Ep. 115 | Top 5 Gifts From The IRS

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Welcome back to the podcast, everybody. Today, episode 115. We are gonna dive into the top 5 gifts from the IRS. That’s right. It’s the holiday season. Are

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they really in the, the season of giving? We’re about to find out. But before we do that, let’s take a brief moment and thank our episode sponsor.

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This podcast is brought to you by Legacy Lock. If you are new to estate planning or simply need to review your current plan, Legacy Lock makes it as easy as pie. Legacy Lock is a unique platform that enables you to to easily complete your attorney drafted documents conveniently from the comfort of your home or office. Your first step to this peace of mind is simply visiting teaching tax flow.com/legacy.

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Back here again on the podcast, as you heard of the intro, seen in the title, or you just read it or seen it somewhere else, we’re gonna talk about those top 5 gifts. That’s right. Gifts, not gifts, j I f’s. As you know, you’ve probably seen enough of those on social media over the past decade. We’re talking about gifts, presents from the IRS.

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So we’re gonna jump into these, and the good thing about these is if you actually are a die hard subscriber of the podcast, you’ve heard a little bit about each one of these as we’ve gone along or, I should say, progressed along. But now we’re gonna run through them a little bit more condensed version. And, again, they’re gifts. It’s something that the IRS is giving you. It’s up to you to use it.

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So best guy we can always think of to tell us exactly how to do this. My brother from another mother, but he also has much less hair. If anybody’s watching this, you can kinda see I need to I need to take a gift, give myself a gift, and go to the barber. But, Chris Pacquero, how’s it going, brother?

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It’s going well. Happy holidays, and I know that I’m on Santa’s good list. I can’t I can’t speak for you, but I know I’m on Santa’s good list. You know? And,

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I’m I’m at, like, 80%, I’d say. I got, you know, there’s always room for improvement. Right? So

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Well, I would say that I’m definitely on the good list, and and since it is a holiday season, that was the inspiration for this podcast episode, and the IRS doesn’t give us too many gifts. But I wanted to identify my 5 favorite gifts that the IRS gives us, and these gifts are good because they’re not specifically for certain high income or high net worth people. These are gifts that any almost anyone can use. And, I’m excited about that and you might say, well, what do you mean that what is a gift in your mind? A gift is when, in the teaching tax law system, we call this a a goal diagnosis, but a gift is when you get some type of financial benefit and don’t have to pay tax on it.

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Think about like that. That’s very rare. Right? Typically, we have to pay tax on it. We’re supposed to pay tax on all of our income.

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And I love that you came up with this title because it is it’s something that I wouldn’t say they’re so easy, but these are all pre and we reviewed these obviously before we talked about them. There’s something that so many people can take advantage of, and and here I am staring down at at number 1 here. I’ll let you say what it is. I’m not gonna spoil it for you. It’s a it is amazing to me how many people don’t know about these.

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So, basically, this is our gift. We’ve been gifted the gift to regift to the community. So let’s run through these things, shall we?

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Yeah. I’ve and I’ve used 4 of the 5. Thank goodness I haven’t used the 5th one yet. So which I’ll which I will explain. So yeah.

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So the first one was gonna be and and like you said, John, many of these, there’s actually additional content. All of these, there’s additional content on the teaching tax flow YouTube channel. Many have their own tax TTF podcast episodes. But the first one’s gonna be the 1031 exchange. This is one we’ve used.

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What that means is that section 1031 of the tax code allows you to sell real estate at a gain and defer any payment of the tax on that gain if you reinvest it into like kind property. And like kind property, there is a pretty general concept. Right? So you can sell, like, commercial property and buy residential property. You can sell an apartment complex and go and buy 5 or 6 short term rental properties.

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The key is though, now we have to remember with the 10/31 exchange, is that you can’t take cash to complete a full exchange. You can’t take cash or what they call boot out of the deal. You have to and you can’t put the money, from the exchange in your bank account. You have to use a qualified intermediary or QI. So the the process looks like this.

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I go to sell my property. I before I close, I contact a qualified intermediary. Let them know I I’m gonna do a 10 30 one exchange. My property sells. The funds from my property get wired right to the qualified intermediary for my benefit.

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So it’s kinda like an escrow account or trust account in a way, and they sit there until I buy replacement property. Now there are rules for replacement property. You’ve got to identify the replacement property within 45 days. You’ve got to close within a 180, and that’s something that you’re gonna work with your qualified intermediary and your real estate professionals. And the point is, if you can defer any of the gain, that’s pretty attractive.

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Right? And you just deploy it into a different asset class. And this one actually could get paired with our final one, but that it, but, yeah, the 10 30 one exchange is really a gift from the IRS.

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And, really, with this one, Chris, too. So, you know, anybody that’s listening to this, you know, we talk about capital gains a lot because that that is a let’s put it what it is. That is a giant kick in the you know what if you don’t see it coming. Right? So if somebody you know, say you’re listening to this and you say, oh, well, I don’t really know what capital gains is.

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Go go do a little research on it. I mean and, honestly, Chris, I don’t know if we’ve actually really broken down too much on a specific episode that I can think of of what exactly it is. So may maybe that’s something we look in the future, but my my little advice to anybody on this one again, you know, I Chris brings the knowledge. I bring the I don’t know. I’ll figure out what I bring one day.

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But, get a good grasp of what capital gains are or is, and then you will immediately realize how powerful a 10 30 one exchange is. So it’s kinda like a secret weapon, but a lot of people don’t know about it. Right?

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Absolutely. No. It’s it’s it’s a really powerful tool. So I’ll I, I’ve used it myself, and in in, you know, practically speaking that it could the exchange could straddle over a year. So, again, work with a tax professional, work with the people that you need to work with to make this happen.

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If you’re in a situation where you’re selling property and you don’t need the cash and you wanna deploy it into something else real estate related, this could be a great opportunity for you. So that’s number 1.

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And here’s a bad example of that of what not to do is it’s not like you calling your significant other or saying, hey. I’ll call you on my way home and you forget to call them and then you get home and they’re mad at you. You if you’re too late to start at 10:31 in your process, you can’t go back. So you need to to initiate that early on. So

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alright. It’s interesting, though. There are reverse 1031 exchanges where you actually buy the replacement property before you sell the property because sometimes you have timing issues. But but you can’t but if once you close on a property and put the money in your account, you can’t do the 1031 exchange. So definitely talk to a QI qualified intermediary.

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Number 2, health savings accounts. I know I talk about these a lot. They are phenomenal. They’ve got they they are what we call the the the a triangle tool. Right?

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3 a triple tax advantage tool. It’s kinda like a remember those old well, that was an those ninjas, that was like a triangle, you know, that the,

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Oh, the little Chinese star?

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Yeah. So that’s a star, but a triangle. What do I mean by 3 3 triple tax advantage tool? 1, when you contribute to a health savings account, you get a tax deduction for that in the year you contribute. So that’s a tax that’s a tax deduction.

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You actually have until April 15th, just like an IRA, to contribute to the house savings account, and count it for the previous year.

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So you

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have April 15th and count it for the previous year. So that’s number 1. Number 2, the money grows tax deferred. So you could have your HSA could be invested in savings. You could actually buy CDs.

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Some people just leave it in a checking account, but most people want it to grow. Right? And in earn money. So all of the income you receive from it, as long as it’s in the health savings account, is tax deferred. Part 3, when you take a distribution from the health savings account, that is tax free.

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As long as the distribution is used for medical expenses. So that is the 3 pronged health savings account. Think about it this way. You get a deduction for putting the money in, the money grows tax deferred, and it gets taken out in a in a qualified distribution tax free.

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That’s a beautiful one. That’s beautiful. Hopefully, you never need it, but if you do, it’s there.

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Well, later on in life, you could actually use it to pay your Medicare premiums. There’s a ton of flexibility now with those health savings account assets. So I hope you do need it in a way that means you’ve lived long enough to use that. I mean, we’re all gonna have medical expenses at some point. Right?

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So Absolutely.

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But yeah. So that is, that’s that is number 2. Number 3, the section 121 exclusion. What the heck is that? AKA, this is the capital gain exclusion from the sale of a primary residence.

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So if you have a primary residence and it’s been your primary residence 2 out of the last 5 years before you sell it, you could typically exclude the capital gain from being taxable. Now there are certain rules, if you’ve used it as a rental property in the past, if you, there there could be unique situations. But for the vast majority of people, this is the primary residence exclusion or section 121 exclusion. If you are married filing jointly, you can exclude up to a half a $1,000,000 of capital gain. All others can exclude $250,000 of capital gain.

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So this is one of those three laws of teaching tax flow. We talk about tax flow and cash flow are different. So I’ll give you an example, John. Let’s pretend you bought a home, where do you wanna move, John? I always shouldn’t say that, but let’s say you move to where are we gonna put you?

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Well, let’s say, somewhere in Montana. Stick me out there for a while.

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Ute, Montana or something. Cyan or I do. Whatever. You buy a home in Montana for for for $400,000. Right?

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And you we have a $300,000 mortgage. You live there for for 10 years. The property goes up in value to $800,000. Let’s assume you’re married, and let’s say you paid the mortgage down to $100,000. Are you with me?

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So when you sell that property, you have $800,000 it’s worth, minus $100,000 of mortgage, you walk away with $700,000 This is where cash flow and tax flow come in. You might be saying, because this happens all the time in the teaching tax flow community, awesome. I have this house. I could just walk away with 700,000. I know the first 500,000 is tax free, so I have to pay tax on 200.

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Actually, the news is better than that. Your basis in the house, meaning what you paid for it, is 400. You sold it for 800. So you have a $400,000 capital gain, which is less than the exclusion of $500,000. So the entire $700,000 you walk away with is tax free.

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That’s the section 121 exclusion.

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And this one’s so interesting to me. And, honestly, like, I I really don’t know it. I know we talk about this. I you know, the concept. I don’t know a lot of the details on this one.

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So so here’s a question too. Like, I I’m gonna feel that the older generation, they tend to stay in their homes a lot longer. So without getting into, number 5, which we’re gonna talk about. I don’t wanna say what it is. We’re gonna we’ll leave that as

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a small cliffhanger.

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So with this, though, I mean, what’s the is there a caveat to this at all? Like, is this is there any recapture or anything anywhere down the line, or is this basically truly a gift from the IRS that some people just may not know to take advantage of just like this. Gift.

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Now you can only use this once every 2 years. Okay. If you’re not there the entire 2 years, there could be unforeseen circumstances and I mean, we I think we have a whole podcast episode just on this topic alone. So yeah. No.

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It’s just the gift from theirs. It’s commonly thought by many of the tax planners out there that this section 121 exclusion was put in the law because of 2 years is the is the term for someone in the house of representatives. Just think about this, John. You now live in Montana, not Wyoming. So I was wrong.

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I’m like, you live now in Montana. You become popular as normal, and you get elected to the house of representatives. Good for you. You move to Washington DC and you buy a home. You serve your 2 year term.

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You still have your house in Montana. Right? You still but, you know, you used to serve your 2 year term, and you do a terrible job, and you don’t get reelected. Sorry to hear that. You then sell your house in Washington DC after living there 2 years, but because of market has gone up, you make $200,000 as a parting gift, like some loser on a on a game show.

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You get to walk away with a parting gift of a $200,000 capital gain excluded from tax and go back to the house you lived in on Montana. And you as long as you stay in that house for the next 2 years, you can go sell that one and get another 121 exclusion because the rule is you’ve got a you can only you can only be claimed once every 2 years.

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So, really, with that being tied to politics, it’s kinda like the powers that be. It’s probably pretty safe to say that this isn’t gonna change for a while

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Right.

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If that’s the case.

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No. I don’t think this is gonna change. In a lot of times, you sell your house to the next next person that’s gonna be in the house of representatives.

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Right. Right.

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But so yeah. So it’s pretty cool. I mean, that is a really nice nice benefit. So up to half a $1,000,000 of capital. Yeah.

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Now when you’re calculating this, remember to include any improvements that you had on your house. And sometimes someone buys a new home and they put an addition on or they do landscaping or they they you know, anything like that, you can add to the basis when you’re figuring out that gain.

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And, actually, before we skip a lot of that too, Chris, if you don’t if I can ask you this. So how many times in your career, you know, in your private practice have you seen say somebody’s doing their own tax prep. They’re using a DIY service. Mhmm. And then, you know, you get introduced to them and you go you’re like, wow.

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You just sold your house a couple years ago and you paid capital gains to it. Do you have you seen that a lot in the past where you have to really go back and do an amended return and get get things?

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We haven’t had to do the people that we amended a return because they paid tax on it. But a lot of times, before someone’s gonna sell their homework, working through the tax ramifications. First of all, figuring out if it’s even gonna be over that threshold, and then if it does, how to plan around it, especially over the last few years in some of the higher, area or some of their geographic areas that we’ve seen a a large increase in house house pricing. I’ve had quite a few people that are over the half $1,000,000, which is Good. I mean, good for you.

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Right?

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Right. Awesome. No. As you can tell, I’m super intrigued with that one. So I’m hovering around the 121.

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So without further ado, let’s keep moving along here.

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Alright. Number 4 gift from your friends with the IRS.

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It’s section 280

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a, you’re saying. Section 280 a, you’re saying. What the heck is that? The Augusta rule. Why is it called the Augusta rule?

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Well, the Augusta rule is named after Augusta, Georgia where the Masters Golf Tournament takes place every year. And have you ever been to Augusta, Georgia, John? I’m wondering because you were pretty close in Charleston.

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Yep. Yep. I’ve actually been through there a couple of times. Obviously, not anywhere near the golf course during the Masters, but you know?

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Well, it’s it’s there’s not tons and tons of hotels, and and a lot of times these golfers have a team of people or families, so they rent out of a home. And what the gust rule says is it says you can rent your so, yeah, there’s a couple applications. Let’s talk about the the bottom line is you can rent your primary home, up to 14 days without having to pay any tax on that rental income. So it’s tax free rental income. Right?

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And it could work a couple different ways. One, it could be just somebody like, we’ve used this here in in Franklin. We’ve had people because we had travel out of town for Thanksgiving and Christmas. Excuse me. We’ve had people during Thanksgiving rent our house for a week.

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And because there’s only one week of the year, I don’t have to pay tax on our rental income under the Augusta rule. So if you own a home, you can rent it out for up to 14 days a year tax free. So if you live in like, you know, you live near a certain school that that I don’t care for in Ann Arbor, Michigan.

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You’re gonna say it. One day one day, you’re gonna say it. One day, I’ll pry it out of you.

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And when you they play football games. Right? You could rent your house out every home football game for the weekend, or let’s say you would do 4 of them for 2 nights or, you know, whatever. Let’s say there’s 6 of them at 2 nights each, 12 nights, and pocket all that money tax free if you want it. Now the practical part is you gotta get the family out, get Cooper out of there, and and that sort of stuff.

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But for a lot of people, then college towns, near big festivals, These are opportunities to do that. Absolutely. About the Olympics. Like, if the when the Olympics are gonna be going to Los Angeles, next summer Olympics, I believe, there’s gonna be a lot of opportunity there.

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Mhmm. Then What is this? So it’s 14 or 15 days, and it they don’t have to be consecutive. Just 15 days within a calendar year.

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It’s up to 14. Yeah. Under 15, but up to 14 days. Correct.

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Awesome.

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And it’s tax free. And then there’s another more advanced application of this where, let’s say, you own a business and you utilize your home for business. The business can rent the home out, at fair market value and pay no tax on it, and the business gets a deduction. So an example of that would be someone that that that owns a business and has a holiday party there. Let’s say you have someone that is a that is a business coach and they have retreats there, or what if they’re marriage counselors and they have retreats at their house?

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You know, there there could be a lot of different applications, for that. You know, holiday parties, But I

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love that they come up with these names too. Like, I I I would love to be in a meeting or some form where they they name these where they’re having, like, a really structured, extremely serious conversation. And then someone goes, just name it. You know? Surprised they don’t name it like the, well, like the Comic Con rule or something.

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You know? It’s it could be anything.

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Well, I was thinking that the gust rule I wonder if there was a a someone from from Georgia then that, came up with this.

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You know

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what I mean? Maybe maybe if someone in the house of representatives.

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And, like, some laws, right, or or bills that passed, they’re they’re almost named, like, after the lawsuit or something. Right? So maybe somebody got PO ed. They they couldn’t run out their house, you know, for, 20,000 a night, which they probably get if they live near, near that course. But this is a great one too.

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And and I like that you did kinda bring in the the other side of it from, you know, the business side of it because that’s another one. I mean, I’ve learned that from you a while back. That’s another one I very, very, very rarely ever hear anybody mention. You’ll hear the Augusta rule mentioned a lot, but very rarely how a business could take advantage of it, which is extremely powerful. Right?

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Remember your first condo in Charleston. Right? Very desirable area. You ended up putting it on Airbnb, but let’s say you didn’t you live there all the time and it just you know, you knew you’re gonna come up to Michigan for a couple weeks, in the summer to escape the heat and humidity down there, and you rent and the only time you rented that cat in a while was for those 2 weeks. You could have pocketed that cash.

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It had been a pretty penny tax free. Now once you converted your property to an Airbnb and you’re remember, you’re renting it out more than 14 days. We had to we had to really look at how many personal use days versus how many rental days. It’s just to get the tax free treatment. It’s that that, that 14 day rule.

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Awesome. Awesome. Well, let’s, my dad joke. Here we go. You ready for ready for my dad joke?

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Oh, yeah. Let’s take a swing at number 5.

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Number 5. Right. The number

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5 joke There you go.

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Is a step up. I know. That was that was that was amazing. Well, Chris, the step up in basis is number 5. You might be saying, what’s that?

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Well, the step up in basis means that if you inherit an asset, your cost basis on that asset is the fair market value of the asset the day you inherit it. What the person that that basically, left it for you or passed away, their basis is irrelevant. So this is a huge opportunity, and this even this plays a role between spouses. There are special rules in the states that have, that are, common law states, common law marriage states. So let me let me give you an example, John.

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Your your uncle. Right? We don’t wanna knock out our parents yet. Right? Your own distant uncle.

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He lives in Texas somewhere. Many years ago, bought one share of stock in, an oil company for a $100. Right? That stock share is now worth $10,000. Your uncle passes away, and for some reason the uncle remembered you and said, I leave to Johnny t this one share of oil stock.

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You get the share of oil stock, and you say, you know what? I don’t want this oil stock. I wanna go take my daughter on a shopping spree at American Girl store.

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That stock ain’t gonna get very far.

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You’re not gonna get far for the $10.

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Uh-uh. Nope.

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And, oh, American Girl, if we’re happy to to have real sponsorship opportunity on the show, and and and, we’ll retract these statements. We’ll change our tune. Yeah. We’ll change our tune. We’ll pick on somebody else.

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You go, you sell it. Right? And by the time you sell it, the stock goes up to be worth a $100,200. Wait. No.

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I said 10 I’m sorry. $10,200. You’ve got tax flow versus cash flow. You got $10,200 in your pocket. Your uncle paid, wouldn’t I say $100 for it?

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Yep. $100.

00:24:33.960 –> 00:24:52.345
That’s irrelevant. Your basis on the stock is a fair market value when you inherited it when he passed away at $10,000. On your tax return you’re gonna report I sold a share of oil stock for $10,200. My cost basis is $10,000. You will pay tax on a whopping $200.

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That’s it. Mhmm. That’s why a lot of times you’re gonna

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Oh, Oh, no. Go ahead. I’m sorry. I got you. Yeah.

00:24:58.100 –> 00:25:12.255
You’re gonna hear people a lot of times say, it’s much better to inherit an asset than gift it. Because if he would’ve gifted it it gifted it to you a day before he died, you would’ve taken over his cost basis. You wouldn’t have got the step up in basis.

00:25:12.575 –> 00:25:26.115
And that’s exactly what I was gonna ask you. Right? Because sometimes you might run it and not to sound morbid at all. Right? You might have a a family member or somebody or and they you know, they’re they’re on their last, you know, run.

00:25:26.440 –> 00:25:36.940
And they say, hey. I want you to I want you to have this. I wanna make sure that you have this. I wanna watch you have this kind of deal, and then they gift it to you. You’re you’re in trouble potentially.

00:25:37.560 –> 00:26:00.630
Mhmm. And, I mean, I could I could see that being an issue. Say somebody got a, I mean, you know, crazy scenario. Say somebody was, you know, at a modest lifestyle, average household income, and then they were gifted a multi, multimillion dollar home that has, you know, been in the family for eons. Right?

00:26:00.630 –> 00:26:30.710
And they and they can’t take advantage of that step up in basis. That can cause a serious problem where it’s like, don’t gift it to me. Like, kick the can first and then give it to you. And I get that, you know, there’s some emotional ties in that decision making process, but I love the way that you described that as well too. It’s like the really the the pinnacle or, if you will, the the fork in the road is really once that person is no longer an active Social Security number or actively on the census, we should say.

00:26:30.710 –> 00:26:31.095
Right.

00:26:31.575 –> 00:26:31.975
Right.

00:26:31.975 –> 00:26:59.950
So So those are the 5 gifts, man. And here’s one more thing and as we wrap it up on the step up in basis. We know well, you know, because you go listen to this podcast. Long term capital gains are taxed at a much less rate than short term capital gains. The great thing about inheriting something is even if you don’t own long term gains are triggered when you own something for a year or more, any inherited property automatically gets long term capital gain treatment even if you only owned it for 2 days or one day.

00:27:00.035 –> 00:27:18.780
So you’ll get that long term capital gain treatment. And, yeah, those are our 5 gifts from IRS. So I hope that your gift giving and giving season is great as well, and thank you so much, for listening to this podcast. We’ve been really we’ve really enjoyed it. We enjoyed doing it.

00:27:19.240 –> 00:27:29.855
We’ve we’re excited about a lot of new topics, and and if and, again, run into the teaching textile YouTube channel and hit subscribe because we’ve got a lot of other content on these 5 topics and more.

00:27:29.955 –> 00:27:53.840
Absolutely. And all the quick tips that are rolling out there, little 60 to 72nd, little tips, little reels are are fantastic. We got into endless amount of those. And what we’ll do too in the show notes here, whether you’re watching this on YouTube or wherever you, you know, subscribe to the podcast or even just listen to in the show notes, we’ll we’ll go through and we’ll put links of previous, episodes that touch on each of these because you might look at and say, oh, you know, I’m not interested in this one. But, hey.

00:27:53.840 –> 00:28:02.035
You know, I wanna learn more about the Augusta rule. We’ll put those links in there. So look at the show notes. Direct links are in there. And as Chris mentioned as well, you know, get on YouTube, subscribe there.

00:28:02.035 –> 00:28:21.600
Subscribe to the podcast if you haven’t already. You’ll get a notification. Usually, we drop these things about 4 or 5 AM every Tuesday. So think about it as something you can listen to in, the way into work or put in your headphones and let your kids scream in the background and pretend like you’re listening to them. Either way, it’s, it’s, we appreciate having it, and hopefully, you enjoy the enjoy the content as well.

00:28:21.600 –> 00:28:38.930
So everybody, you have a great week. We’ll see you next week as we do the very last podcast from us for 2024. So we got a good one coming up as we wrap it up, and we’ll see everybody back here again next week, roughly the same time, different topic on the Teaching Tax Club podcast.

00:28:40.430 –> 00:28:57.885
The content provided is for educational purposes only. We encourage you to seek personalized investment advice from your financial professional. For all tax and legal advice, please consult your CPA or attorney. Investment advisory services are offered through Cabin Advisors, a registered investment advisor. Securities are offered through Cabin Securities, a registered broker dealer.

00:28:58.425 –> 00:29:08.510
The content of this podcast does not constitute an offer of securities. Offerings can only be made through an offering memorandum and you should carefully examine the risk factors and other information contained in the memorandum.