Which Business Structure is Best for Real Estate Agents & More! Tax Tuesday #149
(upbeat music) - All right, guys. Welcome to the Tax Tuesday. Hopefully everybody's out there live and kicking. This is Toby Mathis and I got Jeff Webb there on a different cam.
- What's up? - All right. So, let's dive in. We got a lot to go over. We have a people diving into the room, so we'll let you guys kinda come on into the room. Let us know, by the way, if you can hear us, if you could tell us where you're at.
So, just city and state would be great. There's Atlanta, Titusville, Alaska, San Francisco, Plano, Silla. Muckle Tio. Oh my gosh. Now it's just going fast.
Acrane, Westlake, Pennsylvania, Fayetteville, Huntsville, Baltimore, Tampa, Florida, San Jose, Largo, New York, Birmingham, Alabama. Prima, Louisville. We've got people from all over the place. So, we'll just dive right on in since we're, Jeff and I, how are you doing Jeff? You haven't said anything yet. - Yeah, I am. (Toby laughs) - You're all right, Jeff? - No, I'm fine.
- All right. So, we got a lot to dive into. We've got a lot to do, so let's just jump right on it.
So, you can ask your questions. You can ask them live via the Q&A feature in Zoom. So, you'll see the question and answer not the chat, but the question answer is where you ask your questions. You can always send them in via firstname.lastname@example.org. And if you're needing a real detailed response, like a professional response to a specific set of questions that pertain to you, we need you to become a client to do that. If it's just general tax questions, we just answer them.
Then, what do we say? It's fast, fun and educational. Yeah. We always try to make sure that we demystify this world of taxation and see what we can do.
We have a whole bunch of questions. Before we go into all the questions, so we'll say that we have a bunch of accountants that are here to help you. So, we have Ian, Elliot, Christos, Pio, Dana. You got Jeff and me, got Patty. You got Matthew and Zander.
I never know who, Alexander. Mr. Kratz helping us with the tech. How do you want me to like, okay, I'm not gonna ask. - [Ander] Ander is fine. - What's that? - [Ander] Ander is fine.
- See, but then it says Alexander and I feel bad calling you Ander. So, I'm just gonna call you Alexander since I can be that way. But we have a whole bunch of people there to answer your questions and we can make sure that your questions get answered.
So, let's dive into the main questions for today. And as always, we will go through each one of these, I'll go through all the questions that we're gonna answer. And then we'll go through each one, as well as answer your comments and your questions as you go along. Number one is what is the 1031 exchange? How was it used? And is there any concern that it might go away? Seems like the only option if you're trying to avoid long-term capital gains on property, we'll answer that. As a new wholesaler, what is the best way to set up my business structure? Would I have been to that one too? How does the tax work on rent-to-own? How does it work? How do the taxes work is really what I think it is, the non-refundable deposit, monthly cashflow and the backend.
How are all those things treated from a tax standpoint? I have a SFR which stands for single family rental that has been passive rental properties since 2003. I have not taken depreciation on my 1040. Now I wanna sell the single family residence, take the profits and pay the long-term capital gains. However, if I have not taken depreciation, then there is no recapture, correct? Or will the IRS take depreciation recapture regardless? So, we'll go through that one. Does a disregarded Wyoming LLC pay the $800 franchise tax in California? Please advise on any strategies to avoid having to pay the $800 franchise tax in California. By the way, I'm seriously considering moving to Nevada if I can convince my employer to allow me to work remotely.
So, somebody is having a lot of fun with California franchise taxes. I am a full-time real estate agent with the brokers license, though I do not currently run my own brokerage. I am planning to begin investing in rental properties as well.
Is it a good idea to put together these businesses under an LLC or S-corporation, or is it more beneficial to keep things separate? Good question. And we'll answer that. I have a rental and Airbnb on my property plus I work from home. What part of home repair landscape, etc, can I write off? So, we'll jump into that one as well. I need to create an entity for my business as a real estate agent. I'm not sure which entity is best for me and pay myself out of my business and come separately, not sure which court is best? So, we'll get into that. You got some choices there.
I have been buying investment properties for the past five years and are under my name. I have a separate personal account where my rental income is deposited. My question is how should I formalize my business structure if they are under my name and my personal account? So, great questions thus far. So, we'll keep answering. Then the last question is, I buy and sell vacant land. I typically buy then resell with owner financing, data trust, mortgage deed, etc.
My question is twofold. One, would I be considered a dealer given I do 400 properties a year though there are no structures and my intent is to resale on terms not flip for cash? Number two, would it be possible for me to save on taxes by becoming a limited partner, create a general partner operated by an LLC that my team owns operates, I just put in the money and stay out of the day-to-day. I'm not very actively involved as it is. So, we will go through all of those. There sounds like we got some good ones today. So, Jeffrey.
- Yes, sir. - Here's the first one. What is the 1031 exchange? How is it used? And is there any concern that it might go away? - Section 1031 allows you to sell an investment property through a qualified intermediary and then replace that property.
So, you've really pushed one property and replace it with another property. In general, you have to pay more for the you've replaced from property, or at least as much for the replaced on property as you do for the relinquished property. There's timeframes.
You have to identify that replacement property within 45 days and purchase it within 180 days. And you can actually identify several properties and just choose one or two, whichever serves you. (Jeff clears throat) So yeah, it gets quite a bit more complicated than that.
If you're gonna do a 1031 exchange, first thing you wanna do is go find a good QI, good qualified intermediary. And they will walk you through this transaction and keep you out of trouble. Is there a concern that it may go away? My personal feelings is this isn't going anywhere. Unlike you hear them talk about one to do away with a step-up in basis and things like that, those are permanent changes that make taxes go away. Whereas this 1031 is just deferring when the tax is gonna hit, it's not gonna be on this sale but may be on another sale down the road. So, I really don't see a logical way or logical reason for this going away.
What's your view, Toby? - I'm kind of the same way. I know that it became part of the Biden platform on taxation that they were saying, "Hey, we'll let you 1031 exchange "that we're going to put a threshold limitation on it "of a million bucks and things like that." I've never looked at it. I always looked at that as kind of the red herring, that was a negotiating tactic. I can't see them making it go away 'cause too many people utilize it. And like you said, it's not like it's a tax avoidance.
It's a tax deferral technique. Now, if you pass away with the replacement property and then you have that step up in basis, you could avoid paying tax entirely. So, they're addressing the step-up in basis. I believe they wanna limit it to a million dollars a step up. And they even tried talking about a million dollar limitation on the 1031 exchange.
I just don't see it going anywhere. - Yeah, I agree. - Big things for 1031 though. Like if you're somebody who buys properties and you can buy multiple properties.
So, if you wanna do a 1031 exchange, you certainly can. You could sell one property and buy 10. You can sell 10 and buy one.
As long as you're using a qualified intermediary, there are some pretty tricky ways to use 1031 exchanges, including in conjunction with like a 121 exclusion on a home. There's some interesting things you could do there to minimize your tax hit and to take advantage of multiple provisions. The other thing is just depending on your scenario, a lot of people get this weird fear of capital gains when realistically, if you spread it out over a period of years, it's not that big of a deal. And they'll oftentimes run to the 1031 exchange without considering alternatives like an installment sale.
So, I would just say that if you're in the real estate world, familiarize yourself with a bunch of the benefits to being involved in the real estate side and that there's other ways that you could defer taxation, including spreading it out over a period of years. Somebody said, let me see if there's anything here. - Yeah. A real important point of this, when you do a 1031 exchange, you don't get any cash out of the deal. That goes into your next property. So yeah, I agree with you, Toby.
Maybe the installment method. If you wanna sell and get out from underneath the property cash out, 1031 is not the way to do it. - Somebody just made a good comment. They just said, "Hey, if I'm under $80,000, "is my capital gain rate zero?" Technically yes, your long-term capital gains rate would be zero up till 80,000 and then it goes into the 15% tax bracket. And so, depending on what your scenario is, what your income is as to whether or not you even need to be worried about the 1031 exchange, you might be shocked that you don't really have that much tax dough anyway, which is why you always do the calculation ahead of time. Here's another one.
As a new wholesaler, what is the best way to set up my business structure? - I got a really short answer for that. I think I would always, most always do this to a corporation. - Yep. - Yeah. I got nothing to add to that, Toby.
- Well, I always say like, we know what the terms mean. So when you say wholesaler, what are you really talking about, and a wholesaler is somebody who basically gets a property under contract and then sells the contract right. And so, they're either gonna sell the right to close on that property. So for example, let's say that I got up a property under contract for $50,000, and I go to Jeff and say, "Hey, do you wanna buy my right to close?" I upsell it to you for 2,500 bucks? And Jeff says that it's actually a really good deal.
I was looking for a property like that. Great. I'd make the 2,500 bucks, right? Or I close on the 50. And then I immediately turn around and do a double close and sell it to Jeff. And neither one of those you're looking at, you're gonna have ordinary income that's hitting you. When you're really going out and you're running like when we see wholesalers that are true, businesses where they're going out and they're dropping a lot of mail, they're shooting out text messages, they're using prop stream and some of these other tools to figure out who's behind properties and they're reaching out, they're negotiating deals all the time, that individuals is going to be some sort of business.
It's going to more than likely be an S-Corp or a C-Corp from a tax standpoint, a corporation or LLC from the state standpoint. And of course, an LLC can be taxed as an S-Corp or as a C-Corp. So, it always depends on what it is that you're doing. So, I'm with you. I'm looking at this going, you're a wholesaler, you're a business.
I'm putting it into some sort of corporate structure, more than likely an S-Corp to start. - Yeah. We sometimes have people talk about, well, how can I make the... I don't want it to be ordinary income.
I want it to be capital gain or loss. Actually, you don't, it's the same tax rate for both capital gains and ordinary in a corporation. Ordinary losses, they're of lower use unless you have capital gain stuff. So, they kind of get trapped there.
- Makes sense. And if this is the first time you hearing some of this stuff, by all means visit our YouTube channel. There's a number of videos on this and our tax and asset protection courses. We always go into some of the good, the bad and the ugly when it comes to taxation. Speaking of workshops, we do have the Infinity Investing workshop coming up on September 11th. So, just to let you guys know, if you haven't been doing Infinity Investing workshop, it's really straightforward.
We go over two types of investments. Specifically, we're looking at stocks and we're looking at real estate and we spend a day diving into the appropriate way to invest and how we see our most successful clients investing. It's year after year, month after month. It doesn't matter whether it's going up down sideways.
Our clients, the good investors tend to make money no matter what, and we'll show you what they do and how they do it. It's not a difficult process to get involved in. You have to be a little patient because it's not a get-rich-quick. It's definitely a mindset and a different philosophy. That is a long-term philosophy.
So, if you wanna be successful over a long period of time, do what other people that have been successful over a long period of time have been doing and apply the same principles. We're not gonna be doing anything that's crazy. It's gonna be, here's mathematical certainty. The easiest way to look at it is we don't wanna be gamblers. We wanna be the casino. So, we'll show you how to be in the casino.
So you can, by all means, join us. It's absolutely free. So, we'll hopefully, Patty shared out that link with you all.
If you'd like to come on in and join us, it's actually fun. If you've never spent a day learning investing, it's actually kind of a blast because we bring in some really great people, P.O. Washington, Nicole and Aaron Adams, just great people who are just have a ton of knowledge and a lot of success. So, they do a really great job. All right.
How does the tax work on rent-to-own? That a non-refundable deposit monthly cashflow in the back end? What say you, Jeff? - This seemed to be an easy answer but it's not because the way it's treated and the way the IRS looks at it. The non-refundable deposit that you've mentioned is typically what we would call a lease purchase option. So, that can be treated one of two ways. IRS is gonna either look at that as an unexercised lease purchase option, or it's gonna look at it as a sale at the time the option's paid.
And the two main factors they look at is, have you increased the rent? Are you asking more rent payment than is fair market value, is fair rental value? And the second factor is that back end, that closing price or sales price, is that a bargain rate? So, if they're seeing those two things where you're asking for more for rent, but you're asking less for that purchase price, then it's expected they're gonna consider this a sale, that non-refundable deposit will be a down payment on property. A portion of those monthly cash payments are going to be considered a part of the sales price gain on that. The other side of that is if they don't do that, that if you're just getting fair market rent, it's just a future, say in the next five years, they could exercise this deposit or this lease option, they could do that. They're not gonna do. It'll be treated just like a normal rental.
It's just once you trigger certain things that you start triggering income like a sale. - And you'll hear it called a land contract or contract for deed and things like that, where they call them different terms than what you have to figure out is what the relevant rights are between the parties, 'cause all of those things would be an installment sale. So, is it a lease with an option or is that an actual lease-to-own where you're, in essence, you're making a partial payment every month on that deal, on that purchase? If I see a rent-to-own, I'm almost always wanting to see two agreements. So, I wanna see the lease and I wanna see an option.
And if they put down money on the option, then until they exercise it, then that money hasn't been earned yet. And the way option money is earned is the expiration of the option or somebody actually exercising. So, if they never exercise it, then you'd have a taxable event.
We've seen this so many times. I mean, there's folks out there that have some pretty interesting interpretations of the tax law. They'll get there. They'll take option money and they'll think it's never taxable, including when the person moves out or they said, "Hey, I'm not gonna exercise the option." Well, that just became taxable to you. And you'll have people argue with you that, no, no, no, it's not.
It's like what? You just get to have free money, just to pay tax on it when you received it? No. It was an option. And options are taxable on exercising it when it expires, or when it expires from either a time or whether you walk away and you say, "I'm gonna abandon it "or sell it." So, it's no different than options are in the stock market, right? So, when you do a rent-to-own, you do need to be careful as to how it's treated. The non-refundable deposit, if it's for the option, then we would have to look and see what rights were triggered.
Is it the right to have the option? Because if in that particular case, it's not taxable too. If you're receiving monthly cashflow than it is at under the lease, or is it a payment that is being made. So, is it rents and upon expiration, or excuse me, upon exercising that option is all of a sudden, a portion of that attributed towards a purchase price? So, again, you have to look at what the rights are inside of those contracts regardless of what you call them.
- Yeah. We talked about rent-to-own, and I prefer, like you were saying that that lease option, you actually have to exercise that lease option, rather than you're buying a little equity with every payment you make. I think that makes it a lot more complicated. - It does. That's why we always have to take a look at it.
So, people are always like, "Hey, I'm doing a lease option." It's like, okay, but can we see the documentation? And then it'll wind up being a disguise sale. Oops. And like, hey, that's not exactly how it works.
I don't care what you call it. I care about the rights that are between the relative parties. All right.
So, I have a single family rental that has been passive rental property since 2003. I have not taken depreciation on my 1040. Now I wanna sell the single family rental, take the profits and pay the long-term capital gains.
However, I have not taken depreciation. And there's no recapture, correct? Or will the IRS still hits you with a recapture? Jeff, what do you think? - Yeah, there's actually a couple of issues here. Not only will there be recapture, your basis will be lower. So, let's say that you had this for 27 half years and it's fully depreciated. Your basis would be zero and the sale.
So, what you wanna do is find, find a good CPA EA tax preparer, or somebody who knows what they're doing, and if you're selling it in this year, you need to do a change of accounting method, this year. It will allow you to take all the depreciation in the current year, you're still gonna be subject to recapture, but I would rather pay the recapture and have that deduction than just... - You're gonna end up with a big... Chances are they're gonna put the passive loss when they take the depreciation, and that'll be released, right? That'll be a released as ordinary loss when they sell the property.
So, you definitely want to make that change of accounting method. But to answer the question here, the real specific question is, if you haven't taken depreciation, you still have to pay recapture. So, the way the IRS words it, and it's not the IRS, the Congress works is, you may take depreciation, but you shall recapture. So, you're gonna have to pay recapture no matter what, whether you took the benefit or not. So, I'm a hundred percent with Jeff saying, you're gonna get hit here.
You may as well, it's a good thing you're asking now before the tax year is over and before the sale's done, because what we wanna do is make a change of a tax election before you file your final return, or before you file your return in the year of the sale, we wanna capture this in 2021, for sure. And make sure that we are getting the benefit of all that depreciation and then fire the accountant that you've had since 2003 in the meantime. (Toby and Jeff laugh) Yeah. Like this is well enough now.
I mean, you see this all the time with people that'll have a second property or a third property and they're renting it out. And they're like, "Oh, I'm just renting it out a little bit." So, it doesn't matter, right? You gotta make sure that if this is an investment property, that you are taking that depreciation because there they will make you pay taxes though you did. Anything else on that one, Jeff? - Now, if you look at the form where you calculate this game actually says depreciation allowed or allowable, meaning either you took it or didn't take up or should have, it's done. - It's not very nice. Definitely not very nice.
Let's see, I sent over a question via email yesterday, whenever we answered on this call, I'd probably not. Guys, we get about 400 questions a week. My guys will go through and answer them and then we pick about 10. So, yeah. So, somebody who's like, "Hey, I just sent it. "When are you gonna hit it?" (Toby laughs) You could always ask the question in the Q&A if you want. And then somebody was asking about the capital gains.
So, the way it works is long-term capital gains are gonna be zero, 15 or 20%, depending on what your income is. So if you are married, filing jointly, and you're below, I think it's $80,800 this year, then you are in the 0% long-term capital gain traits. So, the easiest way to think about it is if you are somebody who's making $50,000 a year and you do have long-term capital gains, you have about $30,000 of long-term capital gains that you can use up.
That's at the zero rate. And why is that important? Because you can adjust your basis if you've owned certain stocks for a long period of time and they've popped up, and let's just say you had a year, let's just say that COVID dealt you a low blow and you didn't have a great earning year, it might be this is the year where you sell some things to recognize capital gains and buy them right back, all you're doing is resetting your basis so that if you sell them in the future, you don't have any gain. And is the gain included in the 80,000? Yes. So if you had, hey, I made 70,000 and then I had $50,000 long-term capital gains, 10,000 of it would go in the 0%. And the remainder would be in the 15%. So, it is utilized for that figure.
- So, that $80,000, that's for married filing joint. The single is for 40,000, married filing separate is 40,000, head of household is I believe 53, somewhere around there. 54,000. - Yup. And then somebody just said, "Hey, I heard Toby say on the wholesaler questions, "he'd recommend an S-Corp to start.
Glen sometimes says C-Corp. It's always gonna be based off of your facts. So, if you're living off of the money, so if it's a wholesale and they're living off the money, I'm probably gonna start them with an S-Corp. If they are not necessarily living off the money, or they're gonna take it all out as a salary and you wanna qualify for loans, then that would be something where I'd probably look at the C-Corp, depending on what your scenario is. So, there's a lot of moving parts there. So, there's not a hard and fast.
What I look at is if somebody is making money, active income that they need, the S-corp is almost always gonna save you money as opposed to just doing it as a sole proprietor. And if you're living off of that money and that money's coming out to you, you're gonna be better off as an S-Corp from a tax standpoint. Now, what would push us to the side of saying, hey, maybe we should be a C-Corp, lots and lots of medical bills, lots of expenses that I can't write off necessarily as an S-Corp, that might be a factor.
And also if I am trying to qualify for a loan and I don't want them to have to go through my S-corp, but in the case that I just gave you where somebody is making their living at it, they're almost always gonna have to. So, again, it's usually you're sitting down and doing your weighing test with somebody who says, all right, what type of activity are you engaged in? What are you gonna be doing over the next four or five years? Is it something where we should start off to where it's easy access to the capital? Or should we add that little bit of extra complexity via the C-Corp because you're building up a portfolio of property? And that's what we're looking at. So, you're doing a little bit of balancing. You're doing a little bit away, so this is the only rule. This is like, "Hey, here's the considerations "that we're looking at."
And again, actually, if somebody is just somebody who's working, I wanna make it easy for them to get their money. And that's usually where we're gonna start. Now, no matter what you do, you're not stuck.
So, quite often you start off, like every corporation pretty much starts off as a C-Corp, but then you make the S selection. So, sometimes we're looking at it going, "Hey, this beginning year will be a C "and then we'll make the S maybe next year. "Let's just see how we're doing money-wise." It's not like you have a gun to your head and you say, "Hey, you have to make this decision right now. "And then it's forever." No, it's not like that. Like we can go back
and we could change things up as needed. All right. Does a disregarded Wyoming LLC pay the 800 franchise tax in California? Please advise that any strategies to avoid having to pay the $800 franchise tax in California. And then it says, "By the way, "I'm seriously considering moving to Nevada "if I can convince my employer "to allow me to work remotely." So, they must not like their taxes in California. What do you think, Jeff? - The Wyoming LLC is set up to avoid taxes in California because the presumption is that the Wyoming LLC is not doing business in California.
It's doing business in Wyoming where it's organized. Now, it can sometimes get pulled in to California. The most notorious way is California says, well, your shareholders members, whatever, all live in California. And they're doing all the work for the Wyoming LLC. So, when we set these up, we try to set them up in a way that does not draw California's Iyer. I don't know that I would move to Nevada, just to avoid the $800 tax.
But if you're paying, like I was serious amount of personal taxes in California, that's a good reason. - A lot of this depends on where you reside and where the... So, it sounds like you like this individual resides in California. So, it used to be, I'll just tell you how it used to be. Used to be, as long as the LLC was owned by a trust, we would win these and the franchise tax board would tell you, you didn't have to pay it if the trust was the member. And then they went back and said, "Oh no, if it's a living trust or if you're the grantor, "then it's still the individual.
"And we want the LLC to pay the, what is it? 4568." As a foreign business doing business in California saying, hey, since you're the member as the trustee of the trust, or they would always concoct some, "Hey, you're ultimately in control. "Therefore we think that the LLC is doing business "in the State of California." Obviously, it sounds neat for the franchise tax board, but from a legal standpoint, that doesn't necessarily meet the constitutional requirements of doing business in a state.
And then you end up with lots of franchise tax board court cases, and everybody, there's all over the place. So, here's what we do. There's a way to avoid it completely. And there's two really easy ways right now. Number one is you use a California disregarded limited partnership, that is still a viable option. It sounds weird, but the franchise tax board recognize that it is not a taxable entity from a tax standpoint for franchise tax.
And it's called a disregarded limited partnership. It's a limited partnership in which, in essence, you are controlling both the limited partnership and the general partner interest more than likely doing it through an LLC. So, that if you have multiple properties, let's say we have a bunch of properties and you're using limited partnerships to hold them, You might have one entity that's ultimately taxable in the State of California so that you can avoid paying multiple $800. That's not our favorite. Our favorite right now is the Wyoming Statutory Trust where it's considered a grantor trust, and it's not taxable for franchise tax purposes. And it's still given the same protections as the limited liability companies.
So, what you'll oftentimes see us doing now is going for the Wyoming Statutory Trust as opposed to using the LLC or the limited partnerships. The limited partnership has been on their target since, I think it's been about a year, I wanna say it's been about a year and a half since the franchise tax board came out with their opinion on it. And we think that the legislature is going to address it by saying, "Hey, we're either gonna make it something "that this definitely applies to "because they need the funds." So, we think that's the route they're going. They just haven't done it yet, which leaves the Wyoming Statutory Trust is our best friend. Yes, you could use other states if you really wanted to.
We find that Wyoming is very effective and very economic. So, it's like why spend thousands of dollars a year doing something in Delaware when you could do it for a couple of hundred in Wyoming? So, that's where we ended up going. So, hopefully that answers that question and you don't have to move. But if you do, just make sure that you're not doing the pretend mode, "Hey, I bought a condo in Nevada "now I'm saying that's my residence." Now you actually have to move and you have to spend more time in Nevada, you gotta make sure you're registering your cars here, register to vote here and all that jazz to make sure that it's legitimate.
Otherwise, California would more than likely be giving you a look-see. - But California gained a lot of notoriety over their $800 fees, but it wasn't because they had the highest fees in the country. It was the tenacity that they went after. Very tenuous relationships in California that really got them in hot water.
Even the courts had to tell them that they needed to back off on certain relationships. - I (indistinct) be commissioner. They actually followed somebody into Nevada. And here's the other ones. People always assume that if I leave California that the taxes don't follow me, that's not true.
If you had gain that it's unrealized capital gains, so if I owned shares in a company that gained substantial value and then I leave, California can still follow me around and say, "Whenever you sell that, I want my piece." And that's ultimately what happened in the Hyatt case and a few others, is they're following somebody who sells after they are no longer a California resident, but a big portion of the growth was while they resided there, and then California says we're entitled to our tax. And they usually win those. It's just one of those weird things.
Somebody says I think California still wants taxes on 1031 deferred gains. Absolutely, Bill. You just hit a nail on the head. They actually say like, going back to our very first question today about the 1031s, it's a deferral. And they want you to track it if it's from California property.
Even if you go into another state, they still want you to track it in case that ever becomes taxable, because then they just raise their hand and say, "Hey, the portion that was deferred for California, "pay up now." So yeah, California is, we call them vampires 'cause man, they can smell that, but they can smell that money and wherever you may be, and they follow you around and they'll just latch on. All right.
I am a full time real estate agent with the brokers license although I do not currently run my own brokerage. I am planning to begin investing in rental properties as well. Is it a good idea to pull together these businesses under an LLC or S-corp or is it more beneficial to keep things separate? What do you think, Jeff? - I would prefer to keep all of these separate. Ideally, I keep each property separate and I don't mingle them with my real estate business. I'd hate to be held personally liable for something that happens on each properties and having have to hand over my commission to somebody to make good on an accident or something on one of my properties. So ideally, I keep all of these in their own entity.
Now, could you group them as all disregarded LLCs under an S-corporation or something like that? Yeah. You probably could. Do you see any danger with doing something like that, Toby? - Yeah, I wouldn't put the rental properties under an S-Corp just because if I ever have to take it out to refy it, it's appreciated. I would get smacked with the tax wack. So, but your point's taken. Just because you have a separate entity doesn't mean it's a separate taxable entity.
So, you could have a, for example, this particular case, this person's real estate agent. Well, this goes back to the same question about the wholesaler. If I have an active business where I'm making my living out of it, I'm gonna start with an S-Corp. In your state, it probably requires an S-Corp. In other words, they wanna know who the owner of the brokerage is, and the only way they can know that is if it's gonna be an S-corp or an LLC taxed as an S-Corp, because then they can see who the actual owners are on the 1120s that gets filed.
So, that's always where we're gonna start there. On the rental property side, it's a little different because rental property is presumed to be passive, which means you don't have to worry about taking a salary out of it. You could literally set up a disregarded LLC if you wanted to do it that way, or you could set it up as a partnership as an LLC, and you could have all your properties and sub-LLCs underneath that one LLC.
You could have a hundred pieces of property going on a single tax return. There are reasons that you do that. The big ones are from a lending standpoint. There's a big difference between being on page one of scheduling in page two, for the amount of credit they'll give you for the revenue.
They'll give you 70% of page one. They'll give you a hundred percent of page two. So, there's reasons that we do that. There's reasons you do it all.
So, if you're selling properties, but in any case you want to keep those activities completely separate. So like Jeff said, if you have a liability occurrence on one of your rental properties, that it doesn't follow you into, "Hey, I have three closings this month." And then all of a sudden you have some lawyer trying to attach those proceeds. And you're like, "Gosh, bless it. "If only I had listened to Jeff and kept it separate, "right?" No, it's not hard to do to keep your rental property separate from your active business. And it's absolutely essential in many cases, and that's the route I would go.
So, I would keep those separate if I was you. Anything else on that, Jeff? - No, some of you were saying about the S-corporation for the real estate brokerage because they need to know who you are, who is actually doing... On the other hand, putting those rental properties in a partnership each under their own LLC, you can have anonymity there that you may not be able to have in that S-corporation. - Absolutely. Great point. And again, if you're a successful real estate agent and you're putting your face out there, obviously in advertising, do you want somebody to be able to pull up every property that you own and say, "Well, let's just see here's Jeff, "Jeff Webb realtor. Let me see what Jeff owns." And I find 20 properties.
Sometimes it's begging an issue. So, we're big privacy buffs. We see that not a lot of people get sued when you can't find out what they own.
Just back to the matter is usually takes the impetus of someone to chase after you. But we've had plenty of clients have frivolous suits when they were easy pickings. So if we can, we wanna defer. We want to make sure we avoid that if possible. Let's skip through some of the Q&A, And I could see that the guys and gals, I should say the guys and gals, but our professionals are absolutely knocking it out of the park. There's over a hundred answered questions in writing thus far, and they're just pumping through it.
So, if you have a question, this is the day to do it. These guys are on fire right now. So, Dana and Christos and Ian, and they're just doing a great job. Elliot. So, Pio, he's killing it.
I can just see all these guys knocking them away. So, that's awesome. So, I'm just gonna go jump right into another question. I have a rental and Airbnb on my property plus I work from home.
This is your type of question, by the way, Jeff. Whenever I look at these I'm always like, "Jeff will break this down." What part of home repair landscape, etc, can I write off? - I'll be honest. When I first read those question, I was like, wait, what? You have a rental and an Airbnb? And apparently it's your primary residence too.
So, how do you see this working, Toby? - Well, okay, so let's break it down into little pieces. So, it's where they live. So, it's their home and maybe they have this hack (Toby clears throat) and they have Airbnb. So, maybe they have a long-term tenant that stays in the upstairs. Let's pretend it's three bedrooms or three levels. The upstairs, they have a rental that somebody is there for the long haul.
And then on the second floor, it has a beautiful view. And the Airbnb, people come in all the time because it looks out over the ocean. And then on their first floor, they have where they reside. But one of the rooms is used as their home office too, their administrative office of their home.
So, then the question becomes, what portion of the home is rental? What portion of the home is this Airbnb? And is it rental or is it not rental, gets kind of fun. And then what portion of the downstairs, let's just say it's the first floor, what portion of that can they get reimbursement for? And there's a few little question marks there. So, let's knock out the easy one first. You have a rental upstairs and let's just say they're using up a third of the square footage on the rental. Then we would get depreciation. We would be able to ride off their property, the real estate taxes.
We'd be able to write off any expenses and repairs associated with that area, number one. Then we go to number two and say, Airbnb, and the question is, is the Airbnb rental or is it ordinary income? And in order to do that analysis, you'd have to figure out how many days the average rental is. So, let's say it's average Airbnb is three days and you're providing some sort of service with it, cleaning or coffee and things like that, that's not rental income anymore.
That's a hotel. You'd still get your depreciation, but it's no longer rental income. So, we wouldn't bunch it with the rental upstairs, it would be its own little creature.
And let's say that you were the one that was managing that, it would be active of ordinary income that would be subject to self-employment tax too. But you could take a ton of depreciation on that third of the house. Technically we could accelerate that depreciation, right? Can write off a big chunk of my house in that first year. So, like it's gonna end up being a huge positive. Then we look it downstairs and we say, all right, we add some landscape and things like that, was the landscape required for the Airbnb? Was it something that was necessary? If you have a home office, are you meeting people there? So like, for example, if let's say that you were managing your Airbnb at your home and they were coming in, yeah, I would write that off.
I'd write that off in a heartbeat. I'd say, yeah, it's necessary because that's where people come in. So anyways, so that's how I'd be breaking it down.
I would have a few questions for this individual to get some more clarity on what it is exactly they're doing, but just off of that, I'm kind of thinking that that Airbnb is gonna be their ticket to getting a nice deduction. On the same token, we have passive rental income and passive loss that'll probably be coming off of the part of the home that's used for that. And then I still have my home office, which again, it really depends on whether you have another business or whether you're able to do an administrative office in the home, 'cause you might find yourself in a reasonably really great situation from a tax standpoint, operating your business this way. - Oh, sounds good. I like the way you set that up.
(Toby laughs) - All right, Jeff. Now, with the Airbnb, with some things that we oftentimes do, and this might be one of those cases. It just depends on how the numbers line up, is quite often, you'll have a rental property that is a long-term rental. You'll have the Airbnb which isn't, you can just rent it to a corporation that acts as the host. So, quite often what you'll do is you'll have an individual create a corporation and you'll rent the other, again, I used a third, a third, a third you'd rent that one-third to the Airbnb corporation and let it be the host.
And the reason I would do that, would it really be because I don't want necessarily to have a huge chunk of loss is coming out to me. But also because I wanna be able to offset the income via deductions, something like the administrative office, and maybe I'm not too worried about the tax bill. Like I might be making my living off of this. So, maybe I don't wanna take all the accelerated depreciation in one shot.
But that would be something where like guys like Jeff, they do a really good job. It just, here's option number one, here's option number two. We get to break it down. Don't you love questions like this? It's like we can just make them do whatever we want.
Usually... - I have so many other questions. - I know. There's a ton of questions coming in too. Our guys are killing it today. All right. I need to create an entity for my business as a real estate agent.
I'm not sure which entity is best for me and pay myself out of my business income separately. Not sure which Corp is best. So, I think we've talked about this a couple of times today, but what do you think? - I'll go back to what we said earlier, for a real estate agent, I like the S-corporation. - I think you have to, in many cases. - I think there's gonna be some states that may allow you not to be, but I still think the S-corporation is the best choice, it has an easier way of getting money out of that S-corporation. You put it in a corporation, you're either gonna have to pull that money out either through salaries, which is okay, or dividends, which is less okay.
I don't know that you'd wanna do this as a partnership. I'm gonna settle for S-corporation 'cause I can't think of a better way to do it. - Somebody says, well, some states won't pay the commission to an entity and they must be paid to an individual. Yes. But there's a way to get that over there, Justin. There's actually a IRS case, and it's not nominee. (Toby laughs) No, actually there's a, if you show and you give to your broker, for example, that you're under the exclusive control and you have an employment agreement with your S-corp, then even if they pay it to you, you could reassign it over to the S-corporation.
You have to show those two things that you need to have an employment agreement and you need to make the payor who is going to pay you individually. You need to need to make them aware that you are under the exclusive control of that S-Corp. And I always screw up the case on it. I wanna say it's like the, the Fit Gym Ins or Fitzgerald case or something like that. But there's actually a case on it. But yeah, usually you're gonna look at your state law and say, "Hey, what kind of entity can I be?" A lot of real estate agents start off as a sole proprietor.
For some unknown reason, I say that bad taste is timeless. But the reason I say that, and I say that in (indistinct). Your audit rate is about 800% higher as a sole proprietor and you lose, no joke, 94 to 95% of the time. So, I'm like, ENO. I don't want that.
If I am an S-Corp, I will save money. Even I've done the numbers, even just straight across apples to apples. Even at $25,000, you save about $1,500 a year as an S-Corp. Even at 25,000, if you're at a hundred thousand, it's close to 10 grand, it's right around the eight and $9,000 mark. That's without even giving all the other tax incentives that come along with having an accountable plan, which is only possible through an S-Corp.
In other words, if I wanna do an administrative office in the home, I have to have an S-Corp, SRC, and if I'm in real estate, chances are I have one choice. I'm gonna be from a tax standpoint and S-Corp. It could be an LLC taxes and S-Corp, don't get me wrong. But from a tax standpoint, it's gonna be that S-Corp. Now, there's lots of other benefits.
There's the not only is the accountable plan there, but I also I could still do a 401k, I'm paying a small salary, which I could dump straight into my 401k. There's lots of other bells and whistles. But when I just look and I say, here's my S-Corp, here's sole proprietor. You're making 50,000 if I did nothing else, like we know that the S-Corp gets a whole bunch of other benefits, but if we didn't even take advantage of them, all we did was use this as a money comes in and we pay a small salary and the mess of the money comes out.
If that's all we did with the S-Corp and kept it super simple, you're still gonna save yourself somewhere around four to $5,000 a year being the S-Corp. And I'm still shocked people wanna be sole proprietors. I'm like, stop that. So, the answer to your question is, as a real estate agent, I would immediately go right to an S-Corp to start. And if you get really big and we have guys that clear seven figures on a monthly basis, not on an annual basis, but we have some that are some big hitters.
That's when you add some complexity, that's when your defined benefit plans. That's when you might have a management company. That's when you're starting to do whether it's activities in real estate to create losses that can offset. If you can qualify as a real estate professional, things like that. There's lots of other ways to lower the tax bill.
And then at the end of the day, I always say, people is, look, if you have a tax problem, that's a great problem to have. Means you're making a bunch of money, quit whining about it. Minimize it. But be happy that you have that issue 'cause there's a lot of people out there going, "Boy, I wish I had a tax problem." Sorry, Jeff. I just go off sometimes. - That's very interesting. - (indistinct) on that.
No, no. I think pretty well. - All right. You can follow Anderson on social media. The one I would drive you to guys, the one that where we have so many people get a lot of use is out of that YouTube, aba.link/YouTube, or just go to YouTube and look for us.
All right. I have been buying investment properties for the past five years and are under my name. So, the last five years, I've been buying a bunch of properties.
They're under my name. I have a separate personal account where my rental income is deposited. My question is, how should I formalize my business structure if they're under my name and personal account? Let's hear you, Jeff. - My suggested route for this would be to form a partnership. I would have a corporation be the general partner and maybe the limited partner or limited member. And I would then put the properties, I would contribute the properties to the partnership, going back to what we always say, one LLC for property, if you can do that.
If you can't, you just need to consider what your risk is. So, I have all my properties in the partnership. The corporation is responsible for running them. The corporation, we can pay them a management fee to help manage how much income is coming to me personally. The one thing I kind of wonder about is if we're looking at substantial losses, do we wanna consider real estate professional here? And in that case, maybe we don't put them in a partnership, but we could still have a corporation managing these entity.
Well, I'm gonna ask you what you think about this. - Well, at its most simple phrases, just because you own it individually now, it doesn't mean that you can't put it into a separate LLC. And depending on how much equity you have in the properties, like the best advice, the best practices is to separate each property in a separate LLC, unless you just don't have a whole bunch of equity in them. And then there's some argument that maybe you could divvy them up.
Me personally, at this point, I'm always like just separate LLC. And like, why mess around with it? Just keep it the best thing for you because those properties are all income generators. You don't wanna lose the income off of a property because you decided to play at cheap on an LLC or you wanted to avoid the a hundred dollars fee or whatever it was every year with the state. So, don't do that. It's not that difficult. It's very, very common.
So, even though you have your own separate bank account, that nobody cares, from a standpoint of the IRS or asset protection, if it's in your name, it's in your name. It's like, it's in my right pocket versus my left pocket versus my back pocket. They don't care. It's all you. So, what we wanna do is set up separate boxes to hold onto those assets. So, if anything happens to them, you don't lose all of your assets and same thing with you.
If something happens to you that you don't lose all your properties as a result. One of your kid gets into a car accident or whatnot, you just don't want these to come into play. So, we tend to use LLCs, Jeff mentioned having a singular LLC that was a partnership that held the other LLCs, that singular LLC that would be taxed as a partnership, nine times out of 10, it's gonna be in Wyoming so that they could never take it from you, because Wyoming says, "Hey, creditors can't take it." The most they can get is a charging order, which is a lien.
So, it keeps you from having to worry about the asset disappearing. But I wouldn't worry about it. Two seconds. Just everybody generally has to start off buying things in their name, especially, gosh, I remember 20 years ago, you couldn't get alone in an LLC.
You had to get it individually then. And then at closing, you'd put it in the LLC. So, it wasn't that uncommon.
Nowadays, they're far more likely to let you close directly in the LLC. But in some cases, if you have a traditional loan, there's still, the bank's gonna say, "Hey, Jeff, could you put it in your name "so we can close and then we'll put it back?" All right. That's still not that uncommon. So, don't think this is not fixable. And there we go. Thank you. All right. I buy and sell vacant land.
I typically buy then resell with owner financing due to trust mortgage deed, etc. My question is two-fold. One, would I be considered a dealer given I do somewhere around 400 properties a year, even though there's no structures? And my intent is to resell on terms, not flip for cash. Would it be possible for me to save on taxes by becoming a LP, create a GP operated by an LLC that my team owns and operates, I put in money and stay out of it? I'm not very active as anyway.
What do you think, Jeff? - Doing 400 properties a year, I would say you're dealer in land. You're selling on terms, which I'm assuming that means seller financing, but you're not gonna be able to use the installment method to recognize gain on these. You're basically selling inventory. It's gonna be an ordinary income rates and if you sell 400 properties this year, you're gonna have to recognize that income all this year when you filed this tax return. Would it be possible for me to say taxes by becoming an LP? Possibly, if you're doing this many sales in your own name, that's probably a really bad idea. Something is bound to go wrong.
So, I would at least put these in an LLC. What about an S-corporation, Toby, rather than an LP? - Yeah, so I think you bring up a good point. When you're buying and selling any property, it's an active business. So, if people weren't following you close enough, the installment sale is not available to you if you're a dealer in real estate. And a dealer is somebody who buys property to sell it, it doesn't matter whether you're doing terms or not.
Did I buy that property to hold it as inventory and sell it? It's no different than being a car dealership. So, just like in a car dealership, when the car dealership sells the property, they may get financing for you, but they have to recognize all that income, whatever they receive immediately. And that's the same thing here. So, going down the path of using limited partnerships, I don't see that being something that's necessarily relevant here, you are in an active business of buying and selling inventory. So, what I would be looking at is, how do I isolate off my liabilities on those properties? So, depending on the value of the land that you're buying, I might put separate LLCs together, depending on the area of the country, or if there's any distinguishing features so that if something bad happens in one area, it doesn't take out my entire business. And I might even systematically close them periodically as I buy and sell.
I might be doing that through a separate LLC for each traunch, so that when I'm done, that my liability, I can close down that LLC and my liability goes with it. Just 'cause we've seen, I mean, I've seen 15 years after a sale somebody coming after people that were in the chain of title. So, it's not something you wanna see. I actually had a land dealer, somebody who did exactly what you're doing and up in Seattle, and they came in, and I think it was 11 years after the sale. And what happens is if they ever discover a defect, they just associated with everybody that had previously owned it and assert the claim against them all and let them fight it out.
- So, one thing that the question asks is, become an non-LP, create a TP operated by an LLC that my team owns. Is that the best way to give some ownership to your management team or would an LLC do the same thing? - Well, so, I mean, it's the same thing, right? They're just using the vehicle limited partnership and saying here, the general partner is this other group and they're in control of everything. I would never advise a client to give up control, unless it was something where I said, "Hey, you know what? "If this is really them, "then maybe you should be doing participating loans. "Maybe you should be doing, just being a lender, "a hard money lender to them "and letting them make their money and your money," at least that way, it's still be ordinary income, it'd be portfolio income, but you wouldn't be subject to self-employment tax. That's the only thing I could think of.
Whenever I see this type of thing and they say, "Well, I'm not really doing anything." Yeah. You're probably in control of the whole thing and you control the purse strings, and everybody else is going out and doing this. Which again, just because we're saying, "Hey, this is a regular business." That's not a bad thing. Again, it's like being a really successful car dealership, except instead of selling cars, you're selling land.
I would treat it identically, then make it an active business that I'd make sure that I'd probably be looking and saying, how much income is being generated on a consistent basis? And should I be using things like defined benefit plans? Would I be better off saying since I'm in real estate, maybe I need to start accumulating some and becoming a real estate professional and using that to offset the income that I'm gonna be forced fed over these installment sales, right? 'Cause the installment sale does not work for dealers. period. It's specifically, it's 453, right? 26 USC 453, it specifically says except in the case of a dealer. So, you don't get to spread it out over a period of years.
So, you're gonna have to recognize that income. So, we'd probably wanna deploy some tax strategies to offset that. And real estate happens to be the best game out there for those types of benefits.
So, good questions, guys. Let's, here we go. Hey, there's Infinity Investing again, I'm just gonna throw that back up at you. If you guys wanna join us on September 11th, we're gonna have a really good group. P.O. Washington will be in the house, teaching the stock market landlord.
Nicole Debross will be going over real estate. And I'm sure I'll have Aaron Adams sticking his head in there too because there's so much cool stuff going on in the real estate market. If you haven't been paying attention, real estate is going nuts and it doesn't look like it's slowing down. I wish I had a nickel for every day somebody said, "Oh, it's gonna crash."
I'm not in the numbers. I see. It might flatten, but it's definitely not going down. Somebody says I'm gonna keep going on. There's the YouTube, said if there was one area that I would go and spend some time, that's where I would go. And let's see, are there any other questions that you saw out there that you wanna answer? - I did not see any others that I want to answer.
Maybe I should probably (indistinct). - Perfect. Well, if you guys like this sort of information, if you like Tax Tuesdays and you like a little bit of brain food, I guess is the best way to put it. Andersonadvisors.com/podcast, please go in.
We have actually a really good listening base. Like we were looking at the year over year numbers and you guys are good. You guys go in and you guys watch. And even if you can't be here, you guys are really good about popping on, but you'll see that we're always throwing different guests in, we're having some fun talking about finances and tax and all that good stuff. If you're a platinum member, you can go on and watch the Tax Tuesdays. They're always a kick in the pants.
And if you wanna ask questions, just email us, email@example.com. our guys today, between Dana and Pio and Elliot and Christos and Ian and Ander and Patty, like, I think I already said Dana, you guys just all, they've already answered 185 questions in writing. So, you can always just pop on in and ask us a question.
I'm just gonna tell you guys that I'm not aware of anybody else out there that's an attorney or that's an accountant that would grab their staff and answer these types of questions just live. Most people are too scared. They always wanna go back in and read up on everything.
And I'm like, no, let's just do the best that we can, share information. Every day that every now and again, Jeff and I screw something up, and you know what? There's always a CPA out there that says, "Hey, guys, you screwed that up. Here's this." We're like, "Oh, that's a good thing we have people listening." (Toby and Jeff laugh) And it's great.
So anyway, somebody says, love, love these things. I'm a customer and helps me be a better customer. Yep. Thanks, guys.
Well, then I would just say, Jeff, have a great day and thanks for being willing to jump on the Zoom. All right, guys, bless you. And we'll see you guys in two weeks.