Welcome to another episode of the Tax Tuesday show. Host Toby Mathis, Esq., joins our regular guest Eliot Thomas, Esq., Manager of Tax Advisors at Anderson Business Advisors, to help answer your questions. Even though it’s tax season, we have nine Anderson staffers on board to answer your questions
On today’s episode, Toby and Eliot answer listener questions including inquiries about purchasing a bar/restaurant and all the aspects you need to take into consideration around this difficult industry, a few questions (as usual) around rental properties and when/if you can take deductions and write off losses, and an interesting code question about oil and gas and intangible drilling costs (IDC).
If you have a tax-related question for us, submit it to taxtuesday@andersonadvisors.
Highlights/Topics:
- If you have a corporation with your children as board members, can you write off vehicle, maintenance, and gas? – If they are not employees, they are eligible for “reimbursements” not written off as business expense.
- Spouse and I are filing joint 2022 return, she had a $6000 W2, can I make a $3000 contribution, or must it be made to her IRA because it’s her W2? – If you made less than the $13K deduction, no taxes are owed. If you contribute to a Roth, no taxes….
- Can you discuss Tax benefits of retirement funds to fund/start/loan my business? – buy shares of a C Corp with your retirement fund.
- Tax effects of intangible costs for oil and gas? – IDCs can give you a 100% deduction in certain cases
- Paid kids $12K for my rental business, should I issue a 1099? If its disregarded or a partnership, kids under 17 can be issued a W2, if under age 18 no taxes due.
- Bought a house in 2022 with plans to rent, still working on repairs, do I get tax benefits for this project? – No, it has to be placed into service to be eligible for losses/expenses…
- How do I do cost seg if I purchased and rented out in 2022? Accelerated depreciation? – Cost seg is all about depreciation, yes you can do it to take advantage. Once cost seg is done, extend until Oct 15.
- I purchased Airbnb 2022, and put into use same day, purchased furniture/renovated, my accountant says I have a loss and am unable to do bonus depreciation? – There are other factors, but did you materially participate? If so, yes that is ordinary loss.
- When should I file as S-Corp instead of disregarded entity? not single entity…. – Don’t put real estate rentals in a corporation, when you take it out it’s taxable…
- Is there an AGI limit for claiming passive losses on a return? – If you have rental activity, under $100K, you can write off $25K. Can they be carried forward? How to claim next year? – Yes, passive losses can be carried forward as “suspended”.
- I’m considering purchasing a bar/restaurant in FL, already established but not doing well, what should I consider before doing this purchase? – Are you buying the assets, or the entity that owns the bar – if the entity, you may inherit any legal issues and no depreciation. If you buy assets, you can depreciate assets at the price you paid.
Resources:
Tax and Asset Protection Events
Full Episode Transcript:
Toby: Hey, guys. You’re watching Tax Tuesday. My name is Toby Mathis.
Eliot: I’m Eliot Thomas, Manager of the Tax Advisors here at Anderson.
Toby: If you’re looking for some tax stuff, you’re in the right spot. By the way, I mean tax stuff is we bring tax knowledge to the masses. Let’s go over the rules real quick. In case this is your first time, this will be your first time here in the rules. If you’re an old hat at it, just pretend to play along.
We’ve been doing this for years. I don’t even know how many episodes. We’re getting close to 200. We always wanted a forum where people could ask questions and not get billed because we don’t like tracking billable time. Do you like tracking?
Eliot: I hate it. I hate it with a passion.
Toby: We just said, hey, let’s just go give it away. We’ve been brewing that day ever since, but we can’t stop. I’m just kidding. No, it’s a lot of fun. Reaping and sowing, guys. We always figured it out, do as much as we can. All right, let’s see how everybody’s doing.
First off, you could ask live questions in the Q&A. Because it’s tax season, we have one, two, three, four. five, six, seven, eight, nine. I thought we had two people, but I just counted nine people to answer your questions. You can ask questions specific to you in the Q&A. If it gets too detailed, we’re going to ask you to become a client and join our Platinum. Platinum is $35 a month, and you can ask all the questions you want in writing. That’s on the tax side.
If you’re Platinum, you can ask all the questions you want orally, verbally. Sit there and talk to a lawyer all day long. But the accountant, we like to get things really concise because the words have meaning, and it’s so nuanced in the tax, plus we know you’ll ask the same thing again next year, so we just put it in your portal.
Anyway, you can go to the Q&A. Ask questions. You do not get billed on this. You can email questions in at taxtuesday@andersonadvisors.com. How many did you pull today?
Eliot: Eleven or 12.
Toby: Eleven or 12 questions that we’re going to read out and we’re going to answer live. That’s where we get those. We also answer people’s questions anyway just for kicks and giggles. We try to make sure that you don’t have to sit there and have that fear to google stuff, where you get a bad answer. Just ask somebody here, and we’re always willing to help.
The whole idea is that this is fast, fun, and educational. We used to do these for hours at a time. When I say hours at a time, how many of you guys remember the two and three-hour Tax Tuesdays of yesteryear? I would just answer questions until people could ask them. Now we do it in about an hour.
We record it and we put it on YouTube. Surendra, there’s the answer to your question. Go to my YouTube channel. I’ll show you where to go here in a little bit, but somebody might share with you the link to go to YouTube and get all the recordings. I post them on my channel all the time. There you go.
I go back when these guys are doing them. If I miss a version and it’s pretty interesting, I’m like, hey, that’s a good question. It always keeps us sharp. Believe me, we’ve been doing this ourselves.
Eliot: I think this is 192.
Toby: This is 192?
Eliot: I believe so.
Toby: Hey, Kenny, is this 192? All right. Kenny says, sure, so 190 something. I’ve been doing this for 26 years, so I just started. All right, let’s go over the questions. I can’t read them. I can read them here, and I can’t read them there. I’m just hosed either way.
All right, “If you have a corporation and your children are the board members,” That’s pretty fun. You’re working for your kids. “Are you able to write off their car and or maintenance and gas for the vehicle?” Eliot is going to answer that. Every time I see that, I’m like, you have to answer that.
All right, “My spouse and I will file a joint 2022 tax return. She had a $6000 W-2 in 2022. Can I make a 2022 $3000 contribution to my IRA and we take the 2022 IRA contribution on our joint return? Or must the 2022 contribution be made to her IRA because it is her W-2?” That’s going to be fun.
Somebody says thanks for the videos. Surendra, you are my new favorite. We get a lot of chats. Hey, if you’re out there in the internet world, I know we get a lot of folks on YouTube. Eliot is looking at them right now, aren’t you? Yup, we get a lot of them. Let us know where you’re at. I’m always curious as to where people are sitting.
I was just in Miami yesterday. Now, I’m in Vegas. I love traveling around and meeting people all over the place, but where are you sitting? What city and state if you’re willing to share? Delaware in my chair. State of exhaustion. Lexington, Kentucky, the horse capital, Carlsbad.
They’re just going too fast. Gilbert Boseman, Old Town, Alexandria, Westminster, California Waldorf, Maryland, Fort Worth. They’re flying. There’s somebody from Miami. Buenos Aires, Argentina. Beautiful Austin, actually Georgetown, where Carl used to live here, Eagle, Idaho, Pasadena, Bakersfield, Honolulu, Hawaii. Nice. San Clemente, Houston, Texas.
We get people from all over the place. Today we’ll have hundreds of people in Tallahassee, Florida. Not to be confused with Tallahassee, Alabama. My dad was from Mobile, so I’ve spent a lot of time in that area. Let’s see, Lafayette, Louisiana, Brooklyn, New York. We got people from all over the place.
It’s always fun to see. We can have a little community here. Everybody’s all over the place. All right, let me go back to this. I still can’t read this. I already did that one, so let’s go into more questions. We will answer these here in just a second. I read them out, then we’ll go through, and answer them in turn.
“Can you discuss the tax benefits of using retirement accounts to fund, start, and loan my business?” How do I do that?” Great question.
“Can you discuss the tax effects of intangible drilling costs under Section 461 for oil and gas properties?” They’re pulling some code out.
“I paid my kids $12,000 for labor in my rental business. Should I issue them a 1099-NEC, non-employee compensation form?” It used to be the 1099-MISC. Little changes there, but great at being very specific.
“I bought a house in 2022 with plans to rent it, but I’m still working on repairs. Am I able to write off any of the expenses for the 2022 tax year? If not, does that mean I get no tax benefits for this project?” They should do one of those frowny faces. We’ll get into that, and we’ll tell you all the rules, The good, the bad, and the ugly.
“How do I do cost segregation when I purchased and rent it out in 2022? How do I take the accelerated depreciation for that house in the first year?” Really good questions.
What everybody should be asking themselves when they buy a house and put it into service is, should I be taking this stuff and should I be accelerating it? Because you might get some tax benefit you didn’t realize you had. Even if you create a loss, a lot of people don’t realize that there’s something there for them. It’s like a little present waiting to be opened.
“I just purchased an Airbnb September 1st, 2022 and put it into use September 1st, 2022. I purchased and put it into use the same day. I purchased many items such as furniture and fixtures for renovation. Due to that, I have a net loss for the year. I also want to do bonus depreciation on my furniture and renovations. My accountant said I have a loss and I’m unable to do bonus depreciation. Is this true? Can I not take advantage of the 100% bonus depreciation in 2022?” If you wrote this question, let us know you’re out there because you’re getting some bunk advice, and we’ll go over some of it.
“When should I file as an S-corp instead of a disregarded entity if I own single houses each in a separate LLC?” Great question. There’s some specific instance when you would use an S-corp because everybody’s going, no, S-corp and real estate, I heard it was bad. Not always, but there are certain times when you use them.
“Is there an AGI limit to claim passive losses on a return? In other words, if W-2 income is more than $200,000, can I claim passive losses on my rental LLC? If not, can they be carried forward? And how can I claim them next year assuming the income is more than $200,000 for next year also?” Good questions.
This is great. I saw a bar and restaurant and I just started smiling. “I’m considering purchasing a bar and restaurant in Florida that is already established but not doing well due to a change in ownership resulting from divorce. What do I need to consider before making this purchase?” We could just give you the laundry list.
Anybody out there owns a bar or restaurant who wants to weigh in? Because we’ll open it up to the group at that point because there’s about a million things that somebody might have to say. If some of you guys are asking, you will be receiving.
This is my YouTube channel. You can go on there. Patty, again, we’ll share it out. We do not solicit. We do not hit you up for business. What we do is post probably two or three videos a week, including the recordings of the Tax Tuesday.
All right. There’s the YouTube. There’s the link, aba.link/youtube. Some of you guys remember Norm? Norm. You can always tell how old somebody is whether they can remember all that stuff.
All right, “If you have a corporation and your children are the board members, are you able to write off their car and or maintenance and gas for the vehicle?” What say you?
Eliot: First of all, I want to distinguish what’s going on with these children. They’re board members, sometimes they can also be employees. If Anderson sets it up, we have specifically in our documentation that they’re not employees, but they are board members, and they are eligible for reimbursements. But that’s very different from paying for their car or something like that.
If it’s a reimbursement, you’re looking at the mileage reimbursement, not specific expenses as much. If you’re going to depreciate it like that, it has to be titled in the name of the business. It couldn’t be their car at that point.
Toby: There are a few rules to look at when you’re thinking of a car for an employee, period. If you’re going to write it off as a business expense, you need to go over 50% business usage, which means you’re tracking every mile on that car and making sure that that car is being used primarily for business of more than 50%. Otherwise, you have some bad things that can happen as far as recapture.
You also only get to write things off up to the threshold of how much you’re using it. If you’re using it 70% for business, you get to write off 70% of the expenses, including the depreciation. A lot of people get this horrible advice from accountants. They say, go out and buy an expensive car that has greater than 6000 gross vehicle weight at the end of the year, and you’re going to get to write it off.
That sounds neat for that year, and then you got to recapture the whole amount the next year when you drop below 50%. They forgot to tell you that part. Or you’re going to have an income value of that vehicle as a benefit, so it’s wages to you. You’re going to have to do withholding, employment taxes, and whatever that value is of that car.
You go buy a Land Rover, Range Rover, or whatever. You get a $100,000 car and you’re like, I’ve rolled it off, man. Then the next year, you have $20,000 of taxable income that you have to report and you’re like, but it didn’t pay me $20,000. But you drove the car, and you got to recapture the $100,000. You didn’t get them both.
Eliot: If you’re going to have this, it’s best to just have a title in the kids name, turn it in for reimbursement for any mileage, and they do drive on behalf of it.
Toby: That’s the thing. You have $65 and ½¢ a mile right now.
Eliot: Yes.
Toby: If you are an employee, it doesn’t matter whether you’re using it 10 miles, 1000 miles, 10,000 miles, you track your business use. I use something called MileIQ, a little app on your phone. With that app, it’ll track wherever you drive and say, was that a business or personal? I think you swipe left if it’s business, right if it’s personal, or whichever way.
Once you’ve done a few, like this is one of our offices here, so we have offices. McCloud, Rainbow, another office in Summerlin, and I have a home office. I drive in between any of those four locations and it knows it’s a business expense, period. It tracks it. Easy peasy.
If your kids are working on your board, then you could say, hey, you know what, we’re going to make them employees. We don’t have to pay them a wage, but we are going to reimburse their mileage expense and anything that they incur. If it’s an officer, it’s even easier because those are automatically employees.
A lot of accountants say that isn’t true so that you have to pay a wage. You do not have to. You can just be receiving beautiful, tax free, fringe benefits. Here’s the hint. They’re not reported anywhere on your taxes.
Eliot: Correct, tax free.
Toby: Yup. If I drive for Anderson and I say, here’s 100 miles and it’s $65 or $65.50 because that’s $65 and ½¢ a mile. I say, can I get reimbursed? They reimburse me. The company writes it off as an expense, and I do not have to report it. Does the principle apply to any board member? Yes.
I have a friend who’s a board member and not a kid or an officer. As long as you choose to treat them as an employee and are commuting from home to work and back, a business expense only if you have a home office. That’s where the administrative office for the home comes into play.
Having a home office and then having another place where you work, if you’re a real estate agent or something, you want to make sure you have a home office and administrative office for your home so that every time you drive to work, it’s a deductible expense. Otherwise, it’s a commute and that’s what you consider personal.
I’m reading the chats, I apologize. Sometimes I do that. You get them off of YouTube. If you started reading them, then we’d be in a real problem, so don’t.
All right. “My spouse and I file a joint 2022 tax return. The married filing jointly. My wife has or she had a $6000 W-2. Can I make a contribution of $3000?” This is the question. I’m looking at this going, how much did they make? Because you don’t have to pay any tax if you are under the standard exclusion, which right now it’s at 13,850 for single.
Eliot: 27,000-plus.
Toby: For last year, it was probably $25,500. You don’t have to pay tax, which means yes, you can contribute to an IRA, but why would you contribute to a traditional IRA when you could do a Roth and not pay tax ever again? It’s a pretty good question going in. I just love that. But this one, specifically.
If you’re above, and let’s just say that they must have mistyped. It’s $60,000. Can I make a contribution? Yes, any spouse can make a contribution. If you have a spouse who works, a spouse who stays home, you can make a contribution to a spouse who stays home and has no W-2 income or active income. You can make a contribution to that spouse’s IRA, traditional or Roth, as long as you file a joint return.
Eliot: Correct. I think that’s the important issue of knowing that. Just because one spouse earns income, it doesn’t mean that the other can’t contribute. In fact, they can, married filing joint.
Toby: Yup. It’s one of those little nuances that sometimes they mess up and they say, oh, but my wife didn’t make money, my husband didn’t make money, or my spouse didn’t make money, whatever. The whole idea is that no, when you’re filing jointly, then you can make contributions on each other’s behalf as long as you have the active income to do it. Don’t forget, you have HSAs too. Health savings account is $7700 this year for the family, 3800 something.
Eliot: $3850.
Toby: What was it last year for 2022? You could still make contributions up to the tax deadline till April 15th. It’s a large amount that you get a deduction for. You never have to pay tax on it ever as long as you use it for health services, including copays, deductibles, and things like that. Even if you don’t use it for health, there is a way to avoid penalties when you get over a certain age. I think it’s 59 or something like that, when you get old enough, then you just pay tax when you take it out like a traditional IRA.
Eliot: Just for clarity, it’s April 18th this year, not the 15th because of the holiday.
Toby: I’m going to go and I’m going to do one caveat here because Gail’s writing something about, hey, with the husband and wife, you have to look at your total income. There are phase outs for when an IRA is deductible and whether you have access to another retirement plan, but there is no income limitation on putting money into a traditional IRA. There’s an income limitation to deducting the amount that you put into a traditional IRA.
Just put that caveat because there’s some banter going forth on the chat. I just want to be specific. All right, here’s a good one. I’m going to throw this at you so I’m not tempted to answer it.
“Can you discuss the tax benefits of using retirement accounts to fund, start, and loan my business? How do I do that?”
Eliot: I don’t know if benefit is the word I would use. There’s probably one of the more common known plans. It’s what they call a ROBS, rollover business, where basically your retirement plan buy shares of a C-corp that you’re setting up. The money comes out of your plan into the C-corp in exchange for those shares, so now your plan owns the share that owns the C-corp, and then you can operate an operating business through your C-corporation.
It’s been popular. People sometimes like it. You’ll hear success stories out there, but I think probably you see more failures than you do successes. Remember, this is your retirement money going into business. Many people have that dream of opening their own restaurant or something like that. That’s probably the toughest business.
I’ve opened restaurants. I wasn’t funding them, but I’ve been in the startup of them. As an employee and saw the stress that happened to the owners, those types of things. It wouldn’t be my first recommendation to a client using the ROBS system, but it is there. It is available.
Alternatively, you can take a loan up to $50,000 out of your 401(k). That might be a little bit more useful. Use that $50,000 for however you want, whatever you want to invest it in. You do have to pay it back with interest into your plan. But that way, if you have more than $50,000, you still have something left in your retirement plan. It didn’t all get sucked into your C-corporation, where anything in the world can happen, good or bad.
Toby: You basically have traditional IRAs, Roth IRAs, 401(k)s, and different types of retirement plans. You have your different choices. Can I invest that money and partner with it? A lot of people believe the answer is no because they’ve heard this disqualified person issue. You can’t do ongoing transactions with disqualified parties, but you can do an initial investment into an entity like it has to be a C-corp, where you make a one time contribution.
Let’s say you have $400,000 in your 401(k). You want to buy a franchise and you’re like, it’s $200,000 for the franchise, where am I going to come up with that money? That’s where a ROBS transaction could be your friend. That’s where you set up a corporation and one time funding. Maybe there’s cash being put in and you’re putting in cash, it’s one time. No more continuing transactions between the entities once that’s done.
What it does is it gives you access, and you’re partnering with your qualified plan, and then you’re spot on. The other route is to borrow. A lot of people don’t. You can’t borrow from an IRA or a Roth IRA. You can withdraw from a Roth IRA, the amount that you put in without penalties. If you have to, there’s a potential to take it from there.
The other thing you look at is when you’re talking about a fund, start, and loan my business, sometimes you’re looking at it and you say, hey, who could I borrow from? Could I go to my brother and say, could I borrow from your IRA? Maybe that’s something. You’re thinking it has to be yours, but you don’t realize, wait a second, I could go to a family member who may want to stake me, and perhaps I could borrow the money.
There are disqualified parties there, but siblings are not one of them. I couldn’t borrow from one of my kids, or I couldn’t borrow from my parents or their IRA, but I can borrow from a siblings, friends, or something like that. You’re succinctly put on a 401(k) we can borrow. It’s up to $50,000 up to 50% per participant.
If it’s a husband and wife or spouses, and they have a certain dollar amount in there, they each have let’s say a couple hundred thousand dollars of retirement funds, you could borrow up to $100,000 paid back over five years at federal AFR rates, which are right around 4% right now. Not bad. And fund your business.
As far as tax benefits, there’s really none. We’re just trying to avoid penalties and getting smacked. If you’re in a bad year like, hey, I’m starting up a business because I lost my job, and I’m going to be in a low income year, maybe that’s the time to take an early distribution out of a retirement account. I hear all the accountants or financial planners screaming and going, no. Do so with your eyes open, it’s your money.
I’m just gonna say, hey, if you had the opportunity to do something that’s life-changing or that you make your living out of, and you can calculate the hit as 12% or something like that, I don’t care. Pay that. It’s one that’s a big hit that you have to be worried about. Anything else you want to add on?
Eliot: No. I think that’s it.
Toby: We could take any small subject and make it long and windy. Alright.
“Could you discuss the tax effects of intangible drilling costs under Section 461 for oil and gas properties?” What is that? What the hell is this?
Eliot: I got to come clean on this one. I had to go up and ask Jeffrey about this one. Jeff Webb, our CFO, because he’s worked a lot with oil and gas. Your intangibles, I’m familiar with that. In oil and gas, one of the big breaks out there is people could invest in it. The startup costs are basically intangible, drilling costs, IDCs as we call them. You could get 100% deduction on those costs right away.
Section 461 is something they put in place to tame the investment to make sure that it’s actually going towards its stated purpose and getting that well drilled. Basically, what Section 461 says is that, if you can imagine if we started this project back in January of 2022, we incurred these intangible costs throughout the year, and now we get to December of 2022 year end, Section 461 says that if you’re going to be able to deduct those costs on your 2022 return, you must have commenced the drilling, which they call spudding in the industry, which is actually in the title of the code.
You have to start commencing drilling the hole within 90 days of the next tax year, so basically the end of March. If you do so, then you’re allowed to take those costs back in 2022. That’s how Section 461 impacts intangible drilling costs.
Toby: Yes. Section 461 is a punishment. If you syndicate an oil and gas investment opportunity, and you raised $10 million, but you only put a million of it into action, into drilling, you’re not going to get a deduction for the $10 million. You only get to write off what they’re actually doing.
By the way, the reason people invest in oil and gas is because you get ordinary losses. It is not passive as long as you’re at risk at the investment side, and it’s at the liability side. Generally, these are partnerships, you become a member of the partner of the partnership, and you’re digging for oil. The whole idea is when all that cost of digging the hole, you’re going to write off in your first year. Usually, it’s about 80% of the investment value, somewhere around there.
If I invest $100,000 into oil and gas, I’m going to get an income stream for many years. But in that first year, I might get an $80,000 deduction against my W-2 or other income. It might be worth something nice to me. I don’t get to double dip, so I don’t get the depletion allowance and things like that. I have to start recognizing income pretty early on.
A lot of people do oil and gas for that reason. They’re looking to harvest the tax benefits. I’ve known several clients over the years that do it. I just always say it’s hit or miss. Don’t do oil and gas because of the tax breaks. You do oil and gas because of the return. You get a nice tax break and factored into your return like, hey, I immediately got $37,000 of savings by investing in this thing. Yeah, okay. I’m going to add that in, and then here’s the return on the investment, which makes it even more attractive.
Fun stuff. All the oil and gas guys are like, yes. We’ve been saying this for years. Yes, There are very few investments that give you a big old attaboy when you start in real estate and oil and gas.
Eliot: Just get that drilling commenced, though, within 90 days at the end of the year.
Toby: End of the year, so not within 90 days of your investment. If I invest in January 2023, as long as they start drilling by March of 2024, you’re good. That’s what that code is about, right?
Eliot: Correct.
Toby: Yeah. All right. “I paid my kids $12,000 for labor in my rental business.” Very smart. “Should I issue them a 1099-NEC form?” What do you think?
Eliot: Perhaps. It depends at this point. You’ve already paid them. If we’re talking 2022, probably now, yes, you would issue them a 1099. The better route is if they’re being paid from an entity that’s owned by mom or dad that’s disregarded to mom, dad, one of the parents, or it’s a partnership owned by mom and dad, then you can pay them W-2 as an employee, and they won’t have to pay any employment tax if they’re under 17.
Toby: Would you run that through payroll?
Eliot: Yeah, it has to go through payroll. You’re going to want to go through payroll so that you have withholdings and things like that, but I guess you don’t need to.
Toby: If it’s kids, they’re not going to even have a tax return. The kids paid $12,000, and if they’re 18 or under 18…
Eliot: Yup, but that’s the only income they earned.
Toby: They don’t even have a tax return. How do they know?
Eliot: The W-2 would still get reported to the IRS. There’s a master form with all the W-2s.
Toby: What if that’s the only W-2 like, hey, I just paid my kid?
Eliot: It’s fine. They wouldn’t have to file a return, you’re correct, especially if they’re below the standard deduction.
Toby: They just don’t have withholding requirements or employment taxes. If they’re over 18, different animal, 18 and above. If you have kids that are 18 years old or 19, 20, 21, 22, 23, they’re in college, you pay them. You’re going to give them that 1099. If you didn’t run them through payroll, then they’re going to have employment taxes. They’re going to have the self-employment tax, but that’s it. They’re probably not going to pay any federal income taxes.
Employment taxes, old age, disability, and survivors, 12.4%, Medicare, 2.9%. You get to write off a portion of it. It’s going to end up being a total of a 14.1% tax up to about $170,000. If it’s $12,000, that’s the only tax they’re going to be paying, period, end of story. You’re in a very little tax, which we like. It’s not free, but it’s super, super good.
Eliot: I was asking about employing a one-year-old. I want to be reasonable.
Toby: There’s a tax court case of a child who was six years old. They were using the images of the child in their advertising. The child was allowed to use I think Screen Actors Guild’s rates, which were pretty high and that was considered reasonable compensation.
You got to look and see, what are they doing? I suppose you could do that with people that are really, really young if you’re using it for advertising, but then you have to have a business that aligns itself to where you can use your children in advertising for marketing purposes. You got it?
Eliot: The next Gerber maybe or something.
Toby: That was Michael’s grandmother.
Eliot: Really?
Toby: The Gerber Baby was actually a woman. It was Michael Bowman’s—I think it was either his great grandma or his grandma. Hey, Kenny, do you remember? Yeah, great grandma or grandma.
Eliot: That’s great.
Toby: Weird stuff you didn’t need to know. Every time we say something that you never knew about, Michael always comes out and says, Gerber Baby. Gerber Baby was a girl. All right. Fun stuff.
Speaking of fun stuff, come and join us for our one-day tax and asset protection workshop. Clint and I do these every other week. I think it’s every other week, maybe it’s more often. We’re doing a live one, as in people are showing up. Even the virtual events, we’re doing them live. But the live, where we’re actually all getting together in Orlando. That’s May 18th to the 21st.
I think we’re having an Infinity on the first. Was it 18th, 19th? The 18th is the Infinity day. The 18th, 19th, 20th, 21st in Orlando. There are still tickets. We sold out the one last year. We did one in Las Vegas. We said, hey, let’s go to Disney World and goof off doing an event. For us, it’s goofing off. We always have fun with our clients.
You can come and check it out if you like to immerse yourself with around a bunch of really cool investors. That’s what it is. We just have a hoot. I think it’s going to be Ryan Gibson. Hopefully, it’ll be Ryan Gibson, Eric Dodds, and a few guys coming out, teaching on the investment side. That day one is going to be a really cool day.
We do something called Infinity Investing. If you want to pick brains of people that are big, successful right now, this is a good place to do it. The free events or the one-day virtual events, the Tax and Asset Protection event, where Clint does a really good job, we’ve been doing these for a while now. We’re dialing it in pretty tight. He does a great job on land trust, LLCs, corporations, how to use Wyoming statutory trust. If you’re in California, how can you work around for the franchise tax and minimize a lot of those?
We do that, and then I go over legacy planning on a lot of the tax planning for real estate, including the difference between dealers, wholesalers, and the active income that those things earn, Airbnb. Airbnb when you can take those losses against your W-2 when you can’t. Real estate professionals, depreciation, how to calculate, and all that fun stuff. We do that on Saturdays. By all means, feel free.
People always ask for the recordings of those. We do not record and send those out. Those are live events. One of the things we do is twice a month, we’ll do an offer that is available for about an hour. I’m not going to tell you when we do it because it’s a reward for those people that are willing to spend the day with us. It’s always pretty savory. It’s always the good stuff.
All right. “I bought a house in 2022 with plans to rent it, but I’m still working on repairs. Am I able to write off any of the expenses for the 2022 tax year?” Let’s answer that one first. What do you think?
Eliot: That’s a no. Unfortunately, all those costs prior to being available for rent, placed into service, which have you, whatever have you, it’s just going to go to basis to be depreciated. No costs up to that point.
Toby: You get this weird thing. (1) When you have either a vacant home or when it’s not put into service, you can’t have losses. (2) You can’t depreciate and write off expenses until it’s available for service. It has to be available for rent. The facts here, it sounds pretty clear that it’s not available for rent, maybe it was. Maybe you bought the house and it was a rental, you waited for the tenants to move out, and then you started fixing it up, in which case, we might have a different story.
If this thing was, hey, I bought it, it was empty, I’m going to rent it, but I have to fix it up first, so I’m fixing it up, those expenses are just going to be added into the basis. You’ll get them eventually. You’re going to get to depreciate them, but you’re not going to get a big loss. What if I’m house hacking, can I deduct the expenses? Somebody asked that.
Eliot: You can at the very least up to the amount of income you have.
Toby: Proportionate.
Toby: Yup, proportionate. Yeah, if you’re house hacking, you have your two. Imagine house hacking is a duplex. Instead of having a traditional duplex, you just have a house. That room is yours, that room is yours. You’re going to have to figure out which square footage is used for what, and then you can do proportionate.
Somebody has asked, can their 2022 expenses be added to the cost basis? Yes, that’s a very yes, Brandon, 100%. You nailed it. We should give it a I-nailed-it-on-Tax-Tuesday t-shirt.
Eliot, “How do I do cost segregation, which I purchased and rented out in 2022.” You bought a property in 2022, so what do you think?
Eliot: This is the reason I put the flow of questions in the order I did because Toby mentioned, once it’s in service, you’re going to do depreciation. Cost segregation is all about the depreciation and how we’re going to deduct it. In fact, it’s actually the proper way in the code to deduct. If you purchase and rent it out, now it’s placed in the service, you will have depreciation. Yes, you can do a cost segregation study and take advantage of that.
Toby: You can do the study. How do I take accelerated depreciation for that house in the first year?
Eliot: Now you’re looking at the code back in 2022, which I believe we are still under 100%. bonus. Now in 2023, we’re at 80% bonus. Once the study is done, the cost seg, and it’s broken up the pieces of the house into 5-year property, 10, 15, 20, maybe 27½ or 39 if it’s commercial, anything under 20 is going to be eligible for the bonus depreciation. You can deduct in 2022 up to 100%. That doesn’t need to be done until your 2022 return is filed. What extension is, we always tell you to extend, that’s going to give you out to October 15th.
Toby: You just hit a bunch of really important topics. I’m just going to break them down just real quick. The cost segregation is separate from the accelerated depreciation. That’s the first thing to always know.
Cost segregation is taking a property like we’re in a building here, commercial building, and it’s breaking out the carpeting, the cabinets, the appliances, the parking lot, the land improvements, and separating those all out from the structure. Anything that’s easy to remove, I’m going to write off over a shorter lifespan. This carpet here is a five-year property. It’s not going to make it 39 years. This is a commercial building, so it’s non residential.
Step number one is in cost segregation, you’re breaking those down. People conflate these all the time. I don’t blame them because they go hand in glove, but understand that you can do a cost save on anything, even without bonus depreciation. It just breaks it down, and you write things off faster.
If I have carpeting, that’s $20,000 carpeting, I’m writing it off over five years, so I’m getting $20,000 of deduction in five years, as opposed to spreading it out over 27½ years if it’s residential, or 39 years if it’s non residential. That’s number one.
I’m breaking it into 5-year, 7-year, 15-year property, and then you apply the accelerated depreciation, which is any of those or all of them, I have to pick a category and say, write it all off in this year or whatever the amount is. In 2023, it’s 80%. But if you put a property into service in 2020, and you do the cost seg election in 2023, you still get to use whatever the amount was when it went into service. You’d still get 100%.
If we’re using 2022 for our example, it was 100% bonus depreciation. What that means is even if they choose to, hey, I’m going to cost seg it, and I’m going to accelerate the depreciation, even if they wait a couple years to do that, they still get the 100% bonus depreciation. But I can do 100% bonus depreciation on the 5-year property, I could do the 100% bonus depreciation on that 7- year property, I could do the bonus depreciation on the 15-year property, or all of them, or two of the three, but I have to just choose to treat them all the same as long as it’s assets with those similar lifespan or property that has similar lifespan.
Once I do that, then I can get these huge deductions. That’s what you hear about. You see people doing cost seg and bonus depreciation on apartment buildings. They’re single families that are a little bit more on or probably on the higher end, but they get usually 30%-ish of the improvement value. When it’s self-storage or manufactured homes, it can be 80% of the improvement value. You’re getting these huge deductions, just huge.
It’s very potent, but it’s the 5-year, 7-year, and 15-year property. First, the cost seg, then the bonus. You can never do bonus without a cost seg, which is why you almost always hear them being conflated with each other. You get to choose. You could wait.
All right, “I just purchased an Airbnb September 1st, 2022 and put it into use in September of 2022. I purchased many items such as furniture and fixtures for renovation. Due to that, I have a net loss for the year. I also want to do bonus depreciation in my furniture and renovations. My accountant said I have a loss, and I’m not able to take bonus depreciation. Is this true? Can I not take advantage of the 100% bonus depreciation in 2022?”
Eliot: That’s the whole point, to be able to take that loss to offset against other W-2 income. I don’t know all the details here. Your accountant could be right in the fact that maybe the loss won’t go against your ordinary income if you didn’t materially participate in the running of that. There are other factors to it. Either way, you’re going to get the deduction, and you can take bonus depreciation.
Toby: Yeah, I think they’re conflating two things here. If you have an Airbnb, the question is, is it a rental activity, or is it a regular trade or business activity? If you’re averaging seven days or less, tenant or guest, each guest each day is averaging seven days or less, then it is not a rental activity according to the IRS and the Regs. It is an active business. The only question is, did you materially participate in it? It sounds weird. You’re like, what?
Did you run the place, or did you have somebody else do it? If you ran it and you handled everything, or you spent at least 100 hours and nobody else spent more than 100 hours, or your spouse spent at least 500 hours, whatever it adds up to, that is ordinary loss. There’s no restriction. Yes, you could get bonus depreciation. You could write off everything and wipe out a ton of your income. I think there’s a slight limitation of half a million dollars or something.
Eliot: $540,000 married filing joint.
Toby: You could take a big deduction, even if you were passive. Let’s just say that your Airbnb, seven days or less, and you had a property manager do everything. You could still create the loss. It’s just going to be a passive activity because you did not materially participate.
No different than if Eliot and I opened up a pizza parlor. Eliot worked at the pizza parlor, I didn’t. I stayed home and ordered the pizzas. He stayed in the shop and made the pizzas. He’s a material participant, I’m passive.
It makes $100,000, let’s say we’re 50/50, he would get $50,000 of active income. He’s going to have to pay self-employment tax on it. Me, no, I get passive income. It’s still ordinary, but I get passive. I’m not going to have employment taxes.
We turn it around. We lose money. Eliot’s a crappy pizza maker. We paid too much for the dough. We bought a big pizza oven, whatever, fill in the blanks, and it creates a $100,000 loss. He could take half of it and write it off against his W-2 income. Me, it’s passive. I need passive income to write off my passive losses.
It looks around for any other passive income sources, which might be rental real estate. It might be other businesses that I don’t materially participate in. It could even be I sold passive real estate, and I have capital gain that is passive capital gain that I could use my passive loss to offset.
There are all these little options. But what I can tell you for sure is you do get to take advantage of it, and that is bunk advice, unless possibly, you misunderstood him. There’s not even a case where it can be wrong, where they didn’t have it put into service sitting vacant. I can’t think of it. They’re just wrong, period. Move on.
All right, “When should I file as an S-corp instead of a disregarded entity if I own single houses in a separate LLC or if I own single houses in a separate LLC?” What do you think?
Eliot: We’re going to go with the normal general rule. You never want to put appreciable assets, that would be real estate rentals, into a corporation SRC. Now there is an exception or two there that Toby is going to probably go over here. We often like to see those continue to be in disregarded LLCs that are going to flow through to your return through maybe a Wyoming holding, but not through a corporation.
Toby: The problem with real estate in a corporation is when you take it out to refi, it’s a taxable event. It’s really tough. Once it goes in there, it’s really tough to get it back out. If it’s a C-corp, it’s really horrible. S-corp, you could sell it. You still get capital gain treatment. It just flows through.
It’s like, hey, if you leave it in there, it’s not horrible. But getting it out at some point can be frustrating because again, if you refi it and they say you gotta take it out, that’s a sale. They’re going to treat it as though you just sold the property and you’re going to have all that gain recognition, or you’re going to have a taxable event to the shareholder because it’s going to be considered wages. But whatever the case is, it’s bad.
Usually, the time you put an entity into an S-corp is if you’re going to sell it. It’s part of a dealer activity. In other words, you’re not an investor, but you are actually buying to flip houses, then the S-corp is your friend because it can help you eliminate a bunch of the employment taxes, it’s great for asset protection, it’s great to give you an accountable plan, and a whole bunch of write-offs. In that particular case, you could have a single LLC that owns a bunch of disregarded LLCs. Each LLC, you do a flip-in, and then you close it down afterwards so that you don’t have to worry about the legacy liability that goes along with having flipped a house.
I know a lot of folks that do this. They just keep setting up additional LLCs. It’s part of the reason why we have our Titanium service so that they’re not worried about the price because it’s included. They just boom, boom, boom, boom, boom, and they flip a house, they set up another one, flip another house, they set up another one, flip another, and then they’re just dissolving them as they go so that, again, if something bad happens on the property in the future that they don’t get drug in as a previous owner. From a tax standpoint, it’s really hard for me to justify using the S-corp with anything other than doing development or dealer activities.
Eliot: Exactly. One more point to why we don’t like to do it. Toby talks a lot about this. What if you hold a bunch of rentals, and you want to leave them to your children, your beneficiaries, or something like that? They were trapped in an S-corp. What they’re going to inherit are shares for the S-corp stock, which might be up to fair market value, whatever the value of the houses are when they inherit it, but they’re not going to be able to take any more depreciation. They’re not going to get the stepped up value in the houses themselves to be able to depreciate.
Toby: Because the shares are stepped up.
Eliot: Exactly. Yeah, very bad.
Toby: Let’s say that I was selling to a third party, and instead of selling the property, I sold the entity, maybe then you’d be okay. But otherwise, it seems like you’re losing a pretty big size tax benefit.
Eliot: Absolutely.
Toby: “Is there an AGI limit to claim passive losses on a return?” Let’s just answer that one first off.
Eliot: There is no limit to being able to show passive losses on your return. There might be the $150,000 overall limit for the $25,000 that you can deduct.
Toby: That’s the active participation loss, where if you have rental activity as a taxpayer, is it married filing jointly?
Eliot: Correct.
Toby: And you make $100,000 or less, you can write off up to $25,000. It phases out between $100,000-$150,000. For every $2 you make over $100,000, you lose a dollar of the deduction. You get up $250,000, you lose it, but there’s no other limitation. That’s not the passive loss. That’s treating a passive loss as an ordinary loss.
There’s really no AGI limit on passive losses. Passive loss is passive loss. It can only be used against passive income with exceptions. The exceptions aren’t even that, hey, I can use a passive loss against something else, it’s that it’s no longer treated as passive loss. If you’re a real estate professional, then your losses from rental activities are no longer passive, they’re considered ordinary.
If you are an active participant in real estate, and you make less than $100,000, then it’s no longer passive loss. It’s $25,000 of ordinary loss. I’m trying to think of what the calling of the question would have been. Maybe if they make too much money, and they have a bunch of passive loss coming through whether they’re not allowed to use it against the…
Eliot: Suspended passive loss rules.
Toby: That might be it. I’m trying to think of a scenario where somebody might be confused about that. If you have a doctor making $700,000 a year and they’re worried about this, I get it. Maybe they buy into a syndication, it kicks down a whole bunch of passive losses, and they have other rental activity that’s generating income, but they’re afraid they’re going to lose the passive loss because of AGI limit, there isn’t one. You could absolutely run that.
Somebody says, if not, can they be carried forward? And how can I claim them next year assuming that didn’t come as more than $200,000? We can ignore the $200,000? There is no limitation. Can passive losses be carried forward?
Eliot: Absolutely. They call it suspended.
Toby: When are those unlocked? If I have passive losses, do they ever switch to ordinary loss?
Eliot: They can. If you sell the property as creating the losses, that will release the PALs. We call it the passive activity losses, the suspended losses. They’ll come out and help you reduce any taxable income for that particular year of sale. It would be a big one, or if you had other passive income.
Toby: You have to get rid of substantially all the activities. They use this substantially also. Let’s say you’re aggregating your rental activity to get 10 rentals, and you sell one of them, it’s not going to unlock. If you sell eight of them, you probably could. That’s a question for an accountant.
I could spin your brain a few times. I just keep running through these. There are some good questions here. I’ve been enjoying this today. You guys asked good questions today. The chat is actually fun. It’s something about a game of chickens running wild.
All right, “I’m considering purchasing a bar, restaurant in Florida that is already established, but not doing well due to a change in ownership resulting from divorce.” I’ve just tried to visualize this. It was doing great, then they started fighting, and nobody would show up and drink anymore.
I would just show up to watch the theatrics. It was getting worse, then they started fighting, and everybody’s watching. No, I’m just kidding. Somebody’s probably not paying attention. “What do I need to consider before making this purchase?” Whether you want to own a bar.
Eliot: That’d be number one, the type of business you’re getting into. That aside, one thing that we always look at when we’re buying a business, are you buying the assets or are you buying ownership of the entity that owns the bar? In this case, big differences between the two. If you buy the entity, you’re picking up any prior litigation that has yet to surface with it. We never recommend that one from the buyer standpoint.
If you’re doing an asset purchase, which would be the alternative, you’re going to get the cost basis that you bought the assets at, which means you can now depreciate those assets at the value you paid for them. If you buy the entity itself, it already has the assets in it. It’s already depreciating some amount, at least if not fully. Again, just like we talked about in the previous question, you don’t get any stepped up basis in those assets, so you’re going to just take over depreciation right where they left off. You’re putting yourself at a tax disadvantage.
Toby: Again, you just put it really well. Most people that are buying a business want to buy the asset because they can depreciate it. Let’s say this is a corporation, S-corp or an LLC taxed an S-corp, and I want to buy the shares of that entity, I don’t get to write that off.
Let’s say I spend a million bucks, I get no tax benefit out of it. If I buy the assets instead, I can write a lot of it off depending on what the asset is. Even if it’s just the goodwill of the name, it’s 15-year property, I can write that off over a stretch. But if I buy the equipment, I can write it off immediately.
Toby: The other thing is if it’s real estate. When you buy a business that has a physical location, quite often, the physical location is being self-rented to that business, and people aren’t really good about breaking these things out, you can do what’s called a grouping election and treat the real estate in the bar as one activity, so you don’t have passive losses from the real estate. If you’re buying this because of the real estate, you might find a little tax benefit that comes out as a result, but you do want to make sure you have a very good either a business broker or transactional attorney who does the asset sales.
This is not something you cut your teeth on. Hey, I’ll get that experience, I’ve never bought or sold a business before. You don’t want to be doing that. You want to have somebody who’s been there, done it a couple times, a few times.
There’s a really good one. I had a guy, Trent Lee, on the podcast. I think I’ve had him on a couple of times. He’s on my YouTube channel. I would suggest that you maybe take a gander because I think he’s the number one business broker in the country as far as transactions.
He just buys and sells a ton of businesses. You want to run by somebody like that and say, what is the bar worth? Not somebody that’s going to like, hey, I’m a valuation expert. How about somebody that actually buys and sells businesses all the time, including a lot of bars? They could say, this is usually how it’s valued.
For example, if I’m looking at a services industry, it might be seven times EBITDA or something like that, or, hey, it’s a rule of thumb one times gross, 1.3 times gross, or something like that, in particular businesses. In a bar, it might be some other calculation. But that way, you know whether or not you’re paying the right price. Then I go back to my original to make sure that this is something you want to do. I want to buy a bar because a lot of people romanticize it.
You might want to talk to some people that are in that area that have bars, or maybe already have and they say, it’s a great lifestyle, we love it. But you want to talk to them and say, what’s the good, the bad, and the ugly? But from a tax standpoint, it could have a huge impact the way you actually structure the deal.
Again, maybe talk to your banker too to see what they’ve seen. Covid killed a lot of restaurants and bars. There, Patty pulled up the Trent Lee video. He’s just a great business broker. Again, if you want someone who sees it, does it, swims in those waters day in and day out, he’s a really good guy to talk to. He’s a really nice dude. I’ve known him for years. It’s always fun to have him on because he’s pretty generous with his time.
All right. We’re back to the YouTube channel. There you go. If you like this type of stuff or if you have other questions, I’ve probably done a video on it. How many videos are on here? It doesn’t say on here.
Eliot: 544.
Toby: Really, where?
Eliot: Look at tax planning.
Toby: 544 videos, there you go. There’s just a couple. You can go there. If there’s a topic, you may want to take a look at it and see what we’ve done. You can check us too. You could check us from years ago.
I was doing events back during Covid, and we could see what was going to happen in the real estate market. We were calling it for a long time. We called exactly what’s happening right now last year, and people were yelling at us. Clint and I were at odds, and I was like, facts don’t care about our feelings. Here’s what they’re saying. People are still like, I don’t know why it hasn’t crashed.
Eliot: Nine million, I think they’re looking for houses.
Toby: Seven million. We’re shy. There is a lot of demand. People don’t want to sell their house when they have a 2% loan on it. If they refi it, it would double or triple their payment. They’re just not going to do it. You have no supply, tons of demand. What’s that going to do to prices? It’s going to keep them pretty steady.
It’s not going to drop like a lead balloon like we had in 2008 when everybody was underwater and the rents wouldn’t support it. Although you are seeing a huge corrective cycle right now, the cost for real estate is up here, and the rental values down here. I hate seeing that. What that just means is everybody who can’t afford their house if they have an arm or something and they can’t afford it, then guys like me buy it down here. BlackRock and everybody’s going to be saying, hey, and that’s what you don’t want.
Hopefully, rents are going to keep going up. Rents are going to keep going up and they’re like, no. But that’ll keep you from having a big crash. Otherwise, you are going to see some price adjustment. It might be like 10% or less, but I don’t see us doing 2008. I stand by that.
All right, guys. Questions, by all means, send them in to taxtuesday@andersonadvisors.com. Send in your questions during the next two weeks. We might grab your question.
Eliot: Yeah, we might.
Toby: Visit us at Anderson Advisors. Anything else, Eliot?
Eliot: No. Thank you so much for joining us. Pleasure to be here. One way or another, I’ll see you next time in two weeks.
Toby: Yup. We’ll see you guys. Have a great couple of weeks and enjoy tax season.
Eliot: Get those extensions in.
Toby: You have to pay your taxes. You don’t have to file your return on April 15th. File an extension and give yourself a nice long stretch to make sure you get it right.
Eliot: April 18th.
