All Forum Posts by: Account Closed

Recently I've heard (or seen) some real estate guys preach and preach and preach about how keeping mortgage debt is good because you don't lose the mortgage interest deduction. This is very misleading to a new investor who may not have a grasp on taxes and tax deductions and how they work.

Let me explain why the mortgage interest deduction is not a good justification for not paying off debt:

The first reason is that 1. Mortgage interest is a DEDUCTION not a credit. A tax credit reduces the taxes due....after you've run your tax calculation if you owe $1000 and you have a $100 tax credit, the tax bill is reduced to $900. This is a direct $1 for $1 write off. Great. Too bad mortgage interest is not a credit, it is a deduction. This means it only reduces your taxable income. Assuming your tax rate is 20% and you pay in $1 of mortgage interest, the deduction would reduce your taxable income by $1. The $1 deduction in taxable income X 20% = $0.20 savings on your tax liability. You're still down $0.80 for that dollar, it's not a wash as some people make it sound.

This next part does not really apply to a properly run rental business because if you're treating it as a seperate business, the mortgage interest is an expense of doing business.

But when talking about your primary residence, I hear uneducated Realtors and bankers suggesting to keep a mortgage to keep the tax deduction. As seen above, you are only saving $0.20 on your taxes for every $1 you pay to the bank. To add insult to injury, the small benefit is only received if you itemize your deductions. If you claim the standard deduction ($11,600 for married couples) then you receive no tax benefit for your mortgage interest paid. What this means is your itemized deductions MUST be more than the default $11,600 deduction to receive any benefit (if married, $5800 if single). So, say your only itemized deduction is $12,000 in mortgage interest, you're good right?! All clear!....well, not really. Sure, you are itemizing, but are you really receiving $12,000 in true deduction? I vote no. I like to look at things incrementally. What i mean is without itemizing, you get $11,600 deduction by default, with itemizing you're getting $12,000 worth of deductions. The true felt benefit is only $400 INCREMENTAL deduction ($12,000 itemized - $11,600 standard) . Now take that $400 and multiply it by the above 20% tax rate and you only save an incremental $80 on your tax liability over the standard. Is that worth $12,000 in interest paid?

What I'm saying here is, the interest deduction is not that sweet and certainly not worth justifying keeping debt if you have the means to pay it off. Lets think of it in terms outside of real estate and taxes, people get in a la la land when they hear tax deduction (i think due to a lack of understanding). Lets think of this in terms of a pizza and a coupon. If I had a coupon that would save you $20 on your pizza, would you pay me $100 for it? The obvious answer is no, so why would you pay $1000 to the bank in the form of mortgage interest to save $200 on your tax liability? If you're going to be giving money away, donate the $1000 to charity instead and you will get the same $200 tax benefit.

That's it for my rant,

D Payne

I've got a question for all my debt-free investors. My strategy I'm employing is buy and hold rentals purchased with all cash. I've got my entity set up and have already begun contributing cash to accumulate to buy my first property (should be able to pay for my first $50-75k property in the next 2 years). Saving up cash is a slow process by nature, but I need to know, where do you suggest I hold the cash while I'm accumulating it? Business Savings and Business Money Market accounts aren't paying a squat and I'd like to make a little money on my money while I'm in the slow saving phase.

This is not a cash vs leverage post. My mind is made up. I've seen too many people lose their shirts being over leveraged. I'm trying to build a nice solid base here in my 20's to bring my cash flow to where I want it in my 30's.

It's simple, not complicated, and it works for me. If you want to run your rental business on the financial redline and be 2 months of vacancies away from bankruptcy, by all means go for it. I have been raised to focus on strong cashflow and mitigating risk. Running negative every month is stressful and hoping for appreciation to outweigh your cost of borrowing money is like playing the roulette wheel IMO.

There is nothing fundamentally wrong with this accounting wise. If he's paying you after tax dollars, the method of collection is between you and the tenant.

It also shouldn't make your accountants job any harder. The transaction on the books will be a recurring journal entry and at the end of the day your revenue figure is no different month to month than if he mailed you one check in.

P.S. I'm an accountant, but this is not to be taken as advice ;)

I think it depends on what you're comfortable with. However, If you only have $5-10k in equity on a property, I wouldn't think it would be worth the time and effort to set up a new entity for each property.

Just keep in mind for each entity you've got a new set of books, another k1 to issue, another 1065 to mail off, another bank account to keep up with, another annual filing to do and transactions between LLC's could be tricky. If entity A needed $5k and you had $5k in entity B, to keep your corporate veil intact you'll probably need to do a draw on Entity B to you, then a contribution to Entity A. Things just get messy and its not worth the fuss unless you have a significant amount of equity in each entity, IMO.

As an accountant, we like the people with one entity per property....more books to keep, more k1's to issue, more 1065's to file, and more complicated tax returns = more $ for the firm....I'm joking...maybe.

If the numbers made sense, there was a strong cashflow position and a good appreciating market, I would consider buying it with less than 100% down. I mean even if I took out a 15 year fixed on the property and serviced the debt with rental income, I would own the property outright by age 37 (assuming I didn't vary from the amortization schedule).

Basically, I completely understand the numbers side of it. With leverage it looks like a no-brainer on paper, but what we can't account for is the risk that comes along with leverage. That is a little harder to quantify and factor into deals. 10 properties that cashflow $150/month, if you have mortgages on all 10 properties and you have vacancies on 3 of them, you are in a tight spot unless you've built up a solid emergency fund.

It's all personal preference, I suppose, and I'm no expert seeing as this is just my PLAN. I'm sure I may adjust my course once I set sail on this journey.

I know not all CPA's are risk adverse, but for me I want to mitigate it as much as possible. I don't think I would sleep at night knowing I'm upside down on a few of the properties I own and having staying power is important to me. Thanks for the input!

I am looking for the guys who live and breathe this business with ACTUAL notches on their belts, rather than just completing the latest and greatest seminar (no offense, as I am a rookie too) to evaluate my proposed real estate strategy I'd like to begin implementing this week.

A little background information: I'm 22 years old, a recent college graduate in Accounting and am currently employed at a CPA firm here in town (about to begin studying for the CPA exam...pray for me). I live on the Mississippi Gulf Coast and have always had a passion for real estate (I get it from my grandpa I believe).

Anyway, here is a rough game plan for how I want to build my business. I'm focusing strictly on cashflowing rentals for long term appreciation and basically buy and hold (I need them to be strong cashflow performers so I can actually follow through with the 'hold' part of "buy and hold"). This is truly a "get rich slowly" strategy and I'm OK with that.

ACQUISITION:

I've just formed my LLC and am opening a business account to stick EVERY extra dollar in I have each month. I'm on a strict budget (I'm an accountant, remember?) and am trying to sack away as much cash as possible to buy a cheap first property with cash in the next year or two. In this area, you lower end working class rentals can be had for $45k-100k roughly and depending on the area will pull between $500-1100/month in rent.

As I'm saving up money for my first deal, I am getting maps of the area and basically zoning it out by price ranges and also by market rental rates (when I can find that). I'm trying to get a good cross-section of the market I'm working with and also a feel for the areas of the coast that are more likely to contain properties closest to the 50% 2% rule. While I'm saving up the money, I figure its prime time to get to really know my market and I'm going to commit time daily to get to know everything about my market I can. I feel this is critical for landlords rather than buying and praying you're in a good area.

Fast forward to a year or two and I've got money to buy a property cash, or nearly cash. I buy the property, get it rented through my system I am creating (more on that later), and have good cashflow (from both the 50% 2% rule AND no debt servicing requirements). I take the cashflow from this property (after setting aside roughly 50% in a seperate account for an 'emergecy expense fund, i.e. new roof, etc' + continue my contributions to the business account monthly. Now with a larger monthly contribution than originally done, I should be able to stack up money faster to acquire a second property with cash, or nearly cash in about another year or 2. Repeat the process, snowball both property cashflow + personal contribution and should be able to buy a property in a year or two again. Basically I want to keep snowballing the cashflow to buy property cash like this and not personally draw anything off the LLC until way later in life when I get tired of being a CPA. I figure by age 45 if I've been diligent I should have a nice cashflow situation and built in equity from appreciation. After about 10 years of this I should be buying properties 2 or 3x a year. All along I will have never sold a property (unless certain circumstances make it a very good deal) and will have a large net worth in my real estate portfolio and a strong cash flow position. I feel I will have mitigated risk as much as possible in this game.

TENANT PLACEMENT:

I am going through all of Bigger Pockets and finding everything I can about effective Tenant Placement and am going to try to build a system that works for me. I will have tenants understanding that if they don't play by my rules, they are out. They are not my friend, they are a customer. (I'm not heartless, I'm just not going to waste time and money on a deadbeat, I will stick to this philosophy within reason.)

Once I've got enough properties to make management a full time job, I'm outsourcing to a property manager and will focus my efforts on managing my property manager.

EXPENSES:

Mentioned earlier, I realize that on average 50% of collected rents go to expenses along the life of the properties so I will set 50% aside diligently in the LLC's savings emergency fund to kick Murphy out of the business.

MY LOGIC:

I am risk adverse. I've seen way too many landlords not treat this as a business and buy too high, negative cashflow (in hopes of appreciation??), have a bump in the road personally (and can't pay the negative cashflow!) and ultimately file BK. I'm not buying these to "live" on in the short term, so I really want the ensure that I can hold these for the long term while also building up funds to acquire more and more properties and ultimately be a huge property snowball for me. I'm a huge believer in systems and systemizing things to be as efficient as possible and will do this as much as possible.

Don't tell me that I need to keep a mortgage on a property for the tax deduction...NEXT...you pay out 10,000 to the bank to save 3,000 from Uncle Sam. If your CPA tells you to take out a loan for the tax deduction, GET A NEW CPA WHO CAN DO MATH.

Anyway, where are my flaws? I'm looking to move on this soon. Thanks! Sorry for the long post!

Daniel J. Payne

I think it really depends on what you are looking for as an Investor. If I was in your shoes, I'd be more attracted to lower risk and higher cashflow. I feel that owning the properties outright strongly mitigates your risk and stress should you experience a vacancy or other issues with the property.

Not knowing your complete financial picture, I'd just say you need to decide if you want the cashflow more or more of a speculation on appreciation. If you don't have much money into the deals, your cashflow typically is negative or only a few hundred a month at best.

I'd leave the original property alone and use the $100k I had to invest into a property that meets (or close to) the 2% 50% rule and cashflows. I'd pool the cashflow off the first property with the newly acquired property cashflow into your property savings account and maybe contribute some more money yourself and buy a third property with cash again in a year or two. Keep snowballing the cash like that and buying property outright and before long you'll have a hell of a cashflow situation with minimal risk and still have the classic real estate apprecation on your side over the long haul.

You just won't have a high "Return on Equity" figure, but for ME I'd be happier with paid off properties and a steady stream of cashflow (that you can reinvest in new properties and also pay for regular maintenence of the property to help keep the property value up). You won't be hurting if the market goes down because you won't ever be upside down on those properties. Overleverage is what got us into this mess anyhow.

I may lean too much on the conservative side, but if you have a strong cashflow and you aren't having to inject personal money into the deals each month then you can hold onto the property indefinitely and reap the rewards of property appreciation over the long term. If properties are costing you $-100/door each month, you will be out of business sooner rather than later. Being an accountant, I really just don't ever like the idea of having too much risk and I certainly don't like the idea of a negative cashflowing company for the hopes to sell higher later down the road. That's just a recipe for disaster because if your personal financial situation has a bump in the road, you could be neck deep in a matter of months. Build the business so that financially speaking, it can continue regardless of you staying employed or not.

Just my two cents and I know a lot of people will disagree with me and thats ok.

Daniel

I've got mike Collins' "Wholesaling Houses for a Living" 6 CD Set and 4 DVD set. I've also got the "Rehabbing for fun and for profits" book (with 2 discs included) also by Mike Collins. It also comes with a Forms CD that has all the forms Mike Collins uses in his wholesale deals. It's a good course with a lot of information for a beginner to understand wholesaling. It ramped up my learning curve. I bought it for just over $250.

I'll let it go for $125 shipped or best offer if someone wants it. Let me know.

What you get:
"Wholesaling houses for a living 6 CD set"
"Wholesaling houses for a living 4 DVD Set"
"Wholesaling houses for a living Forms CD"
"Rehabbing for fun and for profits" Book
"Rehabbing for fun and for profits" 2 CD Set

Let me know if you want it. This is cheaper than anywhere I've seen on Ebay.