Alan Clopine

Alan Clopine is the Executive Chairman of Pure Financial Advisors, LLC (Pure). He has been an executive leader of the Company for over a decade, including CFO, CEO, and Chairman. Alan joined the firm in 2008, about one year after it was established. In his tenure at Pure, the firm has grown from approximately $50 [...]

The pros, cons, and mistakes of rental real estate investing, how to eliminate mortgage payments and create monthly income with a reverse mortgage, and potential side hustles and passive income streams in retirement, presented by Alan Clopine, CPA, of Pure Financial Advisors and Your Money, Your Wealth®. 

Free Download: 10 Tips for Real Estate Investors


Andi: Alternative retirement income sources, real estate and beyond with Alan Clopine, CPA, the CFO and Chairman of the Board of Pure Financial Advisors, a tax professional who has been helping individuals, corporations and trusts for over 35 years. Alan directs the tax reduction strategies of Pure’s tax planning department. Specific to today’s presentation, Alan has also personally owned rental real estate since 1986. Now, please welcome your host for today’s webinar, Alan Clopine, CPA. Alan, how are you today?

Al: Good afternoon, Andi. I’m doing well. How about yourself?

Andi: I’m very well. You’ve got deep experience with the pros and cons and mistakes of real estate, don’t you?

Al: Well, I would say this is kind of near and dear to my heart. I think I bought my first rental property in San Diego. I think it was 1986 and I have seen the good, the bad and the ugly of real estate. I can tell you what to do and I’ve had lots of successes. I can tell you what not to do. I’ve done those too. If our viewers are interested in real estate or other alternative types of income, I think this would be a great program.

Andi: Why don’t we start things off with a poll today to see what people most want to learn about? What do you think of that?

Al: I like it. OK, go for it.

Andi: Which topic is of most interest to you today? Is it rental real estate, reverse mortgages, side hustles and other passive income streams or all of the above? All right. So 21% of our audience is interested in everything that you have to say today. We’ve got only about 2% that are specific for reverse mortgages. 32% are interested in side hustles and passive income streams, and 43% would like to hear about rental real estate.

Al: OK, great. Well, now I know where to direct this webinar to. We’re going to talk about alternative retirement income sources, and you don’t have to be retired. You can be any age to do these things. It can be for yourself, it could be for your kids, it can be for your neighbor, it could be for anyone that you happen to know. These strategies can work for everybody. And for most of us, who wouldn’t like a little bit more income? So these are ways to create a little bit more income. We’re going to start with real estate, but we’re also going to get into reverse mortgages-only 2%, so we won’t focus on that too much. And then side hustles and passive income. Side hustles, that’s a new way to say a side job or a part time job or contract labor. That’s what the younger generation is calling it. We’re trying to keep current, so we’re going to call it that.

02:49 – Real Estate Investing

But we’ll start with rental real estate. And when it comes to rental real estate, there’s some pros and cons. I’ll give you a couple of my own experiences, good and bad. Got to pick the right property. I’m going to focus on residential real estate investing, single-family homes, condos, but you can invest in duplexes, fourplexes, apartments, commercial property, triple net leases, there’s all kinds of ways to do this. Today, we’ll talk about residential. You want to make sure you pick the right property. I’ll give you some tips there. You’ve got to consider cash flow. To me, that’s one of the most important things, because if you haven’t got the cash flow, you may go broke before you get wealthy. And finally, once you’ve created a lot of equity net worth, how do you cash that out without paying too much in taxes?

Let’s start with the pros. And you know some of this stuff, but we’ll start with the basics. So you can create a cash flow. So you receive rental income each month, you’ve got expenses. The net is your profit, and hopefully that’s what you receive on a monthly basis for cash flow. It can appreciate in value. We know that particularly if you live in Southern California, which is where we’re at, or any other spot in the United States that’s appreciating (which actually pretty much everywhere is appreciating right now, some more than others), it allows for active investment. In other words, you can control a little bit more what’s going on with your investment as opposed to a stock market or bond portfolio which you don’t have a lot of control over. You have control over what you invest in in the stock market and how much risk you have, what kinds of investments, but you really don’t control what these companies are doing. Finally, there’s tax advantages. For example, when you have rental income, income expenses, you end up with profits, you get to net those profits against what’s called depreciation. Depreciation is simply the cost of the property. The building part, not the land part, the building part. And you get to write that off in residential property over 27.5 years. So what that basically means is you get to write off a piece of the property each and every year against your profits. So that means some of your profits will be tax free or at least tax deferred because of that. And then secondly is when you sell that property, you can pay long term capital gains taxes, which are a cheaper tax rate than ordinary income. Or you can do a 1031 exchange, which we’ll get into in just a minute.

But there’s some cons. Biggest con is it takes a lot of time. I would say it’s kind of like running a business. It’s going to cause you to have to think about the property. Maybe you’re going to be very actively involved, maybe you are going to manage the property, maybe you are going to do the repairs. And if that’s the case, it could take up quite a bit of your time. Maybe you’ll delegate, maybe you’ll hire a property manager, maybe you have a handyman to do some of the work, and that can be a great way to go. It’s a non liquid investment, so if you need cash quickly, it’s difficult. You have to sell that property and there’s costs involved in selling. So just be aware of that. And leverage effects can be negative. This is one that not everyone fully thinks about when they get into properties. Properties over the long term tend to go up in value, but not always. In fact, in my career, I started investing in real estate in 1986, we saw a slight decline in 1991/1992. That was the savings and loan, when they collapsed and properties went down. In San Diego, which is where I’m at, properties went down maybe 15%, 20%. Then we have the Great Recession. Properties during the Great Recession, depending upon where you’re at, in San Diego probably went down 25-30%, depending upon the property. I had properties in Las Vegas that went down 70%. My properties in Phoenix went down over 50%. So that can be a problem. You do all this analysis. You figure out this is a great property in the right neighborhood. It’s got great cash flow or at least decent cash flow, you’ve got a lot of equity in it, so there’s a lot of cushion. You buy a property, you put 20% down.

Let’s just do a quick example. Property is worth $100,000 with 20% down. The loan is $80,000, your equity is $20,000. Now the property goes down 50%. It’s worth $50,000. Your loan is $80,000 and you’re thinking, well, it’s going to come back if I can just hang in there. But guess what happens during these types of recessions? You have to lower your rent. It’s hard to rent it. And so I personally had to give two properties back to the bank in a short sale. And during the Great Recession, it happened to a lot of us. So just be aware of that. I bought an apartment in Vegas during that same time, bought it for over $900,000, had a loan of about $500,000, $400,000, something like that. Property went down to about $300,000 during the Great Recession. It was very difficult to keep that going. I ended up selling it for about $500,000 or $600,000, but I lost money. So it can happen. I’ve also made money on lots of other properties. So it can go both ways. Just just be aware of that.

But how to figure out what property to buy? So here’s a few things you might want to consider. Maybe look at a bread and butter property, a bread and butter neighborhood, as opposed to a luxury neighborhood. That would be like a working class neighborhood, you tend to have a lot better cash flow. They’re cheaper properties. They have better cash flows because the amount of rent that you can collect versus the value of the property, it’s a better ratio. The more luxury neighborhoods are going to have a much worse cash flow because as properties go up in value, rents go up, but not as much. So there’s more of a disparity. So think of it this way. The place that you want to live in with a nice kitchen, granite countertops, great backyard pool, crown molding, that’s probably not your best rental. However, I will say this, in some cases, luxury neighborhoods tend to appreciate a little bit better. So if your number one goal is appreciation, you might want to go a little bit more of that direction. Just realize cash flow is a lot more difficult. You certainly want to look at upcoming neighborhoods versus declining. When you walk through a neighborhood, what do the properties look like? Are they kept up? Are the houses painted? Are the yards OK? Are they improving even if it’s an older neighborhood? Is there pride of ownership? These are all good things. Is Home Depot right nearby? That’s an excellent indication, as opposed to just the opposite of that. And sometimes it’s hard to tell when you walk through, but you can talk to realtors in the area or neighbors in the area just to try to get a sense. Obviously, you want to be in an upcoming neighborhood that sort of goes without saying, because if the neighborhood is growing then you’re probably going to do better appreciation wise and cash flow wise.

Rule of thumb on cash flow. I’ve probably read this rule in every single real estate book I’ve ever read and every single real estate seminar I’ve ever been to. It says make sure that the monthly rents equal 1% of the value of the property. Well, in 35 years plus I’ve never seen that to be true anywhere, ever. But it’s a good concept. And so the concept is this $100,000 property, 1% of that, the rent would be $1,000 a month. $500,000 property, the rent should be $5,000 a month. It’s going to be hard to find that. But here’s the key. Get as close to that ratio as possible. So if you have a couple different properties and one is closer to that, one is a lot further away, then that would be a consideration on which property to buy. And then finally, the condition of the property is really important. You definitely want to get a home inspection if you have problems with the foundation or other things like that. Unless you’re in the business and can look at these things yourself, I’ve found that to be really pretty effective.

OK, let’s go over cash flow because to me, this is one of the most important things, and I have two different examples of two different properties. So Property 1, rental income $24,000, expenses of $19,000. So there’s a $5,000 cash flow. That’s the profit. Talk briefly about rental expenses, everyone underestimates those when they look at a property. They forget about things like maintenance, getting a new dishwasher. Things that go wrong with the roof or whatever may happen. Vacancy. Make sure you factor in vacancy. 5% is kind of a good figure. Some areas you might want to do more. $5,000 in this example is the cash flow. So here’s the important math that you want to figure out: What is your cash on cash? Cash on cash is profits divided by equity. So in this case, equity is $100,000, $5,000 cash, 5% cash on cash. Pretty good. I will tell you, a lease in San Diego and Southern California, when you look at cash on cash for fully paid off properties, it’s usually around 3%, 3.5%. It’s not great. There’s other parts of the country that are much better. But Property 2 is probably more representative of what you might see, which is $30,000 of rent income, $20,000 in expenses, $2,000 of profits, and equity of a couple hundred thousand. Here you got 1% cash on cash. So it’s kind of like your dividend rate or your profit rate. So it’s not that great, but at least it’s positive. I would say most properties you will ever look at in high cost areas will be negative cash flow. And that’s not to say you shouldn’t necessarily buy. Just make sure the negative cash flow is small and you believe that it’s going to appreciate, because in that particular case, you’re not buying the property for cash flow, you’re buying it for future appreciation.

But if we take this Property 1 and look at it a little bit more deeply. How do you make money in real estate? OK, well, this is this property that has $5,000 dollars of cash flow. And we said there’s $100,000 of equity, so let’s assume the property is worth $400,000, the loan is $300,000. So that’s how we get to our equity. And let’s say this property appreciates 5% a year, which is a reasonable figure. So 5% of $400,000 is $20,000. So that’s your appreciation this year. And we already said there’s a $5,000 cash flow. And by the way, you’re paying off the mortgage. So let’s say your principal is being paid off by a couple of thousand dollars a year. These are your profit components. You add these together, you get $27,000. Now you take that $27,000 and you compare that to your equity. You’ve made 27% on your money. Ever wondered how people make money real estate? You make 27% for a few years in a row, your net worth multiplies. So here’s what happens: people get greedy. They see this and then pretty soon their property appreciates. Now it’s worth $500,000. It’s like, OK, well, I can refinance that. I can pull cash out and I could buy another property. That works fantastic when values go up. When it goes down, the whole dominoes can fall down and you can be left with nothing. I have seen this happen to many people. Be careful. This is where leverage can really hurt you. But this is why people make money in real estate: they use leverage to their advantage. So they’ve only got $100,000 basically of their own equity, $300,000 of other people’s money. And because of that, they’ve got a really good rate of return.

Now one other thing I want to talk about with regards to real estate is what to do when you’re ready to cash in or sell it. How do you go about that? And there’s several things to be aware of. Here’s four different ideas on selling. One is the easy one: outright sale. You just put it on the market, you sell it, you get the cash proceeds, you pay the tax. And at least it’s a decent tax rate. It’s capital gains rate. Capital gain rate is anywhere between 0%, 15% and 20% based upon your other income, your ordinary income tax rate. There is that net investment income tax, which is an extra 3.8% if your income is over $250,000 if you’re married, $200,000 if you’re single. But in some cases, maybe that’s a good way to go. You do have to pay extra tax on depreciation recapture. Remember, I said you get to write off a piece of the property each year against your income? Well, you have to recapture that when you sell, that’s at your ordinary income rate or 25%, whichever is lower. So just be aware of that. And in some cases, when you inherit a property and the property tax basis steps up, and you sell it pretty soon thereafter, you don’t really have any gain. So outright sale is not necessarily bad.

Installment sale. This is where you’re selling it, but instead of receiving cash, you are financing it for the buyer. So the buyer is going to pay you. So I’m the bank, I sell the property to someone else and they’re going to pay me. I’ll be the bank. They’ll pay me periodic payments and I’ll pay the taxes, but slowly over time. So that can be a way to go.

1031 exchange. This is where you sell a rental property, buy another rental property, there’s certain timeframes you have to be aware of. You would do that if you want to get a property that has a better cash flow. You’ve got a property that appreciated a lot, but the cash flow is not that good. Certain properties have better cash flows than others, like apartments tend to have better cash flows than single-family homes, or commercial properties may have better cash flow. Triple net leases. Think Burger King. You buy the property, you rent a Burger King, and you get a better cash flow. So that would be a potential way to go.

And then finally, Charitable Remainder Trusts. This gets more complicated, but for people that have property that doesn’t have any debt, it has to be free and clear, you can actually set up a trust. You only do this when you want to sell. You don’t do this otherwise. So it’s when you have a property you want to sell, but you don’t want to pay any taxes right now. So that’s the whole point. So here’s how it works. You set up this trust. We call it a tax exempt trust. You put your property in the trust, you contribute the property to the trust. The trust owns it because it’s tax exempt; it sells it, pays no tax. All the profits principal is there for you then to receive a lifetime earnings stream. And the way these things are designed is that you will receive 90% of your principal plus income back over your lifetime, and the charity will get the remainder in the trust when you pass away. And it can be husband or wife second to pass away, there’s all kinds of variations on this. But this can be a pretty good way to go when you’re just looking for simplicity. You want to get out of real estate, you don’t want to pay taxes upfront, you want to have a much better cash flow, maybe you’re charitably inclined, maybe not. In many cases the numbers work out to your benefit, even if you’re not that charitably inclined. So that was a quick summary of real estate. Charitable trusts are more complicated. We could spend a whole webinar on that, but I think I’ll stop it there. And Andi, I’m sure we got some questions. So where are we at?

Andi: Yes, we do. We have a number of questions. First of all, C.R. asked “I won’t be able to stay for the full presentation, will there be a link to the recording sent out afterwards.” C.R., that is our plan. It will be sent out in the next few days so you can look for that in your email. Sam says, “Where in SoCal are the rates closer to that one percent rule of thumb?”

Al: That’s a great question and when you find out, let me know. It’s very, very difficult. But I would say, I live in San Diego, so if you’re familiar with San Diego or if you’re not, you can sort of look up some of these neighborhoods. But think Mira Mesa and Santee instead of Carlsbad, Cardiff, La Jolla. Those types of things. So think of it as a working class neighborhood or maybe a starter home neighborhood. These are where your cash flows are going to be better. So Lakeside is going to be better than downtown San Diego. East Bay is probably better than Rancho Santa Fe. So the more expensive the neighborhood in general, the worse it’s going to be, and that would apply to whatever neighborhood that you’re in. There’s going to be nicer areas and lesser areas. The lesser areas, that’s not really necessarily where you want to live and it may not be the home you want to live in, but it’s probably going to be the home that’s going to be better cash flow. I do personally have two rental properties in Phoenix right now. Phoenix is definitely a better market than San Diego for cash flow.

Al: That’s a great question and when you find out, let me know. It’s very, very difficult. But I would say, I live in San Diego, so if you’re familiar with San Diego or if you’re not, you can sort of look up some of these neighborhoods. But think Mira Mesa and Santee instead of Carlsbad, Cardiff, La Jolla. Those types of things. So think of it as a working class neighborhood or maybe a starter home neighborhood. These are where your cash flows are going to be better. So Lakeside is going to be better than downtown San Diego. East Bay is probably better than Rancho Santa Fe. So the more expensive the neighborhood in general, the worse it’s going to be, and that would apply to whatever neighborhood that you’re in. There’s going to be nicer areas and lesser areas. The lesser areas, that’s not really necessarily where you want to live and it may not be the home you want to live in, but it’s probably going to be the home that’s going to be better cash flow. I do personally have two rental properties in Phoenix right now. Phoenix is definitely a better market than San Diego for cash flow.

Andi: Next question is from Ann, and this is going back into your presentation a little bit, Ann wanted to know, “is this an example of annual income and expense?” So in your previous example.

Al: Yes, it is. This would be an annual. So this would be a property we’re getting $2,000 a month, this first one. $24,000, your expenses are $19,000, your profits $5,000. So you do this calculation, you can do it each and every year. In other words, you look at your profits and you compare it to the equity to get a sense. So sometimes when you do this, what will happen is the cash flows will slightly increase over time, but the equity will increase a lot quicker. And so what tends to happen is your cash flows go down or at least kind of hit a floor where they don’t really change. That’s where you’re tempted to refinance, use those profits to buy another property. That’s a great way to go. Just be careful because you may regret it if you go too far or too fast.

Andi: Let’s see. Kathy asks if you can explain the cash on cash formula again?

Al: OK, sure. Well, that’s actually what I just went over. It’s your profits for the year, your cash flow for the year. So you have all your income minus all your expenses. And then hopefully, it’s a profit. You take that profit, you divide it into your equity. Your equity is defined as your value of the property minus the debt equals equity. So you’re basically dividing profit into equity to get your cash on cash. I will tell you in San Diego, Southern California, you will in many cases see this number to be negative. That’s why we get the question: Where do you go for cash flows? It’s difficult in much of California, Washington, Oregon, and some of the East Coast. In the Midwest, these formulas tend to work out a little bit better. Texas tends to be a pretty good market cash flow wise. So just be aware you may end up negative here, and that’s not necessarily going to be a reason not to buy. It just means understanding what you’re doing. You’re not buying for cash flow, you’re buying for appreciation, and you feel like you’ve got good resources to cover this in case of the downturn. And I will tell you one more thing, and that is if your property rents for $2,000 a month, you should have at least 3 months in reserve. So that’d be $6,000 for every single rental you have. Make sure you’ve got at least 3 months, and that’s a minimum. And I think a lot of people, myself included, have made that mistake.

Andi: Ken says, “is it legal to rent to a family member and take advantage of tax benefits?”

Al: Yes, renting to a family member is just fine with one caveat: it’s got to be at market rent. But market rent, to be honest, is a sliding scale. It’s hard to know exactly. So there’s a high end of the market, there’s a lower end of the market. I would say as long as you’re renting towards the lower end of the market, you can do that and still take advantage of tax losses. But realize the passive loss rules and once your income is over $100,000, you start phasing out your ability to take losses on real estate unless you’re a real estate professional. That’s again, a whole different webinar. But that real estate professional, if you qualify for that, you can take losses at least on your Federal return.

Andi: Tom said, “Can you clarify what principal payments are? You had it listed as income.”

Al: Sure. So this is an example of how to figure out your rate of return. And so when you’re thinking of real estate, there’s different components of your profit. In my example, you’ve made $20,000 on your $400,000 property, which is 5%. However, you don’t look at it that way, you look at it $20,000 over $100,000. So that’s why that’s a 20% rate of return just on appreciation. Cash flow is actual cash in your pocket. But because you were paying down a mortgage, maybe you had a mortgage that was $300,000 and at the end of the year, it’s $290,000. That’s appreciation in a sense. In other words, that’s added value or added net worth to your overall net worth. That’s why I’ve included it here. It’s not really income per se, but it’s all part of the total return of the property. And there’s one more thing I didn’t include, and that’s tax benefits. So if you can qualify to write off real estate as a deduction, which many of you cannot, but if you can qualify for that, then your tax savings would be another item here that would increase your rate of return.

Andi: Patsy says, “Can you use an SBA loan to finance properties?”

Al: Can you use the SBA loan to finance properties? My understanding of SBA is it has to be related to your business. So you can use an SBA loan to buy a commercial property, as long as, I believe you have to be at least 51% usage owner occupied. It may be different, that’s from memory. But yeah, you can use them to buy a commercial property that you house your business in. But I’m not aware of a way to use it for rental real estate in general.

Andi: We have a number of real estate questions that have come in. We’ve got a few hundred people on the call, so there’s a good chance that we are not going to be able to get to all of your questions today. But of course, you can email them to info@purefinancial.com if you don’t get answers to your questions today. So why don’t we do one more real estate question and then we can get into the rest of the topics? Ken also asked, “If you have a second home, rental or not, and you have a loss, can you lower your capital gain?”

Al: If you have a rental property, which is a second home, which is rental property or not, can you lower your capital gains? Yeah. So whether it’s a personal property, which would be your residence or a second home or a rental property, it’s the same formula. When you sell the property that is your sales price, you subtract out the closing costs, so that’s your net sales price. So that’s the top number. The bottom number is your purchase price plus improvements. And if it was a rental minus depreciation that you’ve taken, you compare those two numbers, the net sales proceeds with the tax basis. And that difference is long term capital gain. But that’s true whether it’s your residence, whether it’s a rental, whether it’s a second home. But as you probably know with your residence, you do get an exclusion of $250,000 of gain, $500,000 if you’re married as long as you’ve lived in the home 2 out of the last 5 years.

28:20 – Reverse Mortgages

Andi: Why don’t we get on to reverse mortgages and then we’ll go to more questions at the end if we have time?

Al: OK, let’s do that. Reverse mortgages, we’ll spend just a little time on this one. A reverse mortgage is a way to stay in your home and actually potentially either eliminate the mortgage payment or if you don’t have a mortgage, create an income to yourself, and/or at least have a line of credit. There are two types, mainly. There’s a Federal Housing Administration Insured Loan. This is the more common one that you would think of. And then there’s private or proprietary reverse mortgages. This is with a private company. Most of us would probably do it through the Federal Housing Administration. It’s called the Home Equity Conversion Mortgage, or HECM for short. You can structure these in several ways. You can do a lump sum. You can request a monthly payment stream, maybe over a fixed period of time. You could request a payment stream over your lifetime. You could request nothing, just have a line of credit that you could draw on. So this is the most common. The private reverse mortgage generally is when you’ve got a more expensive property because there’s lots of limits on how much you can do on a regular reverse mortgage. Maybe you have a more expensive property. You want to get more proceeds out. They tend to be more expensive. Here’s the rules: you need to be at least 62 years of age, or at least one of you as far as spouses. The property must be your primary residence. Any existing debt must be paid off. And the rule of thumb is that you probably need at least 50% equity, if not more, in your property. Reason being is, the most home value that the federal administration will give you credit for this year is $970,000. That’s not how much loan they’ll make. That’s the value of the home, and about the highest they would ever make is about 50% of that. That’s why we say about 50% equity. But that’s completely dependent upon where you live, zip code, what the average house price is in that zip code. It’s also dependant upon your age. You may be 70 but have a very young spouse, and that’s going to factor in as to how much you can receive on a mortgage. But here’s where it works out well is where you don’t have a lot of extra resources to live off of. Maybe you have a little mortgage you can reverse and you want to stay in your home. You’ve got your forever home. You never want to leave. So you get this reverse mortgage, you eliminate your current mortgage, and then maybe even have a line of credit to boot for future expenses down the line. Once you leave, you sell the property, you move out of the property or you pass away, then that loan has to be paid off. So that’s kind of just briefly how that works.

31:20 – Side Hustles

Side hustles. How do we make some money? What are other ways to do it? There’s probably thousands of ways to create extra income, so I just want to go over a few common ones. And I think that the most common one is to be a consultant in your own field. So let’s say you’re really good at marketing or engineering or whatever. You retire and there’s still a need for your services. You don’t want to work full time anymore, but maybe you’re OK working a day a week, or a couple of days a week, or on a project as it comes up. This can be a great way to glide into retirement, because in many cases when you retire and you just completely cut off your income, for a lot of people, that feels kind of scary. So this is a way to make that a little bit easier. But there’s lots of other things like rideshare, like Uber. So that’s really common now. It’s not that difficult to become an Uber driver as long as you don’t have convictions. Food and grocery delivery is another really popular one right now. Obviously during COVID, it was a big deal. I think it will still be around for a while. Virtual assistant or bookkeeping or anything that you can imagine that can be done in a remote setting. How about pet walking, pet sitting? My son tried that. They only got one job one time, but anyway, it can be good. We had a neighbor that was a tutor that helped kids in the neighborhood. I think she charged $50 an hour for high school mathematics and physics, which obviously you have to know something about them, but that can be a great way to create income. Maybe you’re good at being a handyman. So just a couple of thoughts. If you type into Google “side hustle” or “part time income” or “extra income”, you’ll find all kinds of choices. So that would be a way to go there.

33:15 – Passive income

But it’s not just you creating income yourself in terms of your own efforts. How do you create passive income that you don’t have to do as much for? That you set things up and just receive income? So I would say there are four categories. So the first one is buying cash flowing assets. So one of the best ones we just talked about is real estate. You buy the property and if you don’t want to be that involved in it, you hire a property manager, handyman or whatever. And you let them do the day to day work while you just receive the income. So that’s the idea of buying an asset. Maybe you invest in a business that’s cash flowing. Hard to find, but maybe you’ve got a friend that has a business but needs a little extra capital for some reason. Maybe you buy a vending machine. Believe it or not, I’ve known people that have made a lot of money buying vending machines. So think of that kind of opportunity here. Another one is building cash flow assets. Maybe writing an ebook. Maybe you’re passionate about something, some topic that you know a lot about. You write this book that is of interest to people that you could sell. Or maybe you’re really good at guitar and you create a series of videos on how to learn guitar. So the idea is that you create something and then let it sell itself over time on the internet. People will download or subscribe to your lessons, and it could be almost anything. Just think about what you know, what you’re passionate about. You could potentially set up something. Some people do podcasts that promote this kind of thing. Anyway, there’s all kinds of ideas.

Share or sell assets. It’s actually a pretty common one now. Airbnb, we’ve heard of that. That’s where you’ve got an extra room in the house. Maybe the kids have left, you’ve got some rooms, and maybe occasionally you open it up to Airbnb, have a guest come in, create a little extra income. I don’t know if you’ve been to any hotels lately or looked into hotels or Airbnb or VRBO. It’s expensive. You can get a lot of money for renting out a room for a night or a few nights or a week or something like that. So that can be a great way to increase a little income.

Your car. Hard to believe, but you can actually rent your car. There’s websites out there. Turo is one that I know of because I’ve used it. When I went to Glacier National Park last summer, there were no car rentals. There were none. But I found this guy on Turo; I rented his Mustang. Four of us packed into a little Mustang with all our stuff. We made it work somehow. But anyway, that can be a way to go.

And then finally, I would say reverse passive income. What’s that? Well, that’s like lowering your expenses. And that kind of works the same except in reverse. So instead of creating extra income, you reduce your expenses to create extra spendable cash. So how do you do that? Well, I think most of us, if we honestly sat down and looked at what we spent money on over the last two or three months, we could probably figure out some things that if it comes down to retiring versus not retiring, I’ll skip this. I won’t buy this many things or I won’t have as many packages come from Amazon every week or whatever it may be. Now some of you may use Quicken, then it’s really easy to see what maybe that extra stuff is. If you don’t, maybe you sign up with Mint.com or one of those websites out there that track your spending. You link your bank account, your credit cards to that, and then you can see from something like that without even having to enter anything. So that can be a good way to go. But I would tell you honestly that my wife and I do this every year in January. We look at the last three months and what are we spending money on? What are we doing too much of? What can we cut out? Because to me, it’s all about increasing your spendable cash flow to do the things that you want to do. For some of you, that’s actually retiring. You’re in a job that you’ve been for a long time. You don’t want to do that anymore. But the thought of having no income is difficult at best. So you pick one of these things, creates more income, but you also reduce expenses and you live more the life that you want to live. So Andi, with that, we’re going to go back to questions.

Andi: And boy, do we have a number of them. Steve says, “is a reverse mortgage a variable interest rate or competitive fixed rate mortgage rate?”

Al: I think they’re variable. I think the ones I’ve seen are variable. Don’t quote me, maybe there’s a way to get a fixed, but the ones that I’ve seen have been variable.

Andi: Kevin says, “What are the cons of a reverse mortgage?”

Al: Well, there’s plenty. Right off the bat, I will tell you that there’s a couple of frauds going on right now in reverse mortgage. One seems to be related to handymans trying to talk you into getting a reverse mortgage so you can improve your home. Another one is going after veterans, that the Veterans Administration will give you a no cost reverse mortgage. Veterans Administration does not do reverse mortgages, so just be aware of the cons out there. I think honestly, one of the biggest cons is the cost. It’s a lot more expensive than a regular mortgage, so there’s upfront costs, there’s the interest rate. If you think you’re going to be in a house for just a few years, you would not get a reverse mortgage. It’s just too expensive. On the other hand, if you’re going to live in your home for a long time and could use that extra money to pay off the mortgage or to have another cash flow, it can be a great way to go. When you think of Southern California, which is where we’re at, the price of our properties are high enough that it’s hard to get much of a reverse mortgage dollar amount. Not that it couldn’t work, but it’s difficult to get out what you want unless you get one of those private reverse mortgages and then the costs are even more. It’s so confusing, and people have made mistakes in this that the only way to get a reverse mortgage is you have to sit down with a counselor to go over the pros and cons with your exact situation.

Andi: Sue had a good question that kind of ties in with all of this, “What are the income limits in retirement for Social Security?”

Al: That’s a good question. It depends upon your age. So if you retire at age 62, for example, and you’re still working, the IRS says that you can only make about $20,000 and get your full Social Security. If you make more than that, you have to give some of it back to the government. So that’s for people that are still working at age 62. Very unlikely that you would want to collect Social Security then because you’re not going to keep it anyway. Now you get to your full retirement age year, which I think this year is 66.5. That last year before your full retirement age, you can actually make a little over $40,000. So in other words, you can make that amount and still get to keep all your Social Security. Once you hit age 66.5, which will be 67 in a few years, then you can keep all your Social Security regardless of your income. And when I said the $20,000 and $40,000, that’s earned income only, so that’s salary, and that’s business income, active business income where you’re involved in it. It doesn’t count things like your real estate and or your interest or your dividends or your pension or your IRA withdrawals. None of that counts. So as long as you’re at full retirement age, you get to keep your entire amount. Now, on the other hand realize that the higher your income then the taxes could be higher. So once you’re married and your income is above about $44,000, then as much as 85% of Social Security will be taxed. Another way to say that, 15% will be tax free, 85% will be taxable and you’ll have to pay tax at whatever your tax rate is. 12%, 22%, 24%, whatever it may be.

Andi: I know we still have a number of questions, but we are at the 45 minute mark, so I want to post our offer right now. I’m posting a button where you can schedule a meeting, spend 15 minutes or a half an hour with one of the experienced professionals on Big Al’s team here at Pure Financial Advisors. You’ll learn a little bit about Pure, they’ll learn a little bit about you, and they will be able to help you map out strategies specific to your own financial situation to maximize your income in retirement or any time. It’s an online video meeting via Zoom.

So it doesn’t matter where you are in the country, they aren’t going to sell you anything. Pure Financial Advisors is a fee-only financial planning firm. We don’t sell any investment products and we’re a fiduciary, which means that we are required by law to act in the best interest of our clients. Get your appointment scheduled before the calendar’s full. Just click the link that you see there in the chat and choose the date and time that works the best for you for your free introduction to Pure Financial Advisors strategy call. If you’re already a Pure client, then go ahead and contact your advisor today if you have any questions about any of the strategies that Al has spoken about. I’m going to post that message in the chat. Click the link, get your introduction to Pure strategy call scheduled now.

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Andi: Shall we go back to some more questions?

Al: Let’s do it!

Andi: Bill says, “If you have rentals in an LLC, would your heirs get a step up in basis?”

Al: Yes. So you’ve got your rental properties, you put them in a limited liability company, which is a pretty good idea because it helps save some liability in case something goes wrong with that property. So you pass away with the LLC, then what happens is your heirs inherit your interest in the LLC. If it’s just you owning the LLC and you have two kids, then each kid would have a 50% interest in that LLC, and they would get a full step up in basis because it’s what’s called a flow through entity. The whole idea of the step up in basis, and this is true of any asset when you pass away, whatever you bought it for doesn’t matter anymore. Whatever it’s worth at the date when you passed away, that’s the new cost basis for your kids. And when they sell the property, maybe it goes up a little bit more, but they’re only paying the gain on that part, not the gain on the whole part. That’s been the law for my entire career. There were discussions about that going away this year, didn’t happen. So we’ll have to see what happens long term. But an LLC does not affect that, so they will get the step up.

Andi: Duffy says, “Can you explain the depreciation concept of a rental property, as well as the tax rules and limitations of taking losses on the personal tax return from that investment property?”

Al: Sure. We’ll go back to our property example here. Let’s just say this is a new property that you just bought for $400,000. And I would say you could take this to your accountant and your accountant is going to figure out how much of this is land versus building. They can use the property tax statement. They can use almost any method to try to estimate. I would say it would be common in an example like this where the accountant would say, let’s say $100,000 is the land and $300,000 dollars is the building. So the building part, you get to depreciate. So it’s over 27.5 years. So what happens then is you divide $300,000, which is the building part, divided by 27.5 years, and that would be, call it, $10,000. That would be your depreciation. That you get to deduct against your expenses. And your expenses here are $19,000, so $5,000 is your cash flow, but you got an extra $10,000 depreciation deduction. So on your tax return, it’s going to be negative $5,000 which you can write off as a deduction if your adjusted gross income is less than $100,000. If it’s more than $100,000 and below $150,000, there’s a phase out period where you can deduct part of that $5,000 loss. And if your income is above $150,000, you cannot take any current loss. You don’t lose it. It gets captured on your return as a passive loss carryover. You could potentially deduct it next year. Let’s say, next year you end up with a $15,000 profit. Well, you get $10,000 depreciation again for the next year, so you still have $5,000 in profit. You can take last year’s passive loss and use it against that. That’s where you get to take that loss. Unless you’re what’s called a real estate professional. Real estate professional is someone that spends at least 750 hours a year with real estate investing, managing properties, things like that, and it’s more than half of their professional time. Then you may qualify for that status, which means you can go ahead and take that $5,000 loss. So there’s a lot to this. But that’s a quick answer.

Andi: Adi says, “Andi and Big Al, thank you for putting together an excellent content that is easy to follow. If you own a property out of state, do you need to pay taxes in that state in addition to your home state?”

Al: Great question. The answer is yes. I own two properties in Arizona and two properties in Hawaii. So I pay taxes in those states and I also pay taxes in California. However, to the extent I pay taxes in Hawaii or Arizona, I get a tax credit against California taxes. I actually oversimplify this, it’s a little more complicated than that, but that’s the idea. You pay taxes in both areas, but you get a tax credit in your home state. That’s the general rule.

Andi: The next one is from Chris, “If you inherit properties with no loan, should you finance and pull money out or keep it with no loan?”

Al: Great question. What’s your goal? Do you need the cash? So it depends. And to answer that question you’ve got to look at that in a broader financial planning sense. Look at all your assets. Look at what your goals are. Look at what your income is. Are you retired or going to retire? All of these things are going to factor in. The tendency in a case like that is to borrow against it if you like real estate and then buy another piece of real estate. So now you’ve basically doubled your real estate holdings from this one property. And that can be great as long as properties go up and you’ve got a lot of cushion in case there’s a reversal of fortune for real estate. Just be aware that the more you borrow, the more risky it can become.

Andi: Don says, “What are ways to participate beside a direct real estate ownership like a partnership? As you describe ownership, come along owner’s time dealing with routine upkeep and everyday dealing with tenants, what are the typical costs for hiring a property manager?”

Al: So in this particular example, $24,000 is your rental income. If you have maybe just one property, it wouldn’t be uncommon to pay a property manager 10%. Maybe you can find it lower. Maybe in some cases it’s higher. So 10% would be $2,400 which would basically cut your profits in half. But at least you’re not having to handle all this stuff, which is finding the tenants, doing the credit checks, being at the property to show the property, taking the calls when things go wrong with the property. You delegate that. I will say, except for the first maybe 3 or 4 years I’ve always had a property manager. You’re always going to be at least slightly disappointed because they never do as good a job as you. Some actually do a very poor job and some do a pretty good job. And I would say that’s about the best you can do. But at least you can get your time back. In terms of the second part of that question, when you sell a property on a 1031 exchange, you might buy another property, but you could also do something like a Delaware Statutory Trusts, DST’s. That’s where you sell your property and you buy an interest in a larger investment that owns many properties. So you’re diversified. Maybe it’s residential, maybe it’s commercial. You have professional management for that. You just receive a check every month, and that can be a great way to go. Downsides of that, though, two big ones. One is that it’s expensive. So the property manager and the general partner that puts this together will take a nice cut, number one. Number two is you have no control. So if you want to sell, but they don’t or if things are going poorly, you have no ability to go in and fix things up yourself, as you can with your own property. But it’s a way to sort of get out of the management game.

Andi: And then I think we have time for just about one more question, Kevin says “instead of buying rental properties, why not just buy a real estate investment trust? Only thing it seems like you give up is leverage, but they can still pay 4% with no phone calls in the middle of the night.”

Al: I don’t disagree with that. In fact, we at Pure Financial have real estate investment trusts publicly traded in our portfolios. I think it’s a great way to go. It’s a way to get exposure to real estate without having to worry about all this other stuff. What you give up is an ability to make 27%. But what you get generally is a diversified portfolio where you’re not managing it yourself. And there’s cash flow and property appreciation upside. So, yeah, we think so. There are private real estate investment trusts where it’s an investment that they’re illiquid. We don’t like those as much just because it’s harder to get in and out.

Andi: I know that a number of you asked questions that we did not have a chance to get to. I’ve just posted the information so that you can email us your questions or you can also call us at (844) FEE-ONLY. That’s (844) 333-6695. Schedule an intro to Pure Strategy Call. Take 15 minutes or half an hour and talk to a professional on Big Al’s team here at Pure Financial Advisors about what your financial situation is and what your goals are and what it is that you can do to maximize your retirement income. Click on the link, schedule that intro to Pure Strategy Call Alan. Thank you so much for spending the time to talk to us today about your experience and your knowledge on alternative income sources in retirement and before retirement and throughout your life. Again, contact us if you have any further questions and to schedule that intro to Pure call. Have a great day, everybody.

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