Real Synergy At Work For Retirement Income


Manage episode 200480523 series 2124446
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When investing for your retirement, having real synergy at work for retirement income is a real turbo charger.

Transcript: Today we’re going to talk about what really is the concept of synergy as it relates to real estate investing. First of all, let’s start out with I’m with you, synergy is a marketing term that has come to mean almost nothing, and have no value whatsoever. It’s the most over used and abused concept there is in marketing today. I’m with you on that. We’re on the same page. However, my test is pretty down and dirty. It must do 1 of 2 things if not both, or it’s not synergy. It either gets you to retirement more quickly, or it gets you to retirement with more retirement income. Hopefully it does both, but if one or those 2 rules aren’t met, you did not use synergy, you used a marketing term. Let’s use an example. All synergy is in my world is to be able to use more than 1 strategy at a time. Sometimes we use 3 or 4 at a time. Yeah, first of all, the buy and hold real estate investment strategy. Doesn’t mean you buy and hold forever. It means you’re not buying low to sell high immediately like a flipper might. The second strategy you might involve is a particular type of depreciation if you’re a high incomer, or $150,000 a year household income or more, or your might bring in cost segregation as a depreciation strategy. I’ll bring these together when I’m done. In order to make the long term investment and cost segregation strategies work even better, you might bring in discounted notes as a long term strategy. Even that as a standalone strategy will do 2 things, both short and long term. Short term it brings in cashflow now, and it will continue to. Long term you make profits because you’re buying these notes at a discount while at the same time you have more income per month coming in after tax then you would have had you not bought those notes, and this is income you don’t need to live on, so it’s like cashflow from real estate, you get to use the income from the notes like the real estate to advance your retirement plan. Let’s take the strategy of buy and hold, cost segregation, and discount note investment to see how that can enhance and maybe push your retirement date much earlier. You buy a couple of pieces of real estate, and let’s say those pieces of real estate costs you $80,000 for down and closing a piece. You paid maybe $300,000 give or take for them. What you do is your use cost segregation, because you guys make a couple hundred thousand a year, and that means the IRS does not allow you to take any left over depreciation from your properties after sheltering the properties cashflow against your ordinary income. You might have, in this scenario, a $5,000 a year annual cashflow per each of these 2 properties, and each of these 2 properties in cost segregation might have a $20,000 a year depreciation dollar figure. You would have $15,000 left over per property per year. $20,000 depreciation, minus $5,000 a year cashflow. That $15,000 per property, should be according to normal thinking, be able to be used against your ordinary income, but since the tax code says you make too much money, it must simply go onto the shelf and gather dust until you no longer own those properties. Let’s turn lemons into lemonade. You buy those properties knowing that you’re going to use cost segregation as a second strategy to your buy and hold approach. Each year both of those properties combine to generate a total of $30,000 of useless, unused depreciation. Well that goes on for say 5 years, and 5 years you’ve now stockpiled $150,000 of unused depreciation, and you say, “Why on earth would I do that on purpose?” Let’s move to the next chapter. Instead of buying 4, or 5, or 6 pieces of property which you may have had the capital to make happen, you just bought these 2, and then with the rest of it, you bought several discounted notes secured by real property, and these notes generated a monthly income, and that monthly income was taxed, just so you know, interest from notes is taxed just like you have a second job. You take that after tax note income, you combine it with the fully sheltered real estate cashflow every month, and if you can afford anything out of the family budget, you add that too. You gang up on one of the 2 notes until it’s paid off, and you quickly gang up on the second one, because now you have way more cashflow from real estate, because one of them doesn’t have a loan on it. The whole idea is you didn’t start this unless you knew for sure in your heart of hearts that between the note income, the cashflow from the real estate, and the household budget money that you comfortably put forward for this plan was able to pay off both of these loans in 5 years. Here’s what happens. We said you paid $300,000 for each of these properties, and you paid them both off in 5 years, and you say, “Well …” If you sell those properties … Let’s say they went up enough to pay brokerage and fees, closings costs, etc, and let’s say it costs you $25,000 each to sell those things, so you netted $600,000. You paid $300,000 each. That’s what you got out. Problem is you may, or may not have any capital gains in that scenario. We hardly had any depreciation. You took depreciation of $5,000 a year for each, so that’s $10,000 per year combined times 5 years. That’s $50,000 and that takes away from your purchase price, and what we know as an adjusted cost basis. In essence they say you didn’t pay $600,000 for those, you paid $550,000, but then it costs $25,000 a piece to sell them. Well, in this case it’s coincidental, but this happens some times, the cost of selling them is then added to your cost basis, and now you’re back to paying $600,000 according to the tax code. You didn’t have any capital gains, and if you did they were very small. However, you took $20,000 instead of the $10,000 that would have been the normal, boring, vanilla straight line depreciation, and the tax code says that every dollar that you take over straight line is taxed at 25% when you sell the property. Each of these produced over 5 years $75,000 of unused depreciation. Now, each year that was $10,000 of that was over straight line, so that’s $50,000 each times 25%, you owe $25,000 in what they call depreciation recaptured tax. That’s at a higher rate then capital gains. It’s 25%, that’s $25,000. Now you owe that at that sale the next time you file your tax return for that year you’re going to have to pay that except for, let’s say you made $200,000 at your job that year, you have again, $150,000 of unused depreciation that you can now use because you don’t own the properties anymore, and therefore the IRS cannot bar you from putting it against your ordinary income. You didn’t make $200,000. You made $200,000 minus all that unused depreciation. That’s going to save you far more than the $25,000 that you owe. In essence, you sold that money in 5 years, 2 of the 3 sources that you used to pay off those 2 real estate property loans came from other people. One source was your tenants, the other source was the payers on the notes that you bought. Only about 1/3, and in many cases, much less than 1/3 came from the household budget. In 5 years you spent maybe $160,000 or $170,000 on day 1 for down payment and closing, and in 5 years you put $600,000 in the bank after tax. What did you accomplish when you did that? Well, you took other people’s money for the vast majority of the principal pay down of those notes, and you took $170,000 and multiplied it almost by 4 after tax. What’s going to happen in 5 years? What are you going to do with that money, $600,000? Nobody has a freaking idea. My crystal ball’s as cracked as yours. However, look at all the options you’re going to have regardless of what the economy and/or real estate market is at that time. You’ve got $600,000 and you can do with whatever you want. What else did you accomplish? You bought a small portfolio of discounted notes. That didn’t go away. Those notes will pay off randomly and you’ll keep making profits, and they’ll grow, and keep growing, not only until the day you retire, they’ll grow until you die and your heir is given these notes. Every time a note pays off you’re going to buy more notes with higher payments and get a raise. That’s what we call synergy. First off, you paid those 2 real estate property loans off much more quickly then you would have without the notes. Secondly, you avoided the taxes by getting a better tax result on your personal income tax in the year of sale to offset the taxes that you owed because of the sale of those 2 properties, and that is synergy. In 5 years, over 2/3rds of the money used to pay off those loans was out of other people’s pockets, and you’ve got $600,000 after tax, and a bushel full of notes giving you income, and growing because you have a built in profit due to the discount you paid for those notes. Now that is a great example of synergy, and next time we’ll have a case study and we’ll show a different way to do it.

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