Today, attorneys Toby Mathis, Esq., and Eliot Thomas, Esq., delve into listener questions around topics like borrowing from your QRP (Qualified Retirement Plan) without it being considered income, utilizing depreciation from syndications as a real estate professional, and writing off Airbnb setup costs. Learn how to establish accountable expense reimbursement plans for your C-Corp, handle taxes for disregarded property holding entities, and calculate depreciation post-1031 exchange. Discover efficient strategies for paying kids in your small business and choosing between S-Corp and LLC structures. Simplify the complexities of C-Corp taxes and learn how to invest in real estate via self-directed IRAs without UBIT implications.
Submit your tax question to taxtuesday@andersonadvisors.com
Highlights/Topics:
- I am 65. If I borrow $30,000 from my QRP, would that be considered earned income?- No. You have to pay back with interest, but it is not income.
- As a real estate professional, can I also take the depreciation expense from syndications against my spouse’s K-1 income? – Generally yes, if you are a REP, and it’s non-passive activity, if there was an overall loss, it can go on your return.
- Can expenses for building and outfitting an Airbnb spent this year be written off next year when the unit is rented? – yes, but it can only be written off after it has been “placed in service”
- How do I establish an accountable expense reimbursement plan for my C -Corp and a medical reimbursement plan? – Have a corp meeting, and adopt the plans with documentation of that meeting.
- If a disregarded property holding entity isn’t taxed when our individual property expenses like taxes, insurance maintenance, and depreciation considered for income taxes? – Any income/expenses must be reported, flowing up into your 1040.
- How do I calculate depreciation after a 1031 exchange? – It’s your original property purchase price, plus any improvements, less depreciation. This again is on the original building you had, the one that we’re going to relinquish.
- I want to include my kids as employees for my small business and I want to pay them in a lump sum annually. What would be the most efficient way to structure that? – If they are under 18 there’s no employment tax, if you are paying them through a partnership or a disregarded entity.
- Is it beneficial to be an S-corp or an LLC if making under a certain amount of money? – You want to be in some kind of entity, to protect yourself from lawsuits.
- What are the tax differences between an S and a C corporation? How hard are a C corporation’s taxes to do? – Yeah, so the biggest tax differences between an S and a C then in a synopsis is the S corporation doesn’t pay taxes, it passes it to its owners.
- How can I use my self-directed IRA to invest in real estate deals without being subject to UBIT? – don’t buy any real estate with any debt or anything like that and make sure it’s a long-term rental, and not a flip.
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Full Episode Transcript:
Toby: Welcome everybody to Tax Tuesday. If that’s where you’re looking for, then you’re in the right place. My name’s Toby Mathis and I’m joined by…
Eliot: Eliot Thomas.
Toby: And we are going to be your hosts today, bringing tax knowledge to the masses. That is what we are going to do. We’re going to let everybody flow into the room and get started.
Before we dive into today’s questions, let’s go over some of the rules. First off, you could absolutely ask questions in the Q&A. There are two ways to ask questions. Chat and Q&A. If you have a question for you, put it in the Q&A. If there’s a comment, like I say, how’s everybody feeling today, then you could write it into chat. If you have comments, put it into chat. If you have questions, put it into the Q&A.
If you have questions when we are not meeting live—the other two weeks in between episodes—by all means, you can email questions to taxtuesday@andersonadvisors.com. That is where Eliot picks the questions that we are going to answer live during these events, so this is going to be lots of fun.
We have a whole staff. I’m looking right now. I see Matthew, Patty, Elisa, Barley, Dutch—oh my gosh, we got a huge team—Jared—oh, a bunch of accountants on—Jeff, wow, Tanya. There’s Troy. Troy, Tanya, Jeff, Jared, Dutch, Barley, Elisa, Patty, and Matthew, all on to answer your questions and to help, which is really awesome.
Boy, there’s the chat. There are people actually, oh my God, someone just posted a book. Put it in the Q&A. Post your books in the Q&A in chat. That just happens too quickly.
By the way, let’s have some fun. Where are you sitting right now? Why don’t you put the city and state so we could see where everybody is located. Let’s see. Huntington Beach, California, Tampa.
Where else we got? There we go. Durham, North Carolina. Now they’re coming through fast. Victorville, Miami. Oh, Miami. Just got a little rain, didn’t you? St. Louis, Chicago, Pasadena. Oh, wow. San Jose, Olympia, Washington, Atlanta, Georgia. There’s Cincinnati. They’re coming through so fast right now. There are 28 that just shot past me.
San Diego, New York City, Gulf Fort, Florida, Alpharetta, Georgia. Look at that. We got people from all over the place. San Diego, Idaho. There’s Jupiter. Do we have any Hawaii in the house? Let’s see if we can find a Hawaii. Usually there’s Hawaii.
There’s Oregon. I got another Los Angeles, Boise, South Korea. Okay, you’re far enough away. Avondale. We always have a Hawaii on. There’s Hawaii. All right, there we go. There’s Miami, Fort Lauderdale. We got the corners. We got a lot, and then there’s just a ton more flowing in. Thank you guys.
We are sitting in Las Vegas, Nevada, where we are on medium heat today. We are below 100, which is…
Eliot: That’s pretty good.
Toby: That is very good.
Eliot: Sounds like fall.
Toby: That is fantastic. We’re not on fire. We’re in the 90s, which for us is a chilly, chilly day we’re about to put on. There are more. There’s Mark. He’s from Capital AE, Hawaii. Always on. Thank you. Yay, Mark. So great to have you. I’ve been gone for a little bit. I don’t even know how many episodes I missed, but I think one, two?
Eliot: One.
Toby: One? I was on […] right before I took off. I strategically placed my absence so that you guys only missed one. It’s great to be back if you guys missed me.
Let’s go over the questions that we have. Let’s start off with, “I am 65. If I borrow $30,000 from my QRP, would that be considered earned income?” We’ll answer that.
“As a real estate professional, can I also take the depreciation expense from syndications against my spouse’s K-1 income?” Great question.
“Can expenses for building and outfitting an Airbnb spent this year be written off next year when the unit is rented?” I think we’re going to be talking about in-service states on that one.
“How do I establish an accountable expense reimbursement plan from my C-Corp and a medical reimbursement plan? We’ll answer that.
“If a disregarded property holding entity isn’t taxed, when are individual property expenses like taxes, insurance, maintenance, and depreciation considered for income tax?” Okay, we’ll answer that, too.
“How do I calculate depreciation after a 1031 exchange?” Wow. Good questions. You picked good ones, my friend.
Eliot: A lot of 1031 questions.
Toby: “I want to include my kids as employees for my small business, and want to pay them in a lump sum annually. What will be the most efficient way to structure that? Is it beneficial to be an S-Corp or an LLC if making under a certain amount of money?” Good question. We’ll go over that. It’s an interesting question.
“What are the tax differences between an S- and a C-Corporation? How hard are a C-Corporation’s taxes to do? How can I use my self-directed IRA to invest in real estate deals without being subject to UBIT?” stands for Unrelated Business Income Tax, but we will absolutely go over that. Or Unrelated Business Taxable Income if you like UBTI. All these acronyms or whatever they’re called.
Hey, if you like these types of questions, guess what? There are literally over 800 videos that we’ve done on my channel on YouTube that you can absolutely go to and sign up for free. You can even watch Tax Tuesday. It’s a live stream on YouTube, and I’m sure we have a bunch of people right now on YouTube. Thank you for joining us and love having you there. We are always posting new content and we break and take some of these questions and even make them into small videos.
Every now and again, I like to post one where I’m wrong. You guys always nail me on that. You said this. All right, I’m not completely wrong, but sometimes there’s a nuance that they like to point out.
If you like this type of information and you’re an investor, then I would invite you to join us. Just about every week we do a virtual event. If not, it’ll be every two weeks, where we do tax and asset protection workshops. They’re absolutely free. If you want to learn about land trusts, LLCs, corporations, how to incorporate them to your advantage in your investing or into your business, you can absolutely join us.
We’re also doing a live one, I think it’s next week, the 27th through the 29th in Dallas, Texas. We do them live. By all means reach out if you want tickets. They’re a lot of fun to do. We get together and everybody gets to hang out. We like to hang out and see everybody. I’ve had clients for 20 years that we still get together, and it’s always great to have those folks join us.
Here’s a link, but Patty’s already put it in the chat. Let’s dive into the questions because that’s why you’re here, is to get some tax knowledge. Let’s go.
All right, Eliot, “I’m 65. If I borrow $30,000 from my QRP,” which is a qualified retirement plan or a 401(k), “would that be considered earned income?” What say you?
Eliot: No.
Toby: We’re done.
Eliot: Yup. That’s pretty much it. We do get similar questions around this because people think taking money out somehow I’m going to get charged or maybe hit with a penalty, but we’re over 65 so we probably wouldn’t have a penalty. But will it be income? No, it’s not.
If we’re just borrowing money, it’s lending to us. That’s okay. We do have to pay interest back. We have to pay back the loan, et cetera, but that’s not considered earned income. It’s just a loan. Just like having a credit card or a loan at the bank. That’s not income to us, but we do have to pay it back.
Toby: What do we have to pay back in over what period of time?
Eliot: I believe it’s five years, we have, I think.
Toby: Five years quarterly payback?
Eliot: Yes, quarterly payback at least, if not, I think you can do monthly, but they at least want to see quarterly payments. Do have to have some reasonable interest. That’s usually going to be our, what is it at least for interest?
Toby: AFR rates, or you’re looking at a set percentage. It just has to be reasonable. The Federal AFR rates are what are posted, and those are the minimum amounts of related party interest in between parties. That would be a long-term payback, probably at the 4% or 5% range right now. Not astronomically high. And you’re paying it to your retirement plan.
That’s the thing. If you have a 401(k) and you borrow $30,000, you’re paying that back at the rate of, what is that? $6000 a year plus interest. It’s not horrific. And no, you don’t include it in your income because it’s loan proceeds.
Eliot: And while we mentioned $30,000 here, there is a maximum of $50,000 that can be lent.
Toby: Well, $50,000 or half, whichever is less of your account. if you have $100,000, you could borrow the full $50,000 and it’s per participant. If you’re married, you each could borrow that so long as it’s maxed at 50%.
If you have a $60,000 401(k) and your spouse has $130,000, your spouse could borrow the full $50,000, because half of $130,000, $50,000 would be less. You would be able to borrow $30,000 because half of $60,000 is $30,000, so whichever is less $30,000 or $50,000. Obviously, the $30,000 would be less. It’s always that calculation.
If you have IRAs, you can’t borrow from them, but you can roll those into a 401(k). If you set up a QRP, for example, if you set up an Anderson QRPA 401(k) with us, sponsored by perhaps one of your entities, then we could roll the money from your IRA into it, and then you could borrow half the proceeds up to $50,000.
Had a lot of clients that have done that over the years, especially if they’re trying to pay off a credit card or something that’s a high interest, it’s much better to pay yourself the interest and knock out that credit card.
Even if you don’t need the money and you say, Toby, why would I do that? I was like, well, let’s see. You have $25,000 balance on a Visa credit card or something, and you you don’t really want to deplete your savings, then we could always say, hey, let’s roll your IRA into your 401(k), borrow against that, pay much less interest, and get it knocked out rather than continue to pay Visa or MasterCard or American Express or whomever. Who else is there? Discover?
Eliot: Yup.
Toby: Very good. That would be great. All right. Second question. “As a real estate professional, can I also take the depreciation expense from syndications against my spouse’s K-1 income?” Wow. What a question.
Eliot: We run into this actually quite a bit, too. Generally speaking, yes, you’re going to be able to because you are REP (real estate professional) status.
Usually, to get that status one has made an election to aggregate or pull together all the rental real estate activity that you have out there. That could be your long-term rentals, your duplexes, apartment complexes, and your syndications. That gets all pulled together, and if you have REP status, it’s all non-passive activity.
Depreciation expense from a syndication would be considered a non-passive loss or deduction. Yeah, if it was an overall loss from all that activity, it would go against any income on your return, including anything on your spouse’s income.
Toby: Just for clarity’s sake, a real estate professional, what does it mean?
Eliot: It’s going to be the test that the IRS throws at us to do that. Number one, you have over 750 hours that you spend a year in a real estate trade or business that you materially participate in; we’ll talk about that in a second. And you have to spend over 50% of your work week basically in real estate trade or businesses that you materially participate in.
In other words, if you have a regular W-2 job, 40 hours, you’d have to put at least 41 into real estate to meet that second part of the test. But that material participation, that definition that’s in both one and two, you also have to materially participate in each rental activity. So three times material participation comes up on that test.
That’s basically, we say that over 500 hours or over 100 hours or more than anybody else. Those are the number tests. There are 5–7 different tests, but those are the normal ones. We meet all that. We have over 750 hours, over 50% of our work week, and we materially participate in managing some of our rentals for at least the 750 hours or so, then we’ll be able to get that status.
Toby: That was a lot. Let’s take it back even farther. The reason people do real estate professional is because you have what’s called passive activity loss rules. If you have real estate and you have extra depreciation, which is a deduction against your real estate, and it exceeds the amount of income made from your passive activities, you’re going to have excess passive activity loss. You’re going to be carrying that forward unless you can unlock it.
Two ways to unlock it. Number one, if you make less than $150,000 of adjusted gross income, you are going to get up to $25,000 of loss that you can write off immediately. It’s called active participation. If you manage the manager, it phases out that $25,000 $1 for every $2 over $100,000. That’s why I say under $150,000 you’re going to get some portion of it. If you make under $100,000, you’re going to get the entirety of $25,000. That’s not going to be that great. You’re under $100,000. It really doesn’t mean that much to you.
The bigger one is the real estate professional. You could be making $1 million a year, and you can unlock your real estate deduction and use it against your other types of income.
If you’re making $1 million as a doctor, for example, and you have $100,000 of loss, the $100,000 of loss if from your real estate activities, from rentals (for example) and your syndication or whatever, you can use that $100,000 of loss to offset your W-2 income.
It’s actually that tasty. At those levels, you might be offsetting 37% federal and then possibly your state. It depends on your state as to whether they recognize certain types of depreciation, accelerated depreciation and bonus depreciation.
I don’t mean to confuse you, it gets a little complicated. But if you are a real estate professional, that is for your tax return, so long as you file jointly with your spouse and you aggregate all of your rental activities as one activity. When Eliot’s going through this, he’s saying, hey, there’s a syndication, there’s a K-1 that’s coming down. It’s my spouse’s.
Number one is, if you are a real estate professional, is your spouse filing jointly with you? If the answer is yes, fantastic. Number two, did you aggregate all your rental activities as one? And then number three, when you have a K-1 from a syndication, there’s an elevated amount of material participation that you actually have to hit.
It’s 500 hours. You don’t get to use the 100 hours more than anybody else or the sole participant. You have to do 500 hours jointly with your spouse. You could each do 250, you could do 300, spouse could do 200, but you have to hit that 500 hours when you’re passively involved in the syndication.
Now, I’m going to put a caveat on that. If you are a GP in that syndication, so if your spouse is in that syndication and your spouse is a general partner, then you don’t have to meet the 500 hours. You just have to materially participate. That’s why I say these types of questions, there are a lot to them. So now we have three questions. Did you aggregate? Are you jointly? Are you a GP in that thing? And that’s going to lead us to the right answer.
These are great teaching questions because you realize that there’s no straightforward answer. That’s why you always have to work with a professional. I wish it was easier than that, but it’s not.
Eliot: It’s not.
Toby: Anybody who says, oh, this is easy, it’s really straightforward, yeah, out of here. No, it isn’t. It’s always facts-driven and it depends on your situation. But if you get out ahead of it, then you can usually get a great result. That’s why it’s really important guys to work with folks that understand this stuff so they can tell you.
Again, if I’m sitting there talking to you, we already know. Seven hundred and fifty hours, more than 50% materially participate in that, aggregate your stuff, materially participate in that. Are they this, are they that? We can just make a checklist.
You’re saying, as long as you do these things, here’s going to be your result. Your reward could be, again, $30,000, $40,000, $50,000, $100,000, $200,000. It depends on your scenario. We could set it out for you and say, here’s the benefit if you do this, and then you could decide whether it’s worth it.
If it’s, hey, I’m going to make an extra $5000, you probably would say that’s a real pain in the butt to have to do for $5000. You may say no. But if it’s $50,000, you may say, absolutely. I’ll jump through some hoops. That’s a lot of money. And I would like to go ahead and put that money back in my pocket. That’s it.
All right. Next one is somebody requesting to become a panelist. I just love that.
Eliot: Douglas.
Toby: “Can expenses for building and outfitting an Airbnb spent this year be written off next year when the unit is rented?” What’s say you?
Eliot: Yes. Generally speaking, if we’re not renting till next year, it very well might be that we have not placed it into service, that’s not available for rent, common terms that we use. If that were the case, if we had these expenses, we incurred them in November or December, we didn’t start actually using it as a rental to January or February, then it would go over to next year, most likely where we’d start deducting those.
We had a big discussion in our group about this. When is it available for rent? What are all these quasi definitions? It just means as it says. You would be able to rent it right now, you need to be able to defend that position to the IRS.
Evidence of that would be, I put it up on social media that it is available for rent, something like that to show that it was January when it became available for rent, that type of thing. Then, yeah, these expenses would typically go over towards January in this example.
Toby: Again, to step back and do the 10,000-foot view, when you have a property that is not in service, you can’t depreciate it. It has to be in service, which means it’s available for rent. It doesn’t mean it’s rented, it just means it’s available for rent. It could take on renters.
With an Airbnb, it gets funky because you could have it all ready for rent, but then you decide, I’m going to go ahead and furnish it. I think that’s the steps you’d want to do. You’d want to say it’s available for rent now, and we’re going to go ahead and furnish it, and we are going to write off all of the furnishing now.
It’s available, maybe put it on a listing, then buy all the stuff. If you buy the stuff first and then make it available for rent, then it’s probably going to be depreciated over what, five years?
Eliot: Yeah, I think furniture’s five.
Toby: So you really want to put it into service. A lot of times we’ll say, put it into service, then do a little bit of your rehab and furnish. But you want to talk to a tax professional when you’re doing this, especially if we’re talking about a significant amount of money. Half a million dollar unit, you’re doing $100,000 rehab, and you’re buying $30,000 of furniture, then you might want to look at that.
I suppose we could cost seg it and accelerate some of that too, but the cost segregation rules right now (I think) we’re at 30% bonus depreciation. It’d get you close but not quite there. I would love to see that we put it into service first, unfurnished, and then furnish it so that we can get a full deduction for that.
All right, let’s move on. “How do I establish an accountable expense reimbursement plan for my C-Corp and a medical reimbursement plan?”
Eliot: A lot of different ideas about all this, but basically what I would do, I just have a meeting. I just have a meeting in my corporation, maybe one of my Augusta Rule 280A meetings if it’s a corporation. I say, I want to adopt an accountable plan for reimbursement. I want to reimburse my employees and likewise have the same meeting.
Also by the way, I want to adopt the medical reimbursement, 105 reimbursement plan. I would have it in a meeting, document that meeting, so then you have a written document to validate that you had if anybody ever questioned it. Some argue that you don’t even need to do that, but I think it’s a good idea to do that and just be done with it.
Toby: I’ll say this. If we set up your corporation, we already did it. If you’re an Anderson client, we automatically put in your original meetings the adoption of a medical reimbursement plan if you are taxed as a C-Corp. It could be an LLC taxed as a C-Corp, or it could be a C-Corp. In either case, those things are already put in place, and all you have to do is have a written plan.
It’s Section 105 and it just basically says that the corporation will reimburse you for a health, medical, dental, vision. Anything that’s a health expense, that it’ll reimburse the employee for that amount under the accountable plan.
And you’re reimbursing a lot of stuff. You’re reimbursing computers, cell phone, meals, anything that you incur. So long as you’re submitting it to the corporation for reimbursement and explaining what it is, the corporation reimburses you and then the corporation gets a deduction. You do not have to recognize that as income. You do not have to recognize the reimbursements as income.
If Eliot works for my company and I have a medical reimbursement plan, and Eliot has an uncovered procedure that’s qualified as a health expense, it’s $10,000 and he submits that and I reimburse him for $10,000, he does not have to report that as income. He doesn’t put it on his tax return. He doesn’t have a medical deduction or anything like that.
As an employer, I have an employee expense. That’s it. I do get the deduction. I paid $10,000. I don’t have to do withholding. I don’t have to do any of that. I don’t have to do employment taxes. I just get to write him a $10,000 check.
It doesn’t matter whether it’s me as the company and I own it, or Eliot owns the same company. Eliot could still be a shareholder of that same entity taxed as a C-Corp. It could be an LLC taxed as a C-Corp or it could be the C-Corp itself. But in either case, Eliot doesn’t have to recognize it, doesn’t have to report it, and the company itself gets the deduction. That’s why it’s so powerful to have these medical reimbursement plans.
Now, if you don’t have a C-Corp, you would have to include that as income. If it’s an S-Corp, that same expense is still deductible to the company, but you’d have to recognize it as income. S-Corps are not treated the same.
If you do not have a C-Corp and you still want to write off medical expenses and you’re like, gosh, bless it, I don’t have a need for a C-Corp and this doesn’t give me enough bang for my buck to make a change, then look at an HSA plan. If you have a high deductible plan that an HSA may get you to the same place. You can put tax deductible dollars into an HSA that then can reimburse you if you meet the requirements. I think it’s over $7000 this year that you could put in, and then it could reimburse you for your health expenses.
Fun stuff, guys. Again, I wish this stuff was really easy and straightforward, but the tax code is a bit of a riddle. I used to say that you’d have to drink a lot of wine when you’re reading it so you can understand it, but it’s like reading poetry. When you first read it, you’re like, what? Well, this is what they were thinking and this is what they were feeling. Then you have three glasses of wine, you’re like, I get it.
Eliot: Then you have the regs that interpret it all.
Toby: It’s like an artist journal talking about a poem that you don’t understand. It’s just not written straightforwardly. It’s not super easy. We don’t want to do that. It isn’t. They’re not.
All right, let’s jump on. “If a disregarded property holding entity isn’t taxed, when are the property expenses, taxes, insurance, maintenance and depreciation considered for income taxes?” What say you?
Eliot: We’re getting a lot of basic information here today on all these questions. This is certainly a very popular one because we use a lot of disregarded entities. You put a building maybe into a disregarded entity, you’re told it doesn’t have to do a tax return, that it’s disregarded, that’s all purpose. You ignore it, it doesn’t do a tax return.
But as I tell people, any income, any expenses, we still have to report those. Those report on the person or entity that it’s disregarded to. You may have this disregarded, maybe it’s a rental in Missouri, it’s disregarded up to a Wyoming holding. It will flow up to that Wyoming holding.
Maybe that in turn is disregarded. Well, it’s probably going to be disregarded to your 1040, your individual returns. Really all that activity would flow up and just show up on your 1040. All the income, all the related expenses, the taxes, insurance, the maintenance that we’re looking at here, depreciation, so on, so forth, of course the rental income.
Disregarded, yes. That means that entity typically—at least at the federal level—doesn’t have to file anything. But all that information has to be filed somewhere. And it’s usually going to be on your 1040 if that’s where it’s disregarded to. Or it could be disregarded to a C-Corp or an S-Corporation, likely for flipping. It would just go on their respective returns.
Toby: You put it pretty well. Disregarded doesn’t mean that it doesn’t pay tax. It just means that the owner of the entity pays the tax. You can’t have a disregarded entity when there are two or more people owning it. That’s a partnership. But even then, the partnership doesn’t pay the tax. It allocates a portion of the profit or expense to the individual partners.
When it’s disregarded, it’s just basically saying to the IRS, ignore the entity. Look at the individual that owns it. If it’s an entity, then you say, ignore the LLC and look at the entity that owns it. If you have a partnership—LLC, for example—in Wyoming, that’s a real estate holding, and it owns 10 disregarded LLCs in other states, there’s no federal tax return for the 10 LLCs. It’s the one LLC that captures all of the income and expenses. It just makes it really simple.
It just means you don’t have an extra tax return, but it doesn’t mean that you don’t pay taxes. If a disregarded property holding entity isn’t taxed—that’s not what we’re saying—it’s ignored for taxes, so the entity doesn’t file a tax return. When are the individual property expenses and depreciation considered? They’re considered to the owner’s tax return. That’s all it is.
I’ll use a great example. If I’m a realtor and I’m making $10,000 a year, I might just set up an LLC and make it disregarded. I don’t want to have to do an extra tax return. I’m still doing my Schedule C on my 1040. If I am a real estate investor and I buy my first property and it’s not making any money, it’s going to bring me like $1000 and I don’t want to have to do an extra tax return, then make a disregarded LLC.
We still want to prevent the liability from reaching you individually, because worst thing that could happen is somebody trips and falls or you get sued for something from a tenant, and you get a $20,000 judgment, and you’re like, oh man, now they’re following me around and garnishing my other wages because I had no LLC around it.
You want to make sure that you have that LLC around that entity so that it doesn’t come over to you personally, but you may not want to have to create another tax return. That’s what those disregarded entities are excellent for because now you don’t have that added expense.
You could have an LLC in a state $100 a year, $200 a year, and you’re done. You don’t have to do a tax return for it. It doesn’t change your taxes at all. It’s crazy when I hear accountants and stuff say, oh, you don’t need an LLC. You just get some insurance.
I’m like, insurances, yeah. I’ve had so many people denied coverage over silly little things and then they’re like, yeah, I could sue them. Good luck getting that lawyer and then taking the four years to try to get them to actually pay. Now, you just want to be able to say, all right, live and learn, next, and walk away from it without having to pay for it for the next 10, 11, 20 years. Fun stuff.
All right, Eliot, “How do I calculate depreciation after a 1031 exchange?” You’re going to have to tell me what a 1031 exchange is. All these terms that they throw on there.
Eliot: We’ll go all the way back to the beginning. First of all, a 1031. What we’re doing here, I have a rental property, may have had it for 10 years, been to taking depreciation, having renters in there come and go. Now, I want to get rid of it, but I don’t want to sell it and have to pay tax on all the capital gains.
I get rid of it. Then I’m going to pick up a new property we call the replacement. That’s the relinquished, pick up a new one in exchange for it, called the replacement. Done properly, if we check all the boxes, et cetera, the IRS will allow me to defer. I don’t get rid of any taxes, those capital gains, but I get to defer them. I’m going to push them off.
If I wait till my death and leave it to some heir, well they may get stepped-up basis and we never pay tax on that. So it can be really powerful, what I call a capital W wealth generator. That’s something to think for. That’s our 1031. Get rid of one property relinquished, pick up a new one replacement.
Now the depreciation, the one you gave up, let’s say you bought it for—I don’t know—$400,000. Had some land in there—we don’t depreciate that—but it did have a building—we depreciated that. When that goes down, you’re going to have what’s called an adjusted basis. It was your original purchase price plus any improvements, less depreciation.
This again is on the original building you had, the one that we’re going to relinquish. You take that adjusted basis and you subtract it from the original purchase price. That gives you the amount of capital gains that you would have if you didn’t do a 1031.
Now that we know that number, let’s just say it’s $150,000 of capital gains. Now we are doing a 1031. We get rid of that property, and within 45 days we’ve told the IRS what our replacement property is that the one we’re going to pick up. And within 180 days of all that, we have it all done.
Now I got this brand new property, let’s say it’s worth $1 million. I can’t just start depreciating $1 million. Part of the 1031 says I got to take the amount of deferred gain, $150,000 from the one I gave up, subtract it from the fair market value, the one I just picked up, the replacement. That’s going to be how much I can depreciate on that building. We call it a carryover basis. We’re carrying over the basis from the prior building to move it over to the new one.
If you think about it, we really have two different things going on. We still have the basis from the old property I gave up that we’re depreciating and maybe some from the new. What you’re allowed to do, you can go ahead and continue the depreciation schedule you had on the one you gave up.
If you still had another 10 years to go on it at such and such of a straight line depreciation, you can continue for that portion. Then a new portion of extra depreciation that you just picked up, you can do over 27½ years if it’s a single family or 39 if it’s commercial.
You have some options there, or you actually can opt, I believe to pull it all together and just do it under the new 39 or 27½. That’s how we calculate the depreciation. It’s going to be the new fair market value of the replacement property, less the amount of deferred gain. That’s going to give you a number, and that’s the amount that we’re going to use for depreciation.
There’s a lot. Now, I got to say, looking at it that way, it’s A plus B equal C, it sounds like that, but when we get into 1031—
Toby: You just nailed it. I have nothing to say.
Eliot: But there is. Just so you know, it can get a little more hairier than that. You have A plus B plus or minus C plus or minus D equals F.
Toby: Give Eliot a react. Does anybody like, do you have thumbs up? Because that was like a really good answer. I don’t have to say it.
Eliot: I killed them.
Toby: You just worked on it, buddy. I was watching it sail out there and I got nothing. I’m just going to squirt water in your mouth when you come back in the dugout. Pat you on the butt. Well, not on the butt, maybe on the back.
Anyway, that was a really good explanation, and I have nothing to say other than what he said, which is great.
Eliot: Well I picked the question, so it was easy.
Toby: That was a good one. There’s not an easy way to explain that. You just broke it down about it as quickly as you can, so that’s absolutely fantastic. If you want to learn about 1031s, I think I did a video on that pretty recently. Patty, you may know on YouTube. It breaks down the time, the 45-day rule, how many properties, and all that fun stuff. Maybe she’ll share out that just in case, or you just go to YouTube and my YouTube channel type in Toby Mathis. You can get that.
Guys, there are a lot of people that have joined us since we started. I’ll just say that we have Dutch, Jared, Jeff, Doug. Oh, we got a whole bunch of people. My gosh. We got Matthew, Patty, Elisa, Arash, Barley, Douglas, Dutch, Jared, Jeff, Rachel, Tanya, Troy. We have a huge chunk of our tax team available in the Q&A.
If you have questions about your taxes, we don’t bill you. This is a freebie. Jump in there, ask away. Don’t do it on chat. Do it in the Q&A. I’ve seen some books get posted on that chat. I have like this little row and all of a sudden I’ll be like, all that taken up with somebody’s question. Put that in Q&A and we will get it answered for you.
They’re answering questions and they’re just great people. These guys are so knowledgeable. This is what they do day in and day out. It’s a lot of fun. If you like that, reach out in the Q&A. And if you want to become a client and be able to ask them a bunch of questions anytime and not get billed, that’s part of our platinum service.
If you want to learn about platinum, just put in chat ‘platinum’ and Patty will reach out to you and give you a way to learn more about that. It’s less than $100 a month, and you can ask all the questions you want to the lawyers and the accountants, and you don’t get a bill.
All right, let’s talk about this. “I want to include my kids as employees for my small business, and I want to pay them in a lump sum annually. What would be the most efficient way to structure that?”
Eliot: The most efficient, depends if we’re talking from a tax perspective or what’s just going to be easiest, you could just cut them a check, call them a 1099. You could do that.
Toby: Then they would have their employment tax.
Eliot: Exactly. They’re going to get hit with income tax and employment tax unless they’re under $14,000—$14,300 or $14,600—for seeing the standard deduction.
Toby: They have the standard deduction where they’re not going to have to pay taxes. They’d have employment taxes if you 1099.
Eliot: They’ll have the employment, that’s right, if we 1099.
Toby: If they’re under 18 though?
Eliot: Alternatively, maybe you’re paying them—Toby talks about this a lot—especially if you had like that earlier situation where we talked about the REP (real estate professional) status.
Maybe you have a rental building in an LLC that’s owned by you, and it goes up to a partnership owned by you or owned by you and your spouse. If the child works for that one and you pay them, you must pay them as a W-2 employee. But if they’re under 18, they’re not going to have to pay any employment taxes.
Again,if they’re under the, I want to say it’s $14,600 standard deduction for this year, they’re not going to pay any tax at all. There’s your best way from a tax perspective, if we can make that work. Sometimes we don’t have that. I don’t have an entity that’s owned by myself or my spouse. Well then maybe you just W-2 them if that was in particular, or you could 10 99 them, but they would get hit with the employment tax.
Toby: The standard deduction is $14,600, and if you’re married filing jointly, it’s $29,200. You just double that up. That’s a big chunk of money. If you’re paying a child, anybody under 18, you don’t have to do withholding and you don’t have to do employment taxes if you are paying them through a partnership or a disregarded entity. If you’re paying them through an S-Corp or a C-Corp, then you would have to run them through payroll. It’s still not going to be big, but they’re not going to pay tax on that.
This is what’s weird. People are like, wait a second. I can pay my kid $14,000 to do work and help me? They actually have to do something and help you with your property. They could even be doing the tech on it. We all know that normal folks like us really suck at tech, and your kids are doing all the postings on Meta, X, and TikTok. That’s high value work, by the way. You could pay them for it and they don’t pay tax on that.
Sounds weird. And you’re like, well, all they’re going to do is buy bubblegum with it. No, you make them pay for their tuition or their clothes. You could still control it. I used to do this with my daughter. I had a manager managed LLC that she owned. It was great. Still to this day I control it. It’s like, hey, guess what we’re going to do with that money kiddo? We’re going to pay your tuition with it. Great, you didn’t have to pay tax on it. We like that.
Eliot: I just got to spend last weekend with my nephew and my niece, and they brought me up to date on all the tech stuff out there. It was nice. It is the young people know how to use all this stuff.
Toby: They are way smarter than us. Although we always say, oh, they got a lot to learn. Eh, it’s like two ships passing in the night.
All right. Speaking of learning, I say you learn until you earn it. Learn it till you earn it. This is an easy way to learn. If you want to learn about tax and asset protection and learn about LLCs, land trusts, corporations, just join us at the Tax and Asset Protection Workshops. Easy links there. It’s free. Don’t worry. We’re not going to spam you or anything like that either.
We just try to teach. That’s what Anderson’s really are. We are a teaching organization. We take on clients, but our primary focus is to make sure people understand what they’re doing. There’s plenty of business in the world. We’re never hurting for it.
Then we do the live event, which is three days in Dallas. That is next week. If that is too soon for you, we’ll announce another date in the fall that we’re going to be doing soon enough. It’s already there. Look at that. I can’t read it. You guys, this is horrible. I’m borrowing Eliot’s glasses because I was too—
Eliot: Those are my glasses that I got from Patty. It’s a family affair.
Toby: Patty saved us all. Yeah, it looks like San Diego is in September. They’ve already posted it. You could either go to the live event next week or you could join us in San Diego. They’re a lot of fun, frankly because we like to hang out and meet everybody. It’s always really important.
Let’s go on. “Is it beneficial to be an S-Corp or an LLC if making under a certain amount of money?”
Eliot: To get real technical here, you certainly want to be in some entity. You want that asset protection because if you work with someone like me on the other side of a business arrangement or something like that, and I sue you, you don’t have an entity, you’re not going to have to worry about a tax plan because I’m going to take everything from you. You want to have that LLC.
Now whether it’s going to be taxed as an S-Corp, we do often look at that. Maybe you want to have about $30,000–$50,000 somewhere in that of net profit. That will help give you savings because you’re going to have an extra tax return as an S-Corporation, or if it was a C-Corporation for that matter. You get better reimbursements and deductions, but we want to make sure it’s worthwhile that the dollar values there behind it.
You certainly want an entity. Do you want it as an S-Corporation and go through with having an extra tax return? Yes, you do. If you’re making enough of the tax savings from the reimbursements that you can do like corporate office meetings and having a home office, things like that, if there’s enough savings there, maybe on some retirement plans, so on and so forth to make it worthwhile, then yes an entity, certainly.
Toby: Again, it all ends up being your call. But I always think it’s right around $30,000 if you don’t have a bunch of other income coming in. But if you’re already making $500,000, that may change it because you’re already paying into social security. You may not get massive benefits out of it.
If you’re making $50,000, it might mean a lot more to you to save that extra $50 and $100 if you’re around that $30,000 mark. But it’s just math. Here’s what it would benefit you. Here’s what it’ll cost for compliance. Where do those things intersect and start to become really obvious? It’s always personal.
But again, if somebody’s making a ton of money and you’re already paid up into your old age, disability, and survivor’s benefits—that’s about right around $167,000 this year—if you’re already above that, then the benefit is basically 3%. If it’s below that, it’s basically 15.3%. The math is about 14.1% on every dollar. That always comes into an issue.
I always love reading the chats. I just can’t help it. “Please talk about the taxes on sale of property only on option contract.” Love it. Dan, send that in, taxtuesday@andersonadvisors.com. We’ll take a look at it and we’ll put it out there.
Let’s see. Did I miss that? No, there we go. “What are the differences between an S- and C-Corporation? How hard are C-Corporation’s taxes to do?”
Eliot: An S-Corporation’s a passthrough entity. It’s all going to come through onto your 1040. You do a return for it (1120-S), but all that’s going to flow through to the shareholders, I should say, which, assuming it’s you. It’s going to be your 1040. That’s one difference.
A C-Corp does its own return. Just an 1120, not an 1120-S. It’s a separate taxpayer. It gets taxed at 21%. It doesn’t have anything to do with your 1040. It’s in its own different world.
The S-Corporation’s going to have the ability to do your 280-A meetings, reimbursements that we talked about earlier for maybe an administrative office, things like that. You do have to pay yourself. If you make enough, if you want to take the money out of the S-Corporation, you will have to pay yourself a wage, a W-2 wage, we call it a reasonable wage.
It won’t be everything. You’ll have two streams of income in an S-Corp. That reasonable wage, which the IRS hits with every tax that they can throw at you. It’s going to be income tax and employment taxes.
But you’ll have this other stream that’s just a distribution. It’s going to get hit with income tax, but it’s not going to be subject to that employment tax. In a given right situation, that can be quite beneficial. That’s what we like about the S-Corp.
Now, the C-Corp, it can still do the 280-A corporate meetings. It still has the reimbursements in the office, et cetera, but it also has that medical reimbursement plan that we talked about way back earlier. But again, it does file its own return.
If we ever want to get money out of there outside of reimbursements, you’re going to have to pay yourself a wage or you have to do a dividend, which we call double taxation.
Toby: The biggest tax differences in an S and a C then in a synopsis is the S-Corporation doesn’t pay taxes. It passes it to its owners. The C-Corporation pays a flat 21%. Then if those monies are paid out in the form of a dividend, they’re taxed as long-term capital gains to the recipient, assuming that recipient is an individual or taxed on a 1040. Then how hard are the C-Corporations taxes to do? If you have a balance sheet, they’re fairly simple. It’s actually pretty easy.
Eliot: That’s a very good point. You have to have good books.
Toby: The big difference besides the 21% is a C-Corporation, you get to have a health reimbursement plan that is not taxable to the recipient, to the employee. Whereas in an S-Corporation, any benefit, even paying for insurance, is taxable to the recipient who is an employee.
Whenever you’re looking at this, if you have a lot of medical expenses or if you have a dependent who has a lot of medical expenses, so you’re taking care of a parent, or you have a child who has high medical expenses, or you or your spouse have high medical expenses, and when I say high, I mean over $10,000 a year where it’s going to start to move that needle to be able to write that off and make it non-taxable to be able to reimburse that, a C-Corporation really becomes something that could benefit you.
I’ve seen people who deliberately structure their affairs in such a way that the C-Corporation is a managing entity to cover those expenses, because they’re $40,000–$50,000 a year. They want to make sure that they’re not dealing with Schedule A phase outs, missing out on things, and not getting to write those things off. That is a huge difference with the C-Corp. Just to put it bluntly, that can make a pretty massive difference.
We have clients that do that. There’s nothing wrong. There are certain types of activities, like if you’re a realtor, if you’re doing construction, sometimes escrow agents where they have restrictions on the type of business you could be. Sometimes they want you to be an S, sometimes they want you to be a C. It’s always up to the licensing. But other than that, most businesses can pick and choose, and then that just becomes another number. It’s like, hey, should I do this? Well, here’s the good, here’s the bad, here’s the ugly.
What’s really interesting is when you have high net worth, high income people, and they don’t need the money that that C-Corp’s making, and the money if it had flowed to them, would be taxed at 37% plus their state tax. It’s neat when you see that C-Corp being used.
Then people always say, well, but it’s going to have to be paid out as a dividend. No, it’s not. Most C-Corps zero out if they’re accumulating income they’re not required to pay it out. There used to be the retained earnings tax that actually meant something. Now it’s pretty immaterial.
As long as you have a reason to use that money, it could be loaning it to yourself for all that matters or to other entities in replacing the bank. As long as you are documenting why it’s not uncommon. We look at, what is it, Apple sitting on $200 billion? You’re allowed to have stockpiles of cash as long as there’s a reason for it. You’re not always taxed on it.
Here’s a fun one. “How can I use my self-directed IRA to invest in real estate deals without being subject to UBIT?” Sir.
Eliot: The UBIT again, probably needs some explanation. That’s a tax that we put on entities that are basically non-taxable, such as a retirement plan and things like that. Obviously, once they put that on there, it is taxable.
The idea is to level the playing field, so you don’t have your retirement account going out and owning a McDonald’s that puts an unfair playing field against active ordinary business out there. They hit it with UBIT and it’s very expensive. It goes up to (say) 37%–38% very, very quickly within $10,000 of income.
How do we avoid it? Well, one way, just don’t buy any real estate with any debt or anything like that and make sure it’s a long-term rental. We couldn’t flip. We won’t be able to do that. That would be ordinary income subject to UBIT. But if you buy a long-term rental and you just pay it all off, there’s no debt, which is another form of UBIT or UDFI (unrelated debt-financed income).
Toby: I want to jump in here real quick because there’s a difference between a self-directed IRA and a 401(k). If I have an IRA, there’s something called unrelated debt-financed income. When I use debt to make money in an IRA, it becomes taxable. The portion of that money that’s derived from the debt.
If I make $10,000 out of a rental and I’ve financed half of it, then $5000 of the $10,000 would be taxable as unrelated business income tax. It would be subject to the UBIT tax rate.
The other way to make taxes in an exempt entity is to run an active business in that entity. You use the McDonald’s example, but you could be flipping in one. If you go over five flips, that’s about the magic number that most custodians are comfortable with, then you’re looking at becoming an active business, and they would likely tax you as UBIT if they audited you.
There are people that still do flips, knowing full well that if they were audited, they may be subject to a tax on the profit. But they’re very comfortable saying, hey exempt organizations tend not to get audited very often, especially most of the time, it depends on how much they’re making obviously, but for the most part you just don’t see that many, so they’re comfortable with that. Well, you’re doing it with your eyes open.
But in this particular case with an IRA, we’re worried about UBIT for both the active business and whether they’re using debt. If you are using debt, I would just say roll it into a 401(k) and now you don’t have that issue because 401(k)s are not subject to UDFI. You could loan away, you can get loans and make all the money you want in the world, and it’s not taxable, versus an IRA, it would be. That’s a solid reason to roll that.
Otherwise if it’s just, hey, I’m getting into real estate deals, if all you’re doing is investing in real estate passively, you’re not going to be subject to UBIT. You’re just not. You can always invest in an exempt organization and not pay tax on it. There might be a caveat on that. I imagine if you get above a certain amount, you might have a net investment income tax. I think they put like a 1% on some of these huge organizations, but otherwise I’ve just never seen it. For our clients, I’ve never seen it.
If you’re a self-directed IRA and you’re doing, hey, I want to be in syndications, I want to invest in multifamily and storage and things, you’re not going to be subject to UBIT. The only way you’re going to be subject to UBIT is if there’s debt on those and you’re making profit.
A lot of those, you just have to be a little bit careful, I guess if you did a syndication in storage and they’re using debt, make sure you’re rolling it into a 401(k) before you do that. Because If you’re using that IRA, there’s an argument like if they audited you, they would tax you on the portion that was derived from the debt.
And it’s on the K-1. When they send you that K-1, they’re going to say what portions of how much debt there is. So it is reported. A lot of people say, oh, they never reported. No, it’s there. It’s just that a lot of people don’t know what they’re looking at.
Speaking of not knowing what you’re looking at, there’s my webpage that is on my YouTube channel. There are over 800 videos. There are a lot there. You can absolutely sign up and it is absolutely free. I just did four videos today. I was working on those for the last several days, and I’m excited. I always like posting new stuff. There’s a lot there.
Of course, feel free to join us at any of the Tax and Asset Protection Workshops. They’re fun. We’re about to start doing the Infinity stuff again en masse and really start helping people as we go into this presidential election, to make some money, put money in your pocket. It’s been tough. Inflation’s been crazy.
If you were doing what we said years ago and we continue to say, you’re doing great because you made a lot of money on your real estate because everything’s been getting pushed up. Your stocks are doing great. We’re at high highs.
Everybody always says, but can I go higher? Yeah, it can. It always does. If you invest it only on the highs, you’re still way ahead of the game historically. That doesn’t mean there won’t be a pullback at some point. Maybe there will be, but that’s one of those things.
Statistically the best time to invest was yesterday, always. So feel free to join us at the Tax and Asset Protection events. Feel free to sign up for our YouTube channel. By all means, when you start seeing those Infinity events about making money, feel free to take advantage of those. We always make them pretty much free. Sometimes there’s a small fee. Like the live Tax and Asset Protection events, there’s a small amount.
Somebody asks a good question that I’m going to answer just because it’s a good question. Somebody says, “How do you roll a self-directed IRA into a 401(k)?” You set up a 401(k), you open up a bank account for it or a brokerage account, better yet like Schwab, and then you transfer the funds from the IRA into that.
If you do a trustee to trustee transfer, it’s simple. If the IRA custodian insists on giving you the check, then as long as you roll it into the 401(k) within 60 days, there’s no tax. You just negotiate it, deposit it into the 401(k), and you’re good. You’re going to report it on your tax return when they send you a 1099-R. You’re going to say it was a non-taxable transfer.
You’re going to say, here’s the money. How much of it was taxable? You’re going to put zero on your tax return. It’s actually very, very simple. Your preparer will know what to do. That’s it.
If you have questions in the next two weeks, they’re free. Email us at taxtuesday@andersonadvisors.com. Visit us at andersonadvisors.com if you want to learn more about Anderson Advisors. We’ve been doing this for, gosh, bless it, I think it’s 25 years. I forget how long ago we started doing Tax Tuesday. We’re over 200 episodes.
They’re always free. Share them with your friends. There’s never going to be a cost. Just because we believe that it’s hard enough to do and understand taxes without having to pay somebody $500 an hour to explain it to you. So you may as well come here and we’ll do our very best to do it for you at no cost. And we will see you guys in the future. Thanks for joining us today, and we’ll see you in two weeks.
Eliot: Bye.
