What to do with Operating Expense Reserves

Question

Like a lot of newbies here, I was surprised to find that operating expenses run about 50% of your rent collections.  My question is, what do you do with all that money. Obviosuly you are not spending hundreds of dollars to maintain your property every month.  Is it just collecting 0.5% interest in a savings account?  Do you reinvest it in other properties?  Just consider it extra income, and when the roof needs to be replaced get a loan or put it on a credit card?  Or do you actually spend most of it on expenses such as insurance, professional fees, and advertising?

MATT WARDEN · Answer

Are you kidding? Unless you completely misread what I said and think I am suggesting that you should spend money you wouldn't spend otherwise, then I don't know how you can believe this. It is a question of whether you spend the money in tax year A or tax year B, not whether you spend the money or don't. I'm not sure how much clearer I can make this!

Annual insurance payment is not what we're talking about. That is a (relatively) fixed cost and should be built in. Not only that, but you may not have any flexibility there.

Additionally, whether the interest is a lot of money or not is a completely moot point. It doesn't matter whether it brings in 1 cent or 1 million dollars. It only matters whether the cost of taking the action (perhaps factoring in distraction from the business's vision and annual objectives) is less than or equal to the expected benefit. Here it is clearly less than the expected benefit (and would have no distraction), so one should do it.

That is all that is relevant.

Account Closed · Answer

Now that we have that clear....

John Corey

Account Closed · Answer

The question asked did not mention anything about tax. You raised that point. Some good reason to do so but it was not the question.

Spending money to reduce you taxes is a bad idea.

Investing in future growth and pulling forward costs that are certain to happen is a great idea. It is standard advice given to all businesses by tax advisors. You will find discussions on this on most tax advisory letters, mailing lists and forums in the later months of each year.

Yes, earning 4.5% is better than what was asked (0.5%). No matter what the rate of interest in the real point is to save up monthly for costs that only happen ever so often (annual insurance payment, a new roof). The interest earned will be tiny compared to the reserves being collected when it comes time to pay for the expense.

John Corey

Account Closed · Answer

THe suggested strategy will fail.

Pre-paying the principal has no tax impact. You are reducing debt and you get no deduction. It is not an expense. You are transferring cash from savings (an asset) to equity (an asset). Moving from the right pocket to the left pocket but still an asset.

You could spend money on marketing and some other things. Doing so is really off topic based on the initial question.

Cash reserves collected monthly for future repairs really are supposed to stay as cash reserves. You want the money to be there when it is time to do the work that is bound to come up. Borrowing on a credit card is not a great idea if the rate is high.

Some people will use a line of credit where they run it up and down as things happen. The cash reserves pay down loans so they save a bit of interest. As it is a credit line they can tap back into the cash immediately when something happens.

One other thing. You can more or less forget about the 4.5% interest. After taxes you are making less and the return is not why you have the cash.

Having a hefty cash balance will impress the local banker when you need some unsecured financing or a working line of credit. Hence there is value in having the cash laying around if you make a point of picking your bank wisely. It is not what the cash earns half as much as what you can earn having a happy banker willing to approve your deals.

John Corey

MATT WARDEN · Answer

The example may have been poor, but that does not resolve the general question. If you may need to replace a roof in the upcoming tax year, would it make sense from a tax perspective to replace the roof in the current tax year? And similar scenarios.

We are not talking about normal reserves. We are talking about what to do if one finds himself with excess. To do nothing with it and allow it to be taxed seems foolish, unless you need this income personally.

Again, this seems foolish. There is no cost to using ING at 4.5% (or 4% for checking) vs. another account at < .5%. In fact, I personally find ING more convenient due to access to the allpoint ATMs free of charge (I travel a lot for business and local/regional banks cost me a lot of money when I'm out of town and using an ATM).

No additional cost or effort and 9+ times the interest. This is a no-brainer. The money isn't there for the return, but that is definitely not the point.

Absolutely. The question being posed here is how one keeps the most of this cash for a longer period of time rather than making a large donation to Uncle Sam. The $1000 you just made can end up being $500 4 months later. Does it make more sense to spend that $1000 now to avoid a $1000 expense in the next tax year, allowing you to keep the full $1000 you earn next year for 15 months?

N/A N/A · Answer

Oh definately.  I use ING for all my savings accounts.  I was just being fecitious with the 0.5% savings account example.

MATT WARDEN · Answer

First, you should never be earning only 0.5% interest in a savings account. Why would you do that? That's a 2.5%+ loss every year due to inflation! ING, for example, would earn you 4.5%.

Anyway, I have been wondering whether it is a good idea to invest a good chunk of the excess as a loan overpayment at the tax year deadline. I figure there is probably some balance between risk and tax avoidance. This is probably a question for your CPA.