What’s the difference between financial policy and monetary policy? Or between ordinary and passive income? And what asset management strategies can protect investors from high self-employment and other taxes? These are among the questions tackled by host Jason Hartman and his guest, CPA Mark Kohler, on a recent episode of the top rated investing podcast, The Creating Wealth Show.
Real Estate Lessons: Understanding Credit Based Appreciation
Jason Hartman has a new investing course in the works, and he kicks off the segment with a few key points from a recent lesson on credit-based appreciation and the ways people can benefit from US monetary and financial policies.
Monetary policy and financial policy are often confused, Jason notes. But investors need to understand the essential differences between them. Financial policy refers to how the government taxes property and imposes rates and fees; monetary policy refers to ways interactions among the Treasury Department, the Federal Reserve and the government affect the money supply and how money is created and managed both at home and abroad.
Investors must also know the difference between “real estate” and “income property,” which is a subset of real estate. Jason points out that not all real estate produces income – such as a home you live in, or a piece of empty land.
On the whole, real estate is the most stable and enduring asset class there is. But even that can be undermined by outsourcing in some surprising ways. Take, for example, the parking lot. It’s income property, requiring little maintenance and upkeep. But as driving increasingly becomes outsourced to companies like Uber or even taxicabs, parking lots may cease to be as valuable.
Not so with housing. It’s the one asset that can’t be outsourced – and it’s always in demand because people always need a place to live. But it is a credit based asset class, which means that people make purchases based less on the total purchase price than the price of payments. And that’s determined largely by interest rates.
Those rates can be deceptive, too. It may seem that the difference between, say, 4% interest and 5% interest is just one point. But few realize that the difference is actually 25% – which results in a dramatic difference in the final, total purchase price. And if credit dries up, as it nearly did in the years of the Great Depression, housing suffers, since few can buy homes in full with cash.
Mark Kohler Talks Taxes for Investors
Attorney and CPA Mark Kohler is the author of several books on tax and legal planning for investors. He joins Jason in Episode 538 to offer practical, money saving tips from the there key pillars of a successful investing strategy: tax, legal and estate planning.
Every investor must understand the difference between ordinary and passive income, since that’s the distinction that determines certain tax rates.
Ordinary income, Kohler says, is the income derived from typical sources such as commissions, sales of products and services. Passive income, on the other hand, is derived from rents, royalties and dividends – in other words, assets that keep working for you over time.
The IRS imposes self-employment taxes to ordinary, not passive income. For investors, that means income derived from rent is exempt from self-employment taxes. But those who engage in what Kohler calls “fix and flip” property transactions may need to be careful. If a buyer “flips” more than 3 houses in a year, the IRS considers that a side business earning “ordinary income” and slaps the flipper with the self-employment tax.
The solution? Not the typical LLC arrangement, according to Kohler. His advice: place assets under an S Corporation that holds all assets and pay yourself a salary out of the newly formed entity. That sidesteps the self-employment tax as well as additional taxes related to the Affordable Care Act and other business related taxes.
Once an investor has done basic tax planning, Kohler says it’s time to take care of legal planning – putting safeguards around your assets in every way. The LLC is the basic structure investors need to know, along with the S Corp for managing all assets. But even though it’s not necessary to set up an LLC for every property you own, it is essential to make sure that they’re registered in every state in which you own properties.
And while it’s important to maintain a diversified portfolio, it’s equally important not to over diversify – try to spread investments over no more than 3-5 markets.
Tax and legal planning are important for investors, but all that planning can come undone without attention to what Kohler calls the “third leg” of a sound investment strategy – estate planning.
The key to protecting assets, according to Kohler, is the revocable living trust, a flexible easy to amend instrument that goes where you go and ensures that your investments – LLCs, S Corporations and other entities are handled according to your wishes. The one thing a revocable living trust can’t do, though, is protect assets from lawsuits.
The keys to successful investing are knowledge and planning, with reliable advice from Jason Hartman and the Complete Solution for Real Estate Investors and the Creating Wealth Show’s long list of expert guests. (Featured Image: Flickr/imagesofmoney)
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