Tax Strategy #1: Include Tax Planning in Your Wealth Strategy
Too many people ignore taxes when investing and planning their wealth strategy. They look at the return on investment as the return before they pay taxes on their investment income. This makes no sense. With taxes as your biggest expense, wouldn’t you want to look at every return on every investment after taxes? When you do, you may find that you are making a lot less on some investments than you thought and are making more on others in comparison.
Let’s take a couple of examples in the U.S. that we will go into in much greater detail later on in this book. First, let’s look at real estate. Regularly, I hear on the news that real estate is only a moderately successful investment on average. And if you were to compare it directly to some other investment before tax and without leverage (i.e., debt), you would have to agree. Let’s say you purchased a rental property for $500,000, with $100,000 of your own money and $400,000 of the bank’s money. Suppose that the annual return on your investment of $100,000 is 7%. Then, let’s suppose that you make a similar investment of $100,000 in the stock market that returns 10%. Which investment is a better return? It seems obvious that the stock market return of 10% is clearly better than the real estate return of 7%, right?
Not so fast. The 10% return from the stock market will get you $10,000 before taxes. You will pay capital gains tax of about 20%, counting both federal and state taxes, leaving you with an after-tax return of $8,000. The 7% return on the real estate investment will get you a before-tax return of $7,000. Due to the magic of depreciation (chapter 7), you won’t pay any tax on your $7,000. Still, $7,000 is less than your after tax return of $8,000 in the stock market, so it seems you are still better off in the stock market.
Only, your real estate investment doesn’t just give you tax-free cash flow. It actually reduces your taxes on your salary and/or business income, because while there is positive cash flow of $7,000, the depreciation deduction of about $27,000 gives you a tax deduction against your other income of $20,000 ($27,000 less $7,000 to offset real estate income). That $20,000 additional deduction against your other income is worth $6,000 of reduced taxes on your other income in a typical 30% ordinary income tax bracket.
So your real return from your real estate is $7,000 plus an additional $6,000 of tax refund on taxes you normally would have paid on your salary and business income for a total return of $13,000, or $5,000 more than your after-tax return from the stock investment.
This is just one example of how the tax law can have a dramatic impact on your cash flow and your wealth. If you computed your return just by looking at the cash flow before taxes, your return of $10,000 is way better ($3,000 better) than your return from your real estate. After taxes, though, it is the opposite. Your return from the real estate after tax benefits is $13,000 while your return from the stock market after tax is only $8,000. See why you should always consider taxes when you make your investment plans?
Taxes are Fun, Easy, and Understandable
“The hardest thing in the world to understand is income taxes.”
– Albert Einstein
Death and Taxes
“Death” and “taxes.” They’re the two most dreaded words in the English language—or any language, for that matter. And it’s totally understandable. You don’t want to die. And you’d probably rather die than pay taxes. Perhaps we link taxes with death because they represent the death of all for which we’ve worked. Or maybe it’s because we don’t understand taxes any more than we understand death.
Worldwide, the average person pays 30 to 50 percent or more of their hard-earned income in taxes, either through income, sales, value-added, payroll, estate, or property taxes.
The reality is that taxes can kill your hopes and dreams. How? By stealing your wealth and diminishing your quality of life. That surprise vacation for your family? Gone, thanks to Uncle Sam. The improvements you need to make to your house? Kiss them goodbye come tax time. I’m sure you can relate. You’re not the only one. Worldwide, the average person pays 30 to 50 percent or more of their hard-earned income in taxes, either through income, sales, value-added, payroll, estate, or property taxes. Think about that. Almost a third to one-half of the world’s wealth is handed over to governments. That’s bad news.
But here’s the good news. Taxes don’t have to kill your dreams. In fact, 90 percent of entrepreneurs and investors can reduce their taxes simply by learning the basics of tax law.
You might be saying, “Great—another book that helps entrepreneurs and investors. I’m just a regular Joe. What can I do to lower my taxes?”
To you I say, “What if you became part of this privileged class of taxpayers? What if you took the right steps and made the right preparations to not only make more money but to also pay less to the government in taxes?”
Sounds hard, right? Well, as you’ll learn, it’s not. And when you do take the step of becoming an entrepreneur or investor, you will easily pay 10 to 40 percent less in taxes by learning how the tax law can work for you—instead of you working for the government and paying high taxes.
| TAX TIP: | Invest where you travel. Do you have a favorite destination? Consider investing in the area. It gives you a great reason to keep returning, and you turn the travel expenses you already have into deductible expenses, keeping more money in your pocket. |
Anyone Can Understand Taxes
This might make you laugh, but I absolutely love taxes. Seriously. I have a passion for learning everything I can about the tax law and how it can be used to save money for my clients and me. I started learning about accounting and taxes at a young age.
In high school, I took a class on business law and loved it. And all through high school I worked in the accounting department of my father’s printing company. I enjoyed working with money, and I loved learning about the law. So I decided to major in accounting and specialize in tax law. That way, I reasoned, I would get to work with money, learn about the law, and not have to spend my life with lawyers.
My first tax professor was Dr. Haney. He was a lawyer who truly had a gift for teaching and who loved tax law. I was so excited to take tax classes that I took all three that were offered in my junior year, postponing my upper-division accounting classes until my senior year.
I couldn’t wait to get a job working in the tax area. During my first term of tax classes, I took out the Yellow Pages and called all of the local Certified Public Accountant (CPA) firms in town that had more than one name or had “and Associates”
