Sunday, June 3, 2007

Money Matters

The other day a friend called up to talk about his son's new job. The son is 22 years of age and has been working for the last six months with a real estate company that specializes in the foreclosure market. As you can imagine, business is great what with the bank re-sales averaging 10 a month and the foreclosure listings up to 1500 since January. They can barely keep up. Meanwhile, the son is making a ton of money which is driving him slightly crazy because of how much he is going to have to pay in taxes. His anticipated 1099 salary is $100,000 for the year. Yes, you heard me, the employer has all of his staff on 1099s. If I understand it right that means he gets to write them off as an expense but doesn't have to contribute anything to their social security, etc. Right now that means the kid could be looking at paying out well over 50% of his income in taxes. So far, he has come up with the following strategies to deal with this: He has formed a sole proprietorship and leased a car for his real estate business, and he bought into a rental property with his parents that they are going to let him claim on his income tax this year. He's also spent $6,000 on deductible improvements to the rental property. The big question that seems to be looming on his financial horizon is whether he should buy more rentals or buy his first home?

Lets look at the rental idea first: Because of the unique position he finds himself in, he has ongoing access to a tremendous amount of property listings. And because he still has 6 months in the year to find and make a purchase, he can be patient and select the best option available. An unfortunate aspect of this is that he works in San Diego County where the median home price is currently around $500,000. Rentals, however, should produce cashflow income so his tax situation might get worse instead of better.

In several ways, the situation is similar if he decides to purchase a home. Lot of listings, half a year to make a choice, and an average home price $500,000. However, since the money he will use for the down payment is not tax deductible, the only tax gain he will get is in the interest write off and the property tax benefit. One detracting factor here is that if the real estate market changes or he loses his job he could find himself in the very same boat as his present clients.

I don't find either of these options to be perfect but the fact that the rental property uses other people's money (the renters) to pay the costs has me leaning in that direction.

Meanwhile, I don't think he's done anything about IRA or emergency funds or for that matter long term investing. I told my friend that it is an interesting situation that I am going to have to spend more time thinking and researching about before I can say I really have some good answers.

1 comment:

R said...

I thought I'd add something here so I could test out this function, and make sure that it was clear to the reader that another aspect of the tax savings on either real estate choice is the depreciation write-off.