Have you ever asked yourself, "How come I earn so much income, but never seem to have any money?" It’s a common problem and the answer might lie in the type of income you’re earning. Let me show you what I mean.
Right now — reach into your wallet and take out three one-dollar bills and set them on the table in front of you. Look closely. Except for the serial number they’re all the same, right?
Dollars are not all the same. As a matter of fact, some dollars — such as those earned from owning real estate — are twice as good as other dollars! I’ll prove it to you.
Let’s assume you earned each of these three dollars in a different way: the first dollar came from your job as a real estate salesperson, the second dollar came as cash flow from rental property you own, and the third dollar was part of the proceeds you received when you sold your house.
Take a closer look at the first dollar (the one you earned as a real estate salesperson). Think of all the effort that went into earning that baby: cold calls, listing presentations, offer writing, ad writing, driving persnickety clients around in your car, late nights and enough faxes to fill a bucket.
OK, now for a little magic. Wave your hand over all three of the dollars and chant these secret words:
Cold calls, late nights, clients and faxes… That’s ok, but what about taxes?
Dollar number one begins to shrink before your very eyes: 35 percent of it disappears to pay federal and state income tax. Then — poof! — another 15 percent goes for self-employment tax. You’re now looking at a 50-cent dollar!
All that work and you’ve got a measly 50-cent dollar! That’s right, 50 cents. The worst possible dollar you can earn is a dollar from your job. The reason: about half of it goes to pay taxes. It’s no wonder most Americans retire with little or no wealth. They spend all their working days toiling for 50-cent dollars.
People try to save for future expenditures like a new car, a house or college tuition. Sadly, they’ll probably never reach their goal because they’re saving 50-cent dollars. When they begin to realize this, what do they do? They work harder to earn even more 50-cent dollars. That’s nuts!
Think about the real estate magazines you read. Every month there’s a profile of some agent who’s a phenom. The interviewer asks, "How much do you work?" And the answer is always 60, 70 or even more hours per week. Sixty hours per week chasing 50-cent dollars? That’s nothing to brag about!
Now look at dollar number two, the cash flow from your rental property. This dollar has not shrunk — it’s still a whole dollar. Why? Because a dollar earned from your rental property can be tax sheltered. The depreciation shelters this dollar from federal and state income tax. In addition, there’s no social security or self-employment tax.
But, don’t lose your head. It’s true there’s no tax due on that dollar — at this time. However, there might be tax due in the future because the tax shelter created by depreciation is great while you own the property, but it’s not a one-way street. That’s because when you sell your rental property, your taxable gain is made up of appreciation and depreciation. (Keep in mind there are several ways to reduce or eliminate this tax, depending on how you dispose of the property.)
Even if you end up having to pay tax on this dollar someday, you’ll have had the use of the entire dollar while you owned the property. This makes it a much better dollar than the one from your job.
OK, now look closely at the third dollar — the one you received when you sold your house. This is the king of all dollars. It hasn’t shrunk and it will not shrink. Dollar number three is twice as good as dollar number one. And what did you have to do to earn it? Nothing, but live in your house! The tax rules greatly favor this dollar over any other dollar. If you’ve owned and occupied your house as your primary residence for any two of the most recent five years prior to the sale, you can receive profits up to $250,000 tax free. Not tax deferred. Not tax sheltered. Tax FREE. If you’re married filing jointly the amount becomes $500,000!
Key point: the dollars people get from selling their house are twice as good as those 50-cent dollars from their job. If you’re in the business of selling homes, you should be telling your clients this. People ought to concentrate on buying and selling homes…and forget about their jobs!
Well, that’s a bit extreme but not totally bonkers. Since the current tax rules became effective there are people who have become serial homesellers. They buy a house, move in, fix it up, live there a couple years, then sell, and all the profit is tax free. Sure beats having a job!
So, what does this all mean?
Well, if you’re one of those hard-working people who earns a lot of income but never seems to have any money, buck up! Instead of working harder to earn more 50-cent dollars, try working smarter to earn different dollars. Because as you know, all dollars are not created equal.
This material is designed to provide information in regard to the subject matter covered. It is understood that Tom Lundstedt, is not engaged in rendering legal, accounting or other professional services. Everyone's situation is unique, so – before you, or your clients take any real world action – be sure to check with the proper professionals.