This morning, I met with a couple of other real estate investors to discuss year-end and 2013 tax strategies. Part of our discussion was about our emergency funds and when was enough really enough.
Right now, if you’re lucky, money market accounts are paying a whopping 0.9 percent. This means that if you have $10,000 in your emergency fund at the beginning of the year, by the end of the year it will have grown by a whopping $90. Oh be still my beating heart.
Now you know the government won’t let you keep that full $90 of interest you earned, don’t you? Interest income is taxed at your marginal income rate after all, right? For the average family in Georgia, the marginal income tax rate is around 31 percent (25 percent Federal tax plus 6 percent Georgia tax). So the government steals $28 and let’s you keep $62. The net result is an emergency fund totaling $10,062.
But wait a second. Did you notice that the prices you paid for things like gas, bread, sugar, and butter shot up this year? This is called inflation. How does a 4 percent inflation rate affect your emergency fund? The buying power of your $10,000 actually fell to $9,690 (0.9 percent minus 4 percent, equals negative 3.1 percent, then $10,000 minus 3.1 percent equals $9,690). How about them apples?
So how do you keep parasites like inflation and taxes from eating away at your net worth? How about investing in real estate? Sure, you still need an emergency fund, but doesn’t it make sense to also invest in a capital asset that can outpace inflation and be taxed at low rates?
Let’s look at a recent deal as an example. The seller’s house had a fair market value of $80,000. He wanted to sell quickly. The house needed $2,000 in repairs and cleanup. The purchase price was $51,000. The owner agreed to finance the purchase. The down payment was $2,000. The balance was $49,000 with these terms: 30 years at 3.86 percent interest with payments of $230 per month. The property rents for $850 per month. After debt service and expenses, the cash flow is $320 per month.
Now to the big picture: The equity pickup on this deal was $29,000, and the cash flow pickup was $320 per month. At the same time, you can depreciate the property at $1,927 and write off $1,876 in mortgage interest expense – both of these yearly losses are paper losses only. And you also get to write off expenses such as insurance, property taxes, repairs, management fees, etc.
When matching the expenses against your gain, you end up with a net loss – which means you pay less tax at the end of the year and get to keep more of what you earn. In addition, as inflation rises, so do rents.
Most folks don’t yet realize all the financial advantages that come with owning rental property. I’m not a CPA, but with all the taxes going up on January 1, how can you avoid learning about owning rental property any longer?
Bill and Kim’s North Georgia Real Estate Investors Association meets on the second Thursday of each month, from 7 to 9 p.m., at the Hilton Garden Inn off Main Street in Cartersville, Georgia. For more info, go to REIoutpost.com.