Cherie Kerr wants out of her home. The 65-year-old comedian and public speaking coach paid $590,000 for a 1,150-square-foot Los Angeles condo two and a half years ago–only to find the construction so flimsy that her upstairs neighbor woke her up by dropping a coin on the wooden floor.
“A defect hell,” fumes Kerr of her newly built abode. She has moved back into a suburban home she still owns and would love to unload the apartment, but housing values have fallen so far that she figures such a move would lock in a $200,000 loss.
The good news is that Kerr is anything but stuck. A real estate agent recently informed her that the condo can fetch $3,300 a month in rent. That’s enough to cover her mortgage and property taxes. So Kerr has decided to lease out her condo until values rebound. While she no longer harbors visions of becoming rich off the downtown L.A. property, things could be a lot worse.
“It’ll be a tax writeoff,” she says.
Kerr has lots of company these days. No less a financier (and former do-it-yourself tax preparer) than Treasury Secretary Timothy Geithner is leasing out his Mamaroneck, N.Y. home after failing to get for it a bid he was willing to accept. If you’re one of the horde suffering real estate buyer’s remorse, you too may be able to turn a modest profit renting out your albatross of a residence. How can that be? Thank the trove of tax breaks for residential landlords.
The first step in figuring out whether renting makes sense is to find out how much your place is worth. A professional appraisal is best, but written statements from a few Realtors will do as long as they agree on the value and stipulate how much is attributable to land and how much to the building. (The appraisal, as you’ll see later, is essential for two separate tax calculations.)
The next step is to see how much the property will fetch in monthly rent and weigh that against the costs and tax consequences. As a landlord, you can’t claim mortgage interest as an itemized deduction on Schedule A of your tax return. Instead, you deduct interest costs, plus property taxes, monthly condo fees, insurance and anything you pay to a property manager (most charge 10% of rent) against rental income on Schedule E. You can also expense travel and other costs you personally incur to look after the property.
The other big tax deduction for landlords is depreciation. The tax code allows you to divide the value of your building (but not the land) by 27.5 and to claim the result as an annual depreciation expense. Here’s the first place that the current appraisal comes in. When you convert to a rental, your depreciation is based on the cost of the property plus improvements or its market value at the time of conversion–whichever is less.
In Kerr’s case she must use the $390,000 fair market value of her condo, not the $590,000 she paid. Assuming that 10% of the $390,000 is attributable to land under her building, the depreciation expense comes to $12,764 annually (and reduces her cost basis by the same amount). Add in Kerr’s other expenses and the total is likely to exceed her $39,600 gross annual rental revenue. Almost any residential landlord with a mortgage is going to be in that boat.
The amount by which expenses exceed rent is a tax loss that can be used to shelter up to $25,000 in other income–say, from your salary–if your adjusted gross income is $100,000 or less. (The same cutoff applies to both singles and couples.) Above $100,000 the break is phased out, and it disappears completely at $150,000.
“It’s the one and only time you get to use a passive loss to shelter active income,” says Sacramento tax attorney Roni L. Deutch.
If you happen to be a real estate professional–defined as someone spending at least 750 hours a year, and at least 50% of his working time, in the business–then your career managing property becomes an “active” one and your losses are fully deductible against other income. If you fail the income test or to qualify as a pro, your rental losses don’t go entirely to waste. The net loss gets carried forward and deducted if and when you dispose of the loser real estate or you have gains from passive investments. These gains could be from selling the property in question at a capital gain or from owning other passive investments, like oil wells.
Note that “passive” is a term of art in the Internal Revenue Code and does not cover portfolio investing (stocks and bonds). So if you collect $30,000 from stock dividends and have a $30,000 loss on Schedule E, you can’t net one against the other. But you can wise up, sell the stocks and use the proceeds to pay off the mortgage. At that point you’re probably out of the loss column on the rental and pulling real cash out of the property. A good part of the cash return will be sheltered from taxes by your depreciation deduction.
How are gains taxed when you sell a converted property? A lot depends on timing. If you lived in the property for at least two years and then rented it out for less than three, you may be able to use the provision that excludes $500,000 in gains from the sale of a principal residence, per couple, from tax. (You’ll still owe gains tax on the amount claimed as depreciation.) If you sell at a loss, the only deductible portion is the loss occurring after you converted the house from personal to income-producing use. The appraisal is crucial here.
Kerr hopes that sales prices will rebound in two years. Assume instead that they slide and she clears only $340,000, or $50,000 less than what her Realtors said her condo was worth when she converted it to a rental. Her tax basis in the property will be $364,500 (the $390,000 minus $25,500 for two years of depreciation). She’d be left with a $24,500 capital loss she can use to shelter taxable gains on other investments. Also, she could then claim any passive losses she couldn’t use before.
Renting does present problems. You must either maintain a property yourself or pay someone else to do it. Tax and real estate experts warn against hanging on to real estate if rent falls far short of your pretax, out-of-pocket costs. In other words, look to the tax benefits to sweeten the deal, not drive it, says tax accountant William Fleming of PricewaterhouseCoopers.
In a survey I conducted of 200 individuals, who stated they wanted to make the transition from corporate to business owner, the top two things they indicated stopped them were:
- Inability to replace current income
- Not having a stable income
What can you do to counter these top two fears? How can you make it possible to have a stable income that replaces your current corporate salary? Below are the four areas to focus on in order to set these fears aside:
- What do you really want to do with your income: replace, upgrade or down grade? There are many people who would be content earning less if it meant they could do what they loved. Others may want to keep their current level of income or even gain more. Getting specific with what you truly want and need is essential to be able to create your customized financial plan.
- Based on what you want to do, how much money can you make? This includes considering tax breaks that may yield you more income than you thought. Even if you can generate enough money to give you what you need, I highly suggest you find other ways to supplement your income. There are many ways of increasing your income streams, the key here is to increase your financial IQ and then find the investment(s) that will work for you.
- Put together your personal financial plan. Consider things like the consistency of your business and make sure that you are accounting for any fluctuation. What are your short and long term expenses? Talk to someone who’s got a similar business to determine what these might be for you. Once you’ve got this figured out it will help you see what changes need to be made to your business plan in order to pay yourself the salary you desire while investing in your business. This is also an area that supplemental income streams can come in handy.
- Invest in your nest egg. As your business grows, and other income streams grow, the more money you can put away as a nest egg and the more income you can be generating. The number one piece of advice the most successful entrepreneurs suggest, think Donald Trump, Sir Richard Branson and Robert Kiyosaki, make your money work for you. Build up your nest egg and then have it work for you by providing you the passive income you need to live.
The financial fears you may have now, will dissipate once you develop and execute on a plan to create the income you need. The important thing is to think through what you really need and then get creative on how to make it happen.
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Top two fears for people wanting to become entrepreneurs
Academics are not the only thing you should worry about as you grind through the horrendous prison that is college — parties, booze, spring break — oh, the horror!
According to a recent study by Sallie Mae, the average college student will graduate with $4,100 worth of credit card debt, a staggering amount in addition to what they’re already owing from their student loan and other college related expenses.
If starting a new life after graduation with unnecessary debt isn’t your idea of awesomeness, here’s a list of 11 ways you can fail financially while you’re in college: avoid the actions listed below and you just might come out financially ahead when you graduate!
Taking an Excessive Long Time to Finish School
“I’m on the special six-years program,†my friend will often say as people ask him whether if he was a junior or senior in college. While some people will often joke about being a “super senior,†many times there are negative financial consequences if you prolong your stay in college.
Although its perfectly reasonable to switch major as you discover your true passion, lingering while in college can increase your overall tuition cost and prevent you from stepping into your “wage earning years.â€Â For those that are juggling multiple projects or part/full-time jobs while in college, this can especially be a problem as you try and balance between work and academics.
Signing Up for Unnecessary Credit Card Accounts
The Sallie Mae study revealed that on average, college students have 4.6 credit cards, and half of college students had four or more credit cards. The number of cards a student carry also dramatically increases as a student progress through the years in college.
Keep it simple and avoid tackling on additional debts by sticking with one credit card through your college years. If you’re unsure of your ability to properly and wisely use credit, consider opting for a debit card instead — you get the same conveniences, and if your debit/check card is from a major national bank, you get the same level of fraud protection from a credit card.
Doing a Poor Job in Managing Your Financial Accounts
One reason to avoid carrying an excessive amount of credit cards — beyond the risk of increasing your credit card debt — is that managing financial accounts are simply not one of the major priorities for most college students. You can keep the organization simple by using online account access that are provided by most major banking institutions. Many of these online accounts offer bill alerts via email or SMS; they also offer online bill pay along with automatic bill payment — two modern conveniences that should make paying your bill late obsolete.  The more you avoid overdue bills, the less late fees you’ll pay, the more reasonable your interest rate will stay and the better your credit history will look.
Letting Your Vices Consume Your Money and Time
Beyond alcohols and other nefarious substances, your vices can be anything that consumes an unhealthy amount of your money or time: massive multiplayer online games, gambling — heck, maybe even your significant other (yeah we said it). Your college life certainly doesn’t have to be 100% about school work, but when 90% of your time is spent solely on one particular activity, you may be doing yourself a disservice that not only threatens your financial outlook but potentially your very own well-being.
Failing Academically While on Scholarship
Although looking like a stash of colorful curtain when you graduate will certainly make your parents proud, not everyone needs to graduate cum laude. You should, however, do well academically especially if you’re on scholarship or grants. Remember that you’ve earned the scholarship or grants due to hard work — don’t let the free money slip away by neglecting your studies. Even if you’re not on an academic scholarship of sorts, you should still keep academic probation at bay, simply because it will eat up more of your time and money.
Choosing Expensive Out-of-Campus / Away-from-Home Housing
Fact is, some college dorm rooms are just out right horrible. We understand that. But college is also a time where you need to keep the belt tight and the wallet even tighter. Many people make the mistake of taking out additional student loans in order to live in more upscale neighborhoods or housings. Some even move out of the house even though the school may be less than an hour drive away. Being able to find independence is all fine and well, but having to go back to your parents to help with your loans because of your college housing choice probably won’t be a good first step toward independence.
Opting for a Brand New Car Instead of Cheaper Alternatives
Everyone loves a new ride. The soothing chemicals from a new car smell… ahhh. Problem is, new cars are a known depreciating asset. The minute you drive it off the lot, a good percentage of its value disappears into the misty air. Many time it will be practical just to purchase a reliable use car over a brand new car. You can do one step better by grabbing an out-right beater or skipping a vehicle altogether if you attend a college with plenty of public transportations.
Attempt to Keep Up with Peers on Materialistic Possessions
It can get easy to get carried away when you get in the “Keeping up with the Joneses†mentality, especially in our younger years when image may be important. But spending the time and money in order to keep up with your peers on materialistic possessions will only rack up the credit card debt. If you find yourself constantly feeling like you need to buy certain products or apparel just to feel like you belong to a crowd, it may be time to start seeking friends that value you beyond your possessions!
Using Your Student Loans Excessively on Other Purposes
The majority of your student loans should be spent on your tuition and tution related expenses: housing for college, books, transportation and food. Your student loan shouldn’t be spent on a lavish spring break trip to the carribeans, nor should it be spent on a set of snowboard along with snowboard racks for the car. The minute you start allocating your student loan for purchases that are far from daily necessity, you will head down a slippery slope of debt accumulation.
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Living it Up (Beyond the Means of a College Student)
Everyone can probably agree that college life is more than just academics; after all, if you subject yourself to hours and hours of studies without taking the occasional break to enjoy life, college can quickly become a tiresome experience. But enjoying life should be met with some sensible amount of balance. Just because you know an acquaintance that frequently take trips to Europe during spring break doesn’t mean you should do the same. Living beyond your means is always a bad idea, living beyond your means when you’re a poor college student? Even worse of an idea.
Borrowing Too Much in Student Loans
It is a known fact that the cost of college tutition has been increasing at a rapid pace in recent years. A problem many college student face today when graduating is that they grossly overestimate their expected starting salary, often finding themselves not earning enough to pay their costly student loans. Here’s a good rule of thumb: if your total student loan debt exceeds your expected starting salary for your first year in your career, you’re borrowing too much. Be realistic with your expected salary and plan ahead on how you’ll cover the cost of college.
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11 Ways to Fail Financially While in College
According to the Labor Department, the June unemployment rate for those 55 and older hit 7%–the highest on record. That’s bad news for seniors who are out of work or being forced to re-enter the work force to make ends meet. The Dolans have some job hunting tips for the 55+ crowd, including good news about some advantages you may have over the younger competition.
Dear Ken and Daria:
Thanks to the investment losses I’ve suffered, I have to come out of retirement and go back to work. Do you have some job hunting tips for seniors?
–Maureen
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Ask the Dolans: Tips for unemployed seniors
Recently as I sat at a local coffee shop in downtown Charlotte recently I couldn’t help but overhear several patrons passionately discussing the Bernard Madoff case.
“He’s such a crook” one gentleman exclaimed. “They should give him the electric chair” another woman protested. It got hot and heavy for awhile and really had me thinking about something my Dad told me years ago.
He intimated that in a crisis situation before I start pointing the finger and blaming someone else for my problems I need to first check-in with the man-in-the-mirror (my dad said it way before MJ, but we love you for that song anyway Mike – RIP).
In the many years since my dad’s death I’ve had the opportunity to reflect and contemplate his statement on many an occasion. My years in the finance business working with client after client revealed a dire lack of accountability on the part of clients who flatly refused to take personal responsibility for their own financial minefields.
Often I’d develop compelling arguments as to why a couple needed to be involved in their financial makeover so as to learn the basics of what to do and not to do. “Can’t we just pay you to do it for us without being involved?” was the answer I would hear more often than not. I became exhausted with “fixing” a client’s situation only to have them present me with a new bag of goodies (debt, late payments, etc.) 6 months later.
When I consider this Madoff case I ponder how all these supposedly-intelligent and savvy individuals could look at that man or woman in the mirror every day and not hold him/her at fault. They blindly trusted this man who really couldn’t be trusted. How could this happen you say? Where was the S.E.C….(that’s another story).
As far as this situation goes it all starts with poor stewardship. Individuals who, like many of my former clients, refused to take personal responsibily for their own money management. “I don’t have the time”, “I’m not good with numbers” or “My wife handles that” are some of the poor excuses I’ve heard.
Now we are faced with the most horrific financial scam of our nations’ history. And while the victims are applauding the conviction as well as the 150 year sentence they still fail to see the forest for the trees. What Americans still don’t realize is that unless and until we turn off noise of the flat screens, two-ways and I-pods it’s only a matter of time before history repeats itself.
Robert Kiyosaki has preached fiscal responsibility in his numerous best-sellers. However, it’s the same basics grandmom and grandad taught our parents years ago. Have we become so modernized that we can’t do anything for ourselves any more? The irony of it all is that it seems the more sophisticated and advanced we’ve become educationally and technologically, the worse financial decisions we make.
So you couldn’t afford to pursue a degree in finance from Harvard University? Well, that’s understandable. However, for most a Harvard-level education is now availible to the common man or woman today via the world wide web. Never have we in the history of mankind has such a myriad of data and information been available to us right at our fingertips. And the only way for us to change our results is in fact, to change our actions.
Please, please don’t misunderstand my point. There are (still) a few good money managers out there today. However, the magic elixer is YOU. You are the best manager your finances will ever have. There is only one person who’s going to take care of your money like it really matters and that is you.Â
Many people had no clue what there precious dollars were invested in. They knew nothing about the myriad of “investments” or the background of the companies. This is a cardinal sin and one of the first and most basic rules of investing. You should never invest in an industry you are intimately familiar with….ever. Â
And at the end of the day you should be directing the money manager to a large extent, not he or she selling you on the latest hot stock tip. It’s time to take charge of your finances again. Otherwise we may as well prepare ourselves for a few more Bernie Madoffs to be uncovered in the years to come.
I’d like to suggest it’s time to get back in the driver’s seat and take the wheel of your financial future. One thing i can say for Bernie is that he opened our eyes! You can choose to make a change or do nothing at all. The choice is up to you!
~ Jerry King. Jerry King is an Examiner from Charlotte.
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Lessons off Bernie Madoff
