Here’s what I do - Posted by Ron (MD)
Posted by Ron (MD) on December 29, 2000 at 15:29:05:
I’ll tell you what I do and why, but caution you that there may be better ways. Maybe others will offer alternative ideas.
Your main question is what should be done with your profits. Well, I do rehabs, which is very capital intensive. I know that most of the gurus say never to use your own money. Well, I do use my own money because it is much cheaper than hard money which includes a steep interest rate, plus points, appraisal, and many related borrowing costs. Further, even if I’m using other people’s money, I still will pay it back. It’s not like my risk is reduced because I can simply default on loans if I go that route.
So, I take a modest salary and retain other earnings in my corporation for further investment. (By the way, most of my corp’s capital is money it has borrowed from me.) I do have non-real estate investments in mutual funds (including IRAs), and I think it is a good idea to be diversified. But, if I had to choose between one or the other, I would reserve my capital for RE – I make more there than my stocks do (even in good years).
Bottom line, I keep a significant amount of personal cash (loaned to the corp) liquid so that I can operate my rehab business. If you are doing lease options and seller financed deals, you don’t need as much cash as I do and it would make sense to diversify into mutual funds.
Responses to your post got off onto the tangent of corporate structure. Mike talks about generating “legitimate expenses” to reduce corporate profits and, in turn, corporate taxes. Frankly, I don’t get that. I try to minimize my expenses to increase my profits which, in turn, increases my taxes. I hope to pay even more taxes next year.
I do try to avoid taxes where I can. Unfortunately, I haven’t figured out ways to generate “legitimate expenses” that don’t cost me real money. One thing I do do is avoid double taxation and self-employment taxes.
Double taxation occurs when your corp pays tax on profits and then pays you a dividend, which is not deductible to the corp. Any CPA would guide you around that mistake. You just have to be sure you take money out of the corp without using dividends (e.g., salary, rent, interest expense, family salaries, etc.).
I avoid self-employment taxes (as much as possible) by transferring money from the corp to myself without using salary (which incurs a 15% self employment tax) or dividends (which results in double taxation). To do this, my corp pays me a hefty interest rate for the money I lend it (14-15%, which is a legitimate market rate) and a strong rent for my home office space. I still have to pay income taxes on these transfers, but I avoid the self-employment taxes.
I’m sure there’s other, smarter things to be doing, but I haven’t figured them out. Hope this helps.