As the saying goes, there are 2 things you can’t avoid in life no matter how hard you tried or wished it weren’t so: death & taxes. Although this is true and we must all accept as part of the human experience, we all know there are daily habits and steps we can take to prolong our life, and there are also many things we can do to minimize our taxes and in some cases, avoid them altogether. This concept right here is 100% legal and it’s not even in the “gray” area of tax planning. It’s built around the concept of borrowing instead of selling. If you love paying taxes, then please, stop right here! I don’t have anything to give you.
In the classic personal finance book “Rich Dad, Poor Dad,” Robert Kiyosaki gave us a glimpse into this concept, and when I read the book probably like many others I failed to correlate this to my other investments
and asset classes beyond real estate. Here’s how it works in real estate. Say you find a beat up home for $50,000. You work with a solid, reputable contractor and put $150,000 into it. When the project is complete, your home is appraised for $300,000.
Wait – what?!? I put altogether $200,000 cash into it, but it’s valued at $300,000? That’s what’s called “forced equity” – because you had the vision and were willing to put up the capital, the plans, and wait for the home to go through the waiting process, you now have $100,000 in equity – the difference between what you paid, and what it’s worth.
Now here’s where it gets interesting…
What most people would do is flip the property and capture the $100,000 profit. There’s nothing wrong with doing this, as that sale and profit feels pretty damn good. The major problem is this annoying thing called taxes. If I did this based on my tax bracket and it’s under the 12 month mark, $50,000 of the $100,000 is going to my very good friend and fiscally responsible partner in life called Uncle Sam. However, there’s a better way – how can I capture income without paying taxes? Through what’s called a refinance. I’m going to go to my banker, and say “I want to borrow back out 80% of the value of the home”. Banker says sure no problem you’ve got good credit, solid income, and you’ve got a collateralized asset – I’ll be happy to loan you $240,000 secured against the value of this property. (This is why your credit score is CRUCIAL to the wealth building process).
So in this scenario, I’ve got nearly the same net income – $40,000 back vs $50,000 net if I had flipped it – however, the $40,000 is not taxable because there WAS NO SALE. I’ve got my $40,000 in income, I’ve still got $60,000 in
equity value in the home, and I’ve got a cash flow producing asset – I’m renting out the property for $3,000 per month so that covers the monthly expenses – taxes, insurance, property management, maintenance, and the mortgage payment – and the tenant is paying down my mortgage! Not to mention, I can depreciate the house so most of the positive cash flow is tax deferred. So 10 years go by, and the property has gone up in value to $350,000, and the mortgage note is now down to $200,000. So now I’ve got $150,000 in equity – if I’d like to take some of that as income, I refinance all over again, and I don’t pay taxes! And if I just hold it and eventually pass it on to my children, they won’t have to pay taxes on it either.
What is interesting is this same concept also works with high cash value whole life insurance, cryptocurrency, and even stocks. With my insurance policy, as the Dividends and interest accumulate over time, I can always take those as income – but then I’m interrupting the compounding growth of the policy, and again – I’m paying ordinary income tax rates. All I have to do if I want to cash in on the gains is make 1 phone call to my agent and request a check or wire “loan” and typically the funds hit my account within a week. You see, the insurance company is willing to loan me money with no credit check or application and send those funds almost instantly because they have as collateral my policy! I can decide to never pay the borrowed funds back, and when I pass they will pay out the large death benefit to my heirs and simply subtract out the borrowed funds. And on top of that, my heirs receive the death benefit, TAX FREE!!
This same concept is coming to cryptocurrency – that’s why I’m NEVER going to sell my Bitcoin. I’m going to HOLD it for 100 years and through what’s called “smart contracts” I’ll either be able to loan out my Bitcoin to others for additional income, or I can borrow against my value and have money to spend – tax free!
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