the beginning of the year, it has to be by March 15th, 15th day of the third month. However, if we’re starting then setting up the business in June, well then again it would be 15—
Amanda: You can’t go back in time and make an S selection, can you?
Eliot: Well we can do late election sometimes. The IRS has been very generous (usually) on granting those. As long as you ran the business as an S-Corporation, what does that mean? We’re paying payroll, reasonable wage and things of that nature, and showing that it was run as an S-Corporation.
Typically, you could make late election up to the date that you start that. In my case in June. You wouldn’t be able to go back to January 1st because the LLC didn’t exist, so you can do that.
The C-Corporation’s a little more challenging. It’s not that they can’t go back, but we don’t see it as frequently. I think it’s really the S-Corporation we play that game with.
Amanda: Nice. All right. “I have a trading account, but I do not actively trade in it. Should I set up a trading partnership for it?”
Eliot: This is a great question because we do have a lot of ways for it. It is built on asset protection first. There’s no point in having a brokerage account if Eliot sues you, if it’s just in your name and I take it away from you. We want to get it into a box, maybe an LLC that’s a Wyoming LLC for safe assets, if we’re not doing a lot of active trading. If it’s just sitting there, just go ahead and put it in there. No big deal. You don’t need to go through more formal structuring really than that.
But if you are starting to actively trade a little bit more, then it may behoove us to go ahead and put it into a partnership. We often set that up. We always talk about it, but let’s draw it out here.
Amanda: What does this look like? What type of entity is this?
Eliot: It’s going to be an LLC taxed as a partnership.
Amanda: Or a limited partnership, and then the limited partner’s going to be…
Eliot: The individual.
Amanda: You. And then the general partner?
Eliot: That will be a C-Corporation.
Amanda: It’s going to be another entity, a C-Corp. Why are we doing that?
Eliot: Let me just start with what happens if we didn’t do this. If we had $100 of gain and we didn’t do any of this structuring, it’s going to hit $100 of gain on our 1040. But by merely doing what Amanda’s drawn up here, and let’s say the C-Corp owns 10% the individual owns the other 90%, and we have that same $100, right there we’ve automatically taken $10 off of our 1040. We don’t have to pay any tax on it. It goes to the C-Corp.
Certainly the C-Corp if we didn’t do anything else, we’d have to pay tax on it at a flat 21%. But that’s the trick. The C-Corporation has a lot of reimbursements and benefits that can get that $10 back to us tax-free while it’s a deduction to the C-Corporation at the same time. It would be very possible to zero out all income here in the C-Corporation, so we have no taxable income, and the individual ends up pocketing that $10 without any tax on it.
Amanda: We take things out, like 280A meetings, 105B plan, medical reimbursements if you’ve got high medical expenses, just normal accounting plan stuff, then that all gets reimbursed back to the individual and it’s completely tax-free.
So you’ve shifted income off of your personal return onto a C-Corp return, immediately reimbursed yourself back in your pocket tax-free. What types of expenses are we able to deduct from the C-Corp?
Eliot: We can special allocate some of the expenses that you would ordinarily not be able to deduct. When we came out with the Tax Cuts and Jobs Act, we really lost the ability to deduct a lot of that. It was under what we call a miscellaneous 2% rule under Schedule A or itemized deductions. You had to be itemizing to begin with. Then you have to incur these expenses in excess, and you could only deduct the amounts that are in excess at 2% of your AGI. It was really limited.
Amanda: And they’re limited even more now because that went away completely.
Eliot: Exactly, so nothing at all. That’s one reason we like this structure. But really if you weren’t doing the active trading, which was the call, the question here originally, then you could just set up disregarded.
Amanda: Wyoming LLC, just disregarded to you personally. If you’re married and not in a community property state, you might need it to be a partnership there. But if you’re incurring higher fees or account maintenance fees, or you’re doing a lot of trades, incurring fees for options or trading on margin, then you’re going to want to do this LP structure and shift some of that income, because you can take those expenses on the C-Corp. You can’t take them on your 1040.
All right. That rolls into this last question, which are some of the expiring Tax Cuts and Jobs acts items for 2025. That limitation of not being able to deduct those, what is it? Miscellaneous itemized business expenses subject to 2% floor. That’s going to go away.
Eliot: With that, we got a whole bunch of things that are really going to change. First of all, individual income tax brackets. They’re going to be high and it’s going to be less favorable to the taxpayer. They lowered a lot of the brackets for a lot of different groups. Even the overall cap, I think it was 39.6%, was lowered to 37%. Everybody’s going to pay more tax if these expire, including the middle class.
Amanda: It was 10% was the lowest tax bracket, and then all of the other tax brackets dropped down by 2%. At the end of 2025, if this isn’t renewed, then they’re all bumped back up. So you may be looking at a higher tax bill there, the standard deduction.
Eliot: Big changes there. We’ll go back to the way it used to be, and right now they just made a very large standard deduction we’ve been living with for the Tax Cuts and Jobs Act years. But it would go back to about $8350 they think.
Amanda: Yeah, they basically doubled it.
Eliot: Yes, they did. And they took away personal exemptions. That was the trade-off. But if it expires, we go back to the old standard deductions and we would go back to having personal exemptions.
I did some quick math here. If that happens, basically a married couple, you’re looking at about $23,700 that you would now be able to take if it expires. Whereas at this moment without the expiration, you’d be able to take about $30,000. Another bite there, less tax.
Amanda: Significant?
Eliot: Yeah. It can really all add up because remember, you’re at higher tax brackets, you get less of a standard deduction/personal exemption deduction. So you’re already several thousand dollars or more taxable income.
Amanda: It also makes your taxes harder to report and you have to keep track of more. Right now with the standard deduction doubled, most people aren’t even paying attention to what they’re paying for medical expenses because they know they’re going to take the standard deduction. They’re not paying attention to what they’re doing. Really anything that you deduct on your Schedule A, because that standard deduction is so high right now, comparative to what it used to be.
So if it does go back down, you’ve got high medical. If you do a lot of charitable giving, you may actually be able to get more of a benefit there by itemizing. But you are going to have a lot more to keep track of during the tax year.
Eliot: No question. Child tax credit, that’s going to drop. They estimate it to be $1000 down from $2000. The phase outs, the dollar amounts are going to be lower, so less tax credit basically for the children all the way around.
Amanda: They’re taking the tax credit from the children.
Eliot: I know.
Amanda: For the children. So more people that are in higher income tax brackets are not going to have this available to them. It phases out. Then on top of that, it’s half the amount of what’s going to be. Man, that’s not good. I have a lot of kids.
Eliot: Now some good news, maybe one might say, is that if we went back to this, it’ll be more likely that you’re itemizing, that’s our Schedule A, and that’s what Amanda was referring to earlier, but the SALT ( state and local tax) limitations—
Amanda: Are going to be removed.
Eliot: Yes, and that was one of the biggest things. I remember when this first happened in 2017, all the calls—
Amanda: Ooh. California, New York, not happy.
Eliot: I had more calls from you guys on the east and west coast, from tax-achusetts and from California. Some lost, oh, I can’t even say tens of thousand, $90,000+ of deduction.
Amanda: So the rule is now you can’t deduct more than $10,000 of state and local taxes that you pay. That’s including your state income tax. That’s including your property tax. So if you’re in those places with high property tax, high income tax, the maximum amount you can take is a deduction if you itemize is $10,000 now. As you can imagine, that can be 2–3 times more. That could be a benefit for you in those high property tax and income tax states when that sun sets.
Okay, mortgage interest deduction.
Eliot: That was originally $1 million that you could take.
Amanda: The kids say mid. When it’s just so-so, it’s mid. It’s the mortgage interest deduction, though.
Eliot: That’s $1 million that you could take your mortgage on your primary residence. That is the loan that the mortgage amount is $1 million. You could take the interest up to $1 million. The interest against the $1 million loan, they drop that down to $750,000, so that would be one (I guess) bonus. They’d be raising it from $750 million.
Amanda: If you’ve got a $1 million mortgage, which again, most of the country. Property prices have gone up, but—
Eliot: Not mine.
Amanda: Sounds like a coastal city problem, which I am from California, so I sympathize with them.
Eliot: Absolutely.
Amanda: Don’t move to Nevada, please. Thank you.
All right. Medical expense deduction?
Eliot: Man is stirring the pot.
Amanda: I know. Got to generate what’s it called? Engagement?
Eliot: Right.
Amanda: Medical expense deduction, mid.
Eliot: Get the energy going here. Good or bad, it’s energy.
Amanda: So the Tax Cuts and Jobs Act initially lowered the floor.
Eliot: The 7.5%. It was 10%.
Amanda: What does a floor mean, though?
Eliot: Good point. First of all, we have to be itemizing. We have to get into Schedule A to begin with. That means that all of our deductions are exceeding those standard deductions that we were talking about earlier.
Now once there, you could deduct your out-of-pocket medical expenses if they exceed a floor that is 10% of your adjusted gross income. That’s how it used to be. Let’s say you had $100,000 in AGI, 10% of that $10,000. That means that you have to spend $10,000 on your out-of-pocket meds before you can deduct the first dollar on your Schedule A.
They lowered that down to 7.5%. That would be removed. In that case, you’d only have to spend up to $7500 before you got your first deduction. That would be a $2500 difference, obviously.
Amanda: Still pretty high, though.
Eliot: It is.
Amanda: Even in all the tax returns I reviewed, rarely did I see anyone getting any benefit from that medical expense deduction.
Eliot: It really calls for then maybe trying to get an HSA (health savings account) or something like that. Or maybe run the C-Corporation with medical reimbursements. Amanda had shown that earlier.
Amanda: For as high as those medical expenses are these days.
Eliot: Correct.
Amanda: So the miscellaneous itemized deductions subject to the 2% floor. That’s what we were talking about earlier, so same idea. You can only deduct these expenses if they exceed 2% of your adjusted gross income. That will go away completely at the end of the year.
Okay, QBI.
Eliot: I love this one. Qualified business income deduction. Most people refer to it when I’m talking to clients, the 20% deduction. It’s a little more complicated (of course it always is) than the code.
Basically, if you have a sole proprietorship, if you have any business structure other than a C-Corp, you’re entitled to this generally. So if you had $100,000 income, you could deduct 20% off of that. Obviously, there are some nooks and crannies to that, but that’s the general rule. But that would be going away and we’d be back to none of that deduction.
Amanda: You get nothing.
Eliot: Exactly.
Amanda: I got zero. That’s going to hurt small- and medium-sized businesses a lot.
Eliot:. You get nothing and you enjoy it.
Amanda: You’ll take it and you’ll like it.
Eliot: Yes.
Amanda: Estate and gift tax provisions. The Tax Cuts and Jobs Act increased the exemption. The exemption is the amount in your taxable estate once you pass away that is not subject to estate taxes. Estate taxes can be 40%.
Eliot: Brutally high and they grow fast.
Amanda: The amount it currently is?
Eliot: $14 million right now. It was approximately $12 million when they started it.
Amanda: Per person?
Eliot: Yes, so we can double that. Basically $14 million times two. That’s a lot.
Amanda: You get a lot.
Eliot: Otherwise, it’s going to expire and go down to $5 million.
Amanda: My uncle’s always saying it’s a good year to die.
Eliot: It is.
Amanda: Please don’t. But depending on how this goes, maybe you’re in that same boat. Please don’t, though. We like having you around.
Eliot: But given the choice…
Amanda: All right. Business tax, so interest expense, deduction limits.
Eliot: This was the overall limit on the amount of tax that you could have against interest, that is interest expense. I was 30% of an adjustable taxable amount. That’s due to expire. It looks like they say if it does, it’ll become more strict.
In other words, what was going on? Right now you can deduct 30% of your business interest. If that goes away, it’ll be less favorable than that. I honestly can’t remember off the top of my head what it had been before. It’s been so long, 2017.
Amanda: It was probably bad.
Eliot: Yeah, for the next one. Probably the huge one (I think) that everybody’s really looking at, and that’s the bonus depreciation. As we talked about, alluded to a lot, it used to be 100% when they first came out with the bonus in 2017.
Amanda: It was like that for several years, too.
Eliot: Because of COVID, it got extended. We got to really rely on that 100% for quite an extended period of time that wasn’t originally.
Amanda: It was like Scrooge McDuck, but instead of a whole warehouse full of gold coins, it was depreciation expense.
Eliot: Totally what it was.
Amanda: Doing the backstroke in it. Now we’re at 40%, going down to 20% next year, unless we revive this provision.
Eliot: That’s a big one. Who knows what they would send it back to, because it was 50% before. There’s been bonus depreciation available for quite a long time in our tax code. There are periods where it was phased out or whatever and they’ve changed it, so on and so forth, but never really to the level of 100% that we saw with the Tax Cuts and Jobs Act.
It’s significant. There’s a lot of talk. I think it’s going to be one of the more highly debated things within the code if they choose to get something written up here before the end of the year. But that’s a big one.
Amanda: And we got to remember, all laws are designed to either encourage or discourage behavior. If we’re giving out bonus depreciation, what is that doing? That’s encouraging businesses to buy new equipment, to replace their fleet. That then in turn boosts manufacturing, things like that. It was a real big boon for just the economy in general, let alone a great strategy for individual investors to be able to take advantage of.
The last one we’ve got is the R&D (research and development) expense deduction.
Eliot: What had happened here when we originally put this in, it started allowing for expensive research and development expenses. Expensive, meaning you could deduct 100% right away, basically.
Now it’s not really expiring, but approximately in 2022 they did put a limit on this and they started requiring that you amortize, which is basically the same thing as depreciation, only with an asset, an expense. You are taking over 15 years, so 1/15th of the amount or 5 years depending on it, an equal amount each year until you expense all that.
Hopefully, they’re going to bring it back to where you can deduct expense, that is 100% of it right away like it was in the beginning of the Tax Cuts and Jobs Act, but we’ll have to wait and see. That would arguably be another thing that spurred the investment.
Amanda: Spur certain activity.
Eliot: Exactly. No question about it. There are people who specialize in that. We work a lot with cost seg. I always call Cost Seg Authority. It’s now CSA, is that right?
Amanda: I think it’s Cost Seg Association now, maybe?
Eliot: Yes, same group.
Amanda: It’s the same group.
Eliot: But they do all the cost seg. That’s a very specialized area. Likewise, R&D is very specialized. There are groups out there that specialize with research and development expenses and things like that, so that clearly started a new level of expensing and hopefully we’ll see that come back too.
Amanda: All right. Those are the big ones. If these are extended, they don’t necessarily have to all be extended. They don’t necessarily have to all be extended in the same amount of time. It’s going to be individually looked at. We may see some, we may not see others. Put up in chat which one you think?
Eliot: What’s your favorite?
Amanda: Yeah, your favorite. Which one you’d be like, yeah, I’m calling my congress person every day to make sure the state’s coming back through. Which ones do you not really care about? Personally, for what we do, the bonus depreciation is a big one, especially for our clients there.
Eliot: I like that and I’d hate to see us go back to the personal exemption. I’d like to keep the standard deduction.
Amanda: I do like the standard deduction because every time, they ask me at the doc. We have six kids, three at home now. But every time we go to the pediatrician because of the preschool plague, would you like your receipt? I get to say no, actually. I’m good. SALTs. That person lives in California. 100% bonus depreciation!!!
Eliot: I definitely want to see the estate tax. Keep that on there too.
Amanda: Someone said, no idea. That must mean that we didn’t do a good enough job explaining.
Eliot: Just all of it. Bring it all back.
Amanda: Bring it all back, overall. Did a lot of good for individuals.
Eliot: And we got one thumbs up for bringing it all back. There you go. All right. Got that vote.
Amanda: All right, we’re going to wrap it up. Please subscribe to Toby’s channel. This is a channel we’re live on right now. The recording of this will be available on his YouTube channel. He’s got a ton of great videos there. Always coming out with new things as well.
In addition to Clint Coons, who is our other founding partner. A little more focused on the legal side, but again, tax and asset protection do go hand in hand. That’s why we cover both around here.
If you want to learn more, if you want to do a bit of a deep dive, come to one of our Saturday webinars. It’s asset protection in the morning, tax and estate planning in the afternoon. I teach those a couple of times per month. We’ve got a different rotation of attorneys who teach, who are in the background answering questions just like this in the Q&A. We would love to have you as well.
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Not all of this is cookie cutter. I know that we answer specific questions and we can say generally you would want to do this, but a lot of times it’s super helpful to get on the phone with somebody, talk about what they want to do, talk about what they’re concerned about, and get you a customized plan is really what you need.
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Eliot: I review them all.
Amanda: I don’t. This guy does. This guy reads every single one of them, and then compiles, curates, really. He curates like a museum exhibit, curates the list of questions we address each week.
Eliot: Speaking of questions, thank you all for doing this as well. We got 179 questions. Our team’s been out there. We got again, Patty running the show. We got Dutch, Jared, Jeffrey, Jennifer, Marie, Rachel, Tanya, and Troy. All of them just clicking away, getting questions. So thank you to our staff, Matthew and Kenny running the show behind the scenes.
Amanda: Thank you guys so much, and thank you guys for joining us for the reason we do this. Send your questions in and see you in two weeks on Tax Tuesday. Take care, everyone.
