In this episode of Tax Tuesday, Anderson attorneys Amanda Wynalda, Esq., and Eliot Thomas, Esq., tackle a diverse range of tax questions from listeners. They discuss oil and gas investments used to offset Roth conversion income and explain excess business loss limitations. Amanda and Eliot clarify filing requirements for C-corporations with losses, emphasizing that corporations must file regardless of activity. The team explores multiple scenarios involving converting short-term rentals to primary residences or vacation properties, covering Section 121 exclusions, depreciation recapture, and the strategic use of S-corporations to step up basis. They present creative alternatives to 529 plans, including paying children through family businesses to fund education tax-free. Eliot and Amanda also review key provisions of the One Big Beautiful Bill Act affecting small business owners, including permanent QBID, enhanced bonus depreciation, and the SALT workaround. Finally, they demystify passive loss limitations, explaining the hurdles of basis, at-risk rules, and passive activity loss restrictions that syndication investors commonly face.
Submit your tax question to taxtuesday@andersonadvisors.com
Highlights/Topics:
- “I’ve made a Roth conversion earlier this year and am currently in the process of doing another conversion. We have invested in oil and gas to help offset taxes due. Is there a concern that we’ve invested too much?” – Excess business loss limits apply but unused losses carry forward.
- “I have not had any activity in my C-corporation and it had $26,000 of loss, and had some expenses. Do I still need to file an 1120 corporate return?” – Yes, corporations must file tax returns regardless of activity level.
- “We’re thinking of taking our short-term rental out of service and moving into it as our primary residence. What are the tax implications if we sell our existing primary residence?” – Section 121 excludes up to $500,000 gain on primary residence sale.
- “Same scenario with short-term rental and primary residence, but we’re turning our existing primary into a short-term rental instead of selling it. What are the implications?” – Basis transfers to rental, depreciate building over 27.5 years going forward.
- “Same scenario with short-term rental and primary residence, but we’re converting one property into a vacation home with no rental activity. What happens?” – Personal vacation homes lose business deductions, only Schedule A applies.
- “We do not have any education savings set up for our son who is now a junior in high school. Is there any other option to pay for college pre-tax? Most of our income is from rentals.” – Pay child W-2 wages through rental LLC under standard deduction amount.
- “Would you please go over some of the benefits of the Big Beautiful Bill for small business owners?” – Permanent QBID, 100% bonus depreciation, SALT workaround, enhanced Section 179 available.
- “A lot of time you talk about taking passive losses from syndications to offset passive income. However, I’ve encountered passive loss limitations where about two-thirds of losses have been disallowed due to basis, at-risk limitations, or excess business loss. Would you please explain how and why losses are being limited?” – Three hurdles exist: basis, at-risk, and passive activity loss rules.
- “What expenses are incurred for rental properties that are tax deductible and what is the best way to stay organized when keeping records?” – Reference IRS Schedule E page one for complete deduction list.
- “How do we properly track and maximize deductions across multiple rental properties while maintaining compliance?” – Maintain separate books per property, use accounting software regularly.RetryClaude can make mistakes. Please double-check responses.
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Full Episode Transcript:
 This is the Anderson Business Advisors podcast, the show for real estate investors, stock traders, and business owners. We help you keep more of what you earn and protect what you’ve built. Let’s get started.
Amanda: My name is Amanda Wynalda, and this is…
Eliot: Eliot Thomas.
Amanda: He’s also an attorney.
Eliot: Yup.
Amanda: We are here to bring knowledge to the masses. Every other Tuesday, we are live on YouTube as well as in a Zoom. If you’d like to join us, you can register to join us. Let’s see who else is out there.
Eliot: Yes.
Amanda: If you are joining us from somewhere across the globe, put your location into chat. We always like to see where you’re all coming from. The furthest that I have seen someone come from is Dubai. How about you?
Eliot: We got Jared across the hallway in the office.
Amanda: That is true. We are joined by some tax and legal professionals as well. Who do we have joining us this week?
Eliot: Yes. Trying to get that info here.
Amanda: Jared, Jeff.
Eliot: Jared, Jeff. We also have Carrie, Rachel, and Troy was in there. I don’t have the whole list here though this time.
Amanda: Bedford, South Carolina. Usually a lot of people from California. Eliot and I are based out of Studio 210 here in Las Vegas, Nevada. The rules for Tax Tuesday because I can already see some of you jumping in, can’t wait to get your questions answered. All tax questions are going to go into our Q&A. Q for question, A for answer. If you’ve got a question that you need answered, please put that into the Q&A.
Chat is if you’re having any technical difficulties, it is where our team will be dropping links for things that we bring up. Questions go into the Q&A. We’ve got that group of tax professionals in the background answering. It does not have to be related to anything we are talking about, so any question that you might have. We do have a selection of questions and if you have one that you would like to be featured on Tax Tuesday, you can email us at taxtuesday@andersonadvisors.com. Eliot gets to go through all of those, so send them in. He doesn’t have anything better to do.
Eliot: It’s a labor love.
Amanda: It is a labor love. You actually do enjoy going through all these questions.
Eliot: I do. I have a lot of fun. I really do.
Amanda: He specially curates the list. We get both a wide variety, but we also get to deep dive into a couple of issues, which we’ll do today.
Eliot: Yes. Yes, we will.
Amanda: If you need a more detailed response, please consider becoming a platinum client or a tax client here at Anderson Advisors. We’re a unique firm, where we have both tax and legal under one roof, sometimes tax and legal in one body just like us, huh?
Eliot: Yup.
Amanda: Both attorneys, both tax professionals. This is intended to be a fast, fun, and educational way for you to get tax information. Let’s get started.
Eliot: Let’s do it.
Amanda: We’re going to first go over our questions, and then we’re going to go into them in more detail. First off, we have, “I’ve made a Roth conversion earlier this year, and I’m currently in the process of doing another conversion. We have invested in oil and gas to help offset taxes. Is there a concern that we are offsetting too much?” We’ll get into that.
Eliot: Next question. “I have not had any activity in my C-corporation and it had $26,000 of loss, and had some expenses. Do I still need to file an 1120 corporate return?” We get that a lot.
Amanda: We get that a lot. People are often misinformed about it, so we are going to set the record straight right here today.
Eliot: Yes, all knowledge and understanding.
Amanda: “We’re thinking of taking our short term rental out of service. We would then take that property on as our primary residence. What are the tax implications if we sell our existing primary residence and move into our current short term rental? This one’s actually a three-part question. Where we’re going to build off it. What’s the second part?
Eliot: Second part. Same scenario, only we are going to take over that property as our primary residency and then turn the existing primary into short term rental. Just a little bit of a twist on the previous question.
Amanda: Yeah. Flip flop it. The third part of this question, same scenario, got a short term rental and a primary. In this one, we are turning one into a vacation property and they’re no longer going to rent it. Depending on the use, we’re going to have a few different tax implications there.
Don’t forget to subscribe to our YouTube channels. This first one is from Clint Coons. He’s one of our founding partners. He deals with asset protection, hit quite a milestone a little while back, over 300,000 subscribers.
Eliot: Yeah, you probably got there.
Amanda: Yeah. Finally. There are years worth of videos here, everything from how to hold your property anonymously to how to maintain your homestead exemptions.
Eliot: Didn’t mean it that way.
Amanda: I’m telling him. I’m going to tell him you said that.
Eliot: I got a feeling he already knows.
Amanda: All right, next up on our questions.
Eliot: “We do not have any education savings set up for our son. We didn’t like the limitations of the 529 plan, or we didn’t know if he’d go to college. He is now a junior in high school. Is there any other options, something we could do now to be able to pay pre-tax? Most of our income is from rentals, some W-2, some other income. We have a Roth IRA and 401(k) plans.”
Amanda: This one was fun to figure out.
Eliot: It is, yeah.
Amanda: Finding alternative solutions and creative solutions. It’s what we do best.
Eliot: It is, yeah. It’s really nice trying to help the kid out here. It’s a fun question.
Amanda: All right. “Would you please go over some of the benefits of the Big Beautiful Bill for small business owners?” I still think we need those tiny little hands.
Eliot: Some celebration. We did this way back when it first came out, but I wanted to revisit a little bit and narrow it down for small business users out there.
Amanda: Perfect.
Eliot: “A lot of time, you talk about the benefit of taking passive losses from a syndication to offset passive income.” Yes, we do. We talk an awful lot about that. “However, it does not seem that simple or as simple as that. I’ve encountered passive loss limitations, where about two thirds of the losses have been disallowed on my return due to basis, at-risk limitations, or excess business loss. Would you please explain how and why the losses are being limited or disallowed? It’s very confusing.” It is. It’s a fantastic question. A lot of things there that will apply here that can be limitations.
Amanda: We’ll go over that. Toby Mathis, this is the channel you are on. If you’re watching live on YouTube, Toby is our other founding partner. He is nicely known as tax wise Toby. You can also find him on TikTok and Instagram. A lot of tax videos here, anywhere from 121 exclusion to expenses that traders can deduct, to retiring, and also protecting those assets because earning the money is only half the story, right?
Eliot: Yup.
Amanda: We got to preserve it, we’ve got to protect it, and we’ve got to pass it on to the next generation. That’s what these channels are focused on. If you’d like to come and join us, if just the short hour in the YouTube on the interwebs is not enough for you, come join us in Dallas, Texas, December 4th through 6th. We have our live tax and asset protection event. It is three full days, all tax asset protection. We go over nonprofits. We talk about estate planning and so much fun stuff. We get people coming again and again to those things. It’s really nice to see them in person.
Eliot: It is. It’s like a traveling group.
Amanda: Our groupies. It’s really where our groupies come to say hi. Tickets are only $99. Scan this QR code. These events do sell out and they do sell out quick. If you want to come join us in Dallas, beginning of December, please do. All right.
If you can’t join us for free full days, or if you’re nowhere near Dallas, Texas, we’re always available online, our Saturday Tax and Asset Protection webinars. Tip your toe in. It’s one day, starts at 9:00, ends around 4:00-4:30. You get the tip of the iceberg though. If you’re just joining us for the first time, you’ve never been to Tax Tuesday before, this webinar is a great place to start your deep dive into tax and asset protection. The next one is Saturday, October 11th, then Saturday, October 18th, and then we have our three-day event. A lot of people end up going to the webinar maybe two or three times, but everyone ends up at our big event.
Eliot: It really does. It’s a great place to meet people and talk business, strategy, and things like that.
Amanda: Even those attendees that are already clients who I have seen come two, three, or four times, they’ll still come up and say, I learned something this weekend that I hadn’t heard before. That’s just it. You build on it. You maybe are taking one or two things and implementing them one year, and then every year you’re just trying to build it better and better.
Eliot: That’s exactly right.
Amanda: That’s exactly it. If you’re ready to become a client, you can schedule a free strategy session here where you will get a 45-minute session with a senior strategist, where we can discuss your specific situation. You can get your questions answered here. You’re going to hear some info on some tax questions that were submitted. If you want to do a deep dive into your personal situation, your assets, your goals, then sign up and use this QR code to do that strategy session. These are free, no obligation whatsoever. Come see what we’re all about.
All right. First question. “I made a Roth IRA conversion earlier this year and am currently in the process of doing another conversion. We have invested in oil and gas to help offset taxes due. Is there a concern that we’ve invested too much?” First, let’s talk about retirement plans, IRAs, and the difference between a Roth and a traditional.
Eliot: Absolutely. Typically on your traditional IRA, one puts contributions in, you get a deduction for it, and then it grows tax free all that time until you retire, then you take out, and then you pay taxes on the things that have gone up in value over all those years. A little bit different, it’s still called an IRA, but the Roth, there, we put in the contributions, but we don’t get any deduction. Yet again, it grows tax free. Then later on when we take it out, we don’t have to pay any taxes.
That’s the big dividing issue between the two. Your Roth, you put in, you don’t get any deduction right away. It grows tax free. You take it out later on, tax free. IRA traditional plans, same incidentally with 401(k)s. You put in, you get a deduction, grows tax free later on, and then you pay the taxes when you take it out. We also have the same thing with 401(k)s. You can have a traditional 401(k). You get deductions when you put in, grows tax free, and pay taxes when you take it out at retirement or Roth 401(k), which acts like, of course, a regular IRA Roth where you put in and no deduction, and then you take out later on without paying any taxes.
Amanda: Even with 401(k), it will often be both Roth and traditional with the same plan you can allocate. A conversion, we’re typically converting traditional IRA funds over to a Roth. It’s similar to a rollover, but there is going to be a tax effect. Eliot, why do we see people doing these conversions so often?
Eliot: It’s a great question. We do see it a lot because people would like to get it out of that plan that later on they know in retirement, they’re going to pay taxes when they take out their distributions. That would be, again, your regular, traditional IRA or your regular 401(k). If they move it over now and convert, then it will be in the IRA. They will pay taxes on conversion when they move it over. In that year, you pay taxes, but then it’ll be part of the Roth component, and it will grow tax free. When they finally retire, they don’t have to pay any taxes on that. That’s why we see it a lot.
Amanda: The conversion though, because you are recognizing that amount as taxable income, your taxes are going up.
Eliot: Exactly right. That’s where we are here in this question. They did a Roth conversion. They went from a traditional IRA, moved money over into the Roth component. Let’s say it was $50,000. Then they’d have taxable income of $50,000 on that. To counter that, they thought way ahead. They already had tax planning going on. They invested in oil and gas.
Amanda: We love it.
Eliot: Right? We talk a lot about oil and gas. That’s a special investment. If you have what’s called a working interest in it, that’s special for the oil and gas arena, then you can go ahead and take a deduction typically or a significant deduction right away when you put that investment in. Case in point example, you put a hundred thousand into it, you got the working interest. You will usually see anywhere from 65% to maybe 85% of that hundred thousand deducted immediately. It’s not that you don’t get deduct the rest, but those will typically be depleted over time, the next five to seven years or something of that nature. I think of depletion like depreciation, but it will happen for that other remainder.
Amanda: 65% to 85%.
Eliot: Correct. That’s the range we see.
Amanda: That’s an estimate. The reason that you get it is because it’s not really an investment. You’re actually starting an oil and gas business. It being an active business, it’s business loss, essentially. Those rigs cost a lot of money to build and set up, and you’re typically waiting several years to get a return. Those returns often last a very long time.
Eliot: The nature of the expenses actually that are going into it, if you ever really get into the detail that go into this, they really would be deductible in about any other business. It’s not really why they may think that oil and gas is getting a special provision here in the code. It’s really not. These are expenses that otherwise would be deductible, so they can’t really say they’re in business until they get oil or something. They start pumping and that can take some time.
Amanda: Then we run into excess business loss limitations here. How does that work?
Eliot: Right. The principle being here, again, remember we start off with a conversion, first of all. We have this income on our return, and now we’re trying to take deductions. If we knew exactly how much we’re going to be able to take as a deduction, maybe we don’t run into any problems. I got $50,000 of income coming in, so I’ll do an approximation of $50,000 of deduction. Maybe we don’t know that, or maybe that investment has a minimal amount that you have to put into the oil and gas, and it could be quite substantial.
The excess business loss limitation would say because this is a business, when you invest with a working interest that you are limited to approximately $626,000 if you’re married filing joint, $313,000 single. That’s the most business loss that you can have on your return. They would take all your businesses together that you’re participating in and see if you’ve gone over these amounts. Let’s say you’re married filing joint and you had a $750,000 deduction from this oil and gas, you’re going to be limited. You’re going to be capped out at $626,000.
Amanda: You’re having to invest a lot of money into this oil and gas business to hit that deduction amount.
Eliot: It would’ve converted quite a bit.
Amanda: Yeah. To hit that $626,000 for a married filing jointly couple, you would have to invest nearly a million dollars.
Eliot: Yes, that’s right. We do see it. We don’t see it every day. Certainly it’s not the average, but that does come up. With some of these investments, you always want to remember that there’s an excess business loss limitation out there.
Amanda: Never fear. Is there a concern that they’ve invested too much into oil and gas? You may be limited to the amount that you can deduct this year, but the loss carries forward.
Eliot: Excellent point. It’s exactly right. Yeah. We get to carry that forward to next year. Nothing to really be afraid of as far as from the aspect that you’ll never get to see a benefit. It just won’t happen this year, that’s all.
Amanda: Yeah. This is great because if you’re in the highest tax bracket, if we’re in the 37% tax bracket, for every hundred thousand that you are taking as a loss, that’s $37,000 in taxes that you’re not paying.
Eliot: Correct. That’s exactly right.
Amanda: A lot of bang for your buck there.
Eliot: It is. I really love that they’re taking advantage of a situation where they’re getting money into something that’s going to grow tax free. They get to take it out later at retirement tax free, and they’ve already planned. They already got an investment to help offset that. I think that’s pretty wise now. I will say that there are different opinions on the conversion. If you convert too late, if you’re older, when you do the conversion, we have to think in the back of mind. How long’s it going to take me to make up that investment in my portfolio, my retirement?
There might be one of the reasons. I know Toby talks a lot about that. That’s the reason probably, maybe I wouldn’t be a fan of the Roth conversion, but teach your own. Again, you found a way to offset that tax, so that’s really good.
Amanda: Yeah. You do really have to run the numbers because you don’t want to do the conversion and have, at the end of the day, that conversion cost you more than what you’re able to recoup after the fact.
Eliot: Correct. Yeah.
Amanda: All right. “I have not had any activity in my C-corp, so zero revenue, actually lost money of $26,000. Do I still need to file an 1120 corporate tax return?” This is a common misconception, right, Eliot?
Eliot: It is.
Amanda: The obligation to file your tax return for a corporation is based on the activity of the business entity. It’s actually not. It’s based merely off the fact that your business entity exists. Why do people think this?
Eliot: That’s a good question because we get this a lot with partnerships. We might have a different answer here. A partnership, for whatever reason, the code treats it differently. It says if you really didn’t have any activity, no income, no expenses, then you may not need to file a 1065 partnership return. We run into that quite a bit. We set up a lot of partnerships. We set up a lot of all kinds of entities, but we do run into that a lot with partnerships. People wondering, do I really need to file a 1065 return here? Maybe not if we didn’t have any activity. People start to hear that and they think, is that the same with our C-corp?
Amanda: It applies to everything.
Eliot: Right, exactly. C-corp, S-corp. No. As Amanda pointed out, the fact that it exists, it’s going to have to file when it has that corporation word in it, C-corp, S-corp. What about your LLCs?
Amanda: LLC taxed as a C-corp, LLC taxed as the S-corp. Same thing.
Eliot: Exactly. Amanda: That leads to another misnomer because if we say no activity, to me, there’s never an entity that has no activity. At minimum, you are paying the Secretary of State for the privilege of doing business in whatever state your business entity is registered in. Plus, you have to have what’s called a registered agent, which is typically a company that you’ve hired for X amount of dollars a year. That is there to receive service of process, meaning that if your business is sued, that is who gets served.
A lot of people will cut corners and act as their own registered agent, and we don’t want to do that for two reasons. (1) A registered agent needs to be at the same location. That location is listed on the articles filed with the state during normal business hours. During Covid, a lot of us who set up businesses were like, yeah, I’m here all day. I’m not allowed to leave my house, but we’re not in that situation anymore. If you’re leaving your house at any point of the day, you actually don’t qualify as a registered agent.
(2) The second reason we don’t want to serve as our own registered agent is for anonymity purposes. If we’re able to run our business anonymously, there’s no reason to put our name on it. There’s no reason to list our home residence there. At minimum, every business entity, LLC, partnership, corporation is going to have a state filing fee and a registered agent fee. Technically, this isn’t considered business activity, but these are expenses. If you want to capture those expenses and deduct those expenses, you’re going to have to file that tax return.
Eliot: If you wanted to. One can consider they’re not operational expenses. The fact that they have anything to do with the actual ongoing operational activity, that’s true. For that reason, that’s why a lot of the times we don’t with the partnership, don’t file. You’re also right. Any expenses that you may have incurred and you didn’t tell anybody about it, they will be lost on the next return. These returns for partnership go from January 1st to December 31st when we’re talking about individuals being the partners. You want to file.
Amanda: In this case specifically, they say they have $26,000 of lost money, which I’m assuming those are business deductions, common, ordinary, reasonable business deductions. If you want to capture that loss for future years to offset future income, then you’re going to have to do that by filing that tax return.
Eliot: That’s correct. Yeah.
Amanda: There is a small scenario where a partnership may not want to file a tax return, even if it does have some loss. That’s if…
Eliot: If we’re late.
Amanda: If we’re late. Penalties for filing a late return for a partnership are based on the number of months you’re late and the number of partners.
Eliot: It is, and it’s over $200 per partner per month. Same with an S corporation. We’ve got shareholders. We’re just changing the terminology from partner to shareholder, but it’s the same bill. You got to cut to the IRS if you’re late. It really behooves us to make sure we’re on top of this. If you got any set up, make sure that you know what it is, what its obligations, if any, to file R and things like that from the get go so we don’t run into this situation, because $26,000 is a lot to maybe not take as a deduction potentially.
Amanda: Yeah. If you are going to forego that partnership tax return to avoid the penalties, it’s got to be the first year. You’re not going to be able to just do that in a year. Don’t think you just found new one.
Eliot: Yeah.
Amanda: It’s going to be the first year if you happen to be late. Again, still no reason because if you file a late partnership return in your first year, you can typically just ask for forgiveness. That’s pretty regularly given for partnership returns from the IRS.
Eliot: The IRS is very generous at giving out the first time abatement. By all means, they don’t have to. They’re very good at usually granting that.
Amanda: IRS is always nice. I don’t know what you’re talking about.
Eliot: They really are. Every time I’ve dealt with them, I got to say the IRS has been fantastic. I’ve never had a bad agent. There was one, but maybe 50 plus calls before I get to a bad one. They’re really great to work with.
Amanda: It’s actually just the code that’s mean.
Eliot: Yes.
Amanda: All right. This is the beginning of our three part questions. We’re setting the scene. “We are thinking of taking our short-term rental out of service. When we take that property over as our primary residence, what are the tax implications if we sell our existing primary residence and then move into that short term rental?” First off, let’s start with just selling your primary residence. What are the tax implications there, Eliot?
Eliot: We always have to go back and find out, what did we purchase it for? Our original purchase price is our original basis, so we can just pick up a number. Let’s just say we purchased it for $500,000, half a million. That’s our purchase price. Things can happen over time that change that. Maybe we had some business going on there, and we took some depreciation while we would subtract that. That doesn’t usually happen in a primary too often, but it could be.
Also, maybe you made improvements, maybe you added on a new room or something like that to the house. That would increase your basis. If we added on something that would increase our $500,000 basis, now, that’s just on the primary. At that point, when we look at it from the standpoint of selling it, then we got to take into consideration what we’re selling it for. Maybe that was $750,000 that we’re selling it for. We subtract this adjusted basis, which we’ll say is $500,000. That will leave $250,000 of gain. That would ordinarily be what we’d pay tax on.
We know we’ve talked many times that there’s section 121 that can exclude some of that gain. If you’re married filing joint, we can deduct up to $500,000, half a million of the capital gain. If you’re filing single, it’s $250,000. We’re going to calculate the initial gain, take away, in this case, either $250,000 or $500,000. We’re not going to pay any tax under 121, but to get to 121, we have to own it and live in it as a personal residence for two of the last five years. We got to meet those requirements. But if we do, then there’s no reason to think that we’re not here. But if we do, then we would wipe out and there’d be no gain in this particular scenario on the selling of the primary.
Amanda: Yeah. Exclusion here. The two out of five years doesn’t have to be consecutive.
Eliot: No, it doesn’t.
Amanda: In this scenario, it most likely is consecutive, but it really is 24 non-consecutive months. If you are moving, coming back, this is a strategy that take out the fact that this couple has a short-term rental and is moving into a rental property that they used to own. If you have a primary residence, you’ve lived there for two of the last five years, and you own that property, you can exclude up to $250,000 for single filers and $500,000 for married filing jointly. Now, how does the short term rental then play into this?
Eliot: Now we’re moving into the short term rental. We’re going to call that home going forward. Originally, we purchased that at one point for a certain amount. Again, let’s say it was $500,000 we purchased that for, but we did rent this one out. We had it in the business. We took depreciation over time.
Let’s say that depreciation was $200,000. Now our adjusted basis goes from $500,000, less $200,000 down to $300,000. We also made some improvements in it. We added on an addition for a hundred thousand. Our basis goes up, so it’s $400,000. That basis carries over to become our basis in our new home. We don’t look at fair market value. That has nothing to do with it. We continue on with the basis.
Amanda: That basis is important because of depreciation.
Eliot: Exactly. If we ever want to sell it in the future, we’re going to come back to that same analysis we just did on the first house that we sold because now it’s our primary residence. We have to look and walk through all the terms there. If we’ve had some time where we had it as a rental, let’s say five years as a rental, and we live in it for the next two years after that, what Amanda was talking about, the two years out of five years ownership and using it as a personal residence, but we’ve voted for a total of seven, only two compliant, the other five we call non-conforming years, who really cares?
The code says that we have to take a ratio, five sevens in that case, five by seven. That percentage, we take that times whatever gain we have if we sell it, and that’s the gain that cannot be excluded under 121. We do care, and we want to make sure we get all the basis we can because that’s going to help limit any future tax consequences.
Amanda: The depreciation from the rental gets added back into the basis, and then the rental use is going to create some percentage of the 121 that we’re going to be able to use when we eventually sell that short-term rental that we’ve turned into our primary residence.
Eliot: Yeah. We run into a situation there, where the 121 exclusion would be much less than $200,000 in our example here where it was just the primary. In that case, all numbers being the same, that would be five sevenths of that $200,000, which I can’t do in my head, but that would be the amount we can’t do.
Amanda: All right. Now we have a slightly different tweak on the same scenario. Again, short-term rental, primary residence. In this situation, we are turning the existing primary residence into a short-term rental and moving into the short-term rental. Instead of selling same situation, we’re moving into our short-term rental. It is now our primary residence, but instead of selling our primary, we’re turning it into a short-term rental.
Eliot: It gets a little confusing. Okay, existing primary residence, they turn it into short term. We have to go back to the same thing. What did we originally purchase this at? We always have to know that basis, that purchase price. Again, we have to go through, was there any depreciation? Were there any improvements? It’s our primary. Maybe we didn’t do anything like that. That’s fine.
That basis, when it becomes a short term rental, whatever we purchase, let’s say we purchase for $500,000, it just moves over and becomes the new basis on that new now short term rental. Why do we care? Because the short term rental is now in business, and now we do have to depreciate. We want to depreciate. Straight line for commercial billing would be 39 years, so we take the $500,000 and divide it by 39. Remember, we always subtract land first, but assuming that the building itself is $500,000 now. Divide it by 39 years, that’s going to be your straight line depreciation that you take each year.
If you turn it into a long-term rental, that’d be fine too, but you divide it by 27½ years. That’s the depreciation. That’s why we care. We always have to go back to that original purchase price. Was there any depreciation? Were there any improvements? Because we got to know that adjusted basis.
Amanda: Yeah. Can we do bonus depreciation in this situation?
Eliot: We always have to go back and look at what the bonus depreciation rules were at that time. We couldn’t really exactly say in this scenario, but what we can say is that you can do a cost segregation. The difference, a cost segregation, that’s the one that breaks it out from being all 39 year property or all 27½. It says, a component of that is maybe some five year carpet, some 10-year lights and wiring or something like that. That would at least speed up that. Whether the bonus depreciation is going to be available or not. It’s going to depend on some other factors about when we purchase, when we put in the service, and the rules in existence at that time.
Amanda: If this couple had been living in their primary residence for two decades, the depreciable basis may not be very high.
Eliot: It could be real low.
Amanda: It could be very low. What can we do? We love to come up with creative solutions. In this instance, you can always sell your primary residence to your S-corp.
Eliot: I bet we have a video on that.
Amanda: I bet we have a lot of videos. If you want to go to Toby’s YouTube channel, we have several videos. I teach this strategy in our Saturday webinars quite frequently. How does it work? We are selling to our S-corp at the current fair market value, which is then bumping up our basis to that amount.
Eliot: Exactly. What Amanda is saying is once we have that house in our S-corporation, we don’t depreciate over that prior low basis. We got a stepped up basis to what the fair market was that the S-corp bought it at, which could be significantly higher. We depreciate from that.
Amanda: Let’s just say for example, the basis was $200,000 for our primary residence, and then we sell it to our S-corp for $700,000. Now, our depreciable basis is that $700,000. What can we then do now? Does anyone remember 121 exclusion? That allows us to exclude up to 500,000 if we’re married filing jointly, which it sounds like they’re using we, so married filing jointly. That sale is actually going to result in zero capital gains tax for this client because of that 121 exclusion.
Eliot: Just a cautionary note here. Let’s say that the gain was higher than that. Let’s say it was $600,000. We got to wipe out half a million as Amanda just pointed out, but we still had a hundred thousand. Maybe we can just recognize that gain over time in installments. No. When we’re selling to a related party such as our own S-corporation, we got to recognize all the gain in that year. That’s something that could come up and surprise us that we may not be aware of, so we want to just keep that in the back of our minds.
Amanda: Yeah, we do need to recognize all that gain to get that benefit there. Speaking of where to hear more about selling your primary residence to your S-corp, subscribe to Toby’s YouTube channel. If you’re joining us on YouTube, you’re already there. Just hit that subscribe button. You’ll get a notification each and every time he comes out with a new video. He was here in the studio earlier.
Eliot: Yes, he was. We tried to get him in.
Amanda: Clint Coons as well. Quick search for Clint Coons. Hop on over, subscribe to his channel as well. Tax and asset protection, they go hand in hand. What makes Anderson so unique is because we speak both languages. How often do you go to your attorney, you have a tax question, and they say, go ask your CPA? Then you ask your CPA, you have a legal question, and they say, go ask your attorney. You’re stuck in the middle and you don’t speak either language. Never fear. That’s what we are here for. We speak both languages.
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Eliot: It is. It’s great.
Amanda: Some people say you guys are too goofy. Be serious. Taxes are serious, but no. Taxes and tax planning, as we just saw in that last example, can actually be pretty fun.
Eliot: Yeah, it is. It’s a lot of fun.
Amanda: Raise your hand if you like to save money. Yes. Thank you. That is fun.
Eliot: Yeah, we usually get a positive on that.
Amanda: All right. Same scenario. Primary residence, short-term rental. In this situation, we are turning the one will stay or will become the primary residence, and then we’re keeping the other as a vacation home. We are out of that headache of a short-term rental business. We just can’t take it anymore. We want to enjoy our lake house, and we’re going to turn it into our vacation home. What are the tax issues that we may need to think about?
Eliot: First of all, again, it would matter if we are moving from our primary into that new. Let’s say it’s the beach front house. Same concept. That basis, we want to know what it is that’s going in and what it was. We’re not using it for a business purpose, but we still want to know if we ever sell later on. We want to keep track of what year we sold. You think that’s easy to do? A lot of people forget over time. Because if 121 came into play, remember two of the last five years, you’d be surprised how many clients I meet that, well, I can’t really remember what year we moved in. They have to go back, go dig in for information on that.
Those are the tax things because the 121’s going to probably come up again. We were throwing ideas out there. What if we do have this lakefront property and we do just rent it a little? Not a whole lot, just a little. If that’s the case, you’re staying presumably enough over 14 days, at least, as a second home or something of that nature. If you did feel inclined to rent it out a little bit, then just know that more than likely, your deductions for that rental activity are going to be limited to the amount of rental income you get. That’s called the Vacation Rules.
What the IRS is saying is that you stay so much in that second home that you’re going to be limited to the deductions up to the amount of rental income. We’re not going to let you create losses on it. There are other considerations as well because for both properties, you may have a mortgage. You have mortgage interest. That mortgage interest all comes onto your Schedule A if you’re itemizing your deductions. That would be another tax consideration as well as the property taxes.
Amanda: Yeah, because there’s no longer business use of these properties at least if you’re not planning to rent out that vacation home even a minimal amount of time. Things like mortgage interest, HOA fees, taxes, insurance, utilities, landscaping, pool cleaners, those are no longer deductible. You’re still going to have those costs for your vacation home, but we are then shifting some of those costs if you are not taking the standard deduction.
If you’re itemizing, there are still some limits. On Schedule A, you can only deduct up to $40,000 of state and local tax. Now, if you were fully deducting the state and the property tax on your personal residence and you would have to have a pretty big property to hit $40,000, we’re now adding in the taxes for that vacation home, and you may butt up against that $40,000 limit for the state and local taxes. Again, you can get some mortgage interest deduction. If you’re itemizing your deductions on your Schedule A, that’s going to be up to $700,000?
Eliot: $750,000, I believe.
Amanda: $750,000.
Eliot: That’s a change with the new bill.
Amanda: With the OBBA, One Big Beautiful Bill Act. Those are some of the limitations there. Again, if you did rent it out, you would be able to take all those normal deductions you were taking as a full-time rental property, but they’re going to be limited to the amount of income. It reminds me of the hobby loss rule for a sole proprietor, for disregarded entity.
Eliot: Exactly.
Amanda: They’re going to let you deduct the business use portion expenses, but they’re not going to let you take a loss that you’re going to then get to put onto other parts, offset other types of income.
Eliot: Correct. You got it.
Amanda: That was a big one.
Eliot; It is, yeah.
Amanda: These are the things that you have to think about and where planning comes in because same starting scenario, a primary residence and another rental property. Whether short term or long term, that doesn’t change the way that we analyze this situation. Which one do we want to live in? Which one do we want to to sell? Do we want to sell? Do we want to keep one as a vacation home? Where are we going to end up better from a tax perspective? Maybe that final factor helps you decide between these three scenarios.
Eliot: And maybe some tax planning.
Amanda: Tax planning. All right. “We do not have an education savings set up for our son. We didn’t like the limitations of the 529 plan.” Not uncommon. “Or know if he would even go to college.” Also, not as common as it used to be. “He’s now a junior in high school.” My son is also a junior. This question speaks to me. “Is there any other option, something we could do now to be able to pay pre-tax?” Using pre-tax dollars for education. “Our income is from rentals, some W-2, and other income.” We don’t know what that is, but this couple also has Roth IRA and 401(k) plans. Let’s start off, just defining what a 529 plan is, what the benefits are, and why it may not be like these people decided 16 years ago. Good way to save for college.
Eliot: First of all, the idea is that you put money in this plan. You don’t get a deduction for putting into it, but it does grow tax free towards education expenses. What all that means has changed over the years. It’s a better 529 that’s out there today than was maybe 16 years ago. It used to be that the states allowed this plan, and you could only use it for state universities or maybe even for a specific university in that state. It was very limiting. If you live in Missouri and the child wanted to go off to school in Florida somewhere nice, you would be limited and not be able to take those deductions or use those funds towards that school. It has advanced a lot.
Amanda: That’s broader.
Eliot: Yes, it is. What it will pay for, I don’t think you could get room and board. We did a deep dive on that trying to find out which plan.
Amanda: Qualified education expenses, including tuition, books, fees. You can use it for room and board now. Both the Secure Act of 2022 and the Big Beautiful Bill Act made substantial changes. Because these two laws came out so close together, it’s hard to really give credit. Does not matter? Who is responsible for it? If you have a 529 and your child doesn’t use it, you can now roll that into an IRA, which is for their retirement.
There are some limitations to that. You can roll over up to $35,000 maximum, and you do have to roll it over in $7000 increments or whatever the individual contribution limit is. Essentially what it is it’s taking that 529, allowing your child to treat it as earned income, and then contributing it to an IRA or a Roth IRA. The fund must have been open for 15 years. In this example, if this couple had started a 529 for their son 16 years ago, and then he decided not to go to college, he could roll that into an IRA.
The rollover cannot include contributions or earnings from the last five years. You would be rolling over that first chunk of money that you had put in 15 years ago, and then you would keep doing that over time. Max, $35,000 total. You can also roll these over into ABLE accounts.
Eliot: Correct. An ABLE account for those of you aren’t familiar, it’s basically like a 529. It comes under the same code section 529-A. It’s for disability expenses and things like that. It’s a fantastic plan to have out there to help meet the needs and expenses of those who maybe have certain disabilities. I don’t know the full breadth of what exactly is required or what meets the various definitions of that, but certainly a very good use of those funds if we need to roll them over there.
Amanda: That’s not going to disqualify the beneficiary from any state or government assistance. With the Big Beautiful Bill Act, the 529 was further expanded to include both private and religious school education, elementary and secondary education, even tutors, as long as the tutor is not related to you. The annual distribution limit was increased to $20,000, which can be a drop in the bucket quite frankly for how much these schools cost these days.
Eliot: Yeah, and it goes to trade schools as well. That was a change made I think in the Tax Cut and Jobs Act. I think it’s where we got that. A lot of benefits for this. Again, 16 years ago perhaps when we were trying to think about setting this up, maybe it wasn’t as nearly as flexible as it is today.
Amanda: For this couple, they don’t have one. What are we going to do? We can still pay for school with tax free dollars.
Eliot: Yes, we can.
Amanda: We’re going to do it by paying your son directly.
Eliot: Exactly. One plan that we came up with, it was mentioned in here that we have some rentals. If you had a rental property, maybe you’ve talked to Anderson and we’ve set you up in an LLC to surround that, keep it protected for asset protection purposes, if that’s the case, what if we pay the child through one of those LLCs as a W-2 wage? If it’s under $15,000 approximately, the standard deduction, then the child will pay no income tax at the federal level, and they won’t have to pay.
As long as they’re under 18, they won’t have to pay any employment taxes as well. It’s just the same as having to pay this expense somewhere out there, but now you get a deduction because that’s going to be an expense against the rental income. If that creates a loss, if it does $15,000, you do junior year and senior year, pay this child, if that creates a loss, then we have other factors such as passive loss rules or something like that to look at. Still, this is a way we can get that on your return, get a deduction, and it’s not taxable income to the child.
Amanda: For W-2, that’s no payroll taxes.
Eliot: And no federal income.
Amanda: If they’re paid below the standard deduction, so less than standard deduction, that’s no income tax.
Eliot: Correct. At least at the federal, you just have to look at that state, but very likely it might be no state tax as well.
Amanda: All right. This is for W-2. What if I pay my kid a 1099?
Eliot: Still get some benefit. The child would have to pay employment taxes on that income, so we’re still going to hit that. But if it’s under $15,000, approximately, again, the standard deduction, there wouldn’t be any income tax, but we’d still have the employment tax. That’s going to be approximately 15.3. They’d get half of that back actually on the return, so it’d be about 7.65%.
Amanda: Paying them a W-2, this scenario at the bottom and paying no payroll tax and no income tax. Can I do that in any type of business entity?
Eliot: Great question. No. It has to be a disregarded or owned by one of the parents or a partnership where the parents are the only partners of it. We are limited. We get this question a lot with that trading structure that we often set up. We talked about this a couple episodes ago, where we have maybe a C-corp that owns some of our trading partnership. That wasn’t the case here in this question, but could we do it there? Could we pay them through that limited partnership because it’s owned by mom and her dad, but it’s also owned by a C-corp. The code says, no, we can’t.
Amanda: Yeah, my husband and I looked at the strategy. I have three step kids. This strategy would’ve only have applied to our younger three kids because we’re the mom and dad. My three step kids have a different mom, so my husband and I’s partnership would not have been able to pay them a W-2 and have them avoid those payroll taxes. They may still get paid $15,000 below the standard deduction. They may still pay zero income tax or more in this 1099 scenario. There, we’re still going to overall pay that self-employment or payroll taxes scenario.
Is there a situation where you don’t have a partnership? Let’s say you’re an active business owner, you’ve got an S-corporation. Would I choose 1099 or W-2? Does it even matter?
Eliot: In the long run, I don’t know that it really does because either way your economic unit is paying, including the child, 15.3%. I’m not seeing a whole lot of difference myself.
Amanda: Yeah. I’ve seen one scenario where a client in California, as the case usually is, they were hiring their child, their child was going to be their only W-2 employee, so they didn’t have other employees. The red tape and the additional cost to set it up, have an outside company cut payroll checks, and the workers’ comp issues just made it too complicated, so they ended up just giving him a 1099.
The thing is your kid does have to work though. He does have to do job, and you can only pay him a reasonable salary for whatever job he’s doing. That job has to be something that a junior in high school would be able to do. That’s not hard though. We find jobs for everyone. We had a client who had a nonprofit, and he was paying his son who was just six years old to sweep the floor. That client got audited, but sweeping the floors is a perfectly normal job for a 6-year-old child. My kids would not even be good at that, but we could pay him a reasonable salary to do that.
Eliot: I’d pay him for the artwork. My whole office is filled by artwork by her daughter. I’d pay for that.
Amanda: For a junior, what type of activity? For a rental property business, what kind of task could a junior reasonably do?
Eliot: If there’s mowing yards, of course that’s what I had to do.
Amanda: And light bulbs.
Eliot: Yup, all that. We had coin operated machines, so I had to go get the change like that. Maybe they do know something about bookkeeping. It’s not unheard of at that age. They could do some of that, certainly things around the office, so to speak, office things, shredding paper, so on and so forth, cleaning.
Amanda: Managing the Zillow or listing, taking the pictures, cleaning the house. If we’re talking about my junior in high school, very little he could handle. Very little, but some juniors out there can handle quite a bit. For smaller kids, a lot of times parents will pay them as a model. If you’re doing any promotional material, if you have a website, paying your child to pose in pictures for that. I don’t know for passive rental properties. We’re necessarily having a website or any type of marketing material for that, but we can find some things to do at least $15,000 worth of job to get paid over the course of that.
Okay. That’s not our only strategy though. You don’t have to pay your kid. That is one option. $15,000, again, a drop in the bucket for how much college costs these days. What else can we do? We’ve got these two other retirement accounts, so can we get access to these retirement funds to pay for our kids’ school? Let’s start with the 401(k).
Eliot: Yeah, we might be able to. We can certainly take out a distribution, but that’s going to be taxable and probably get hit with a penalty. Maybe that’s not our option. 401(k)s do have something else we can do. We can take loans. I think you were looking at the loan limitations. What is it? $50,000 and 50% of the vested, whichever is lower.
Amanda: You can take a loan out from your 401(k) for up to $50,000 or 50% of the vested amount. You do have to check with your employer to make sure that it offers it. If you are with an outside company and you have a 401(k) with them, it’s less likely they will offer you or you’ll be able to borrow from it if it’s a larger group plan. But if you have a solo 401(k), all of the solo 401(k)s that Anderson sets up for clients have this ability to take a loan. A lot of our clients actually took advantage of this during Covid when everyone was out of work to have some spending money.
A solo 401(k) that you’ve set up that is self-directed investments, maybe you’ve taken your IRAs or other 401(k)s from companies where you’ve separated from service and rolled it into this solo 401(k). You’re going to be able to do that. If you have an old 401(k) from a former employer, and that fund or that retirement plan doesn’t allow you to do the loan, then we can get you set up with that solo 401(k). You roll it in, and then you would be able to do that loan there.
Again, it’s all going to depend on how the plan is written. You need to charge a reasonable interest rate, and that’s going to be based on the AFR, the applicable fed rate, which is published by the Treasury once a year in July, and then you’re going to pay that loan back over the course of five years. If you’re taking $50,000 out, you’re paying it back $10,000 a year over five years. The amount that you don’t pay back is going to be treated as taxable income to you and be subject to penalty. You do want to make sure that you’re paying it back. A second best solution to paying your kid if you’ve got extra income coming through. If you don’t time it right, if you don’t manage that loan correctly, then you’re going to get hit with some income tax there.
Eliot: Yup.
Amanda: What about the IRA, Eliot?
Elio: We do have different provisions here, where a parent can take out and use those funds towards a child’s education without getting hit with the penalties. In this case, it’s a Roth, so maybe we wouldn’t have any taxable income coming out if we were only taking out amounts that we’d put in. That’s something we’d want to look at too. You could do this with a regular IRA as well. They both say that you can take the money out and not get hit with the penalties, so that’s pretty critical to be aware of.
Amanda: Yeah. With the Roth though, it’s not going to be considered income. If you take it out of that traditional though, it will be considered an income. You just won’t get the penalties if you’re not over 59½. For Roth, the amounts that you’re pulling out have to have been in the account for five years though.
Eliot: Since we’re talking potentially higher education here, maybe college, trade school, or something of that nature, if we were also looking for federal assistance to FAFSA, my understanding is that if it did come out, these funds did come out, that they could be considered as income for the next year, the second year, you want to be aware of that as well. Those things seem to be quite complicated to determine what’s on a FAFSA and what’s not. I haven’t seen one myself in a long time.
Amanda: It’s been a while.
Eliot: I think they’ve only made them more complicated if I had to guess. I’m sure they didn’t make them easier. I wouldn’t bet on that.
Amanda: A lot of options. Some better than others depending on how much you have coming through your rentals, how much are in your retirement plans, and such. Kids can always just go get a job too. That’s what we did to ours. Go get a job. All right, there you go.
All right. “Would you please go over some of the benefits of the new Big Beautiful Bill for small business owners? We did a full hour and a half almost going over all of the provisions of the Big Beautiful Bill. That’s going to be on Tax Tuesday back in July on Toby’s YouTube channel. He also did a pretty long one with Scott Estill, which is our good friend. A former IRS attorney, now hangs out with us, helping people save taxes instead of going after people who didn’t pay their taxes. Where do you want to start? Let’s start with bonus depreciation, depreciation, and section 179.
Eliot: Yup, okay. We got the a hundred percent bonus depreciation back. Why do we care? If we get equipment or something like that, we can certainly deduct. Most small businesses do have some form of equipment. Maybe they have vehicles or something of that nature. If it’s over 6000 pounds SUV, we got that hundred percent immediately deductible, things of that nature. Probably the most popular one is the bonus depreciation.
Amanda: That’s going to be a lot for our real estate investors. They have been using that, but it applies to all businesses, not just real estate.
Eliot: You mentioned the 179. That’s just almost like a twin. It’s very close cousin to our bonus depreciation, which is under incidentally 168(k). 179 section, it’s saying if you bought certain tangible property that you can take immediately a hundred percent, such as equipment, many of the things that we would do bonus depreciation on, but the difference here is that bonus depreciation can create a loss, which maybe we want because a loss could offset other income. 179 can only be up to the amount of that particular business’ income, so we can’t create a loss there. Nonetheless, we can use it to offset quite a bit.
There was a lot of changes. We went from 1 million of 179 up to 2.5 million now that we can deduct in 179 expenses. That was pretty significant. If we had a whole lot going on, maybe we want to do some 179 just to get it done and use that 2.5.
Amanda: How about R&D?
Eliot: Research and development, clearly this is a little bit more focused. Not everybody’s going to have R&D type expenses. Maybe your programmers and things like that. The big difference is that it used to have to deduct over five years or what we call…
Amanda: Over five years.
Eliot: Thank you, up. That’s changed, where now we can maybe deduct that all at once in the same year. It does depend if those expenses are US based or overseas. If it’s international, then it’s now 15 years I think to depreciate, deduct most of that, or amortize. US based, obviously they wanted to…
Amanda: Encourage US based research and development, for sure. All right. QBID, qualified business income deduction. What is it? How is it better?
Eliot: Yeah. This isn’t new. This came in back with the Tax Cut and Jobs Act in 2017-2018. Really, what it says is if you’re not corporate, if you’re not a C-corporation, you might qualify for up to 20% deduction just for being there. Okay? Of course, like everything, there’s a lot of complication behind it and calculation.
Basically, if you have made a hundred thousand and you’re a sole proprietorship, you’re a partnership, or you’re an S-corporation, notice I didn’t say C-corp, it doesn’t apply to them, but you’d be able to get up to 20% knocked off right away, off your income. It can’t create a loss because it is coming from your net income. It’s going to be based on that. Just some thoughts there. It’s really the answer to the fact that C-corporation’s got a flat 21%. They got that big favor from Congress. They realized that wasn’t fair for other businesses, so they came up with the qualified business income deduction.
Amanda: It was nice because it was just bam. If you had a business, bam, 20%. Just deduction. You can’t go negative though.
Eliot: Correct.
Amanda: It won’t let you go negative. This really wasn’t a change in the Big Beautiful Bill. It’s just that it made it permanent.
Eliot: Yup. There’s a lot that we get into when we calculate this and specialized trader services, businesses that have limitations and things like that. Some of those were changed, some of the limits, some of what we call the phase in, but really it made it permanent. That’s one of the nice things that came in.
Amanda: Permanent. We laugh about that. It’s permanent at least until the next congress and the next administration comes in and changes it, but it’s here for now. Okay. Qualified small business stock, also permanent.
Eliot: Right, exactly. Yeah.
Amanda: How is it different though?
Eliot: What’s changed here? This is a fantastic one. This is C-corporations. If you have a true C-corporation, you have shares of stock in it, you started your business, maybe you can sell it and not pay any tax. That was in existence, but you had to hold it for five years. You couldn’t have over $10 million of benefit like that, and your business couldn’t be over 50 million total when that stock was issued. They increased it, tweaked it a little bit.
Now it says that it’s still for C-corporations on the shares, but you don’t have to hold the full five. If you hold it for three years, you get 60%, four years, 75%, and then if you hold the full five years, it’s a hundred percent. The dollar amount increased to 15 million. Size of the business, I believe, jumped up to 75 million. It became permanent.
Amanda: Permanent. Okay. I’m doing just all the Q letter soup here. Qualified Production Property, QPP.
Eliot: I think this is a really neat one. This is saying if you went out there and found a manufacturing place, it’s in a building warehouse or something like that, you could do your cost savings and your bonus depreciations, but you still got this large, concrete area that they put all the machines on and things like that. That’d still be at 39 years. This comes in and says, look, if it’s manufacturing and you’re building things here in the us, we’re going to go ahead and let you take a hundred percent bonus depreciation on that qualified business, like on the manufacturing floor and things like that. It really enhances the reason why people would want to set up these manufacturing warehouses and such.
Amanda: That’s to obviously encourage more production within the United States. The caveat here is that this production property, so that building with the concrete floor, it needs to be placed into service after July 4th of this year. If you’re acquiring it now, it’s going to count. If you acquired it earlier and you placed it into service earlier, it won’t qualify under this new rule.
Eliot: That’s right.
Amanda: All right. I like this one, 1099. I know this isn’t a huge change. Previously, if you were paying an independent contractor for work that you had done for your business, if you paid them $600 or more, you would have to issue them a 1099. This has increased to $2000.
Eliot: Now you like this one too. I think it was a great one. I’m glad she found it. I missed this one. She found it when we were looking over. It was like, it is a fantastic one, it makes a big difference.
Amanda: Yeah, because this means that I can pay a bunch of people 1099 income, but as long as I don’t pay them $2000, I don’t have to worry about sending them a 1099. Those things can get cumbersome and expensive. They’re due on January 31st of the following year. This is the first tax document you’ve got to get out the door when you’re a business owner. If you’re late, the penalties are steep. The penalties are steep.
Eliot: They really are.
Amanda: Anything for less paperwork, I’m all for.
Eliot: While I’m not part of the Big Beautiful Bill, just make sure that you get the W-4 from all you independent contractors. Make sure they sign that. Don’t be paying anybody until they give you all their details.
Amanda: So that you can actually issue the 1099 with the correct information. This is the last one we’re going to go over, but we call it the salt workaround. It’s not necessarily a change in the bill that applies to small businesses or businesses. It’s a way to piece one part of it with another part and get a benefit. We do this a lot. We take one section of the code that seems like it’s for you as an individual, like 280A. You can rent out your home for 14 days and not claim that as taxable income, but then we combine it with your business to get you an even bigger benefit.
280A, we’re renting out our home. Let’s rent it out to our business instead. Now we are creating 14 days worth of business expenses, and that is bouncing back into our pocket completely tax free. This is essentially what the salt work around does. Tell us how it works, Eliot.
Eliot: That is exactly right. If we have a pass-through entity like an S-corporation, a partnership, or something like that, that entity could actually pay some state tax on its income. We understand the hesitancy. Hey, Eliot, you’re having me pay more tax, why would you do that to me? Because when you pay the state, which is typically at a far lower rate than your federal tax rate, you get a deduction for it at the federal level.
In other words, if you pay an extra thousand dollars in tax to the state, you’re going to get a thousand dollars of deduction at the federal level. If you’re in a higher tax bracket, you come out way ahead, but it doesn’t impact your salt amount because it basically works around that. It’s located in your business, so you still can get $40,000 on your schedule A, so you can still take advantage of that as well.
We’ve had clients where we’ve been able to plan. What would’ve otherwise been taken into account and maybe we would’ve gone over the $40,000 on our schedule A, well, let’s do some stuff with our business so that we can effectively get that tax taken through the workaround by paying it through the passive entity tax. That’s how we would work it.
Amanda: Yeah. Let’s say your personal residence and your vacation home property taxes already hit that $40,000 mark, but you are expecting to have to pay some more state taxes through your pass through entity, you can have the entity pay them instead. You still get your full $40,000 deduction on your Schedule A, and then you’re getting some tax savings overall. Again, a part of the Big Beautiful Bill, that applies to individuals that we’re going to then use combined with our business entities to give you the biggest tax benefit overall.
Eliot: Correct.
Amanda: All right. This one was confusing, tough, fun, and it is long. This submission, they clearly know what they’re talking about. That’s not always the case, but that’s why you’re here. All right. “A lot of the time you talk about the benefit of taking passive losses from a syndication to offset passive income.” I don’t know if we talk about that, but people out there say that. Get into syndications, you’ll get a lot of loss. As this writer in color has identified, it’s passive loss. It’s not as simple as that. He says, “I’ve encountered passive loss limitations, where about two thirds of the losses have been disallowed on my return due to basis or at-risk limitations, excess business loss. Would you please explain how and why the losses are limited or disallowed?” This is very confusing.
Eliot: It is.
Amanda: Agreed.
Eliot: Yeah, exactly. Okay, next question. What’s going on here is that the tax code has some what I’ll call hurdles to get over before you can take a deduction, a loss on your business. We’re talking businesses here. It could be rental, it could be your snack shop, whatever it be, Toby’s Pizza Shop, you name it. Here, because we’re talking about passive, it’s a little bit different. This applies to active businesses as well, just so you know out there. The first is that you have a basis limitation. All that is saying we talk about a lot more in a partnership, but to be sure, it applies to a sole proprietorship as well. There’s no question about it.
It’s just saying that the amount that you put into a business, you’re starting up a business, you put $10,000 in to get it started, that’s your basis in it, and then the business goes out there and spends the $10,000 perhaps. When you spend it, that’s what allows you to take that deduction because you have basis. It will go all the way back down to zero. You’ll just have to take my word for it. Other things happened.
Maybe you took a loan or something like that and you had other cash. Maybe you had more than $10,000 expenses. Maybe you had $11,000, but you only put $10,000 in. It could be that you run into a situation where you couldn’t deduct that extra thousand dollars. You can only deduct the $10,000. That’s what’s going on with basis.
Now, I mentioned a loan. That’s where we start to get into the at-risk. That’s the first hurdle, the basis. Second hurdle is the at-risk limitations. That’s saying very similarly to what we just talked about, the amount of cash you put in plus any loans you took on and things of that nature, which could increase your basis. We go through the first hurdle and then we see if those losses that we were able to take, do they get through the at-risk? Most of the time they’re going to, because as I just said, you put $10,000 in the first example and your basis went up. You are going to get that credit for at-risk. Most of the time, that’s going to count.
Amanda: These are, conceptually, a lot of times the same thing and will be the same thing.
Eliot: It really is. Yeah.
Amanda: They’re not when you really dig into it, but for the level that most investors need to understand, your basis and your at-risk are going to equal each other.
Eliot: Whenever we have lending going on, that’s typically where there’s going to be a difference. If you’re not personally liable for that lending, then the money can come in. Again, you got that situation where maybe you have more cash than you do basis, you spend it, and that’s where you’re going to get a limit. That’s the at-risk. That’s the difference between the two. Often as Amanda points out, they’ll be very similar until we start getting into some kinda lending going on perhaps.
Amanda: What is our third hurdle?
Eliot: Third one is going to be actually the passive loss limitations, and that just says that you can’t take a passive loss. You can only use passive income against it. I should put it that way. You have to have other passive income, and then you could take the passive losses. If you have this business that we’re talking about and it created $10 of passive loss, we got through those first two hurdles and we have $10 a loss, you have to have passive income of $10 to offset against that.
There are special situations, maybe we’re talking about a single family rental on your property. If you have lower income under a hundred thousand dollars of AGI, then you can take up to $25,000. In that case, that’s very exclusive to real estate. You can take up to $25,000 passive loss until your income gets up to $150,000 adjusted gross income. That’s a unique place where maybe someone can take advantage of this.
There’s actually a fourth that they mentioned here at the beginning. In here, they’re talking about the excess business loss. We touched on that earlier. If for whatever reason we have so many losses and it creates over $313,000 single and $626,000 married filing joint, that’s the excess business loss limitation, typically, you’re going to run into that, usually more active businesses. Just so you’re aware that’s what that’s referring to.
Really, the three you’re going to probably worry about here that run into are these three that [PALS 1:11:42] is really the one that really, you think you made it so far down the track and you got that third hurdle, that’s the one where most people get hurt because they don’t have other passive income. If you ever stop that business, you ever sell that business, those PALs are released, then you can use them in against the gain. Not all is lost. Don’t worry. You got to be patient. The losses just sit there on your return until then.
Amanda: In a syndication situation, so syndication apartment complex. You put hundred thousand dollars in, you’re a limited partner, that’s what makes it passive. You’re not actively involved in managing that apartment complex or storage unit. Do those PALs release when you sell your interest or when the original partnership sells its interest?
Eliot: Fantastic. It’d be whichever happens first. Actually, I think in that case, you’d have to sell your LP interest, your partnership interest.
Amanda: It would have to if they did. Right.
Eliot: I would think so, yeah. Most people do at that point.
Amanda: Then your PALs are released. Whatever increase in value occurred, then you’ll offset it with those passive loss.
Eliot: That’s exactly right. Release the PALs, as we call it.
Amanda: Release the hounds.
Eliot: Yup, that’s what we’re doings.
Amanda: All right. That brings us to the end. Please don’t forget to subscribe to our YouTube channel, Toby Mathis, tax wise, Toby. If you are here, you’re already there. Smash that subscribe button as the kids say, and then head on over to Clint Coons’ YouTube channel and subscribe there. They’re a little bit of a competition as to who can have the most subscribers, Toby. Because taxes are so fun and interesting, Toby has outpaced Clint over the years, but he’s catching up. He is catching up.
If you are ready to come see us live and in person, come out to Dallas, Texas, December 4th through 6th for our live tax and asset protection workshop. Three days of taxes, of asset protection, of nonprofits, of retirement planning, only $99. Use the code Tax Tuesday. If you’re just ready to join the Anderson family, scan this QR code. You will get a free strategy session with one of our senior strategists. We’ll go over your goals, your assets, and the things that you are most worried about, and create a customized plan just for you. Many times, these customized asset protection plans come with built-in tax strategies, a lot of which we’ve talked about and touched on today, 280A, 105B, accountable plans, reimbursements, all kinds of things you can do running your investments as actual businesses.
If you’ve got a question you want featured on Tax Tuesday, email us at taxtuesday@andersonadvisors.com. This guy right here goes through each and every question, hand picks and curates the questions we go over every other week at Tax Tuesday. Visit us at andersonadvisors.com. Thank you, Eliot.
Eliot: Thank you.
Amanda: Thank you, guys. We will see you next time. Take care.
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