Podcast #29 Show Notes: Tax Reform Bills Currently in Congress
Today on the podcast we are talking about taxes and specifically we’re talking about the tax bills bouncing around in Congress. Now obviously these are a work in progress. So by the time you listen to this some things are going to have changed already. And this entire podcast may be out of date a month from now. It’s interesting because this tax bill is being sold as being super beneficial to the rich, you know a tax cut to the rich, but you’ll see as I go through this, that’s not necessarily true. Particularly for the high-income earner.
You can subscribe and download the podcast from ITunes, Overcast, Acast, Stitcher, or Google Play. Or listen to it right here on the blog or if you prefer, just read the transcript at the bottom. Enjoy!
Podcast # 29 Sponsor
[00:00:26] This podcast is sponsored by SoFi, one of the world leaders in student loan refinancing. Do you know how easy it is to start saving money on your student loans by refinancing? SoFi offers a free online application to refinance. As the leading student loan refinancing provider in the country, they’ve already helped over ten thousand doctors save $46,086 on average on their student loans. They can help you too. There’s no obligation and no fees to apply. Take two minutes to see your new low student loan interest rate on SoFi and you could save tens of thousands of dollars on your student loans. As a member of the WCI community you’ll get $300 towards your student loan when you apply to refinance with SoFi. Now medical residents can refinance their student loans with SoFi too and pay just $100 a month during their training.
Quote of the Day
[00:01:12] “Parents should contribute to Roth IRAs on behalf of their working teens, if any such teens still exist.” – Phil Demuth
[00:01:41] It’s now November. Last month was the first time anybody was eligible to receive public service loan forgiveness. And I still have yet to find somebody who’s gotten it. So if you know someone that has received public service loan forgiveness please have them e-mail me or contact me. I’d like to do a story about them.
[00:01:50] Just want to make sure you’re aware of our new 12-Step financial boot camp series. This is going out automatically to anybody that signed up for the newsletter on the website . If you’re not signed up, you’re not getting this free 12 e-mail series about how to get your finances in order. The first two have already gone out. They are on disability and life insurance but you can still get them if you sign up. And then we’ll continue on through the various topics that you need to take care of to have your financial life in order. So sign up today for that.
[00:03:07] We are going to talk about taxes today and specifically we’re going to be talking about the tax bills bouncing around in Congress. Now obviously these are a work in progress. And it is important to look at it from two perspectives- one what is good tax policy and two whether or not it is actually good for me and you.
Here are some of the changes being discussed:
- [00:06:25] Simplification of the tax bracket system. Michael Kitces did a nice piece about this on his blog.
- [00:09:27] Eliminating the alternative minimum taxes or AMT.
- [00:11:18] Expanding the standard deduction
- [00:13:14] Limiting itemized deductions
- [00:16:47] Making alimony taxable to the payer
- [00:17:44] Changes to capital gains when selling your primary residence
- [00:19:10]Phasing out some employees benefits that employers were allowed to provide before
- [00:19:51] Changes to education credits and student loan interest deduction
- [00:21:08]Tax rate change to 25% for pass through entities
- [00:22:35]Changes to Roth recharacterization rules
- [00:23:31]Changes to estate tax rules
- [00:24:17] Changes to step up in basis
- [00:25:05]Lowering the corporate tax rate
[00:26:10] There is a Senate version of this bill though they cannot make too drastic of changes.
- Keep 7 tax brackets
- Make the corporate tax rate cut a year later
- Doubling the exemption in the estate tax but not take it away
USA Today ran an article outlining the changes that you can take a look at as well.
Q&A from Readers and Listeners
[00:28:52] Should I buy a house in a high cost of living area or invest in real estate in another state?
I think buying a rental house out of state is a mistake. I’ve done it myself. I know many, many people who have also done it. I don’t think I can count the people who think it was a good idea afterward on one hand. There are better ways to invest in real estate out of state than to own the whole thing yourself. If you want to own the whole property yourself, make sure it is in the town you live in and preferably between your house and the hospital.
Sometimes in places like LA you have to stretch a little beyond 2X. But “a little” is 3-4X, not 10X. So if you could scrape together $300K as a down payment, then a $1.5M house with a $1.2M mortgage is only 3X your income. Given you have the other ducks all in a row, you’ll probably be okay there.
[00:33:29] Is just buying enough umbrella insurance equivalent to turning a rental place into an LLC in terms of ones liability coverage?
An umbrella policy does not replace an LLC. The wise real estate investor does both. All the real estate I own now is either in a fund or an LLC, limiting my personal liability to just the money I’ve invested.
[00:00:00] This is the White Coat Investor podcast where we help those who wear the white coat get a fair shake on Wall Street. We’ve been helping doctors and other high income professionals stop doing dumb things with their money since 2011. Here’s your host Dr. Jim.
[00:00:20] Welcome to podcast number 29, the podcast all about the tax reform bills in Congress now.
[00:00:26] But first a word from our sponsor, Sofi. Do you know how easy it is to start saving money on your student loans by refinancing. Sofi offers a free online application to refinance. As a leading student loan refinancing provider in the country they’ve already helped over 10000 doctors save $46000 on average on their student loans. They can help you too. There’s no obligation no fees to apply. Take two minutes to see your new low student loan interest rate on sofi.com/whitecoat and you could save tens of thousands of dollars on your student loans. As a member of the WCI community you’ll get $300 towards your student loan when you apply to refinance with Sofi. Now medical residents can refinance their student loans with Sofi too and pay just $100 a month during their training. Apply today at sofi.com/whitecoat.
[00:01:12] Our quote of the day comes from Phil DeMuth who said “parents should contribute to Roth IRAs on behalf of their working teens. If any such teens still exist.”
You know the truth is if you can find some work for even your preteens and your school aged children that they can have a Roth IRA as well.
So a few housekeeping items before we get into our main subject area. It’s now November. Last month was the first time anybody was eligible to receive public service loan forgiveness. And I still have yet to find somebody who’s gotten it.
[00:01:41] So if you know someone that has received public service loan forgiveness please have them e-mail me or contact me. I’d like to do a story about them.
[00:01:50] Also want to make sure you’re aware about our new 12-Step financial boot camp series. This is going out automatically to anybody that signed up for the newsletter on the Web site. If you’re not signed up you’re not getting this free 12 e-mail series about how to get your finances in order. The first one already went out this week. It’s on disability insurance but you can still get it if you sign up. And then we’ll continue on through the various topics that you need to take care of to have your financial life in order. So sign up today for that.
All right we’re going to talk about taxes today and specifically we’re going to be talking about the tax bills bouncing around in Congress. Now obviously these are a work in progress. So by the time you listen to this some things are going to have changed already. And this entire podcast may be out of date a month from now. Also bear in mind that there is really no topic that’s more political than taxes. I mean everything about this is political. There’s no way to avoid political topics with this. And so we’ll try to treat it as dispassionately as possible and go from there. It’s interesting because this tax bill is being sold as being super beneficial to the rich you know a tax cut to the rich, but as you’ll see as I go through this. That’s not necessarily true. Particularly for the high income earner.
[00:03:07] In fact after looking at the details of the house plan I’m pretty sure my taxes are actually going to go up. Right now the tax bill is actually in the Senate and the Senate bill is distinctly different from the House bill. And so what eventually it becomes reconciled between the two of them may be completely different from either one of their bills. So bear that in mind as we look at these topics. One of the big changes in the tax bill is that the corporate tax rate is going to be cut and I hear a lot of press about that. It’s interesting. People see that as this boom, that some person out there, this corporation person that’s got this incredibly great tax break. What people don’t understand is there is no corporation out there that’s getting this tax break. The corporation is you and me and everybody else who owns a 401k or who owns a mutual fund or owns stock, we’re all corporations. It’s just like when you tax products coming from overseas a tariff. Right. That tax is not a tax on Japan. It’s a tax on the Americans buying that product. That’s who pays for that. Just like when you tax a corporation it’s not a tax on somebody that’s not us. It’s just a different way to tax us. Now there’s no doubt that wealthier people own more of a corporation than less wealthy people. And so when you cut taxes on corporations yes it makes that tax code a little bit less progressive than it otherwise was.
[00:04:35] But in reality we’re just taxing ourselves, whether you do it as a tariff, whether you tax corporations, whether you tax individual income, or whether you make it a value added tax or a big sales tax. It’s all a tax on us in the end. And so while there’s different policy issues and different benefits and downsides to having one type of tax versus another you’re not getting out of being taxed. We’re all going to be taxed no matter how we do it. Here’s the other thing to keep in mind. Right. Taxes are super political. Approximately half of the country wants the tax code to be less progressive and approximately half the country wants the tax code to be more progressive. So nobody is happy when you start talking about changing things in the tax code. You know when you send a bunch of Democrats to Washington and the Democrats control both houses and the White House you can expect your tax code to become more progressive. And when you send Republicans to control the Senate and the House and the White House. Don’t be surprised when your taxes become less progressive. As President Obama said elections have consequences. And so that’s what you’ve got to expect to see when one given party working on tax reform. It’s good to see the reform, it’s good to see the simplification but when it’s the Republicans doing it it’s going to become less progressive. And when Democrats are doing it it’s going to become more progressive. So just get used to it.
[00:05:59] It’s important to look at these topics from two perspectives one what is good tax policy.You know what’s a good efficient way to fund our government without disincentivizing us from doing things that we ought to be doing. And to whether or not it’s actually good for you or me. So don’t confuse those two things it’s important to realize that something might be bad for you but still be good tax policy and vice versa.
[00:06:25] OK, let’s shift into the House bill to start with the main change to the House bill is simplification of the tax bracket system and this entire discussion isn’t going to make a lick of sense to you if you have no idea what our current tax code looks like. So you actually have to have a basic understanding of our current taxes before you can understand what the changes are. We currently have a seven bracket system. It ranges from a low tax bracket of 10 percent to a high tax bracket of thirty nine point six percent. And the congressmen are pushing this new tax break a system with four brackets of 12 percent, 25 percent, 35 percent, and that same top tax bracket of thirty nine point six percent but because of the size of these brackets the tax codes actually becoming less progressive. That 12 percent bracket basically eats up the old 10 percent bracket which was pretty small. There’s significantly larger 15 percent bracket and part of the 25 percent bracket and makes that all 12 percent. The 25 percent bracket now goes up way higher than it used to. It goes up to $200000 for individuals and $260000 and taxable income for married couples.
[00:07:43] So basically that combines the 25 and 28 percent bracket and a little bit of the 33 percent bracket and puts it all into the 25 percent bracket. The new 35 percent bracket goes up to half a million for individuals and a million for married couples. So basically combines that 33 percent and 35 percent bracket and a significant part of the thirty nine point six percent bracket and moves it down to 35 percent. So but there’s an interesting phase out written in it that you may not be aware of. And Michael Kittchie’s did a nice piece on this on his blog. But there’s actually a phase out of the 12 percent bracket once you get to a million dollars in taxable income. Which in reality creates an entire different bracket. The forty five point six percent bracket and for a single individual. This goes from a million to 1.2 million. And for a married couple. This goes from $1.2 million to one point a little over $1.6 million. So in reality the worst place to be in the tax code is a little over a million dollars because you’re paying forty five point six percent in just federal income tax. That doesn’t count the Medicare tax, that doesn’t count the special Obamacare tax, that doesn’t count your state income tax. That’s just your federal income tax. So it’s quite possible for a successful doctor to physician couple to have their taxes going up because of this significant change to a good portion of their income.
[00:09:20] OK, one of the cool things about this is we’re eliminating our second income tax system.
[00:09:27] You may or may not be aware of this but right now we have two income tax systems, we have the regular one and we have the alternative one, which was originally put in place in order to make sure that really high income people had to pay at least a certain level of tax. But in reality because it was never indexed to inflation it basically hits people typically in the income ranges of 150000 to 400000 and that’s a lot of doctors. And so the good news is if you’ve been AMT or alternative minimum tax, that’s going away which is pretty great. They’ve done that deliberately to make it go away. But the truth is because of some of the other changes they’ve made a lot of people that were paying alternative minimum tax before, wouldn’t be anyway even if they didn’t specifically eliminate the alternative minimum tax. Here’s an interesting thing about this tax reform. The ordinary income tax brackets obviously have some huge changes but the capital gains and qualified dividend brackets really don’t. You’re basically still have the same brackets, the zero percent capital gains rate up to 77000 for married couples or basically 52000 for individuals, and the 15 percent that goes up to four hundred twenty five thousand for individuals and 479 for married couples, and the 20 percent bracket above that.
[00:10:53] The other thing that doesn’t change are the Obamacare taxes, that three point eight percent Medicare surtax. If you have income over 200000 single or 250000 married you still going to pay that. That doesn’t change and it’s still not indexed to inflation which I think is terrible tax policy to not index everything to inflation, because in reality it just makes the taxes get worse and worse each year.
[00:11:18] Another huge change that honestly is probably great policy even though it doesn’t help me a lick, is expanded the standard deduction. They’re basically doubling the standard deduction and that makes it a lot easier for a ton of taxpayers including a lot of docs. I’m surprised how many docs aren’t going to bother deducting anymore under this new plan. As is about a third of Americans itemized deductions. But Congress is estimating that under the new plan only about 10 percent of Americans will be itemizing their deductions. So that will make the tax code quite a bit simpler and easier. I mean think about all that stuff you no longer have to keep track of, you know all those little charitable deductions, forget that, all the medical expenses, forget that, you know all the all these little deductions you don’t have to worry about. Of course that does have some other effects which we’ll talk about when we get down to exactly what’s being phased out there.
[00:12:13] They’re also changing these exemptions. Basically they’re getting rid of the exemptions. They’re making a few changes to the child tax credits and they have this family flexibility credit as well.
[00:12:26] The net impact of these changes is that most families with children are going to see a tax savings with a combination of the new standard deduction and the child tax credits over the old rules with the standard deduction, the personal exemption, and the smaller child tax credits. But that’s not necessarily the case for every single level of income, including people that are in typical doctor levels of income. But it’s a little bit hard to sort out you really just have to run the numbers yourself and see where you’re going to fall out.
[00:12:57] One cool thing about it is, you know if you remember these personal exemption phase outs or PEPs, since the personal exemptions are gone that phase out is gone, which is nice because it eliminated the personal exemptions for a lot of doctors anyway.
[00:13:14] Bear in mind that the itemized deductions are also being severely limited and when you combine the fact that there’s a higher standard deduction and some of these itemized deductions are going away at least if this bill in the House passes, then you are going to see lots of docs that just no longer have a need to itemize. For example the biggest change is probably this proposal to eliminate your ability to deduct your state and local taxes on schedule. And that’s a huge deduction for a lot of doctors particularly if you live in California or in the northeast. There is a carve out that the property taxes can still be deducted. Right now they’re talking about that being at $10000 a year, which my property taxes in Utah aren’t high it’s only about 36 hundred a year. And so I’ll still get that entire deduction but there’s lots of people that are paying more than that in property taxes particularly in the Northeast.
[00:14:15] But other deductions on schedule A are also being limited including casualty losses and gambling losses. The medical expense deductions are basically being repealed. Not that most doctors could take that anyway because it was subject to 10 percent of you just a gross income. You know kind of a floor there. The doctors basically just didn’t get over because your maxim out of pocket was never that high. Some of your miscellaneous itemized deductions the ones that are subject to the 2 percent of the AGI floor are also going away. I think you can still pay your advisory fees if you have a financial adviser under that. But a lot of those deductions are gone, such as moving expenses to a new job. That one’s gone. Sorry. The electric drive motor vehicle credit, that’s $7500 credit you can use to buy your Tesla. Well you better get it before the end of the year. The adoption tax credit is also going away. That mortgage interest that you deduct on schedule A is also being limited. You only get to take the deduction on the interest of up to $500000 of acquisition debt for one house. You don’t get it on your second house and you don’t get it for more than a $500000 loan. And so that’s going to limit how much you can deduct on your interest for a lot of doctors. Bear in mind that your existing debt is grandfathered in. So if you already have an $800000 mortgage or if you buy a house before the end of the year that will be grandfathered in. But any new debt after the new year would not count.
[00:15:52] There’s also some changes to the charitable deductions but they’re are relatively minor changes that really isn’t going to be affected much. In fact one of the changes is positive. For example you use to only be able to deduct a charitable contribution of up to 50 percent of your adjusted gross income and that’s been increased to 60 percent. Now I don’t know how many people are actually giving that much of their income to charity. But if there were one year in which you really wanted to do that particularly if you are retired now you can get a little bit bigger deduction for it also. Also and here’s a good tax policy change, their indexing the charitable mileage deduction limit to inflation. With this new change, there’s a few changes to it though you’re not going to be able to deduct you know buying seats for college athletic events. It used to be you can deduct up to 80 percent of the cost of that and you can’t do that anymore.
[00:16:47] OK. Another important change in the tax code has to do with alimony. Now I’m always a big advocate of one house one spouse. But if you do end up getting divorced. Bear in mind that it just got worse. At least the financial treatment of it, if you’re the doctor and you probably are if you’re listening to this, your payments are no longer a tax deduction. It use to be that there were a deduction for you and taxable income for the recipient. But they’re actually going to reverse that so that that income is taxable to you as the alimony payer and tax free to the recipient.
[00:17:26] I guess it doesn’t matter as long as everybody recognizes that and adjust for it in the divorce agreement. But I think most of the time people just ignore the tax treatment and so makes it worse if you’re the one paying alimony under this new plan. Those who are already paying alimony are grandfathered in.
[00:17:44] OK. There’s another change. If you are selling your primary residence, it use to be that you could deduct up to $250000 of capital gains on your house. Five hundred thousand dollars if you’re married. Well that’s apparently thought to not be so fair. And so they’ve changed it. They’re worried that people, you know these people that like to flip houses are abusing the law. Right. They buy a place they live in it for a couple of years they fix it up and then they flip it tax free and then do it again. Well of course you’re right the tax laws the way they are people are going to do that but basically they’re changing this so that you can’t do this all as frequently as you used to be. It used to be that you had to use it for two out of the last five years and now they’re changing it to five out of the last eight years. So it’s a little bit harder to do this live in and flip thing.
[00:18:38] Also there is a phase out on this, if you make too much money it’s going to exclude some of your capital gains, that phase out starts with an income test above 500000, married 250 individuals so that’s going to affect a lot of doctors, that you know if you keep moving houses you may end up having to pay some extra taxes.
[00:19:01] OK. There’s a lot of employee benefits that are being phased out. Things that your employer was allowed to provide before. This includes moving expense reimbursements, adoption assistance, employer provided childcare, dependent care assistance, college assistance, you know a lot of employers would give you college funds for you to be able to go. Well they’re not going to deduct that anymore so they’re probably not going to offer. Qualified tuition reductions. Employer provided housing meals and entertainment expenses. That’s not completely going away but that one is being limited in some ways that it isn’t now. And things like on premises gyms, you know some transportation benefits like if they’re giving you bus passes that sort of thing there’s going to be some limitations there as well.
[00:19:51] OK education stuff the Coverdell essays are going away. They weren’t great anyway. I mean a few of you were probably use them but they only had a $2000 a year contribution limit and so it really didn’t work very well for a lot of doctors the one to save more than that for their kids education. But those are being phased out and basically just replaced by 529. Also a bunch of the credits are being basically consolidated for the most part people were only being able to take the American opportunity tax credit anyway which is a 100 percent tax credit if the first 2000 of educational expenses and a 25 percent tax credit on the next $2000 of expenses. But that is still going to be in place. But they’re getting rid of the Hope scholarship credit and the lifetime learning credit.
[00:20:44] Also you’re not going to be able to deduct your student loan interest. It used to be that you could deduct that as a resident once she became an attendant you are phased out of it but now you’re basically not going to be able to deduct it at all. Also if you’re using savings bonds to pay for higher education because of the tax break that was allowed there that’s going away too.
[00:21:08] Another change in the new tax bills is this idea of having a 25 percent tax rate per pass through entities. Now pass through entities like a partnership an LLC or an S corp. And when I first heard them talking about this I got pretty excited. Because basically all of my businesses are passed through entities and the idea here is that a certain amount of your income instead of being taxed at 35 percent or 39.6 percent, it could be taxed at just 25 percent. And that’s a big tax cut. But you know what they’ve thought about this quite a bit and it doesn’t sound like they want doctors and lawyers and financial advisors to get this. And so it’s going to be tough for an active business owner. You know that’s basically defined as one who materially participates in it is going to have to split their income between the income derived from their labor and their income derived from the business. Now this sounds an awful lot like what S-Corp owners do now where they decide how much is distribution and how much is salary. That’s because it is.
[00:22:13] And so the idea is going to be try to maximize the amount that comes from the business and minimize the amount that comes from your labor in order to get that lower tax rate. So I think there’s still a lot of talk and a lot of flux in this. But keep an eye on this because this could have a real effect on doctors being able to get their tax rates lower.
[00:22:35] There are some changes to the Roth recharacterization rules. You know there’s been in the past some strategies where you used multiple Roths and and did conversions of four or five different pieces of a Roth and put each of them into a different asset class and then recharacterize all the ones except the one that did the best. But they’re changing some laws to keep you from being able to do that. They’re basically making the Roth conversions irrovocable. So you can’t actually you know unwind that. The backdoor Roth however is not being changed say you should be able to continue being able to do your backdoor Roths each year.
[00:23:17] If you have an archer health medical savings account that’s going away. Most people don’t. Most of us are using health savings accounts. The HSA. So that’s not really going to affect very many of us.
[00:23:31] And another huge change and maybe one that gets an awful lot of press is this estate tax change. There’s talk about eliminating it completely. There’s talk now in the Senate about just doubling it from you know five and a half million or 11 million for marrieds to double that you know 11 million and 22 million. But you know eventually it may be repealed. We’ll see.
[00:23:59] Honestly though I think this is it will swing right back and forth if this gets repealed in six or eight years when the Democrats are in power is going to get put back in place. And so I would not necessarily make a lot of changes in your estate plans based on this especially if you’re you know 40 years old and in good health.
[00:24:17] There’s also some interesting talk about the step up in basis changing and that is you know could be really painful and I think would be lousy tax policy. The way the law is written now if you die with something and leave it to your heirs, your heirs basis meaning you know what they paid for it for tax purposes, is what it was worth on the day you died. That applies to mutual funds and stocks, your home and all that kind of stuff and makes it way easier for your heirs to manage your estate because they don’t have to go back and figure out when you bought something and what it was worth then there there’s been some talk about getting rid of that step up in basis kind of in exchange for repealing the estate tax. And I think they’d be terrible tax policy but we’ll have to see how that shakes out.
[00:25:05] Another major change in the tax code that’s going to come up is lowering the corporate, and we’re talking about c corporations here, lowering the corporate tax rate from 35 percent to 20 percent. And the reason that the government is interested in doing this is to make the US a little bit more appealing to corporations both to keep their money here rather than keeping it overseas but also to locate here in the first place.
[00:25:34] We have one of the highest corporate tax rates in the world and it’s probably not good for our economy to have that. And so I think it’s probably good policy to lower this tax rate from 35 to 20 percent. But what that does is it makes you start wondering about alternative strategies. For example right now it generally doesn’t make sense for doctors to form themselves up as a C corp but with that lower tax rate it could. And so you have to start looking at things like that and possibly making a change in your corporate tax structure depending on how this changes and how everything is affected.
[00:26:10] We should also probably spend a few minutes talking about the Senate version of this bill although my understanding is they cannot make too drastic of changes and still be able to pass it under the rules they’re planning to pass it on, which basically takes a potential filibuster out of the equation. But the differences between the Senate plan and the House plan include mostly an issue with the brackets. For example the House Republicans want to change it to these four brackets, really five when you consider that forty five point six stealth bracket. But the Senate bill wants to keep seven brackets 10, 12, 22 and a half, 25, 32 and a half, Thirty five and thirty eight point five. The Senate rather than allowing you to deduct your property taxes wants to eliminate those as well. So you get no state, no local, no sales, no property tax deductions under the Senate plan. However the Senate Republicans want to leave the mortgage interest deduction alone rather than limiting it to the $500000 cap.
[00:27:25] Senate bill also would make the cut in the corporate tax rate happen a little bit later. It would be one year later it’s just a minor delay there. The Senate is also looking at the deductions for pass their businesses a little bit differently in order to incentivize people to promote investment.
[00:27:47] There is also a difference in the estate tax, between the House bill and the Senate bill. The House says we’re going to double it and gradually phase it out over six years. In the Senate they just want to double the exemption but never actually take the estate tax away.
[00:28:06] OK so I hope that gives you some information about what’s being talked about in Washington. We don’t really know what the final bill is going to look like much less what the final law is going to look like. And I think it looks pretty likely that we’re going to have some significant changes to our tax code. And when it’s all finalized I’ll be running some posts on the blog talking about the differences and so on and so forth. In fact this year my plan was to be writing a book about taxes and you know how to reduce your taxes for a doctor. But after the elections I decided maybe that wasn’t going to be so wise and I had to wait until we see all the changes before writing that book. And so once they get this finalized out I may need to start on that project and they will probably be something I’m working on a lot in 2018.
[00:28:52] OK I’ve got a couple of related questions today for readers that I wanted to talk about. They’re both pretty interesting and variations of them I’ve seen several times over the years. The first one comes from an employed doc in California who is originally started at about $250000 a year and now is going to be making about $450000 a year and is live in an apartment with a partner. It’s interesting because this doc has several hundred thousand dollars in cash but also a couple of hundred thousand dollars in student loans and was wondering whether the cash that should be used to pay off the student loans and so that was a no brainer. I advised the doc to do that right away. But the question had more to do with buying a home at a high cost of living area. And this is what the doc writes. Here’s where I’m stuck. The homes around me are no less than 1.2 million and more like no less than 1.5 million for something I like. That’s not far from the hospitals where I operate. I just found a dream house one and a half million. It feels like it will be a stretch to afford this until my base pay goes up a little more. But the market here has just been insane as I’ve watched it over the past three years it gets further out of reach every few months. I’ve also been considering staying in my apartment for now and investing in real estate in another state like Texas where I have family.
[00:30:14] Well I thought the doc was doing pretty great. I told the doc to pay off the student loans the next day. I mean it was just ridiculous to be borrowing money at 5 percent invest it at Less than 1 percent and then I told the doc to take the rest of that money which was still several hundred thousand dollars and designated as part of the down payment fund for the house. The doc’s employment situation was stable even if the actual income amount wasn’t entirely stable. But the main issue I saw with this doc buying a house was the social situation wasn’t quite stable. It was still a you know partner kind of relationship and it didn’t sound like that had been nailed down yet and I’d be pretty hesitant to buy a house while I was in a relationship that wasn’t long term.
[00:30:59] But basically I told the doc if the doc could scrape together $300000 a downpayment then a 1.5 million dollar house with a 1.2 million mortgage is really only a 3 X mortgage three times your income as debt and that’s a little more than I like to see. I generally recommend docs keep that to 2 x or less. But if you’re in Manhattan or California sometimes you’ve got to stretch that a little bit. But what I’m talking about stretching it I’m talking about 3 to 4 x not 10 x. So since this doc had all of the other financial ducks in a row I think this is probably OK to go up to a mortgage that big. Assuming the job is long term and the relationship is long term.
[00:31:43] So the doc writes back in about that idea about the out of state rental because I apparently failed to address that in my email back. Any thoughts about the out-of-state rental. I realize it’s more risky and requires research and some work but provided I’m OK with this. Any thoughts on that route rather than a traditional option of purchasing a home to live in.
[00:32:02] Well. You know honestly I think buying a rental house out of state is a mistake. I don’t think that in any way shape or form takes the place of owning your house. I mean I’ve owned a house out there across the country. It’s terrible. It’s terrible to own an investment across the country unless you have exceptionally good management, which is difficult to hire for a single family home. You know it’s one thing if you’re part of a REIT or you’re part of an investment fund or it’s you know being managed through one of these crowdfunded online sites that where they’re lending money to a property manager to a real estate investor. But I think actually trying to do it yourself in another state is just a mistake. I don’t think I can count the number of people on one hand who think it was a good idea after being an out-of-state landlord. There are just so many better ways to invest in real estate out of state than to own the whole thing yourself. So if you want to own properties yourself I think you need to have them in the town you live in and preferably somewhere between your house and the hospital. It just doesn’t replace owning your own home.
[00:33:06] Now that said it’s not like you have to own your own home to build wealth. You know it’s perfectly acceptable to continue to rent even for many years if you’re in a place where rent is controlled and houses are really expensive.
[00:33:19] The difficulty of course is predicting how long you’re going to be there because you know it generally does make sense if you’re going to be somewhere seven to 20 years. It makes sense to buy a house.
[00:33:29] OK. I got a related question from a graduating resident in the Seattle area. So an expensive area. The question he asked was whether he should put a rental property in an LLC or just buy an umbrella policy.
[00:33:46] But the issue was a little bit deeper than that. So I actually started answering the question he should have asked and then I answered the question that he did ask. He said My partner and I own a townhouse in Seattle and we’re going to be moving to another state in a few months and I’m going to be spending some time on active duty in the military. After that we expect will return to Seattle. This is where our families live and everyone seems to think we’d be better off renting this place out instead of selling it due to the growth potential in Seattle which makes me a little bit nervous but we’re going to give it a try. Or plan to use a property management company since we won’t be back in the area for some time. So yes I’ve been reading about turning rental property into an LLC to limit one’s liability but I’m wondering if just buy enough umbrella insurance is equivalent to turning the place into an LLC in terms of one’s liability coverage. It certainly seems like a lot easier of a process to just buy an umbrella policy than to do all the paperwork to place the townhouse into an LLC and make sure it doesn’t disrupt the mortgage etc.
[00:34:45] OK well the first thing I told them was that even though everybody is telling them you should hold on to this thing. I disagree with everybody. I totally sell the house for a couple of reasons. Number one being a long distance landlord sucks. It’s terrible you can’t go by and fix the little rinky dink things, you can’t go by and see how bad it is, something they’re complaining, about every time something’s got to be done you’ve got to hire a contractor to go out there and fix it. You know I can’t tell him that he’s going to come out behind doing it. Maybe houses are can continue growing and growing and growing in value in Seattle over the next six years. I don’t know but the odds that he’s going to want to move back to Seattle and live there in a place he can afford is a resident. As an attending that’s been out of residency for six years is pretty much zero. He’s not going want to live in that house so he’s not coming back to live in this house. It would just be an investment property when he comes back. But the fact is he almost surely didn’t buy it as an investment property. It probably is not that great of an investment property and if he was already living in another state he wouldn’t go back to Seattle and buy an investment property. So he ought to sell it. If everybody thinks you ought to hold onto it because it’s such an awesome investment. Sell it to everybody right. They think it’s great let them own it.
[00:35:57] OK but then I answered the question that he asked. Which is you know about this umbrella policy versus an LLC. I agree that everybody ought to have an umbrella policy especially if you own rental real estate. It really is the first line of protection when it comes to asset protection outside of your professional practice. But it doesn’t replace an LLC. They’re totally different.
[00:36:21] And I think it’s a good idea if you’re going to own rental property to have both an umbrella policy and have each individual rental property inside an LLC. Now I don’t own any properties outright anymore but all the real estate that I do own is inside of an LLC mostly because I own it with other partners that are syndicated real estate properties. And I just think that’s a very good idea to limit the amount of money you can lose to your entire investment. I mean it sounds bad when you talk about losing all the money you invested but it sure beats the alternative which is losing even more money than you invested.
[00:36:56] And so it’s interesting he writes back. My parents definitely agree with you. My spouse’s parents own some investment property in Seattle that has gone well. So there’s some pressure on that side of the family to try renting first with all the speculation about how well the market could keep climbing. I’m certainly not looking forward to being a long distance landlord but we’ll likely give it a try using a property management company. I’ll look into the LLC option.
[00:37:20] So it doesn’t sound like ended up being able to talk them out of it. We’ll see how it goes. Hopefully if he listens to this and and he’ll write us back in a few years and let us know how it goes or how much he hated owning it. But I suspect he’s going to hate owning it. We’ll see how it goes.
[00:37:35] So I appreciate you listening to the podcast today. I hope this information has been helpful to you.
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