Is the “Opportunity of a Lifetime” Ending for Real Estate Investors?
April 28th, 2012
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The housing crisis has offered real estate investors an opportunity of a lifetime to acquire assets at distress-sale prices. But how much longer will this window of opportunity be open?
While everyone has their own opinion, here’s some information that may help you come up with your own conclusions:
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- The Urban Land Institute released its Real Estate Consensus Forecast this month, and the 38 real estate economists and analysts involved predict that housing starts will double by 2014. They also believe home prices will start to rise in 2013 after stabilizing in 2012.
- Existing home sales were up 5% from last year, with prices up 2.5%, according to the National Association of Realtors (NAR). So much for the “double dip” that was so heavily reported by the media last year (except when I was interviewed, of course!)
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Some economists predict unemployment will dip to 7.5% by 2013, and that GDP will grow 2.5% this year and 3.2% next year.
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Warren Buffet announced on CNBC that he’d buy up millions of single family homes if he had a system in place for managing them. And he’s not the only big-money guru thinking this way.
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Morgan Stanley’s confident that 2012 will be a big year for real estate investors. In “Housing 2.0: The New Rental Paradigm” the financial services company says, “…data shows rents continuing to rise…and as the distressed inventory is removed from the market, the overall housing environment should improve and eventually lead to fundamental home price appreciation as well.”
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When will this opportunity come to an end?
Certainly, it's possible these economists and investors may all be wrong. Maybe there are still too many homes in the foreclosure process. Maybe the GDP won't improve. Maybe unemployment will increase.
In that case, consider buying distressed assets simply for the cash flow they yield today. No matter how bad the economy, people still prefer living indoors. And there will likely be more renters than home-owners, which would give you the edge if your property is well-located.
However, if the economy does improve ever so slightly, and the excess inventory does sell out simply because it's more affordable than ever, and builders do come back into the market to keep up with the growing population … you could get more than a monthly rent check.
Once new homes are in demand again, prices will return to at least the cost to build. When you’re buying property at half the cost to build today in areas experiencing population growth, you could see some pretty hefty appreciation gains.
And if you finance your investment property, you get the benefit of locking in rates under 5%, thereby increasing the cash on cash return and beating out inflation. Plus, your tenants pay off your debt for you.
So... how long is that window going to be open? I'm not sure...but I do believe the old saying, “Don’t wait until you’re rich to buy income property. Buy income property and wait to get rich.”
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About the Author: Kathy Fettke is the founder and CEO of Real Wealth Network – “The Real Estate Investor’s Resource.” She specializes in helping people build multi-million dollar real estate portfolios through creative finance and planning. Kathy is also host of The Real Wealth Show on KABC Los Angeles and on iTunes.
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Tags: Depreciation, investing, Leverage, Mortgages, Why Real Estate?
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4 Ways To Reduce Taxes as a Landlord
April 11th, 2012
Most people look forward to getting a big tax write-off when they buy their home. What they don’t realize is that tax deductions are even more favorable when buying investment property.
Here are 4 ways you can reduce your tax bill when buying real estate that is treated as a rental property:
1. Deducting Direct Costs
Investors who own rental property can deduct the costs of maintaining and marketing the property. These include: mortgage interest, insurance, taxes, utilities, maintenance repairs, advertising costs, and professional fees. You can only deduct your mortgage interest and taxes on your primary residence.
2. Depreciation
Depreciation is calculated under the theory that assets lose value over time as they wear out. According to the IRS, furniture, appliances, and other household items “lose all value and become virtually worthless” after 5 years. Obviously, these items can last longer than that, but the IRS says we can treat it “on paper” as if they don’t.
Let’s say you bought a refrigerator for $1000. You could divide the cost by 5 years, and then write off $200 per year as depreciation on that item. You can also use accelerated depreciation for personal property which will generate higher deductions in the earlier years of that assets depreciable life.
Depreciating real estate is similar. Since land does not “wear out,” the value of the land is then deducted from the price you paid for the real estate. The remaining structure can then be depreciated over 27½ years. For example, if you bought a $100,000 home, you would subtract approximately $20,000 for the land and then depreciate the remainding $80,000 structure. Then you would divide $80,000/27.5 = $2909. This means you get to write off $2909 every year for 27.5 years.
3. Trade in, trade up
The tax code allows homeowners to exchange one piece of property for another without having to pay capital gains tax. You might not think an investor with a long term outlook would ever need this, but here’s an example of what could happen.
Say you bought a vacant lot 40 years ago for $10,000 and it's now worth $500,000, selling it could cost you more than $100,000 in federal and state income tax. However, if you exchange the lot for another piece of real estate of equal value – let’s say an income producing property -- then you would be able to continue to defer the capital gains tax.
Many investors say, “Defer ‘til you die.” When your heirs inherit the property, the tax basis is usually stepped up to market value so if they sell, they would not pay the capital gains tax either.
4. Active investors win more
Passive investors can only deduct passive losses from the rental income or other passive income they earn. Even though the list of losses might be higher than the rental income, especially if depreciation is included, it cannot be deducted from other sources of income if you are a passive investor.
However, if an investor is actively involved in the management of the property, he or she could have unlimited deductions from their real estate and use those deductions against any of their earned income.
In order to qualify for unlimited deductions, you have to prove to the IRS that you are a real estate professional. This doesn’t mean you have to be an appraiser, inspector, or real estate agent selling houses.
To the IRS, a real estate professional means you spend more than 750 hours a year buying, selling, renting and managing your properties or performing similar services for your clients. To qualify, you cannot have another job that takes more than 750 hours of your time annually.
If the investor does not qualify as real estate professional according to the IRS, but is still actively involved, he or she can still deduct up to $25,000 from any earned income to compensate for passive losses incurred - as long as the investor has less than $100,000 per year adjusted gross income. Folks who have more than $150,000 per year in adjusted gross income cannot qualify for this benefit - however, the losses can be used in the future during a year when the investor earns less than $150,000. In addition, any passive income received can be sheltered by your passive loss carryovers.
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About the Author: Kathy Fettke is the founder and CEO of Real Wealth Network – “The Real Estate Investor’s Resource.” She specializes in helping people build multi-million dollar real estate portfolios through creative finance and planning. Kathy is also host of The Real Wealth Show on KABC Los Angeles and on iTunes.
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Tags: Depreciation, investing, Leverage, Mortgages, Taxes, Why Real Estate?
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The Amazing Power of Using Other People’s Money to Increase Your Wealth
March 15th, 2012
“Give me a place to stand and with a lever I will move the whole world.”
– Archimedes of Syracuse, 2nd Century BCE Greek mathematician, physicist, engineer, inventor, and astronomer.
Archimedes and his theory could of course never be tested, but the general truth: that levers increase natural ability, still holds true today. Leverage gives great power to he who holds the stick.
Financial leverage means much more than increasing your ability to afford an asset – it’s a multiplier, increasing your ability several fold. This is how it works in real estate:
Even today banks are still lending up to 80% of a home’s value, this is also the case with investment properties.
On a $100,000 house this means an investor would need a down payment of $20,000. Do you see the great power? You get 5X more property than you paid for!
That’s using the bank’s money, but there is still another way to use other people’s money to increase your wealth.
When you finance an investment property, your tenants pay your loan off for you with their rent. There is also a further benefit to this. Once an investor has shown a good track record as a landlord, the bank will even include the rental income when determining the borrower’s income.
When you start out on the path to becoming a real estate investor, you might not be lucky enough to get the benefit of having the rental income of your next investment added in. Doing it on your own steam might mean you have to start smaller, but don’t let it stop you! Many of the investment properties recommended by us are below the national average home price (currently $180,100), and many are half of that or even less.
In today’s market good credit is more important than ever. Make sure you work with a lender who knows the ins and outs of real estate investing, knows the different U.S. markets, and can help you with sound advice.
Your mortgage broker should be able to tell you if you need to improve your credit, how much reserve funds you’ll need, and how much additional money in retirement funds or stocks you need to qualify.
We’ll look at these factors and more in an upcoming blog. For now it’s good to know that banks still understand that cash-flowing real estate is a solid investment, and that they are still willing to back it.
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About the Author: Kathy Fettke is the founder and CEO of Real Wealth Network – “The Real Estate Investor’s Resource.” She specializes in helping people build multi-million dollar real estate portfolios through creative finance and planning. Kathy is also host of The Real Wealth Show on KABC Los Angeles and on iTunes.
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Tags: Financing, investing, Leverage, Mortgages, Why Real Estate?
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Warren Buffet Says Investing in Single Family Homes is Tough to Beat
March 8th, 2012
While most of us don't play in the same league as Mr. Buffet, investors worldwide try to mimmick his strategies in hopes of achieving even a fraction of his success. So, when Buffet hands out free investment tips, the world takes note.
Recently in a TV interview, Buffet surprised those who have been bearish on real estate. He said: "If I had a way of buying a couple hundred thousand single-family homes and a way of managing them, I would load up on them."
Too bad Mr. Buffet doesn't know about Real Wealth Network! We could certainly introduce him to the best providers of turn-key rental homes in the country, and point him to experienced property managers in those areas.
Most of us normal folks would be happy with a dozen or so rental homes, which would provide a steady retirement income and would be much easier to manage than a few hundred thousand. It must be tough for guys like Buffet who need a place to invest millions, and even billions of dollars at a time. Sometimes they have to pass on good deals simply because they are too small.
That's why single-family home investing is best suited for individuals, and not hedge-fund managers. We are able to pay closer attention to our properties, which helps keep up the quality of the neighborhoods, bring in the best tenants and stay on top of the management.
Personally, I'm happy that this time around, Buffet isn't suited to take his own advice. This is the time for the small-investor to get ahead. Thanks for leaving the good real estate deals for us, Warren! This is our playing field.
Buffet also added that if houses are bought at low rates and held for a sufficiently long period of time, single family homes perform even better than stocks. Of course, this is something I've been saying for years. It's nice to finally hear it from a man whose net worth of around $50 billion is made up almost entirely of stocks.
His final bit of advice is for buyers to take out a 30-year mortgage and refinance if rates go down. I'm sure he envies the leverage available for home-buying that simply doesn't exist in the stock market. Where else can you get a loan on an asset and pay less than 5% interest, take three decades to pay it off, and keep all the cash-flow and appreciation along the way?
Thanks for endorsing our industry, Mr. Buffet! Your wisdom will wake up the masses who have been so frozen by fear that they just can't see a good deal, even when they're living in it.
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About the Author: Kathy Fettke is the founder and CEO of Real Wealth Network – “The Real Estate Investor’s Resource.” She specializes in helping people build multi-million dollar real estate portfolios through creative finance and planning. Kathy is also host of The Real Wealth Show on KABC Los Angeles and on iTunes.
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Tags: Current Events, investing, Market Indicators, Why Real Estate?
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Investors: Know These 3 Things To Define Where You Are
February 28th, 2012
"Even the longest journey must begin where you stand." - Lao Tzu, 6th Century BCE Chinese Philosopher
All wealthy people have something in common - and it’s not just that they have lots of money. They have more money coming in than they are spending each month. This is not the same for everyone; not everyone has exactly the same amount of income and expenses. What this does mean is that they all know exactly how much they are earning and spending.
If this difference between income and expenses is positive at the end of the month, that amount is by how much you are growing richer each month. Simple, isn’t it?
If you start from there you are in control of your current situation. It also allows you to plan your path going forward.
Another simple way of looking at things is to add up all your plusses on the one side – that would be investments, stocks, real estate, and other assets. On the other side you list all your debt and subtract it from your total assets. This will give you your net worth.
In case you are unsure about just what to include and where it should go, we can help.
As a member of Real Wealth Network, we will provide you with a free flow-chart that you can use to determine your cash flow. We also have a net worth chart to help you plot your assets vs. liabilities.
This is not a sales pitch. With a free membership you will be able to network and use our tools. Our philosophy is to share what we know, and the larger our network of members, the more everyone gets out of Real Wealth Network.
The third step to take is to know how much you are paying in taxes. Did you know that real estate investing could lower your tax bill? Meet with your CPA (or call our office and we will recommend one in your area that specializes in real estate).
Once you know your monthly cash-flow, your net worth, and your tax liability, you will have a much better idea about your next steps to succeeding as real estate investor.
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About the Author: Kathy Fettke is the founder and CEO of Real Wealth Network – “The Real Estate Investor’s Resource.” She specializes in helping people build multi-million dollar real estate portfolios through creative finance and planning. Kathy is also host of The Real Wealth Show on KABC Los Angeles and on iTunes.
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Tags: Goals and Strategic Planning, Healthy and Wealthy Lifestyle, investing, Why Real Estate?
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A Real Estate Investor’s First Step: Plan With Your Dreams In Mind
February 14th, 2012
“There are some people who live in a dream world, and there are some who face reality; and then there are those who turn one into the other.”
-Douglas Everett, retired Senator
It can be a daunting task to set out on an uncharted course without someone knowledgeable to guide you through the narrow straits, keeping you clear from dangerous obstacles.
However, having someone ask you a few important questions can help you clarify your plans, and in the end, you’ll reach your goals and fulfill your dreams.
It takes careful thought: A strategic misjudgment could end up putting you years back or even worse, prove to be a costly mistake.
Take the following examples:
>>If you’re employed full time or spend 60 hours a week working, why would you buy a fixer-upper?
>>If you have youth on your side, why would you buy real estate with all cash? (Most likely, it would be smarter to leverage the cash you have and maximize your investment. There’s time for you to pay off the mortgage while the value of your real estate and the rental income grows.)
>>If, on the other hand, you’re older and only need cash flow from the investment, why would you burden it with a mortgage?
Important questions, right? To reach your goals and dreams you need to keep your eye on the horizon, steering toward your goal, but all the while taking your surrounding circumstances into account.
Here are some more questions that will put you in a better position to lay out your goals:
>>At what age do you plan to retire?
>>How much money will you need to maintain your lifestyle after you’ve retired?
>>Do you have current retirement income sources? What are they?
>>How much will you invest?
>>Do you want to acquire property for future growth or do you need cash flow today?
>>How actively do you want to be involved with the real estate you’ve bought?
>>Do you have a good credit record?
>>Are there other future considerations to take into account? Do you need to plan for college, travel, or your parents’ long-term care?
>>Are you looking for a tax break?
Now, take a look at where you want to be and what you want to achieve through real estate investing -- and when you’re ready, give us a call -- we’ll help you get there.
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About the Author: Kathy Fettke is the founder and CEO of Real Wealth Network – “The Real Estate Investor’s Resource.” She specializes in helping people build multi-million dollar real estate portfolios through creative finance and planning. Kathy is also host of The Real Wealth Show on KABC Los Angeles and on iTunes.
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Tags: Goals and Strategic Planning, Healthy and Wealthy Lifestyle, investing, Why Real Estate?
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The True Cost Of Flipping Real Estate
February 4th, 2012
When it comes to flipping, new investors often get burned by their mistakes.
Since the housing market crash of 2007, the government has tried to protect consumers from buying homes at inflated prices. One policy that was quickly enforced was the FHA “anti-flipping” rule: no FHA financing on properties that had been bought, renovated and marketed at a higher price within a 90 day period.
Unfortunately, what the government didn’t understand is that not all “flippers” are ripping people off. In fact, many of the investors brave enough to buy dilapidated properties with cash in order to fix them up and resell them are actually helping to clean up the housing mess.
Vacant, foreclosed homes attract vagrants and vandalism, adding further stress to struggling neighborhoods. Banks won’t lend on vandalized homes, and few buyers can pay cash both for the purchase and rehab of a dilapidated property. Investors are the only ones who will take that risk so it makes no sense to limit their ability to do so.
The FHA finally caught on, and temporarily reversed the “anti-flipping” rule last year, and voted to do so again in January. This is great news for the U.S. housing market, since investors accounted for one third of real estate purchases in 2011.
Is Flipping For You?
Everyone wants to make a quick buck, and in theory, flipping could be a way to do that. But please heed this warning: flipping is not for everyone! Here are some tips to help you decide if it’s for you.
The Fine Print on FHA regulations
>>Certain conditions need to be met to qualify for FHA’s “anti-flipping” waiver.
>>The transaction must be at "arms length" – meaning there is no personal relationship between seller and buyer.
>>If the selling price is higher by 20% or more than the original purchase price, the lender has to keep record and justify the increase.
>>The home must also be inspected when the price increases by more than 20%. That adds the cost of the appraiser to the list of expenses.
The Real Costs of Flipping Property
There are other real costs that many new investors fail to calculate at the outset:
>>The cost of borrowed money to purchase and/or renovate the property
>>The cost to sell: agent fees and closing costs can add up to 10%
>>Holding costs - on-going property taxes, interest charges, and insurance
>>Unexpected costs - leave a 10% cushion at a minimum.
>>Potential dip in sales price - 10% at a minimum.
>>Estimated profit - 10% at a minimum (and if this is all you’re expecting, there are much lower risk investments out there!)
>>Short-term capital gains taxes if you sell within a year’s time frame (approximately 35% of your profit). Always talk to your CPA before making any investment!
So, you’ll need to calculate all repair expenses and still be at less than 60% of market value. Is it possible? Yes. Is it easy? No.
Buy & Sell vs. Buy & Hold
At Real Wealth Network, we advocate buy & hold investing for the following reasons:
>>Flipping requires hands on involvement and most working people don’t have the time.
>>The flipper would need to only invest where they physically live. We do not advise managing a rehab from a distance.
>>A buy-to-hold investor can invest anywhere, wherever they can find the best opportunities, have many investments working at the same time, and still make money doing other things.
>>A cash flow rental property can yield over 10% return after all expenses, without the risk of fixing & flipping.
>>Rental income is much more favorably taxed, and capital gains can be avoided upon sale if a replacement property is purchased according to IRS 1031 Exchange Rules.
>>Growth over time, for both rental income and capital growth, works the same as compound interest; it’s one of the most powerful tools in an investor’s arsenal.
30 years ago you would have had to put down $13,000 to buy real estate. Today that property would be completely paid off, and have tripled in value. What’s more: you’ll be earning at least $13,000 rental income per year!
The same power of multiplied growth is available today – real estate bought today will be worth three times its value 20 to30 years from now. There is no other investment that delivers cash flow and capital growth like long term real estate investments do.
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About the Author: Kathy Fettke is the founder and CEO of Real Wealth Network – “The Real Estate Investor’s Resource.” She specializes in helping people build multi-million dollar real estate portfolios through creative finance and planning. Kathy is also host of The Real Wealth Show on KABC Los Angeles and on iTunes.
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Tags: Current Events, Economy, Flipping Real Estate, Government Regulations, investing, Why Real Estate?
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Ten Real Estate Predictions for 2012
January 5th, 2012
Millions of people have been making predictions about 2012, ever since the Mayans ruled Central America. Hollywood even made a movie about it! So I figured I'd take a stab at it.
Here we go:
1. Interest rates will remain low
This was an easy prediction since the Fed announced it will keep rates low through out 2012. Expect rates to remain under 5% for most of the year - at least until the Fall when it might start to creep up.
Get your low 30 year fixed rate mortgages will you can!
2. The US economy will grow by 2-3%
While a massive recovery is not expected, a positive number is better than a negative one. Corporations will consider spending some of the $2 trillion sitting on their balance sheets. As they start hiring, consumer confidence will improve further.
People with jobs can qualify for housing, which leads to my next prediction.
3. The number of first-time home buyers will increase
More and more people will see that owning a property is now cheaper than renting in most cities. As the employment picture improves, more buyers will qualify for loans.
First-time buyers will dominate the market since their credit was likely not affected by foreclosures or short sales and they do not have a bad taste for real estate.
4. The stock market will hold steady
This is historically the case during an election year. "The powers that be" will do what it takes to make the economy look healthy.
This doesn't mean the stock market will actually be healthy, but it will appear to be. It could be a good time to self-direct your IRA and buy real estate. Expect the stock market to decline rapidly after elections, mostly due to the fact that Baby Boomer's are pulling money out of their retirement funds.
5. Oil prices will spike
With US withdrawal out of Iraq, warring cultural groups within the country are free to go after each other... and they most likely will. There is also a good chance the US will be at war with Iran. Some economists predict oil prices in the U.S. will rise to $5 and even $7 per gallon.
Buy real estate close to jobs. Sell your SUV.
6. Food costs will spike
Look at your food bill and see how much its increased over the past year. That trend won't stop anytime soon and is a direct result of reckless money creation by the Fed that lowers our spending power.
Buy property only in affordable markets and avoid areas where renters are already stretched. And stock up on food - it's likely cheaper today than it will be tomorrow.
7. Foreign investors will buy up more real estate
A non-U.S. citizen who invests at least $500,000 in the United States is granted permanent resident status (an "Investor Green Card") and is eligible for full U.S. citizenship (under the EB-5 Visa Program.). The visa-holder has the lifelong right to live and work in the United States without restriction.
30% of real estate purchases have been for investment purposes. Expect that number to increase as more foreclosures hit the market and foreigner investors are able to buy them with cash.
8. Rents will continue to rise
Home ownership is declining, while the number of renters is increasing. In fact, according to the Census Bureau, 3.9 million new renters have been added to the pool. Where there's demand, prices increase. Most of today's rental demand is from younger households under the age of 30. These are Baby Boomer children and are expected to be an even larger group than their parents.
Buy rental properties where young people want to live, or buy in neighborhoods where this generation might want to own their first home in 5-10 years.
9. Apartments will be in demand
Young renters like living near town in apartments, for the affordability and proximity to city amenities. Baby boomers also enjoy downsizing to downtown apartment living.
Apartments will be a hot investment this decade. Sell off before 2020, when Boomer kids are ready to buy their own home.
10. Home Construction will Increase
According to John Burns Real estate consulting, new home construction bottomed out in 2011 and will grow 21% in 2012.
Since the cost to build is currently much higher than the cost to buy, buy property near new home sites for a future boom in values.
In Summary:
Things will look rosey in 2012 in preparation for elections. Good economic news will fuel job growth, and more jobs will fuel home sales. Expect price increases on housing (albeit quite small). Jan-April of 2012 will be an optimum time to buy in order to avoid the buying frenzy expected in Spring and Summer.
Speak with a Real Wealth Network investment counselor for tips on the next hottest emerging markets or join us for one of our next property showcase events!
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About the Author: Kathy Fettke is the founder and CEO of Real Wealth Network – “The Real Estate Investor’s Resource.” She specializes in helping people build multi-million dollar real estate portfolios through creative finance and planning. Kathy is also host of The Real Wealth Show on KABC Los Angeles and on iTunes.
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Tags: Current Events, Economy, Financial Predictions 2012, First-Time Homebuyers, Goals and Strategic Planning, Interest Rates, investing, Real Estate Predictions 2012, Stock Market, Why Real Estate?
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8 Ways Real Estate Investors Close Out 2011
December 22nd, 2011
Everyone talks about New Year Resolutions, but rarely do we discuss how to close out the current year. Here are 8 ways to wrap up 2011:
1. Separate all 2011 statements, bills and receipts and archive them all.
We do this with 12 manila envelopes, one for each month. Then put 'em in a box and store them where you can easily access the data if needed. You can also do this with your on-line files. If you are ever audited, the process of finding receipts and bills will become quite easy.
2. Review reports in Quickbooks or Quicken.
If you are not on a program like Quickbooks or Quicken, make it your goal for 2012 to do so. It is a powerful tool for staying on top of your net worth, budget and spending. Once all your data is inputed (and can be easily downloaded from your on-line banking) you can click on any category and find out what you really spend and what you're really making. It's a great time to compare to prior years, and see how close you are to your financial goals.
3. Create More Tax Deductions
If you want to reduce taxes for 2011, you can create deductions before the end of the year. For example, you can pay some bills early. You can also purchase good and services that qualify for write-offs. Some qualifying expenses for rental properties include: repairs, advertising for tenants, printing, insurance premiums, association memberships, seminar fees, mobile phone services, subscriptions, utilities, etc. You can also stock up on office supplies and office furniture. Consider claiming a home office or work space. Also, talk to your CPA about deducting auto expenses for real estate related activities.
4. Pay Your Kids
Consider hiring your children to help with your rental business. Then you can deduct their compensation as a business expense. They will be in a much lower tax bracket than you. The money can be used to pay for their extra-curricular activities.
5. Accelerate Depreciation Expenses
Your rental property is depreciated over 27.5 years, but the property's assets may be depreciated over a 5-year span. Property assets include: air conditioners, refrigerator, carpets, dryer, etc. Other items may be depreciated over a 15-year span, including fences, patios, sidewalks, etc. Talk to your CPA about accelerated depreciation!
6. Make a list of all your successes in 2011
Our family does this together at the end of every year. We pull out an old calendar and start making lists of all the successes and wins each of us experienced. You can also do it with your business and staff. You may be surprised at how long the list really is! Put it in a binder so you can look back at it over the years.
7. Make a list of all your challenges in 2011
What? Why would you want to remember those nasty moments? There is tremendous value in life's challenges. These are often the times we learn our greatest lessons. So write down the challenges, and next to it, write down the lessons learned. List the new qualities you developed. You may be surprised at how wise you've become!
8. Create a theme for 2011
Once you've reviewed your successes and lessons, you may see a common theme for the year. Give the year a movie-like title. "Rebirth," "Surviving the Financial Storm," "Change for the Good." are just a few ideas.
Do you have other tips or rituals for closing out the year? If so, please share them in the comments below.
Next week's blog will be on how to launch the new year. Stay tuned!
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About the Author: Kathy Fettke is the founder and CEO of Real Wealth Network – “The Real Estate Investor’s Resource.” She specializes in helping people build multi-million dollar real estate portfolios through creative finance and planning. Kathy is also host of The Real Wealth Show on KABC Los Angeles and on iTunes.
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Tags: Current Events, Goals and Strategic Planning, Healthy and Wealthy Lifestyle, investing, Tax Credit, Taxes, Why Real Estate?
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Is Deferring Taxes Through a 401K the Right Choice?
December 12th, 2011
One of our Real Wealth Network members came in for a strategy session last week to get some ideas on how to reduce her taxes this year. I'll call her "Sam," for the purposes of this blog.
Sam and her spouse are self-employed and earned approximately $230,000 this year. Assuming a 35% effective tax rate, they're looking at paying approximately $80,000 in taxes. They have $130,000 in the bank.
Their CPA gave them some suggestions that included:
- Buying more stuff to write off (computers, office supplies & furniture, etc.)
- Buying an SUV, which would be a 100% business deduction
- Contributing to a 401K or other tax-deferred retirement plan
Sam was advised to set up a Solo-401K as the best way to reduce taxes this year. A Solo 401K plan is for self-employed individuals and owner-only businesses. Under a profit-sharing contribution plan, Sam could contribute 25% of her compensation, up to $49K, to her Solo 401K retirement plan. Doing this would reduce her taxes by approximately $17K. She asked me what I thought.
We are often sold the virtues of tax-deferred retirement plans by our financial planners and CPA's as a wealth-building and tax-saving tool. But is it the best choice? I decided to take a deeper look. What I discovered surprised me and actually helped me readjust my tax planning for this year. Remember, I'm no CPA, so please verify any of these ideas with your own tax professional!
OPTIONS
Choice 1 - Pay the Taxes
Sam does nothing and simply pays $80,000 in taxes. She would have $50,000 left over in savings.
Choice 2 - Contribute to 401K
Sam opens a Solo 401K and contributes $49K. This saves her $17K in taxes so she only pays $63K in taxes today (but remember, this is a tax-deferred account. She will pay someday!). She is left with $33K in savings.
Choice 3 - Buy a Vehicle and Equipment to Create Deductions
She buys an SUV for $50K and some new office computers ($5K) for write-offs.
This saves her $19K in taxes, so she only pays $61K to the government. She is left with only $14K in savings.
Since Sam's expenses are $10K per month, she is uncomfortable with Option 3, even though it saves her the most in taxes. She wants at least 3 months reserves set aside in savings. This leaves her with Choices 1 or 2. Since she is wanting to both reduce taxes and plan for retirement, let's take a look at how either choice would pan out 20 years from now. She is 45 now.
POTENTIAL OUTCOMES
Choice 1 - 20 years later (after investing in real estate):
When Sam paid her $80K in taxes, she had $50K left in savings. She used $20K of the savings for a downpayment on a $100K investment property. This left her with $30K in reserves.
If she used all the rental income to pay down the mortgage, she would have it paid off in less than 20 years. Her $20K investment would then be worth $100K (assuming zero appreciation). Her rental income would be $10K per year (assuming no increase in rents).
If either Sam or her husband qualified as real estate professionals (please ask us for more info on this) she could deduct $3K for depreciation each year, plus approximately $3K on various expenses (About $2K in tax savings every year). After 20 years, the tax savings could be well over $42,000.
Summary: In 20 years, Sam would own:
$100,000 asset (rental property)
$10,000 annual rental income
$42,000 in potential tax savings, plus continued tax savings through out the life of the property.
Choice 2 - 20 years later (after investing 401K in the stock market):
When Sam contributed $49K to her Solo401K, she invested in the stock market, gaining 6% annually. After 20 years, she would have $157K, if all went well. If she takes out $10K per year for retirement, the funds would last 15 years. And if she was in a 15% tax bracket at that time, she would have to pay over $22K in taxes over the 15 years - more than the $17K she saved by deferring it.
Summary: In 20 years, Sam would own:
$157,000 in her Solo 401K
But she could owe $22,000 or more in taxes when she uses the money.
Choice 2 - 20 years later (after investing 401K in real estate):
When Sam contributed $49K to her Solo 401K, she self-directed it and bought a property in the Midwest for cash. It yields $5,000 per year, which went directly back into the Solo 401K. In 20 years, she would have over $100,000 cash. In retirement, if she took out $10K per year, it would last her 10 years. Assuming a 15% tax bracket at that time, she'd also pay over $15,000 to the government for accessing those funds. This is approximately what she saved in taxes when she decided to defer it 20 years before.
Summary: In 20 years, Sam would own:
$49,000 asset (rental property)
$5000 annual income
$100,000 cash
$15,000 or more due in taxes
There are many assumptions in this little story: Assumptions that the tax laws will not change. Assumptions that our government won't go after our retirement funds as some senators have suggested. Assumptions that the property values and rents won't increase. Assumptions about Sam's tax bracket.
Given the outrageously irresponsible money printing by our central bank, I would argue that the home values would at least double if not triple in 20 years. The average increase in property values over the past 50 years, even though 4 recessions, has been 6%. If that trend continued, the $100K home would be worth $$320K in 20 years. Rents could be expected to continue to increase 4% every year, doubling the cash flow.
It is very difficult to know what the future holds. It's even more challenging to make decisions today that we know will affect our lives 20 years from now. With that said, Sam decided to go with Option 1. Initially, it appeared to be the least savvy choice, but after analyzing the numbers a little more closely, Sam left my office convinced that the best way she could take control of her future was by keeping her retirement in her control.
If Sam continues on this path, she could own several homes outright by the time she's ready to retire. As a high-income earner, she would need at least 10 to replace her current income.
There are many pathways up the mountain. Which one will you choose?
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About the Author: Kathy Fettke is the founder and CEO of Real Wealth Network – “The Real Estate Investor’s Resource.” She specializes in helping people build multi-million dollar real estate portfolios through creative finance and planning. Kathy is also host of The Real Wealth Show on KABC Los Angeles and on iTunes.
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Tags: 401k, Current Events, investing, Market Indicators, Retirement, Taxes, Why Real Estate?
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