High Income – Low Tax

For individual investors in high tax brackets, tax planning should play a large role in investment decisions.

This is one of the reasons why real estate has always been such a popular investment vehicle for the wealthy.

If you require monthly income from your capital, but loath the thought of having that income taxed as interest income, Kalomar has an investment program tailored just for you.

Rather than lend Kalomar funds to purchase a rental property and then receive an 8% 1st Deed of Trust on that property, you could instead purchase the property outright, and then lease it to Kalomar with an option to purchase it from you at a pre-determined price for a pre-determined period of time – the end result of which would be an 8% annual yield for you, all taxed as capital gains.

Lets look at an example:

Suppose we identify a house that can be purchased for $170,000 cash and that house needs $30,000 worth of repairs to get it rent ready for the next 10 years. That would give us a total cost of $200,000.

As our client, you would write a check for $200,000 and the house would be in your name. From a security perspective, you can’t get much more secure than 100% ownership, can you?

Ok, now you own a house and don’t want to have anything to do with property management, maintenance, or repairs, but you do want monthly income, and you do want that income to be tax free or taxed as a capital gain.

Here’s how we make that happen.

As the owner of this house, you are entitled to an annual depreciation that will equate to approximately $5800 per year. If we lease this house from you for $483/month, you will be able to offset that rental income entirely by the amount of the annual depreciation. In other words, you won’t have to pay a dime of tax on all the income you receive until such time as the house is sold, and even then, it will only be taxed at 25%. (This assumes you sell for cash, which you don’t have to do…read on and you’ll see what I mean)

Summary so far: You have a completely secure investment providing you with a 3% cash on cash yield that you pay zero tax on.

So far, so good, but we’re not done yet. (by the way, you’re already earning 2.5X what the bank pays when you take taxes into account)

We now need to address a few other issues that will complete the picture of this completely hands off investment.

Maintenance and repairs: as a part of our option agreement, Kalomar will cover the costs of any and all maintenance and repairs.

The option agreement gives Kalomar the right to purchase this house from you for a specified price by a specified date. This is good for us, and it is good for you.

Given that our goal was to have you earn 8% on your money and we’re paying you 3% each year in income, you still need to earn another 5% per year to achieve the 8% goal. To do that, we’ll structure the option agreement to increase the price of the house by 5% for every year that goes by prior to our exercising the option to purchase the house from you.

Let’s go back to our example to see how this works. Lets say that we waited 10 years to exercise our option. According to our formula, the price we’d have to pay you for the house will have increased by 5% each year. That means the price we’ll pay your for the house in the 10th year will be $329,401.

Upon sale of the house, you’ll have a capital gain of $129,401 (sale price of $329,401 – purchase price of $200,000) taxed at 15% and you’ll have recaptured $58,000 in depreciation, taxed at 25%. The result of this is that you would receive $129,401 and pay $19,410 in capital gains tax and another $14,500 in taxes for the recapture of the capital gain for a total tax bill of approximately $33,910.

But wait, lets suppose that you still don’t want to pay a lump of tax when I exercise my option to buy the house from you.

We can help you with that too.

Instead of selling me the house for cash, you could instead sell it to me via an installment sale.

What that means is that I would give you a promissory note, secured by a 1st deed of trust, that outlines the monthly payment, interest rate, etc… (at this point, I’ve been making payments to you as a lessee for 10 years, so you are pretty comfortable that I’m an upstanding guy, however, your promissory note is still secured by the house and if I fail to pay you, you can foreclose and take back the house that I’VE BEEN PAYING TO MAINTAIN FOR 10 YEARS. Obviously, I’m not going to let that happen, so rest assured, your checks will arrive on time EVERY month, until the debt is paid off). You can now spread the payment of the tax bill over the life of the promissory note; effectively giving you another very nice stream of income taxed at a very low rate, for a length of time of your choosing.

Voila: you had a super secure, completely hands off investment, that provided you with income and appreciation, all taxed at a far lower rate than if it was interest income. What could be better than that?

If you would like to know more, please call Trent at 760-840-7172 or contact me by email.