Somewhere in the fall every year, I stop focusing on new projects and start mentally winding up activities for the year. With an eye to taxes, I begin the process of gathering together all the income and expenses, to see how much my net income is going to be from all my various activities. From this, I make a rough calculation of how much I’ll be paying in taxes, and, after I get over the shock, I look for ways to defer more income while I accelerate expenses.
Bear in mind, that deferring income and accelerating expenses increase tax problems at the end of the next year, so January is a great time to consider using the cash you’ve saved from taxes to buy more long term highly leveraged rentals that need a lot of fix-up. This will increase deductible expenses for the next year while laying the groundwork for much higher net worth in years to come.
Deferring income and gain is the most effective way to lower my annual tax bill. One way to do this is to hold off year-end closings and receipt of discretionary income until after the first of January. As a rule, invoicing customers at the end of December results in bills being paid the next year. When confronting the new year, there’s nothing more bracing than to have a bundle of money arrive to help pay for all those holiday parties.
Alternatively, you could do a Section 1031 delayed exchange with property that is selling near the end of the year. If you can identify a replacement property within 45 days and complete a qualifying exchange, you’ll pay no taxes. But, if, after making a valid effort to complete an exchange, you fail, and must take delivery of the proceeds from the prior sale, it will be taxed in the year of receipt, thus deferring tax on any gain on sale into the next tax year.
You can’t exchange stocks tax free, but you can offset capital gain by selling stocks with capital losses. To avoid losing out in the event that the stocks you sell go back up, you get around the “wash sale” rule by selling shares around Thanksgiving then buying them back at a profit more than 30 days later just prior to the end of December. That’s when last minute sellers will be depressing market prices by year-end selling. Or, you can immediately either buy-back identical shares in another entity, or buy-back similar shares in the same entity to offset the risk that the market might spurt ahead, leaving you behind.
Increasing necessary expenses ahead of the new year works well. In 2004, Code Section 179 allows a business to write off up to $100,000 in vehicles and equipment used in a business. In my county, property tax bills arrive in November. By paying property taxes in December, I get a 4% discount. I also inspect rental properties and do a lot of preventative maintenance, painting and other cosmetic repairs. This makes the tenants happy just at the time that my annual leases renew, and improving their living conditions justifies any rent increases.
If you haven’t got some sort of retirement plan in place, now’s the time to get this done. Initially, almost any bank, stock brokerage, or mutual fund will get you up an running with little more than a phone call. A Roth IRA will be of great benefit when you take out the money, but a qualified retirement defined benefit or profit sharing plan will give you the highest up-front deductions from current income. What you save from taxes today can provide a very comfortable retirement once you stop earning money; but you’ve got to plan a long way ahead.
December is a great time to take advantage of year-end clearance sales to lay in stocks of repair materials to be used over the next few months. For fixer-uppers and dealers, the year’s end is a great time to stock up on inventory that will be sold in the following year.
DON’T MAKE NEW YEAR’S RESOLUTIONS; SET GOALS!
So much for defensive actions to reduce tax costs; the end of the year is an excellent time to look forward to the next year and to plan how you are going to improve your cash flow. Whether you’re just starting your asset-building and net-worth-building career; or are in mid-stride, well on your way to fame and fortune;
or are a full-time investor looking for ways to increase yield, you’ll do much better being an aggressive entrepreneur than you will spending a lot of time trying to avoid taxes and protecting your assets. You can easily do both with little effort or foresight simply by remaining poor. Like Sophie Tucker once said, “I’ve been rich and I’ve been poor, and believe me, rich is better.”
Whether you’re invested in stocks, bonds, or real estate, long term interest rates are going to have a greater effect on your future than any other single factor. The proof of the pudding is to compare the go-go markets of the past three decades with down-markets of the same period. When interest rates were low in comparison to inflation, real estate flourished. When interest rates were high in comparison to inflation, real estate floundered. The trick is to try to figure out how to predict what is going to happen before it happens. I don’t know anybody who really knows what the future holds, but false prophets abound who claim they do. I always wonder why they didn’t invest with Michael Dell when he got started. The truth is that you’re going to have to draw your own conclusions about next year, and it isn’t going to be easy. Maybe I can give you some tips as to how to get started:
1. When trying to figure out what the next year will bring, focus upon local factors. Bear in mind that what happens in the Wall Street Journal doesn’t necessarily affect your market at the same time. I’m deluged with FAXed articles from highly esteemed national publications purporting to be able to predict single family house markets. What they don’t seem to recognize is that housing is not a commodity that lends itself to macro-economic theories. If a factory or military base closes, it depresses the market whether or not the rest of the country is booming. When the EPA forced the residents of Love Canal and Holmes Beach to abandon their homes, it made little difference whether or not real estate was booming or not. When Punta Gorda was devastated by Hurricane Charley, it was cold comfort to those who lost their appreciated houses that 100 miles away, Tampa shore areas suffered very little damage.
2. Houses have appreciated over the past few years for a fundamental reasons: Low interest rates, 100% financing, and liberal loan qualifying criteria opened the housing market to millions of new buyers who had never been able to buy a house before. The resultant housing demand created burgeoning markets that spawned most of the money made by equity-lenders, fixer-uppers, house and contract flippers, brokers, and indirectly, The Home Depot, and Lowes. Let‘s not overlook gypsy real estate Gurus who sprang up like Dandelions and roamed the land dispensing wisdom to the masses. Regardless of their expertise or insight, almost everyone who got into the single family house market (including Mobile Homes) made money.
3. Anything that excludes people from the housing market will slow sales and reduce profits. Some, but not all, factors that can cause this include:
a. Higher interest, insurance, and tax rates that increase mortgage payments.
b. Tighter loan underwriting credit score criteria, and higher down payments.
c. Reduced personal income caused by unemployment and lower after-tax wages.
d. A slumping economy caused by the falling dollar and world trade.
e. Inflation that drives prices out of the price range of buyers.
f. Demographic shifts of the wage-base and growth from one area to another.
g. Government borrowing and spending that monopolizes available credit.
h. Higher energy costs that change how and where people live and travel.
Your financial future will depend upon the degree of vulnerability your area has to any or all of the foregoing. For both wheeler-dealers and landlords, available credit and disposable income are the real key to making money with houses.
BASE YOUR SUCCESS ON SKILL RATHER THAN LUCK . . .
Scan back over the foregoing factors that can affect your financial welfare and see how many of these you can control. No matter how big you get, external factors are going to have a lot more to do with the way you operate than your own plans. When a person focuses solely on a single aspect of the housing market, any little change can be a financial disaster. When I first got started, I was a real estate salesman earning 100% of my income from sales commissions. In 1971, Richard Nixon, without my permission, reneged on America’s promise that 35 American dollars would buy one ounce of gold. Almost immediately the dollar-price of gold doubled on world markets, making our gold reserves worth twice as much. Nixon also devalued the dollar by 10%. In so many words, foreigners bond holders and creditors to whom Americans owed fixed dollar amounts were gypped out of over half of what they’d been promised.
Almost immediately the wheels began to come off of our financial wagon. The dollar plunged on world markets. As a result, OPEC doubled the price of oil and we all paid more for gasoline. The US Treasury had to offer higher interest rates on its 30-years bonds to attract foreign investors. This had the effect of slashing the value of bonds being held by trust funds, retirement plans, and Social Security. Mortgage lenders failed by the thousands as their fixed-rate loans were repaid with devalued dollars. Many people were driven into poverty. You may remember that New York almost went broke. Rising interest rates completely shut down the housing markets. Builders and developers by the tens of thousands failed. So did many businesses and real estate brokers.
Over this period, I had begun buying houses and selling them rather than merely earning commissions. Florida suffered its worst recessions since the 1930s; one that lasted four years. Nobody was buying, and I was stuck with a dozen houses that had been leveraged to the hilt. As house prices fell, buyers turned into renters, and rents rose. I stayed alive by learning how to become a landlord.
When Jimmy Carter was elected president, his solution to the debt problem was to print money. Everyone went back to work and house buyers returned in droves, clamoring for houses. The resultant inflation drove house prices out of sight along with interest rates. FHA loans at one time required 11 points and as much as 17.5% mortgage interest. A 30 year T-Bond yielded 16.5%. Those who already owned houses and those who built and sold, or bought and sold, reaped fortunes. Rents fell far behind as tenants moved up to become buyers.
Once again, I began to buy and sell, but this time around, I leveraged my “inventory” with Options rather than high-rate loans. Options enabled me to avoid holding costs while capturing the appreciation driven ever skyward by inflation. While I was making a fortune, those who held long term bonds and mortgages were losing out. I began buying houses from distressed owners with fixed-rate mortgage financing and selling them on loans that were indexed to both inflation and to FHA interest rates. As inflation and interest rates soared, so did my profits from these loans.
In 1980, Ronald Reagan was elected with a mandate to curb inflation. He did this with a vengeance by raising interest rates and running up the national debt. He also passed tax legislation which at first rewarded highly leveraged real estate investors with 15 year depreciation, then taxed away their gains with the Tax Reform Act of 1986. TRA-86 severely limited tax deductions on highly leveraged real estate, and taxed capital gains as high as 37.5%. This caused the greatest real estate crash in history. It wiped out the S&L industry, and plunged many areas into deep recession. I found myself buying houses with nothing down that had been handed back to lenders by those who couldn’t keep up with their payments. My only recourse was to hold them as rentals. By learning to sell, manage, and finance houses, then discovering when to do each to take maximum advantage of the economic situation in which I had to operate, I was able to continue to make a lot of money when all around me were losing theirs.
YOUR OBJECTIVE FOR 2005 SHOULD BE TO DIVERSIFY!
Diversification is a term that should encompass not only the kind and type of investments you make of your time, talent, credit, and money; but also the range of skills you seek to acquire and cultivate to provide a margin of safety against the uncertain future. Like most New Year’s resolutions, people don’t keep those dealing with going on a diet and keeping fit mainly because they don‘t suffer more than a few pangs of guilt when they forget them. But, when it comes to money, you’re playing for keeps with your financial security and that of your family. Here are just a few simple resolutions that would reward you beyond measure for the rest of your financial life if you can achieve them by the end of 2005:
1. Learn to LIKE to manage houses. Management skill is crucial to being able to use Lease/Option techniques to buy houses, and Master Leases to create income. It will also enable you to prosper anytime that the sale market collapses and you are forced to rent your own properties. Once you become a good manager, very few real estate activities will give you as much personal satisfaction.
2. Learn to Negotiate with intelligent and well informed people. Negotiation is the skill that enables you to buy low and to sell high. When you restrict your negotiation to uninformed and ignorant people, you may be able to exploit their lack of sophistication, but you’ll wind up with less desirable properties. This will have a negative impact upon the satisfaction you get from managing your way to the top of a growing leased house portfolio. Conversely, there are few times that can equal the joy of knowing you’ve bested a worthy adversary by buying low or selling high; furthermore, it pays extremely well too.
3. Learn creative financing. Creative financing comes into its own during times when credit is tight. In such a market, the person who knows how to structure transactions to reduce taxes for the seller; or increase tax advantages for the buyer; or increase income to the seller without increasing cost to the buyer; and how to control property so it produces income and gain without ownership, will be way ahead of those whose livelihood depends solely upon credit based upon the good will and approval of institutional lenders.
4. Learn to market both your property and your skills. Often, marketing is the key to capitalizing on all the other skills you acquire. It boils down to letting buyers and sellers — as well as those who need management skills and information — where to get it, from whom, and at what cost. Marketing skill reduces the time that money is tied up in a project. It opens up new sources of revenue. I discovered to my surprise that proper marketing creates spin-off opportunities. By first acquiring, then offering my skills to the market for a fee, then offering my counsel to those who needed it, I also was able to inaugurate a seminar business, and from there this newsletter, a book publishing business, and most recently a travel business. All of these came about because of the marketing skills I acquired.
5. Diversify your activities and investments among the following:
a. Buy/Sell and Buy/Fix houses to create high profits while this market lasts.
b. Buy/Hold moderately leveraged houses to create income and growing equity.
c. High-yield discounted first mortgage Notes on owner-occupied homes.
If you can’t find these, create indexed debt by selling houses at high
mark-ups via indexed contracts that wrap around existing loans to
create a “spread” in both the principal balance and interest rate.
d. Highly leveraged Options to hedge against near-term inflation.
e. Liquid assets such as 90-day T-Bills, Exchange-traded index funds, Cash.
f. Short term (6 months +/-) equity loans on fast-turn houses.
g. Mobile Homes on rented lots for high cash flow yield.
h. Mobile Land/Home packages for stable income and sale profits.
i. Small private joint ventures on Mobile Home parks with others you know.
j. An aggressively managed Self-Directed Retirement plan to defer taxes.