MONEY 25 - TAXES/RETIREMENT ACCOUNTS

THIS IS MY 25^TH POST ON UNDERSTANDING MONEY TOOLS

Money, Money, Money.  This will be a short blog to get your mind going on upcoming tax changes.  I would render the advice to see your tax advisor or accountant on what appears to be coming down the pike.

For one, if you are selling real estate owned by you and have held it over 12 months you are currently eligible for long term Federal capital gains tax.  This rate has been 15% for some time, however the tax rate will go up. Rather than trading a piece of “like property”, for instance real estate for real estate under a 1031 Exchange you may be better off paying the tax at 15% rather than deferring taxation with a trade. Eventually you will be paying a higher tax rate.

If you have stocks held over one year and are thinking of selling, consult your broker or advisor in this area so you can take advantage of the 15%.

Another area of interest would be IRA’s and investments in them.  Consult your advisor to see if it may be wise to start a Roth IRA, or sell some assets out of your current IRA and place the money in a Roth IRA.  A Roth IRA is for money you have already paid taxes on. Any compounding in the Roth IRA is tax exempt, and then when you are eligible to take money from your Roth IRA it is tax free.

If you roll the money from one retirement custodial account to another it is advisable to do so directly versus taking a withdrawal as we all must place the money into a new account within 60 days.  If you miss the time permitted time period there is a penalty of 10% plus ordinary income taxes owed to the government.  There are two numbers you should remember, 59 1/2 and 70 1/2. You cannot take a withdrawal of this retirement money except in certain situations, such as for education, before the age of 59 1/2. And, you must take money out of your retirement account at age 70 1/2.

A quick story.  A friend of mine had about $850 in an IRA and was quitting their job.  Needing the money, they did not roll it into another retirement account thinking the government had “bigger fish to fry”.  Well, in this computerized world a few years after they did this, the government sent them a notice that they owed the 10% penalty, earned income taxes on the withdrawal and interest penalty…..ouch, there wasn’t much of the $850 remaining.

MONEY 24 - BANKING/LOANS

THIS IS MY 24^TH POST ON UNDERSTANDING MONEY TOOLS

Money, Money, Money.  We will continue from our last blog on banking and ideas. 

As we talked about banks are mainly in business to either deposit money into, or take money out, and I don’t mean in terms of robbing, instead borrowing money.  In line with savings accounts are “certificates of deposits” (CD’s) that the banks offer.  The interest rate you receive may vary according to the bank you use, the amount of money of the CD and the length of time the CD is for.  A CD is for a specific period of time and a defined dollar amount.  Early withdrawal will have a financial penalty.

In our wonderful world of financial technology you can go to websites like www.bankrate.com or www.money-rates.com and compare national rates for CD’s. These sites can also be used to search the lowest loan interest rates for cars and other things.  Make sure you check into the financial stability of the bank you are doing business with.

A bank savings account offers little interest these days, but you have liquidity of money, meaning you can take money out without penalty or tying your money up for a period of time as with the CD.

Let’s look at borrowing money.  Of course, this is one way banks make money.  They take in deposits and lend it out to customers.  The “spread” is profit for them.  Popular loans at banks are auto loans, home improvement and mortgage loans.  Banks love lending on collateralized items.  With this type of loan the bank will place a lien on your car or home, and file that document with the county clerk and recorder’s office so that it is of public record.

Banks offer safety deposit boxes to their customers to keep safe business documents, jewelry or any smaller item you may want to keep outside your home or office.  Some banks offer this as a free service although the free safety deposit boxes are small.  If you are using the depository for business this is a tax deductible item.  Some banks offer larger vaults, and there are private companies that offer large vault storage. You might want to store a collectable item in these private vaults that are temperature and humidity controlled.  Such items may be wood musical instruments, rare pieces of furniture or any items of value. Insurance is always recommended.

Another place you can check for rates and business similar to banking are credit unions.  Many times these institutions are better for serving the public than banks and they have been around since 1909. They are federally chartered by the US Government, however owned by individuals such as teacher’s unions. Credit unions are less for profit than banks. These chartered unions have the backing of an insurance fund and the US Government to $250,000 per account, similar to banks.

MONEY 23 - BANKING

THIS IS MY 23^RD POST ON UNDERSTANDING MONEY TOOLS

Money, Money, Money.  With these educational tutorials I am trying to bring into context practical, everyday and simple lessons about money.  Another friend of mine asked me questions very basic about banks, so I thought we could re-visit banking and delve into more parts.

What’s the purpose of a bank?  These days we all wonder, right?  Well, banks are around for two specific purposes, other than drive us crazy, these are to deposit money and to borrow money.  Some banks have more adjuncts like investment counselors as well so that you can buy and sell mutual funds, stocks and bonds; set up and manage trusts, life insurance, credit cards, etc.

We’ve covered much of this banking material in other blogs.  My friend wants to open a checking account.  First, is it going to be for personal use or business use?  Duplicate copies of each check is helpful at the end of the year accounting and for tax purposes. Yes, a lot of banking today is done “on-line” so we would need to call the bank or meet with them if there were  issues.  Getting down to even the most basics of a check. In the upper right hand we have the check number.  Most banks will start off with a three or four digit number, rather than “1”.

Next, we have several lines….date, who the check is to be made out to, the amount to be written in, the amount numerically written in and your “John Hancock” signature.  When writing in the amount I like to draw a short line prior to writing so someone else can’t add on, and a short line following the writing, again so someone can’t add on to the amount.  If you are writing a check for a small amount you might want to say as an example, “Only two and no/100”.  This way it deters someone dishonest person from adding a six or an eight in front of the two.

What are all those numbers at the bottom of the check.  Going from left to right is the routing number for your bank and processing.  The next numbers is your checking account number. You will notice the last four digits is your check number on a particular check.

When you endorse another person’s check on the back, I like to write in where the check is to be deposited to avoid screw-ups.  For instance, write in “Only for deposit into checking account 1234567 (your account number) and then sign below that.

When opening this checking account you will be asked to sign a “signature card”.  I like to sign my checks differently from the exact name on the left top of the check.  For instance, if my name was John H. Doe on the check I might sign J. Doe, so that check forgers or people who have stolen checks have a harder time cashing the check, as your name is different than at the top of the check.

It may be a good idea to do something similar with credit cards.  A friend of mine with his credit cards writes in “Ask for photo/personal ID” where the credit card is to be signed on the backside.

Ask the bank if you can have “overdraft protection” on your checking account.  This is a line of credit, a reserve account, like a credit card so if you don’t have adequate money in your checking account you will automatically have money transferred into your checking account so that your check does not “bounce”. If you don’t have this and a check does not have sufficient funds it is returned to the party you wrote the check to, and this can get expensive with a bank transaction fee of $35-50.  The interest charged on a “overdraft protection” account is high, approximately 20% in most cases.

When selecting a bank for a checking account ask about all fees.  There are many banks that have free checking.

We will cover more in banking and practical information in our future blogs.

MONEY 22 - INVESTMENT CALCULATIONS

THIS IS MY 22^ND POST ON UNDERSTANDING MONEY TOOLS

Money, Money, Money.  In the last post we covered simple interest, compound interest and rates of return.

 Let’s talk about quick ways to figure out how an investment might look without a lot of figuring.  There is a rule of 7 and 10.  That means that you are going to be close in figuring compound interest using these two numbers if you want to make 7% or 10% on your money.  If I make an investment at 7% it will take me 10 years to double my money.  If I make an investment at 10% it will take me 7 years to double my investment.

What if you want to get an approximate return on investment other than 7% or 10%?  Some people use the rule of 72 to figure how long it takes to double money.  In this case, divide the percent you are receiving into 72.  An example is an investment at 9% and you want to know how long it will take to double your money?  Divide 9 into 72, and the answer is 8 years.  72 is most commonly used, as many numbers can be divided into it without decimal places.  It is a quick estimate,  The more accurate number to use is 69.3, or even 70, a whole number.

Have you heard of APR?  Annual percentage rate may be different from the interest rate quoted to you at time of purchase of a home or car.  There are essentially two types of APR.  Nominal APR is the same as simple interest on a loan, as we have discussed.  Compound APR, or effective rate, takes the simple interest on a loan and then adds in extra charges to the loan, this may include service fees, loan origination fees, transportation and set up fees on cars.  On mortgages the big ones are appraisal fees, loan origination fees and perhaps PMI or private mortgage insurance.

Here is an illustration:

Nominal APR: $100 for one year and cost of money is $5.  Therefore divide $100 into $5 and you will get .05. Move the decimal point two places to the right and you get 5%.

Now, let’s assume the same $5 in cost of money and the same $100 loan for one year under compound APR. We need to add in all costs for the loan.  Let’s assume $.50 for loan origination, another $.50 for service fees, and $1. for filing fees with public recorder’s office.  The extra charges on the loan are $2. thus we have $7 instead of $5.  Now, divide $100 principal amount of loan into $7 and you will get .07.  Again, move the decimal point two places to the right and you will see your loan interest rate is not 5%, but in actuality 7%. These additional costs are normally paid up front, however they are amortized over the length of the loan.

You’ve probably heard the terms “future value” of money and “present value” of money. 

Future Value: Future value of money is the value of money at a certain time in the future that would be equal to today’s value.  This is similar to interest rate returns we have talked about to date.  As an example, if inflation is running at 3% in the USA, after a year what amount of money would I need to have the same purchasing power as I do today if I held $100?  The answer is $103.

Present Value: This is the opposite of future value.  You take a figure in the future and bring the amount back to the current value, based upon facts or assumptions like inflation rate. In other words you are discounting the value of money back to today.

MONEY 21 - INTEREST CALCULATIONS

THIS IS MY 21^ST POST ON UNDERSTANDING MONEY TOOLS

Money, Money, Money. A friend from Flagstaff, AZ, recently asked me to post a tutorial on various types of interest and returns on investment, so here goes. Even though he is an accomplished businessman he told me he lacks knowledge in this area.  We will cover only a couple types and give simple examples.

Simple Interest: What is my return on investment over a one year time period assuming I can have the total return of my capital investment back?  So you loan me $100 for exactly one year, and I give you $105 back what is your return as measured in “simple interest” terms? 5%.  I determined this by calculating the difference between $100 and $105 which is $5.  Then, take the original capital amount, or principal amount, $100, and divide it into $5. The result is .05. To make .05 a percentage move the decimal point two places to the right….5%.  For us lesser brained individuals it helps to remember to divide the larger number into the smaller number!

Compound Interest: You can figure this amount with a calculator that has the symbol for compound interest, or do it on paper like we will here. Let’s assume we have $100 again and you lend it to me for a three year period again at 5%. How much will I return to you after three years? 

Year one: $100 X 5% equals $5, then add that on the next year’s principal.

Year two: $105 X 5% equals $5.25. Now, I owe you $110.25 the end of year two. Add that onto your principal.

Year three: $110.25 X 5% equals $5.52 (rounded up to the next penny).  Therefore, at the end of year three I will pay you $115.77 for the money I borrowed for three years.  The interest for each year is calculated on the principal amount adding in each prior year’s interest, thus the term compounding of interest.

Rate of Return (ROR):  We covered this in a real estate blog, but let’s go over it again. This is similar to simple interest. Let’s say we invest or buy something for $100 and sell it one year later for $105.  $105 minus $100 is $5.  The original principal or invested amount $100 divided into $5 is .05.  Again, the larger number into the smaller number!  Move the decimal point two places to the right and you have 5%.  Conversely, to work mathematically from a percentage move the decimal point two places to the left, thus back to .05.

Internal Rate of Return (IRR):  This is a bit tricky, but is commonly used in investments such as oil and gas and real estate.  Oil and gas wells are depleting assets, and hopefully the other, real estate, is an appreciating asset. This takes into consideration a different ending principal amount, or a principal/invested amount, that may differ from the original (the effective rate of return).  It is used in capital budgeting and analyzing investments.  It can also be referred to as “discounted cash flow”.  In oil and gas, wells are a depleting commodity, therefore are worth less over a given period of time or perhaps not worth anything at the end of a period of time. This needs to be factored into your investment decision and return on investment.  In theory let’s assume you and others invest $100 each in a partnership for oil and gas drilling. The well may produce a return of 50% the first year, 30% the second year and 25% the third year, and on and on for a few years until the well is depleted or waters out.  At that time, excluding equipment, the well is essentially worthless and you need to figure out over a period of time what your returns are.

Another case for IRR is real estate.  Real estate is made up of commodities, like materials that can fluctuate and many times go up in value over time. In this circumstance, let’s say we take our $100 and invest in a real estate partnership (perhaps a REIT on the New York Stock Exchange). The partnership may pay out 6% the first year, 5% the second year and 8% the third year.  At the end of 3 years the partnership, or your interest in it, is sold for $112 because of appreciation in value of the asset or assets.  Now, you need to figure out the internal rate of your return.  The formula is fairly complex and we won’t cover this, but this is the theory.

In the next blog we will continue from here on this topic into annual percentage rates, present values and future values of money.

MONEY 20 - TAXES

THIS IS MY 20TH POST ON UNDERSTANDING MONEY TOOLS

We are back to Money, Money, Money on this tutorial blog.  Let’s discuss taxation.

No doubt about it the wealthy pay less a percentage in taxes, although the total amount paid is quite great.  Today, the wealthy have moved their total assets owned in the US from about 14% ownership 15 years ago to about 50% today.  No wonder the dollar amount has gone up! They also have the ability to do this legally as they hire the best law and accounting firms for tax planning and asset preservation.  God bless the wealthy, however the middle class cannot afford these financial services and the poor have no money, perhaps they are the luckiest!

I will have to admit that I am not the smartest individual, so unlike other blogs I have written I needed to look up current income tax percentages to relay them to you.  Hope you find this of interest and help.

First, let’s talk about tax avoidance for long term and off shore accounts which has been common for a long time, however in recent years there has been attention drawn to the usage.  In my varied history I was involved with a very wealthy family and our law firm had the following scenario to minimize taxation and then shuffle money to various currencies.  In the US we invested in mortgages via a partnership. These mortgage packages had lives of over 12 months to take advantage of long-term capital gains.  As previously discussed the long term Federal capital gains tax rate is 15%. Then, state tax is paid depending on which state you reside in.  Several states do not have state income taxes, like Texas, Nevada and Florida. 

When we established this partnership we structured a corporation in the Cayman Islands that owned the partnership, thus as income came into the partnership we paid taxes on that entity and then the money was transferred to an offshore account. All legal.  Large US corporations are doing similar today.  They have offshore accounts, book the income and assets here however keep the money outside the US to avoid taxation.  I don’t see this changing much even if out corporate tax rate is decreased. Most large corporations are already paying very low rates and not 35-39% at the high end.  There are many world wide tax havens including the Isle of Mann and Isle of Jersey off England.

How are partnerships taxed?  The income is a pass-through to each individual’s income tax rate and reported on their Form 1040 and Schedule E.  The partnership itself needs to file a Form 1065 to inform the IRS that the partners are reporting the proper amount on their tax returns.  The partnership supplies each partner with a Schedule K-1.

Let’s address Federal tax percentages for individuals, head of household, for 2012.  In October the IRS looks at inflation rates and may adjust the tax rate accordingly for the following year.

If you make up to:     Tax rate:

-$12,400.                      10%

-$47,350.                      15%

-$122,300.                    25%

-$388,350.                    33%

-more than $388,351,   35%

If you are filing as single, (not head of household) or married filing separately the rates will differ from above. The income level can be adjusted by some personal expenses and giving, including donations to non-profit organizations like churches and charities.  Also, contributions to ERISA plans like 401-K’s and IRA’s.  Best to talk with your human resource director or accountant for planning.

Now, let’s look at FICA.  If you are an employee of a corporation the employer pays a portion and you pay a portion.  If you are an independent contractor, as is common today, you pay all of the FICA.  FICA is broken into two parts, 1) Medical/Hospital Insurance and, 2) Old Age, Survivors and Disability Insurance.

Through December 31, 2012 employees pay 4.2% (a 2% Holiday temporary cut) and the employer pays 6.2% to the Old Age, Survivors and Disability Insurance portion of FICA.  Both the employee and the employer contributes 1.45% to the Medical portion. Self employed individuals pay 10.4% to “OSASD” and 2.9% to the Medical part. In 2012 at $110,100 of income contributions are not required. The max is adjusted on an annual basis by the government and is indexed.

Let’s look at corporate income taxation.

If the corporation made up to or between:       Tax rate:

-Up to $25,000.                                          15%

-Between $100,000-$335,000.                   39%

-Between $335,000-10 million                   34%

-Between  $10-15 million                           35%

-Between $15-18,333,333.                          38%

Is this percentage weird, or what?  To account for the differences there has to be more companies falling into different adjusted income ranges to vary percentages paid.

These income levels are after expense adjustment, and again this is where  good tax law firms and accounting firms add great value.

I hope you enjoyed this informational blog and found the stats of interest.

MONEY 19 - REAL ESTATE

THIS IS MY 19^TH POST ON UNDERSTANDING MONEY TOOLS

Homes: Renovation, to buy new, resale.

In this blog we’ll discuss briefly the benefits of keeping your home and renovating parts of the home, or to buy new or resale in today’s market. These are thoughts to go through before making important decisions.

The first question is what is my motivation, emotional or rational? If you renovate your current home you need to ask, “how long do I intend to live in this house”? With most renovations you won’t get your money back in full.  This varies according to where you live in the US, and what you decide to renovate and to what degree.

If your mind has decided a new home, this is probably one of the best times to do so, pending that the economy of the country can move forward.  The reason for this is that many of the large home builders are still buying developed lots and land from banks that are in bankruptcy.  There are exceptions to this as in Boston, NYC, Washington D.C., parts of southern California, North Dakota and Wyoming where prices have held up.

The builder is starting with a developed lot that he has purchased from a distressed seller at $.20 on the dollar and then material costs are down from the highs of 6-9 years ago. You can’t do better than that!  The homes come with new warranties, build times of 4-12 months and you get to select the options you desire.

The insulation and energy factors are so much better today, including radiant barrier roof sheathing to reflect heat, blown in insulation, insulation wrapped vents, energy efficient windows, etc.  Your maintenance costs will be lower on a new home. 

Many builders offer built-in pest control systems like “Taexx” tubing which is installed in the exterior walls and a pesticide company can service the port on the outside of the home with the pesticide passing through the wood studs on a regularly scheduled basis.  Many builders offer “hot water loops” so that you have quicker hot water no matter where in the house.

When looking at costs for a new home don’t forget that most people will select options for the home that add on 12-20%.  On top of that new home builders normally don’t include exterior landscaping, or in warm areas the swimming pools are at your expense.

If you renovate your current home, select which rooms and how far you want to go with the renovation remembering you may not get all of this money back.  Normally, when the work is completed you will only see 60-85% back as a financial improvement to the home. 

House “flippers” normally do the minimum amount of work to make a house appear clean and improved so they can sell it; this is different.  The house “flipper” will improve the yard and landscaping for “street appeal”.  Inside the house they will paint and re-carpet, but that is pretty much all, unless they are certain the market will dictate getting their cost back plus a profit.

Many people start with the kitchens and bathrooms.  Kitchen cabinets and appliances are expensive.  Does a person want to update the plumbing, electrical, replace windows, carpet, tile, scratched doors, etc.  Where does one draw the line?  How about more insulation in the attic?  How about the basement and finishing that area into part of the house?  In many areas a finished basement is not included in the square foot livable as of record.  If this is the situation you will get a minimum return on investment.

Many people who renovate love the area they live in and their neighbors and don’t want to give that up.

MONEY 18 - LAND DEVELOPMENT #6

THIS IS MY 18^TH POST ON UNDERSTANDING MONEY TOOLS

Land Development Part 6

Now, we’ll take a brief look at Parcels 3 and 4.  Again, if it is convenient please go to my website: www.premierewisconsinland.com.

Parcel 3 totals 10 acres.  The water ditch that flows through Parcel 2 extends through this section and eventually the water flows to the Rock River to the north.  This ditch divides off two acres on the eastern side of the parcel.  Prior to construction of the highway there was considerable slope to the east.  Here our strategy was to use extra clean dirt that the DOT wanted to truck off, and fill this sloping area.  Again, similar to the other parcels we first removed existing topsoil.  After completing perc tests in case a septic type of sewage system needed to be used we isolated enough land (100’X400’) and did not compress this area with heavy equipment.  This would be adequate for 15-20 condos or apartments.  Single family homes would not be an issue.  We brought in about 25,000 cubic yards of clean dirt and replaced the topsoil for farming purposes until the real estate market returns.  On the southern border we took advantage of the DOT’s highway demolition work and received crushed concrete to create berms.

The best usage for this acreage would be single family homes or low multi-family, probably nice apartments.  With permission by the DNR we would like to create a walking bridge across the water ditch and make a park out of 2 acres for the residents of this area.  In conjunction with the DOT we placed commercial weight and size culverts for entry to the land.

On Parcel 4 we did very little work. This is a beautiful 84 acre parcel, treed with varying topography and views.  It adjoins a State nature conservancy on the northwest side. It would be prime land for a few expensive homes on sites of 5 acres or more.  A septic system or alternative septic system could be used.  Water is not an issue.  Good, clean potable water can be obtained from wells, which is common to the area. We placed commercial weight culverts for entrances to the property.