May 17th 2021
The point of the Money Machine seminars and the principle behind it, is to build wealth, both by way of asset value, or net worth and also by way of a passive income stream that will carry you comfortably into retirement.
The challenge however is that whenever wealth flows into your hands, the government is there too with their hand out. They expect to share in the profits. And this reality can create real hardship if you are not aware of it and plan ahead.
With the Money Machine model, there are two distinct times when taxes can be very much a reality and a hardship. The first is when you are in acquisition mode and working hard at paying off your mortgage. The second is when you look to pass on your investment to your heirs. We need to take a close look at both.
If you recall, the simple plan of the Money Machine is to acquire 10 properties, one a year over a ten-year period. Amortize them over a period not exceeding 15 years each. And never sell. This will ensure that you will have a very comfortable income to enjoy during your retirement years. The tax challenge however becomes very real during this process. Suppose for example each of your properties costs an average of $500,000 and carries an initial mortgage of $400,000. Because we have adopted a very aggressive approach to repaying the debt (15 years) the principal balance of the mortgage will decrease very rapidly, probably on average by about $30,000 per year. You don’t actually see the money. It goes straight to the Bank and is applied in reducing the mortgage. But it is profit. It increases your net worth and it is taxable. That’s around $30,000 that must be added to your annual income statement at tax time. And the taxman expects to be paid. But that’s just one property. You acquired 10! So at the peak, between year 10 and year 15 you could be reporting and paying taxes on as much as $300,000 annually without actually seeing a dime of it. That’ll require some careful planning and aggressive actions: depreciation, rental surplus going straight to your tax account, belt-tightening. It’s tough, but fortunately, it’s not forever. Years 11 through 15 there are no new outlays for purchases. Years 16 and on, the properties are paid off generating significant surplus cash.
But then we come to the point in life where it’s time to pass the asset on to the next generation, your kids. Normally this is done through your Will and takes place at your passing. But here again, planning ahead is required. The moment anyone passes away, their real estate holdings are dealt with just as if they had been sold – ‘deemed dispositions’. With your principal residence, no income tax is triggered. But in the case of investment properties, two taxes apply. First capital gains, and secondly recapture.
By way of illustration let’s suppose you acquired an investment property some years ago for $200,000. And let’s suppose today it is worth $700,000. That’s a capital gain of $500,000. Today capital gains are taxed at 50%, so that means $250,000 is added to your estate income tax as income. But let’s suppose to defer taxes you depreciated the property over time by $50,000. That amount is now taxable. So your actual taxable income is increased by $300,000 instead of $250,000. But that’s just one property. You have 10. So your estate could be on the hook for $3,000,000 as added income or something in the vicinity of $1,500,000 income tax. Add to that the cost for probate and executor’s fees, and your actual tax hit could be closer to $2,000,000.
Unless you’ve taken out and maintained a huge life insurance policy, your estate will have one of two choices. Sell off some of the holdings, which seems counterproductive, or re-finance, and your heirs will be starting off very well, but back a few steps from where you’ve gotten to.
Taxes – one of life’s unavoidable realities. And really, they’ve got you two ways – during your acquisition and during your disposition. Coming and going. Be aware of it and plan accordingly. You’ll be glad you did. And, for that matter, so will your kids.
Wayne Quirk, Author, “THE MONEY MACHINE”, wayneq@remax-gc.com