Posted on February 22, 2008 @ 11:58 pm - Written by BawldGuy
The concept as it relates to the Internal Revenue Code is what we’re talking about here. There is an incredible benefit to successfully filing your tax return as a Professional Investor.
It boils down to a simple exemption. Taxpayers owning investment real estate are allowed to use depreciation to ’shelter’ the income generated from their properties. As usual however there’s a hitch. First though, let’s define depreciation from a practical viewpoint.
It is, plain and simple a fantasy loss, what many have termed a phantom loss. The taxpayer gets to claim a fantasy loss which offsets real income. The common phrase used to describe depreciation is tax shelter. Also, once all the property’s income is covered, the remainder, if there’s any depreciation left, is allowed to offset your ordinary (read: day job) income. This results in paying less income taxes. In other words, it’s another form of cash flow.
How cool is that!?
Back to the hitch. The key word here is Tax. Sheltering it or paying it.
Regardless of how much depreciation you as an investor have, the IRC caps its use against your ordinary income at $25,000 annually. Wait, 
that’s not all. The more you need it, the faster they take it away. Uh, duh, it’s the government. It’s not their job to make us happy. Once your ordinary income exceeds $100,000 they begin decreasing the maximum $25,000 until you get to an income of $150,000 — by which time you’re not allowed any use of depreciation to reduce ordinary income. Don’t be confused here. This limitation applies only to your ordinary income — not the cash flow income from your real estate investments.
The sighs I just heard tells me reality just sunk in for some.
To review — you get $25,000 a year in phantom losses (depreciation) up ’till you make $100,000. It then begins to fade away ’till it’s eliminated from your world at the point your annual income reaches $150,000.
There’s a way to get around it — but it ain’t easy.
All you gotta do is say yer a real estate professional. Once you’ve successfully received the IRS’s blessing as a Pro Investor Dude (Dudette?) the $25,000 limitation is lifted, along with any ordinary income limitations. Let me make as clear as a spring sky in San Diego at noon.
As a Pro Investor you can make an unlimited amount of income and take an unlimited amount of depreciation (phantom losses) against that income.
Wowie wow wow wow. The coolest of the cool.
Got a million bucks in ordinary income and a million bucks in depreciation? Do the math. 
This doesn’t take into account all the other tax laws that whipsaw us back and forth reminding us why our Forefathers gave us the 2nd Amendment. Don’t go around quoting me — check out what I’m saying here with yer own tax guy. This isn’t some hidden or little known factoid I’m trotting out here. That said, just like the Alternative Minimum Tax has for years taken away much of what the rest of the IRC gives — ensure you’re acting with complete confidence and massive professional expertise behind you.
If you need a referral, I’ll try and help you out with one.
The IRS has a whole bunch of tests to see if you qualify for the designation. I’m a full time real estate broker which some would say is the gold standard. Nobody qualifies easier than a full time real estate broker who also owns his own real estate investment firm. The only bet safer than that is the sun setting in the west.
The trap is set when folks see this as an easy workaround for tax reduction. That is a stainless steel bear trap that will cause IRS pain you don’t want in your life. Take my word here — talk with your tax advisor to see if you might qualify for this. If you claim this designation and it’s disallowed, you’ll wish you’d stepped in a bear trap instead.
I currently deal with many clients who’ve successfully cleared all the IRC hurdles for this coveted designation. Here’s one example.
He was an attorney — quit his job to become an investor — and now he’s a recovering attorney. He easily passes the required tests and has qualified to file his tax returns as a Professional Investor for years now. It’s made a pretty big difference in his life — especially around the middle of each April.
A final note
The motivation for this post was the recent proliferation of so called ‘advisors’ who were counseling 
folks to claim the designation while kinda sorta telling them to seek expert advise or consultation. By the fourth or fifth time I read one of these hacks I felt this post was necessary.
Go ahead and explore the subject with a CPA or tax attorney — it’s worth a try.
Please, as a favor to me and yourself, don’t read somebody’s claims on the internet and go for it. Those bear traps are as nasty as they appear to be.
Posted on January 11, 2008 @ 12:51 am - Written by BawldGuy
How’d you like to wake up one day and discover your incessant pursuit of cash flow as #’s 1,2, and 3 on your A List agenda has probably cost you well over $2 Million? You think that’s pretty rare? It’s nearly as common as folks taking 20 seconds to order what passes as ‘coffee’ at Starbucks.
For the record it takes me about .9 seconds to order coffee there — Grande coffee please.
Matt and I met not quite three years ago. He owned a four unit property in San Diego in a great location not far from Balboa Park. He wanted my opinion — what should he be doing? I told him, and let’s just say he wasn’t too motivated to make it happen. He didn’t buy what I was saying back then. Long story short, that non-move probably cost him in the neighborhood of $1.5-2 Million — a dollar amount with which he fully agrees.
Matt is a very, very smart guy. As a recovering attorney, (his phrase — no offense David) he’s pretty much a self taught, pretty successful investor. In fact, since quitting his other life, he hasn’t worked in the real world since. He’s bought land in Wisconsin of all places, split it and sold for enough to live handsomely — or at least pay the bills and save some to boot. He’s invested in a large state (has a football team that just embarrassed Arizona to death on national TV) to the extent the cash flow is not only impressive, but also pays the bills — all under the cooling umbrella of some pretty impressive tax shelter. 
Don’t get me wrong here. When Matt moved from the old life to the new one, he wanted at least enough cash flow to make it worth his while. In the end though, he discovered he’d become at least a little infatuated with it. When this happens investors often unknowingly chase after quarters at the cost of dollars.
He’s bought, fixed, and sold probably a dozen houses. He had to, as he needed to constantly keep producing income on which to live. He succeeded. Now he realizes there were at least a couple of those houses worth keeping. Ya think? Lord in Heaven! If he’d been able to keep just two of them, he’d have several times the equity he’s about to trade from his four unit property. Furthermore, he’d then have the where-with-all to produce literally six figures more a year in cash flow than he enjoys now.
But I digress. A quick note before proceeding. Matt knows all this, because as I’ve already mentioned, he’s a very bright guy. Today on the phone there were a few times his quick, almost instantaneous understanding of fairly sophisticated concepts saved us time. He gets it. I think he probably got it the first time I ran it buy him. Like in church as a kid, the old ladies in the second pew used to say — “He had a head belief, but not a heart belief.”
Sometimes being a PK comes in handy.
Yep, Matt not only taught himself, but figured out how to make a living as a real estate investor ever since. Thousands of people say they want to do it. They’re positive they can — but never quite put the Firestones on the pavement. Know what I mean, Verne? Matt figures most stuff out, and then figures out how to make it work for him. ‘Course it doesn’t hurt to have a wife with a reliable job as a teacher. All these years and I’ve never met her. We’re gonna remedy that real soon.
So what’s the problem? 
It’s recently has Matt fully grasped how the constant obsession with cash flow has cost him millions. The only real estate he’s ever really kept, went from under $300,000 to $1 Million — more than tripling value. Ironically, it’s my opinion he kept it only because after fixing it up and increasing the rents, he fell in love with the dang cash flow. It’s human nature. Cash flow acts sometimes almost like a fantasy come true — kinda like surfing on air.
By not executing a tax deferred exchange when I advised him to do so, his capital is now literally a comma short of what it should be right now — accounting for the market correction.
We’re gonna rectify this oversight in the next several weeks. His four units sold recently — for the same million bucks they were worth when we first met. His equity isn’t as large as you might expect since he refinanced for a much larger amount. Nevertheless, we’re heading outa Dodge, as investing in San Diego would be foolishness on a grand scale.
If you own property in San Diego, California in general, or any place with stoopid high prices — find the exit door and use it. Denial or infatuation with cash flow doing nothing for you now, is the reason you’ve lost a ton of money in the last several years. Cash flow is wonderful when you’re retired. When you and maybe your spouse both have jobs enabling you to endow retirement plans, save for your kids’ college education, and generally enjoy life — cash flow shouldn’t even be on your B List.
BawldGuy Axiom: To the extent the real estate investor goes for cash flow — their capital growth will be inhibiited — and vice versa. Corollary: You’re not the exception.
If you’re really, really thirsty, do you spend the next few minutes searching the fridge for a carne asada burrito? No, you don’t. You grab some water, or whatever else is available to quench your thirst.
You need to grow your capital for the expressed purpose of creating the largest monthly cash flow — at retirement.
We’ll probably increase Matt’s tax shelter to the tune of roughly $30-40,000 yearly. His capital growth rate? How do you fail to improve on zip zero nada? His capital has been floating face down now for quite awhile. That’s what happens when you allow your real estate investment capital to remain in San Diego.
Over the next few years we suspect his capital might grow at a rate of 20% yearly, probably much more. I’m trying to be conservative here. In any case, by the time we make the call to 
get rid of what he’s about to acquire, his capital will have grown phenomenally. That’s kinda misleading though, isn’t it? Any capital growth rate would be phenomenal compared to a market like San Diego. That’s where investment capital goes to die.
Ouch! Did he really say that?
He did indeed — and that’s why Matt can’t wait to take his moribund equity and haul buns outa Dodge.
What’s holding you back?
Please don’t say cash flow.
Posted on December 29, 2007 @ 12:34 am - Written by BawldGuy
There are coaches, mentors, and advisors armed with advice on exactly how we all should be planning for next year. It all boils down to the various parts of our lives, which are important and which are relegated to the B-List.
What has priority in our lives? It changes of course, over time.
I’m a middle aged man who decided a priority in 2007 would be my long term health. Silly me thought health as a priority would be like falling off a log. After all, since my teenaged years health professionals have given me not only great advice, but incredible training. I should’ve known it wouldn’t be as simple as, eat better, sleep better, exercise more, and generally demonstrate more discipline.
Health, like real estate investing, is conceptual, not ticking off items on a to-do list. It’s not that a list won’t get you there, it’s that understanding the concepts driving your success or failure tends to help. Go figure.
If your A-List includes finally pulling the trigger on a real estate investment Plan, listen to the Purposeful Planning podcasts. They’re located on the right column towards to top.
Follow that by the Grandpa Economics podcast.
Yeah, I know it’s almost an hour of your time. Get over it, and then think of the time spent in retirement. Most folks are gonna be alive far longer than their parents and grandparents were — especially when they retire years earlier. Since we all prefer that to be quality time, and know higher retirement incomes are better than lower — listen to the dang podcast.
Grab my White Paper. It’s on the right under Free Reports — Early Retirement. It’ll take you over to my regular website and give you a taste of what’s in the paper.
If yer over 50, there’s a podcast just for you — Close To Retirement.
About your health? While listening and reading about how to retire earlier and better, why not get serious about your health too? This isn’t a health oriented blog, nor am I anything close to an expert. Your reading this online, which means you probably can figure out how to find solid info. 
What’s the use of retiring high on the hog, younger than you thought, if you’re not gonna be in spectacular health? My mom is gonna be 77 next April, and she still works out several days a week. Grandma turned 94 this year and we’re just now having to ensure there are able bodied folks around to help when needed. Until about a year ago she was still walking a mile — twice a day!
She did well with her money over the years, and has been retired since Nixon was in office. Her robust health has made that time productive to say the least.
Do the same for yourselves. Don’t let me get you to a magnificently abundant retirement only to find yourself unable to take full advantage. How lame would that be?
So here’s the goals, or maybe a simple to-do list for you to consider. It’ll help get you out of the gate for 2008.
1. Once and for all — Figure out a Purposeful Plan just for you. I’ll help if you want.
2. Take a closer look at your current financial status. Stop doing things you shouldn’t be doing, and start doing what you know you shoulda been doin’ a long time ago.
3. Ascertain the current net equity in all of your income properties. If any (or all?) are around 35% or more of the value — call me, cuz it’s more likely than not time to make a move.
4. Review the financing on your properties, including your home. Regardless of what the media says, there are some pretty enticing loans out there, some of which just might make your month end up with more cash. I can point you to the right guy if you wish.
5. Does your income property reside in a region where prices have reached levels of stoopid? It’s probably time to get outa Dodge. Sell/exchange now. Don’t fret about how much you net, cuz yer gonna more than make up for it on the other side. Really.
6. Reassess your choice of CPA’s. Yeah, I know, yours is really good — so is everybody’s. Most, like doctors with the different disciplines in medicine, know parts of the Internal Revenue Code much better than other parts. You want the one who knows the parts talking about real estate. Trust me, that’s not a big percentage of accountants. It matters — big time. So please do it, OK?
7. What strategy have you been using to allow your investment capital to grow as quickly as conditions allow, while remaining safe? How’s it been working for ya so far?
8. Stop doing the following three things:
Chasing cash flow when capital growth is far more beneficial for you now.
Holding your investment properties either too long, or forever. You’re leaving huge piles of retirement cash on the table.
Aiming for a retirement funded by savings, Social Security, and a free & clear home. I guarantee you that won’t be a retirement — it’ll be a life sentence.
9. Take a look at how much depreciation you’re claiming. If it’s a lot, you should strongly consider heading over to your employer to increase your exemptions. This will immediately increase your take-home pay, which is a good thing. Why wait ’till April 15th every year?
10. Decide whether or not you’re happy with the results (see #7) you’ve seen so far. If you sense you’re driving a Corvette, but haven’t been able to get your capital growth to exceed 70 mph — change what yer doing.
Finally, my first post for the new year will point to new empirical evidence of the strategy employing Grandpa Economics failing on a nationwide level. What I’ve uncovered, ironically through the media, will hopefully lead many to an epiphany.
Enjoy the year’s final days, and be safe. I appreciate all of you, and wish you all the best year possible in 2008.
Posted on December 22, 2007 @ 12:31 am - Written by BawldGuy
I’m rapidly approaching the entrance to Apathyland. It’s a fun place where the mind goes for rest and recharging. Imagine an eight year old visiting Disneyland for the first time. Every time I’m able to visit Apathyland that’s how it is for me. I’m allowed to go there once, sometimes twice a year.
Usually I’m happy as an umpire behind the plate in a playoff game when it comes to Investmentland. I love what I do. There’s nothing better than watching clients become wealthier. Talking with new clients is like vitamins to me. If I could inject numbers, I would.
Once or twice a year though, my brain starts flashing the Energy Low warning light. That means there’s at least a week of inertia to keep me going sans any real power source. A little past five today it began flashing. This year, unlike most years, I’m gonna do the right thing. Starting tomorrow — the only real estate investment stuff I’m messin’ with will be ongoing business in need of BawldGuy’s presence. Otherwise, I’m in Apathyland.
Here are some end of the year ramblings. Since I’m low on energy, give me a little leeway OK? Thanks.
Ever notice how the average TV or editorial page economist has predicted 11 out of the last 4 recessions?
Know what Texans call mashed potatoes and gravy? Dessert.
Is it possible for the DOW, this time next year, to be over 15,000? Very — or not as the case may be.
In my first 30+ years in the business, interest rates under 7% were almost mythical. A few years ago when I saw my first rate below 6% I was astounded. Yet real estate did just fine with the higher rates. Capital always finds a way.
In fact, the price run-ups during those years were fueled by 7-8.5% interest rates. It was what we had, so we made things work.
Although it keeps falling out of escrow, an acquaintance of mine owns a million dollar fourplex here in San Diego. The first income property I ever sold was a duplex for under $50,000.
Have you noticed the media have been predicting higher interest rates for the last six years? Isn’t there a statute of limitations on predictions? Of course there is, except for media. They’ll say they told us so. Which of course they did. They just don’t report when they’re wrong. Duh
Here’s a few real estate investment tidbits.
Confusing appreciation of property value with capital growth rate is common. Here’s how to think about it. You buy a property for $100 using $10 down. It goes up in value 5% the first year. People aren’t impressed with 5% growth rates for real estate. However, you’re focused on the $10 you put down, cuz that’s your money. Since the property rose in value $5 — your capital growth rate was 50%! (5 is 50% of 10) Now how impressive is a 5% appreciation rate?
Often missed by the more inexperienced investors — the benefit of depreciation. You buy an income property and it generates no cash flow — you break even every month. However, since each year your depreciation is say, $10,000, your income taxes are reduced. That is after tax cash flow. Assuming a combined state/fed marginal tax rate of around 30% (usually more), you’d be keeping $3,000 you would’ve paid in taxes but for your investment property. Your ‘break even’ is now $3,000 ‘positive’.
A 30 year fully amortized 5.75% fixed rate loan has the same payment as a 7% interest only loan. Contrary to popular belief, it often makes sense to take the 7% when there’s no 5.75% money around.
If you did have to settle for the interest only loan, your month to month operations won’t change. However, if you held the property for five years, with a beginning loan balance of $200,000 and an interest rate of 6.5% — you’d have lowered your balance by just under $15,000. As long as you can afford the $97.49/mo. payment difference, yer good to go. In essence, you’d be trading less than $6,000 over five years for the $15,000 ‘extra’ when you sold in five years.
What’s the right amount of time to hold an investment property? No particular time — it was a trick question. The market is your advisor when it comes to picking a time to sell. If it’s been just 12 short months, or seven years — the market will speak to you.
Decisions in real estate investing often come down to a judgment call. Here’s the policy I’ve used successfully with clients. If it’s a close call, marginal, don’t do it. For example, if you’re wondering if it’s time for a tax deferred exchange up into more property, are you improving your position dramatically? If not — stay put. I’ve told dozens of clients over the years — “I can make this happen for you, but I’ll be the only one really reaping any benefits.” That usually convinces them to stay put. If it’s not a no-brainer, don’t do it.
I believe it’s more likely than not my Christmas shopping will be completed before it gets dark on Christmas Eve. It’ll be close though. Babydoll (daughter) has already offered a mercy shopping trip.
I thought for sure 2007 would end with the DOW at over 14,000. Though it closed up over 200 today, I’m still about 550 points short. Without a late and surprising surge, I’ll just have to deal with being a little off.
Is there anything better than Christmas morning with family? Everyone sitting around the living room, all cozy with coffee and something hot and sweet to go with it. Maybe a fire going if called for. When that moment hits you — reflect on how lucky we all are. Promise yourself to remember what’s of real value in our lives, and that it has not a thing to do with real estate.
Though I’ll be littering this space for the rest of the year with random tidbits of who knows what, today I wanted to wish all of you a Merry Christmas. I’m off to deal with that flashing warning light.
Posted on December 13, 2007 @ 12:33 am - Written by BawldGuy
Leaving Thursday for Austin, then Dallas on Sunday. I’m conducting a seminar Saturday in Austin.
Friday I’ll be taking a long and in depth look at a project or two. The numbers are lining up. We don’t like to recommend investments which haven’t had our own boot prints stamped on their dirt. The fourth dimension in real estate investing is what experience adds after all the before and after tax cash flow numbers have been analyzed. Numbers aren’t the whole story by a long shot. Quality of construction is merely a chapter, as is location.
It’s the gut feeling that comes after the romance of the first impression passes. There’s nothing that replaces boots on the ground. Having been there and seen that is invaluable.
I can’t wait to meet the folks attending the seminar. Excitement is having the Firestones hit the pavement in person. After the first cup of coffee of course.
Texas offers real estate investors many choices, as do most regions. I like the trends. One which seems to have legs is the migration from states to the north and east ending in Texas. There are more options than I have time over there. So far I’ve been able to sufficiently research both Austin and Dallas/Fort Worth. (Known there as the Metroplex.)
They’re two totally different worlds. Austin is San Diego with nowhere to surf, but a cool river. Dallas is, well, Dallas. It’s a big, big place — in population and size. It’s what they have in common that attracts me though. Locations harboring pockets of opportunity rich in potential.
It’s not hard to find property combining solid location with demand. When have you seen one without the other for very long? Add relatively high rents and we’re still not surprised, right?
In San Diego a 40 year old duplex offering a couple 2 bedroom 1 bath units with garages, will rent for $1,000-1,200 a side. They sell for $400,000-700,000. Our favorite Metroplex location offers duplexes too. There are some differences though. Real estate investors typically notice these differences.
The Texas duplexes offer 3 bedroom 2 bath units and garages. They’re brand new. They rent for $1,100-1,225 a side. The tenants are very solid. When you drive by on Wednesday afternoon, shortly after lunch, hardly anyone is home.
They’re all at work.
One more thing. The Texas duplexes are generally half the price of their San Diego cousins. Often less than half. The $500,000 SD duplex requires at least $160,000 to buy, including down payment and closing costs — that is if you want it to break even every month.
$160,000
That much capital in Texas will get you the following:
6 brand new well located duplexes
$50-60,000 in annual depreciation
Properties that pay for themselves
Great leverage and loans with principal pay down
Steady capital growth made even better by leverage
The potential future ability to offset over $100,000 in capital gain
Selling each side as a separate dwelling — at a premium price per side
Imagine, if you live in a market like San Diego, how a tax deferred exchange into these properties would turbo charge your capital growth rate over the next 3-7 years. More likely than not it would put you years ahead of where you would be retaining he status quo.
Decisions this easy are what we look for in real estate investments.
The technical term is No-Brainer.
We’ll take a look at some examples in Austin in a day or two.