Where’s Your Emergency Fund?Posted on December 17, 2012 by
We’ve all heard the wise, old saying: Save for a rainy day. Dave Ramsey calls it an emergency fund. Whatever you call it, it should be enough cash to support you and your family for three to six months. Because these funds need to be liquid – in case of an emergency, you want to be able to get to your money quickly – it’s best to keep this money in a money market account.
This morning, I met with a couple of other real estate investors to discuss year-end and 2013 tax strategies. Part of our discussion was about our emergency funds and the question of when is enough really enough?
Right now, if you’re lucky, your money market accounts are paying a whopping 0.9%. This means that if you have $10,000 in your emergency fund at the beginning of the year, by the end of the year it will have grown by a whopping $90.00! Oh be still my beating heart!
Now, you know that our government won’t let you keep that full $90 of interest you earned, don’t you? Interest income is taxed at your marginal income rate, which, for the average family in Georgia, is around 31% (25% Federal tax + 6% Georgia tax). So, the government steals $28.00 and let’s you keep $62. The net result is an emergency fund totaling $10,062.
But wait a second. Did you notice that the prices you pay for things like gas, bread, sugar, and butter shot up this year? This is called inflation. How does a 4% inflation rate affect your emergency fund? The buying power of your $10,000 actually fell to $9,690 (0.9% interest – 4% inflation = negative 3.1%; and then $10,000 – 3.1% = $9,690). How about them apples?
So how do you keep parasites like inflation and taxes from eating away at your net worth? How about investing in real estate? Sure, you still need an emergency fund, but doesn’t it make sense to also invest in a capital asset that can outpace inflation and be taxed at low rates?
Let’s look at a recent deal as an example. The seller’s house had a fair market value of $80,000. He wanted to sell quickly. The house needed $2,000 in repairs and cleanup. The purchase price was $51,000. The owner agreed to finance the purchase. The down payment was $2,000. The balance was $49,000 with these terms: 30 years at 3.86% interest with payments of $230 per month. The property rents for $850 per month. After debt service and expenses, the cash flow is $320 per month.
Now to the big picture: The equity pickup on this deal was $29,000, and the cash flow pickup was $320 per month. At the same time, you can depreciate the property at $1,927 and write off $1,876 in mortgage interest expense. And you also get to write off expenses such as insurance, property taxes, repairs, management fees, etc.
When matching the expenses against your gain, you end up with a net loss – which means you pay less tax at the end of the year and get to keep more of what you earn. In addition, as inflation rises, so do rents.
Most folks don’t yet realize all the financial advantages that come with owning rental property. I’m not a CPA, but with all the taxes going up on January 1st, what better time than now to learn about the advantages of owning rental property?