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Joe Anderson
ABOUT Joseph

As President of Pure Financial Advisors, Joe Anderson has led the company to achieve over $2 billion in assets under management and has grown their client base to over 2,160 in just ten years of the firm opening. When Joe began working with Pure Financial in 2008, they had almost no clients, negative revenue and no [...]

Alan Clopine
ABOUT Alan

Alan Clopine is the CEO & CFO of Pure Financial Advisors. He currently leads Pure Financial Advisors along with Michael Fenison and Joe Anderson. Alan joined the firm about one year after it was established. At that time the company had less than 100 clients and approximately $50 million of assets under management. As of [...]

Published On
April 7, 2020

The CARES Act Coronavirus stimulus package: Today we discuss recovery rebates, new rules for retirement account distributions, stimulus checks for those on Social Security and unemployment benefits. Plus, should a listener invest his forbearance, buy foreclosures, and capitalize on the financial crisis? We also get into the cash-on-cash math for rental real estate and potential property tax deduction changes for Californians under a revised Prop 13.

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Show Notes

  • (00:40) CARES Act: Distributions from Retirement Accounts
  • (05:52) CARES Act Recovery Rebates, Social Security Beneficiaries Will Receive Stimulus
  • (10:06) CARES Act: I’m Retired, Collecting Social Security, and My Son Claims Me as a Dependent. Will I Receive a Stimulus Check?
  • (13:58) CARES Act: Can 1099 Contractors With Multiple Contracts File for Unemployment?
  • (17:05) Should I Invest My Forbearance and Buy Foreclosures to Capitalize on the Financial Crisis?
  • (28:00) How Does the Cash on Cash Math Work for Rental Real Estate?
  • (42:51) Prop 13 in California: Property Tax Deduction Changes

Resources mentioned in this episode:

 

 

10 Tips for Real Estate Investors

WATCH | Can I Buy Real Estate in an IRA? 

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Transcription

Today on Your Money, Your Wealth®, we’re diving into the new CARES Act Coronavirus stimulus package: what distributions can be taken from retirement accounts, the recovery rebates, stimulus checks for those on Social Security, and unemployment benefits for self-employed 1099 contractors. Plus, a listener asks whether he should invest his forbearance and buy foreclosures to capitalize on the financial crisis, and we get into the cash-on-cash math for rental real estate and potential property tax deduction changes for Californians under a revised Prop 13. I’m producer Andi Last, and here are the hosts of Your Money, Your Wealth®, Joe Anderson, CFP® and Big Al Clopine, CPA.

Joe: It’s been a wild, wild ride here. I don’t know. I guess the past month, month and a half, it seems like anyway. This month feels like years. The days just seemed to drift for months.

Al: It does. And I know this is a lot of hardship for a lot of people. A lot of folks are suffering; a lot of folks have loved ones that are sick or you’re sick, and our heart goes out to you. We obviously wish you the best. But let’s all try to hang in there the best we can. We’ll get back to normal someday. Just a matter of when.

Joe: A lot of questions are coming in for the CARES Act that was just signed so Al, what do you think? We’ll just kind of dive right in?

Al: Let’s do it.

CARES Act: Distributions from Retirement Accounts

Joe: So we got Terry from Minneapolis. So when you say area code, Andi, that means you stalked him.

Andi: No, it means that when he filled out the contact form he gave us his phone number and that’s the only way we have any idea of where Terry is from.

Joe: Got it. So he didn’t really want us to talk about Terry.

Al: He’s probably like you Joe, he’s probably transplanted somewhere else.

Joe: Yeah, well Minneapolis right?

Al: Yeah.

Joe: What was 763, 612?

Andi: I don’t remember at this point.

Joe: Got it. “So hello all, I have a couple of questions about the CARE Act. For the $100,000 withdrawal from a qualified account, is the income limit, I make too much to take advantage of, I’m married, filing jointly, can both husband and wife take out $100,000 for a total of $200,000? Thank you.” Al, let’s kind of take a step back to explain a little bit about what he’s talking about in regards to the CARES Act.

Al: So with 401(k)s, or 403(b)s, or employer plans that allow you to take a loan from the account, not all plans do, and we’re not talking IRAs we’re talking 401(k)s-

Joe: He’s talking about a distribution.

Al: Oh, he’s talking about distribution. OK. Sorry. I was not looking that carefully. So he’s talking about a distribution. So taking a withdrawal from the qualified account- So there’s something called the Coronavirus Related Distribution. I think that’s what he’s asking about?

Joe: So what do you can do is you can take $100,000 out of retirement account, IRA, 401(k), 403(b), TSP, and you have the option to do a couple of different things. You can pay it back over 3 years. Or you could pay the tax over 3 years. If you’re under 59 and a half there’s no 10% penalty. And if you’re taking it from your employer-sponsored plan such as a 401(k), there is no mandatory withholdings. So if you’re looking to take out $100,000, no there is no AGI limitation on the distribution. The only AGI limitations that are applicable in the CARES Act is if you are going to get any recovery rebates, which I’ll explain in a second. So, Terry to answer your question if you want to take $100,000 withdrawal from your retirement account, there is no income limit. So if you want to pull out the $100,000, you can. But it’s only $100,000 per tax return. So if you file jointly it’s $100,000. So it’s not $100,000 for you and $100,000 for your wife is what you’re truly asking here. So you can only take out $100,000. You can then elect to pay it back in 3 years, not pay it back at all and pay the tax over 3 years. So it gives you a little bit of flexibility if you do need some excess cash flow in these trying times.

Al: That’s exactly right Joe. And I think when you take that money out it just depends upon how long you think you’re going to need it. In other words, you can roll it back in. Instead of a 60-day rollover, which is the normal rule, you have up to 3 years to roll it back in. So when you roll it back in, that means there’s no taxes whatsoever. But of course, then you’d have to have the money to roll it back. And if you don’t, I think a lot of folks probably if they’re pulling money out to live they may not have it to put back in. So you’re going to pay tax on it and you will avoid the 10% penalty even if you’re under 59 and a half. And the default is that 1/3, 1/3, 1/3, is taxable in 2020, 21 and 22. So in this particular case it’s $100,000, $33,000, $33,000 would be taxable in 2020. Same amount in 21, same amount in 22. You can make an election to tax it all in the first year if you want to but I’m not sure a lot of people are going to want to do that. But just be aware that you can do that.

Joe: I think you might want to if- so if I’m going to tax it, I’d much rather tax it in 2020 if I know that I’m going to be back to normal in 2021- if the tax is not due until April.

Al: It depends on the cash flow. So the concept is if you’re in a low income year in 2020, you’re probably in a lower tax bracket. So you’d pay less tax. Big caveat though is you’d have to have the tax money available to pay it in April of next year.

Joe: Correct.

CARES Act Recovery Rebates, Social Security Beneficiaries Will Receive Stimulus

Joe: Let me talk a little bit about the Recovery Rebates. So this is where the phase-outs happen when it comes to AGI. So right now basically what these rebates are it’s a tax credit against your 2020 taxes. But they understand that we need cash in our pockets today. So they’re doing things looking at 2018 or 2019 return. So it’s $1200 for individuals, $2400 for married couples. So you’ll get an additional $500 per child that has to be under 17. So it’s under 17 years of age. So if you’re married, it’s $2400 plus $500. So if you have two kids, married, it would be a $3400 check deposited in your account or mailed to you. $1200 for individuals. The phase-out is $150,000 for a married couple; $112,500 if you’re head of household; or $75,000 dollars if you’re single. So that’s when the phase-out starts. So your phase-out will end depending on how many children that you have. Because if you have a married couple with five children, their phase-out is going to be a lot larger than a married couple with one child just because they’re getting that much larger of a credit. How the credit is reduced, it’s every $1000 or every what $1000 over the AGI limits, they reduce $50 from the credit. So that’s kind of the game there probably- what would you read Al? About 90% of the population will give some sort of check? It’s good. I don’t know if it’s enough but at least it’s something.

Al: Well at least it’s something and you are right. So it’s gonna, for most people are going to be able to get it. A couple of considerations- One is if you qualify in either- well the IRS looks at the most recently filed returns, so if you have not yet filed 2019 they’re going to look at 2018. And in 2018, let’s just say your income is higher than these limitations and you know that 2019 it is lower than you might want to go ahead and file that- you do want to go ahead and file that, so you can actually get this advance credit. In some cases Joe, folks are not going to qualify in 2018 or19 but 2020 they probably will because their income may be lower. And in that particular case, you’re not out of luck. You just have to wait till you file your 2020 returns. So you don’t necessarily get it upfront but you will get it later with the return. So just be aware of that. And the way the refund comes to you or this advance payment comes to you, stimulus refund they call it, is basically the same way you get a tax refund on your return. So when you file your tax returns if you asked for a paper check then that’s how you get this stimulus check. If it’s direct deposit like about half of us do, then it’s going to be a direct deposit. And as far as timing Joe, we don’t really know. Mnuchin said that he’d like to have it come out within 3 weeks. But when you kind of look at history other types of stimulus checks that have come out in the past have taken a month or two. So we just don’t know. And we also don’t know when the cutoff is going to be. Because like if you have 2018, you have too much income but 2019 it’s lower, you want to go ahead and file that as soon as you can so that the IRS is- I mean the government’s going to look at 2019. But when, what date they’re going to look at this, no one knows at this point.

Joe: There’s still a lot of unknowns. This bill just came out a week ago.

Al: Exactly.

Joe: I’ve already saw that they’re adding other things and clarifying other things is that if you- Let’s say you didn’t file a tax return but you’re collecting Social Security benefits because a lot of retirees don’t necessarily file a tax return because their income is too low. So because they didn’t file would they get a check? The answer’s yes. So there’s a lot of things that we’re still clearing up but we can kind of give you a high level.

CARES Act: I’m Retired, Collecting Social Security, and My Son Claims Me as a Dependent. Will I Receive a Stimulus Check?

Joe: We got a few more emails here on the CARES Act. We’ve got Karen. She writes him from Massachusetts. She’s like “No one can answer my stimulus question. I retired in 2016 and receive Social Security. My son claims me as a dependent. Well I get a check? Thanks.” Couple of things here. So since she hasn’t- so she retired in 2016. Here’s the rub, is that the son claims her as independent. And, from what I read it there are dependents, they won’t necessarily get a check. But then I read if they’re claiming Social Security- all- anyone that’s claiming Social Security would get a check.

Andi: Is it safe to say there’s still stuff that they’re figuring out?

Joe: Yeah I saw something this week or earlier today actually. What do you think Al?

Al: My first impression was just like you. Which is being claimed as a dependent would eliminate the ability to get the stimulus. But I also heard that same thing about Social Security. It’s not clear to me. I will say this. This Stimulus Act just came out on Thursday, March 27. It’s pretty recent and it’s 880 pages. It’s kind of difficult to get through this whole thing.

Joe: Let me ask you a question Al. Why would anyone claim their parent as a dependent? Because like before the JOBS Act, I could see because of exemptions that they could write off on their tax return. But I mean if I’m claiming my parent as a dependent what tax benefit would I received if I did that?

Al: That’s a great question. First of all like we live in California, so dependents still make a difference in California, although it’s minor. I think the reason why you might still do it is a dependent, even a parent, you could likely deduct their medical expenses on your return. And for you to claim them as a dependent, you have to be paying at least half of their care and support. So that could be a reason Joe. But otherwise, I agree. There’s no longer a dependency deduction on the federal return and so if you haven’t filed in this case 2019, you might. And there’s no particular advantage, Karen, for your son. Maybe he doesn’t claim you as a dependent. So you make sure you get this credit. But in all honesty, this is such a new thing, Joe and I have heard conflicting things on whether you get a check or not. And so I understand why no one can answer it because it’s not clear.

Joe: But maybe the workaround- because we know if her son didn’t claim her as a dependent she would absolutely get a check.

Al: She would.

Joe: I mean if she qualifies under AGI. But if her son’s claiming her as a dependent I would imagine her AGI is $100,000. That would be a fair guess, right?

Al: Yeah. Her AGI would be low enough to qualify for it. But I’ve also heard that if you didn’t file a tax return in 2018 or 19 even though you didn’t have to, maybe you should. But then I heard conflicting information on that too. That if you’re with Social Security they’ll take care of it. It’s a bit confusing to be honest. Because there’s a lot here, but to be on the safe side certainly be- if you want to be 100% safe on what we know Karen, is if your son does claim you as a dependent for 2019, you go ahead and file right now even though you may not owe any tax. That would definitely put you on the safe side.

Joe: Okay so we got another one on the CARES Act Al. And by the way, we’re doing this all remotely. We’re all in different places, we can’t see each other either. That’s what kind of throws this off just a smidge.

Al: It does.

Joe: Because usually, I could see Al laugh.

Al: Yeah.

Joe: Because we start to laugh with the smile. But now it’s just like dead air. It’s like I feel like-

Al: You don’t know what my emotions are. Well, you always have the same expression. So I can imagine that.

Joe: Yeah it’s perfect, right?

Al: Intense.

Joe: Yeah, pissed off.

CARES Act: Can 1099 Contractors With Multiple Contracts File for Unemployment?

Joe: Another one on the CARES Act. “If you retired from one company but you were 1099 on two different companies and you still work for one 1099 company, can you still file for unemployment?” The gig economy it sounds like here. He’s 1099, meaning like a contractor. So he was doing a little bit of work for one company, doing a little work for the other company. One company laid him off but he’s still working on the other, can he file for unemployment? What do you think?

Al: One of the things about this unemployment compensation under the CARES Act is it was never allowable if you were self-employed. But that’s changed for this. So if you are self-employed and you lose your income then you can apply for it. Now Joe I honestly have not read the section on this either but here’s what I think. What I think is if you probably, if you have a certain reduction in your income you would probably still qualify. But I could be wrong about that. Because I mean any self-employed person theoretically could have a lot less income but still have income. So I’m not quite sure how that’s written.

Joe: Because in the past as a self-employed person you couldn’t file anyway.

Al: That’s right.

Joe: This is brand new. So now we got self-employed people filing for unemployment benefits. So I guess if one gig- I don’t know I’m driving for Uber and Lyft and then Uber lays me off and then I’m still driving for Lyft, can I claim benefits on my Uber income? I would go ahead and try it. You know what I mean?

Al: No harm, no foul. So there’s probably a provision that says if you lose X%age or x dollars, I’m not really sure that. But anyway that’s what I would look into. I wouldn’t give up on that. I think there’s a potential opportunity.

Download our new CARES Act Guide from the podcast show notes at YourMoneyYourWealth.com to learn more about this new Coronavirus stimulus package. Find out if you qualify for any of these recovery rebates, what the new rules mean for you if you’re a small business owner, what happens if you’re currently taking or about to take required minimum distributions. Click the link in the description of today’s episode in your podcast app to get to the show notes, download the CARES Act Guide, watch the latest Market Update webinar with Joe and our Director of Research, Brian Perry, CFP®, CFA, and send in any questions you have.

Should I Invest My Forbearance and Buy Foreclosures to Capitalize on the Financial Crisis?

Joe: We got one from Luis, or is that Lewis from Corona, California.

Al: I’d say Lewis.

Joe: Lewis?

Al: Yeah.

Andi: I would guess Luis. But I guess it depends on who he’s talking to.

Al: True.

Joe: “Andi, Al, and Joe.” Look at Andi gettin’ the front billing.

Al: Look at that, right?

Joe: Look at who’s carrying the caboose here.

Al: That’d be right.

Andi: Savin’ the best for last.

Joe: Oh thank you, Andi. “I’m Luis from Corona, California and I love, love, love your podcast and I have listened to pretty much all of them, some multiple times.”

Al: I’m so sorry for your wasted time.

Joe: Yeah, just hanging out. Confined to his bedroom just listening to Your Money, Your Wealth®. “I first got turned onto your show a few years ago when I was in San Diego for my military reserve drill and turned on the morning TV show and watch your TV show while I was getting ready. I was late to the formation roll call.” Oh boy. “That day I got into trouble but it was worth it. I’ve been hooked ever since.”

Al: He probably said that it was because Joe and Big Al, to the military.

Joe: I just envision like him running up to get in formation and the drill sergeant yelling the hell right in his face.

Andi: He had to do like 150 pushups and run laps.

Joe: ‘Do you know what time it is son?’ “Totally the best podcasts out there. I listen to them once a week while I walk my dog on Saturdays and replay them on Sunday mornings and I can concentrate and really digest on what you’re saying. My question is more theoretical in nature and hopefully others will find it useful too.” All right sounds good. Here we go. “Considering this current health crisis that’s turning into a financial crisis, I’d like to know who’s actually going to profit from it and how can a small investor like myself protect my interest and maybe get a little ahead? 47 year, old federal employee. My income hasn’t been, won’t be affected whatsoever. My TSP has lost over $125,000 since this started. Current balance about $210,000 but I’m worried about it-“

Andi: “-not worried about it.”

Joe: -but I’m not-” Thank you Andi. “-I’m not worried about it since I’m contributing to it. And won’t need it for about another 15 years. Buy low, sell high. I’ll be mandatory retired at age 57 but work another job to keep my current income around $145,000. However I’m seeing that I’m being offered forbearance.” Am I reading this right? Okay. Yeah. “However I’m seeing that I’m being offered forbearance on my mortgage and other financial liabilities. I was thinking about taking out a small personal loan, approximately $15,000 to $25,000, and buying some stocks in American Airlines, Boeing, Disney, Marriott and others that have pretty much bottomed out, but have been basically promised a bailout by the fed so I know they’ll come back. I know society and people and I have no doubt people will return to their spending habits once things return. I’m also thinking about exercising the forbearance being offered and throwing some of the money at some investments that well. Further, what’s your thoughts on real estate market? With foreclosures in the near future my thoughts are it will, consider some people will exercise their forbearance options but that will increase their monthly payments once this is over unless they get a pay increase, it’s just a matter of time until the foreclosures start. The eviction coverage will eventually end and banks will want their homes back to sell at a reduced rate and takes the loss. I’m thinking about buying a rental condo when the price dropped-.” This guy is a market timer.

Al: Yeah, right? Trying to profit. You bet.

Joe: “So thanks for any opinion you guys have on this topic. I’m sure I’m not the only one thinking about this stuff. I’ve loved the show and would love to hear two podcasts a week possible.” Luis, do you hear how I read these emails? Not a chance in hell we’re doing two podcasts a week. “One for Saturday morning and one for Sunday. P.S. Since I’m in So Cal. I’ll probably look at attending one of your seminars this year. Thanks again.” All right well we would love that. So let’s buy Disney, Boeing, American Airlines. What if you know- Yeah I get that. I mean if you got a couple of bucks to play around and you think they bottomed, out go ahead and buy them. But one of the things that you gotta be careful of, is that he says well the fed will bail them out so they’ll recover. OK. Well you’re not the only one that knows that. So when- you got to be careful with pricing. It’s not- the prices are going to skyrocket once American Airlines is flying again. You know what I mean? It’s like the market is already anticipating that they’re not going to- they’re cutting their flights by 70% for the next three months. And then thereafter they’ll return to normal. So the pricing of the stock is- you’ve got to be careful on how you’re trying to time all of this I guess is my thought.

Al: And I would add I don’t really like the idea of borrowing money to do this. I mean it’s to me that’s pretty speculative. If you’ve got extra money available and you want to do something like this but realize you’re taking a risk. I mean if these companies are going to be bailed out and I would tend to agree with you. It doesn’t mean that they’re strong. It means that they need a bailout. And so there’s no guarantee that that’s even going to work. So just just be aware of that. I mean when you’re doing stuff like this, you have to have a mindset that you’re buying this for future appreciation, you believe in the companies, you think this is a good risk to take. But there’s no guarantee that any of these companies will make it. I mean these are strong companies but we’ve seen other strong companies show in the past that we thought were strong and ended up not making it.

Joe: But I mean if it’s just play money and that’s how I would consider this, but if I’m looking at so you have $200,000 and you want to take 10% and buy some stocks that have kind of got rocked. I don’t know. It’s a little high. But I think he’s going to probably have a fairly good pension, federal government guy, steady income. So I don’t mind what he’s doing. He reminds me of Mikey Martin, buy yesterday’s winners today.

Al: Exactly. And I agree with that. If he’s using existing money. But if you’re going to go out and borrow money to do this, it makes me nervous.

Joe: Yep. And what do you think of real estate Al? You’re a big real estate guy.

Al: Well certainly real estate may tank, but it may not. I mean I guess in my professional career there’s been three pretty good recessions. One was in the early 80s, one was in 92 and one was in 2007, 2008. And the latter two, real estate went down. My experience in California, real estate went down quite a bit during the Great Recession; not quite so much in 1992 and really didn’t go down at all, at least in California, in 1980, and that was actually a fairly rough one. So there’s no guarantees. I mean I do agree with the premise that if people don’t have jobs and they can’t make their mortgage payments and everything’s getting deferred and then they have now higher mortgage payments, will they recover? Yeah there’s that. If there is going to be an impact on real estate but there’s no way to know that for sure. We’ll have to at least- when I checked recently when we were whatever, a month-plus into this crisis, real estate values at least in California have held their own. And we just don’t know. Now I’m not generally- I would say a market timer when it comes to the stock market because it’s so hard to tell, highs and lows. But when it comes to real estate I think one of the things that I’ve learned over time is real estate in growing areas like California for example, which I know a lot about because I live there. People are moving in. There’s a lot of demand. So long term it looks good. If you can buy on dips, then that can be a good thing. But that may or may not happen. I think there’s really no guarantee that that’s going to happen.

Joe: Yeah I mean he’s is thinking all these people, they’re out of work, they’re renting, they’re going to get kicked out, the landlords don’t have rents, so they’re going to blow up their loans, they’re going to be a huge downside in regards to some of these markets and that’s when to buy. If you can time that and if you actually think that that’s going to happen long term then by all means. But that takes a lot of dominoes will have to fall for all of that to play out. You know we’re a month in, people are I guess- we’re hurting for cash, but there’ll be some programs. I think people are not going to get kicked out of their houses, right away anyway. I mean right? He’s an optimist. He’s looking on the other side of the coin here maybe for some opportunities.

Al: But I do agree with the concept that things will get better and it’s better to buy low than high. There’s no question about that- but there’s no way to predict that yet. I’ll go back. I know we’re almost out of time but I’ll go back to 1986 and the Tax Simplification Act where they added the passive loss rules where you can no longer deduct your rental losses. It was predicted that the whole real estate market would collapse and then we ended up having a big boom from 87 to 90, 91. So you just don’t know because there’s too many other factors going on when it comes to investments, including real estate.

Speaking of real estate, we have a couple real estate questions that we recorded back in the beforetime when all of us could be in studio together, so we’re going to go through those now. If you’re an aspiring real estate investor like Luis, you’ll find our 10 Tips for Real Estate Investors in the podcast show notes at YourMoneyYourWealth.com, along with Big Al’s video on things you should consider before buying real estate in your self-directed IRA. If you have questions about real estate, the markets, or any other financial topic, click the ask Joe and Al On Air banner in the podcast show notes to send them in as a voice message or an email. Click the link in the description of today’s episode in your podcast app to get to the show notes, where you can also read the transcript of the entire episode.

How Does the Cash on Cash Math Work for Rental Real Estate?

Joe: Mark writes in from San Diego. Hi Mr. Clopine.

Al: In Mark’s defense he did write it to my direct email.

Joe: Then you forwarded to Andi?

Al:  I did.

Joe: Got it. Does he know that we’re gonna be reading this? I’m just-

Andi: Yes. Because you actually replied to him and said we will answer this on our podcast.

Al: There you go.

Joe: “I’m a big fan of Your Money, Your Wealth®. I DVR the Sunday show and listen to the podcast whenever I get a chance.”

Andi: Hi Mark.

Joe: “Today I watched the episode about real estate and the cash-on-cash math. I’ve heard of cash-on-cash. But never did the specific math breakdown with the equity. I have a couple of duplexes that I’m hoping will fund my retirement in about 25 years and I would love to get your opinion. Here are my numbers.” So you got your calculator ready or you’ve already done the math?

Al: I’ll do it my head.

Joe: Oh geez.

Andi: He’s such a pro.

Joe: I know.

Al:  It’s not that hard.

Joe: So he’s got a place, “rental income’s about $41,000, rental expenses are $25,000 so net cash flow’s $16,000; property equity $200,000; cash-on-cash return 8%.

Al: That’s about right. Because you take your net property cash flow and you divide it into your equity. So $16,000 into $200,000 is 8%. Simple observation though and that is cash-on-cash, you would want to deduct your mortgage payments. I don’t know if that’s included in here or not. It’s unusual to have an 8% cash-on-cash anywhere in southern California.

Joe: So his expenses he says is $25,000. Do you think you know this duplex is not included in the mortgage?

Al: That’s my guess. That seems a little bit too good to be true. But anyway we’ll go on. So that’s one property.

Joe: He’s got another property bringing in $38,000; rental expense $24,000 bucks. Net cash flow $14,000; property equity $400,000.

Al: So now he’s taking $14,000 cash flow into $400,000, now he’s getting 3.5% cash-on-cash. So that’s the calculation. Again, you have to deduct your mortgage payments as well, which may or may not be in there.

Joe: Let’s just say he’s got a duplex in San Diego and he’s got equity of $200,000. A duplex in San Diego is probably going to be at least what, $800,000?

Al: Yes.

Joe: In the area that he’s in here, National City. I would say- I mean it’s not La Jolla.

Al: It’s I mean it’s probably $600,000, $700,000, $800,000. So in other words, the point is that sounds like there’s debt on it.

Joe: There’s the $600,000 of debt. $600,000 of debt is gonna be more than $25,000. So this cash-on-cash on the second one is 3.5%. “So as you can see Sherman skyrocketed in value over the past 7 years.”

Andi: That’s the second property.

Joe: “Is it bad to have too much equity? Should I consider selling Sherman even if I have to pay capital gains tax? I also have been paying all the extra cash I’m making on both properties.” What does that mean?

Al: From all his profits.

Joe: “I’ve also been paying all the extra cash I’m making on both properties?”

Al: Extra on the National City mortgage.

Joe: Oh. He’s paying extra – “$2500 extra on the National City mortgage because it’s a 7/1 ARM and got a great interest rate.” So he’s paying $2500 extra a month?

Al: That’s what he’s saying.

Joe: What’s $2500 times 12, Al?

Al: Well that’s $30,000.

Joe: His regular expenses are $25,000. So you gonna take $25,000 times $30,000-

Al: Maybe that’s annual. He doesn’t really say. That has to be annual.

Joe: “Should I not be dumping all the extra cash to pay off this loan ASAP? Please Big Al, any advice to help me stop pulling my hair out over this would be greatly appreciated.”

Al: Let’s start with his first question because apparently- let’s just say these were similar properties with similar cash flows with similar equities. But one of them has gone way up in value and has a lot more equity and the cash-on-cash calculation is net cash flow after mortgage payments divided into equity. That’s the cash-on-cash. So what he’s thinking is I’m only making 3.5% on the one property because there’s so much equity. Is that a good thing? Or should I do something different? And the answer- you’ll talk to real estate agents that will call that debt equity. That’s what they like to call it, debt equity. In other words, you got equity that’s not really doing much for you.

Joe: Flip or flop.

Al: So then if you want to maximize your future wealth building, although there’s risk, if you want to maximize your future wealth building you would sell the property. You wouldn’t pay taxes on it. You’d do a 1031 exchange and you take that equity of $400,000 and you’d buy instead of- let’s say this property is worth $700,000, $800,000. You buy one worth twice as much. $1,600,000 just to throw out a number. So now you’re controlling a lot more real estate with the same equity. And as long as real estate goes up, that’s a great idea. That’s the big caveat. But I can tell you from experience that doesn’t always happen. Because when real estate goes down you’ll see your equity evaporate rather quickly. So it’s yes, if you want to maximize your wealth and you’re going to retire 20, 25 years from now so it’s not exactly around the corner. So you probably have the ability to wait these things out. But here’s the huge caveat is the more you do this, the more risk you’re taking. And the more this can fall down like a house of cards because you’re too overextended. So that’s the first part of the question.

Joe: Wow. So Mark is going to blow himself up but what he’s also- what he’s not looking at is the total return on both properties.

Al: We think he’s missing that. So we’re not even sure the calculation is right.

Joe: Let’s say the calculation is correct. So you have to look at total return on any investment. So you’ve got the cash flow and you got the growth component of that house or of that investment. So you look at the growth and the cash flow. Add those two together to get your total return.

Al: I know but let’s just say both properties go up 5%. Just as an example.

Joe: But he’s saying the other one went up a lot higher than-

Al:  I know but that what it did in the past- now you have to look at what you got going forward.

Joe: I understand if they both grew at the same rate. And you’re going to get a lower total rate of return.

Al: On the property that has too much equity. And that’s what he’s concerned about and that is a true statement. In other words, let’s say they’re both worth the exact same thing and they both go up 5%. So they have the same exact appreciation. But one is based upon $200,000 of equity; one is based on $400,000 of equity. So the one with $200,000 of equity, you actually have twice as good a return on your appreciation. The math is relatively simple. It’s that- let’s just do $100,000 property.

Joe: You could also argue this. Rental properties are a lot better let’s say in Texas or Tennessee than they are in Southern California because the property values are that much lower.

Al: Yes. For cash flow.

Joe: For cash flow. So your cap rate or cash-on-cash is going to be a lot higher in areas of the country that have lower market value homes. In Southern California, when you’re living two miles from the beach and you have a $1,500,000 home and you’re trying to rent it out, your cash-on-cash return is going to be a lot lower because you have that higher market value.

Al: That’s accurate.

Joe: And then even if you have smaller equity you’re going to have a lot larger debt and that debt service is going to be included in your expenses. What we feel that Mark is missing could be the debt service that he’s paying on these mortgages that should be included in his overall expenses. We don’t know if it is. But maybe he’s just made up the numbers just for illustration purposes and saying if I have one property that has cash-on-cash at 8%, another one at 3.5%, should I just dump the property and find another one that will give me higher cash-on-cash?

Al: And part of the reason we’re thinking that is it’s very, very unusual to see a property in the San Diego area with more than 4% cash-and-cash. 8% would be unheard of. So it makes us be a little bit suspicious.

Joe: 3.5% sounds right in line.

Al: That sounds a lot closer. But I’ll give you a personal example. I had a rental property that I bought in the ’80s and I held on to it for probably 15 years. And in that time it doubled. So it’s like now I got a lot more equity. I actually put very little into it. Remember in the last segment I was talking about I didn’t have a lot of capital. So now I had some capital and so I took the single family home in Mira Mesa; I did a 1031 exchange; I bought a seven unit apartment in City Heights which was kind of- this would have been in 2002. It was an up and coming area and that property doubled in two years. So it’s like great I got all this equity. I want to parlay this into a lot more properties because that’s how you make money in real estate. So I parlayed that into a 16 unit apartment building in Las Vegas. Big mistake. And a condo in Kauai, which I loved. That was that was actually a good thing. Not necessarily a moneymaker but that was quality of life. But see here’s the thing. So Vegas- and I’ll give you the real numbers. I bought the 16 unit apartment for $950,000. And in about two years, this was 2004, in about two years it went up to around $1,300,000 to $1,500,000. That would’ve been a good time to sell. But I didn’t. I didn’t see the Great Recession coming. And when it came that $900,000 dollar property that was now worth $1,300,000 to $1,500,000, was worth probably $350,000.

Andi: Ouch.

Al: Right?  And my mortgage- and then the same thing I was just talking about- I didn’t have enough to cover the rents. Now this was so- but I made it work. I had the resources- I had some resources, I made it work, got through the Great Recession. I finally got to the point where I was now above water in terms of equity. And I just was so sick of this property, I sold it.

Joe: Right. I saw that it gave you almost a heart attack.

Al: It wasn’t worth it. And so that’s- when I’m talking about parlaying your wealth, mathematically this is great to take your equity and just keep buying more and more property. But there’s a big risk in doing that.

Joe: That’s a good point because you rode the roller coaster up and loved it. And said I’m parlaying buying bigger properties, bigger properties. Recession had blew you up. But if you still held that apartment building today.  What do you think it’d be worth, $2,000,000?

Al: No. But it would probably be at least $1,000,000. Or more. It was in downtown Vegas which at the time was kind of an up and coming area. I think it still is. It just took a huge pause. And partly Joe, one more thing, I base this on many books I’ve read of people that have done this before me and they’ve had exactly the same experiences. They ended up going too fast and the house of cards fell down. It’s a really common thing. I’ve had two clients that have done this and lost everything. So just be careful when you take your equity and you go too far, too fast.

Joe: But if you have time and if you have cash and capital, then you can weather the storm.

Al: Correct. That’s right.

Joe: If you have time to weather the storm- another example of this would be your portfolio, stock and bond portfolio, you’re 401(k) portfolio. If it dropped 50%, you had $1,000,000 and you’re taking $40,000, $50,000 a year from it, and then it dropped to $500,000 and you still needed to pull the $50,000 out, you could see that thing just implode on you. But if I had time, if I had that $1,000,000, but I didn’t necessarily had to tap into it, and I had time to let it come back and fund more money to put more cash into my 401(k) when the markets are down. That’s the best time to do it. So now I’m feeding this thing while it’s down and then when the market recovers then I have that much more money. In real estate, it’s an asset. It’s the same thing.

Al: Same idea.

Joe: Same idea. But what happens is that now you’re funding cash and then people look at their mortgage balances it’s like the house is worth $300,000 and I have a mortgage of $400,000. I’m going to walk away. And that’s what everyone did back in ’08.

Al: That’s right.

Joe: Or if you funnel through it and say I’m going to continue to do this. I got extra cash. But it’s so hard for people to put cash into something like that when they have debt on it that’s higher than the market value. Psychologically people are like screw it, I’m not going to do this. But if you can make it through that time period, things rebound.

Al: Case in point, I bought two single family homes in Phoenix in 2004 for $150,000 each. They both, during the Great Recession, went down to about $70,000, something like that, $75,000 maybe. Held on them. Now at this point I still own them. There worth $250,000 to $270,000. So it does work. You just have to have the wherewithal to get through the storms. And then that’s the mistake people make is they don’t have enough emergency cash flow or emergency capital to be able to handle the things that can happen.

Joe: So with Mark here, he’s like there’s cap rate sucks. I’m gonna sell it, pay the tax and then move on. Al’s saying no. Do what I did. There’s a nice apartment building in Las Vegas for sale.

Al: Yeah do a 1031 so at least you have to pay the tax and then your investment go.

Joe: You don’t pay any tax but you could blow up your net worth.

Al: You know it’s funny a lot of apartment owners at that time in San Diego went out of state because it was so highly-priced and San Diego and not so much in other areas. Every single one of them that I know of regretted it. Myself included.

Joe: Because you can’t watch over it right?

Al: No. And it was different market fundamentals that we didn’t know.

Prop 13 in California: Property Tax Deduction Changes

Joe: Fred writes in from North County. San Diego. He writes “If Uncle Gavin is able to overthrow Prop 13-” Alan, can you help our out-of-state listeners who Uncle Gavin is and what Prop 13 is?

Al: Uncle Gavin is our governor of California and Prop 13 is a special rule that I think came in the late ’70s if I’m not mistaken. And the idea there was that whatever your property tax was at that point in California it could go up no more than 2% per year. And so in general California property has gone up over time 5% a year. So if your property taxes are only going up 2% a year, you’re paying much lower property taxes than you would otherwise pay if you buy the property. So what Fred is saying is that if Prop 13 goes away, his property taxes may go up quite a bit.

Joe: He goes “- it will rise $2000 to $15,000 a year. If I make the same amount of money I made last year which is about $65,000, would I get any of that money back on my refund? Love your show. You guys are not just funny but so entertaining.”

Al: Wow. There’s a difference.

Joe: There is. There’s funny and there’s entertaining.

Al: Funny’s one thing. But entertaining-

Joe: But you take it to the next level.

Al: Yeah and then “Take care.”

Joe: Oh, thanks, Fred.

Al: That’s very nice.

Joe: So property tax goes to $2000 to $15,000. He’s looking for a refund.

Al: He is. Here’s the answer. It’s not Uncle Gavin it’s Uncle Trump- came up with the tax law that said you can only deduct $10,000 in taxes on your itemized deductions in any given year. And so I don’t know what other taxes- I mean you’re in- well you’re in California. So presumably you’ve got some state taxes. You add your state taxes, along with your property taxes, along with the deductible part of your Department of Motor Vehicle fees. And if that amount is over $10,000, which it would be if your property taxes are $15,000, you’re limited to $10,000. But if this higher property tax amount creates higher taxes, at least up to the $10,000, you will get at least some break potentially.

Joe: So what’s the odds?

Al: Slim to none.

Joe: That’s what I thought too.

Al: It’s a very popular proposition in California. I don’t see that going away.

_______

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