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04-13-2012, 08:20 AM   #21
Recycles dryer sheets

Join Date: Apr 2012
Location: Oswego
Posts: 76
Quote:
 Originally Posted by Backpacker I am confused by the logic of mortgaging what you paid cash for? Does your debt free status reflect that you have now paid off the 75%LTV mortgage on the rentals?

Think of it this way. Two entities, Steel Rain the person and Steel Rain the corporation. Steel Rain the Person has no debt on his balance sheet, so in normal conversational terms, he is debt free. Steel Rain the Corporation has on the order of 400k debt against 500k in assets on its balance sheet. Steel Rain the corporation is a separate legal entity and the debts can not be easily migrated to Steel Rain the person (Not a perfect analogy, but for the most part correct). Steel Rain the person collects "dividends" (also not entry accurate but close enough) as a stock holder in Steel Rain the corporation.

Now for the really big part of your question. Why mortgage, The math on this is really simple due to the current real estate situation in this country. I will use actual numbers from each of the 4 houses;

House 1. Purchased 90k, invested another 10k, total 100k. After investment, house appraises for 140k and bank agrees to mortgage for 75% of 140k=105k. pocket 5k after pulling out 100% of investment. Cash flow, not counting any positive tax consequences, \$170/mo.

House 2: purchased for 80k, invested 15k, total 95k. Appraises for 135k, obtain mortgage for 75%LTV= 101K. Pocket 6k and recover entire initial investment. Cash Flow \$400/mo.

House 3: Purchased for 65k, invested 12k, total 77k. exactly the same model of house as #2, even on the same block. Appraises for 125k, obtain mortgage for 75% LTV= 94k. Pocket 17k!!! recover initial investment entirely. Cash Flow \$475/mo

House 4: Purchased for 69k, invested 13k, appraised for 137k. obtain 75%LTV mortgage= 102k, pocket 20k!! recover initial investment. Cash Flow \$470/mo.

OK, so, if we had just bought one house and left it unmortgaged, in this case house 1, our worst deal here, that would have been all we could have done. I would have 1 property with 140k in equity and an in investment yield of about 20.4% (12*170/100,000). Pretty good deal.

Under the Current situation We have;

Total Equity for all 4:

(Total Value) \$537k-(Total Borrowed) \$402k = \$135K

Total Cash Flow: \$1570/mo

Investment returns are essentially infinite, since I have no money in at this point and have in fact taken more money out than put in. this is how i paid for my house. I have glossed over some items such as depreciation, maintenance and vacancy but from our last few years, they all essentially wash out as neutral when taken in total.

If you have stuck with me this far, you may wonder how all this is possible. Historically, it has not been possible and in a few more years, will not be possible any more. Why you ask? Simple, we have a perfect storm that has caused housing to become an inefficient market, and that will correct itself in due course.

If you wanted to buy these houses in a conventional way, it would have been impossible, since they would have been rated uninhabitable and therefore you would not have been able to get a mortgage. Couple that with underwriting standards and the overall condition of peoples credit, you have a situation where there are no buyers.

Once you buy it, fix it and go to a bank, they fall all over themselves to loan you money. The barrier to entry to this scheme is very high, you have to have enough cash to buy, fix, rent and carry it for at least a year before you can get a mortgage.

As you can see from my example, we reused the same money over and over again. If we have just stayed free and clear, that would not have been possible as the capital would have been tied up.

Wow, what a wall of text, but thats it in a nutshell why we mortgaged the rentals. Thanks.

Steel.
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04-13-2012, 12:20 PM   #22
Thinks s/he gets paid by the post

Join Date: Jul 2005
Posts: 3,877
Quote:
 Originally Posted by Steel Rain This is an interesting comment. I have seen other folks who posit the same idea. In one way, i agree with you that your personal home should not be bought with a view that its an investment, however, there is a huge imputed tax free income that is derived from owing your home outight. To me, since you have to live somewhere, it acts like a Muni. Now, If I had bought some sort of huge McMansion, the carrying costs would negate this, but my home is a normal house so since I would either pay rent or a mortgage, paying it off seems like a bond. I 100% agree that when making a decision to purchase your home, that assuming anything about it appreciating is wrong headed. In fact, technically, its a liability, but a special sort of one Steel
If you're going to count your house as a bond/muni, then you need to include the imputed rent/mortgage that it pays as a retirement expense. And make sure your retirement portfolio never drops below the value of the house.

Or you could just exclude the house as a retirement asset and exclude imputed (but not actual) rent/mortgage expenses from the retirement budget.

I don't think a house or any actual property acts enough like a bond to plug it in as one on a retirement calculator, so I don't count it as a retirement asset. You can still account for changes in housing as part of your retirement budget using either accounting method, so it may be a matter of personal preference.
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 04-13-2012, 12:47 PM #23 Thinks s/he gets paid by the post   Join Date: Aug 2011 Posts: 1,928 Steel, I would highly recommend that you check your 401(k) rules to see if they permit the following two features: - After Tax Contributions AND - In Service Withdrawals of After Tax Contributions If that is the case you might be very well served by contributing your \$49,000 per year or so to your 401(k) after tax, and then doing an in-service withdrawal to a Roth IRA. Using this strategy, DW and I managed to quickly grow our Roth IRA balances to six figures in the past few years.
04-13-2012, 12:54 PM   #24
Recycles dryer sheets

Join Date: Apr 2012
Location: Oswego
Posts: 76
Quote:
 Originally Posted by gauss Steel, I would highly recommend that you check your 401(k) rules to see if they permit the following two features: - After Tax Contributions AND - In Service Withdrawals of After Tax Contributions If that is the case you might be very well served by contributing your \$49,000 per year or so to your 401(k) after tax, and then doing an in-service withdrawal to a Roth IRA. Using this strategy, DW and I managed to quickly grow our Roth IRA balances to six figures in the past few years.
Really, can you elaborate a bit more? I think any excess contribuitions are treated like a normal IRA, but I can check on that. Im assuming thats the gist of this. Are there any limits to this?

Kevin;

04-13-2012, 12:57 PM   #25
Recycles dryer sheets

Join Date: Apr 2012
Location: Oswego
Posts: 76
Quote:
 Originally Posted by Animorph If you're going to count your house as a bond/muni, then you need to include the imputed rent/mortgage that it pays as a retirement expense. And make sure your retirement portfolio never drops below the value of the house. Or you could just exclude the house as a retirement asset and exclude imputed (but not actual) rent/mortgage expenses from the retirement budget. I don't think a house or any actual property acts enough like a bond to plug it in as one on a retirement calculator, so I don't count it as a retirement asset. You can still account for changes in housing as part of your retirement budget using either accounting method, so it may be a matter of personal preference.
Im not sure I understand this. Why would i count the imputed Rent/Mort as an expense, no money is going out the door? I guess I may be using incorrect terms. I think the best way to account for this is to not count the house as portfolio, and do my expense planning as it stands, meaning no house payment.

Kevin;

04-13-2012, 01:42 PM   #26
Thinks s/he gets paid by the post

Join Date: Aug 2011
Posts: 1,928
Quote:
 Originally Posted by Steel Rain Really, can you elaborate a bit more? I think any excess contribuitions are treated like a normal IRA, but I can check on that. Im assuming thats the gist of this. Are there any limits to this? Kevin;
My 401(k) administrator is Fidelity. I can send you a copy of the plan document via PM if you like.

IRS limits pretax contributions to about \$16.5k per year or so (in 2011).
There is a second IRS limit, that's discussed less, on total contributions (including pretax, after tax, employer match etc) that is around \$49k per year. I believe it is referred to as the section 415 limit on Defined Contribution plans.

Our plan allows us to send up to 50% of salary to the 401(k).

I have been doing all pretax contributions for most of my career so, since 2010, I started doing all After Tax and then saving the max of 50% but being sure not to exceed the \$49,000 per year limit.

The plan also also allows in-service withdrawals (ie you don't have to quit your job to take \$ out of your 401(k))

I make a withdrawal once or twice a year and then roll the money over to my traditional IRA.

Once the money is in my traditional IRA, I do a Roth conversion with the same IRA custodian (Vanguard).

When tax time rolls around, I get 2 1099-R's one from Fidelity for my 401(k) withdrawal/rollover and one from Vanguard for the IRA Roth conversion. At this point, the only tax that is due is on the growth of the principal between the time it was invested in the 401(k) and the time the Roth conversion is executed.

If your plan allows this and you are interested in looking into it further, there is one BIG issue that you need to be aware of. In general when you make these withdrawals, the withdrawals may be considered pro-rated between your Pre-Tax contributions and your After-Tax contributions. You don't want to find this out after the fact when you are doing your taxes!

The trick is to make sure that you isolate your basis. Do a Google search on "isolating the basis" and "'Roth conversions" to get the details/requirements to sequence these transactions the first year to do this properly. You might want to work with a financial professional who is fluent in this technique. (I did a lot of homework the first year before I did this myself back in 2009 before the income limits were lifted for Roth conversions in 2010 -- more homework than most are probably willing to do)

On the other hand, if you wanted to do a Roth conversion of all your Pre-tax contributions and pay the appropriate tax (probably on the order of \$100k in your case) , then this would not be an issue.

04-13-2012, 04:01 PM   #27
Recycles dryer sheets

Join Date: Apr 2012
Location: Oswego
Posts: 76
Quote:

Wow, this is awsome informaion Gauss. I really appreciate it. I need to talk to the plan administrator and see about this. Nothing on our website that is clear about this. This place is a boon of information

Stell

 04-13-2012, 09:16 PM #28 Thinks s/he gets paid by the post   Join Date: Mar 2007 Posts: 1,088 gauss, when you put the \$49k into an IRA, is it a non-deductible IRA? If so, why not go straight there with it rather than going into the after-tax portion of your 401k first? I'm confused. __________________ "Live every day as if it were your last, and one day you'll be right" - unknown
04-14-2012, 07:56 AM   #29
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Join Date: Aug 2011
Posts: 1,928
Quote:
 Originally Posted by Finance Dave gauss, when you put the \$49k into an IRA, is it a non-deductible IRA? If so, why not go straight there with it rather than going into the after-tax portion of your 401k first? I'm confused.
The \$ ends up in a Roth IRA as opposed to a taxable account --> no taxes on future growth under current tax law in the Roth IRA.

Also, this technique allows up to \$49,000 of new money to get into the Roth IRA each year as opposed to the normal \$5000 limit for new contributions.

If you can structure the transactions so that you can isolate the basis, you end up continuing to defer the taxes on the taxable portion, and just move the after tax portion to the Roth IRA, but this is the tricky part.

Lots of discussions/analysis of this over at fairmark.com. See strategy 3 and strategy 4 at this post.

I also found the online "withdrawal modeler" that was available at my 401(k) plans' site useful to confirm how my withdrawal would be treated (ie how the distribution will be allocated between pre-tax and after-tax dollars) before I executed it. DW's plan had a similar tool available.

You might also want to do just a small amount the first year and then file the taxes the following April to confirm that everything goes as expected.

 04-14-2012, 10:08 AM #30 Thinks s/he gets paid by the post   Join Date: Jul 2005 Posts: 3,877 Can't make after-tax contributions or in-service withdrawals in DW's 401k, so I guess that simplifies things for me.
04-14-2012, 11:16 AM   #31
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Join Date: Aug 2011
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Quote:
 Originally Posted by Animorph Can't make after-tax contributions or in-service withdrawals in DW's 401k, so I guess that simplifies things for me.
I had always wondered, if our 401k plans became more restrictive, if I could accomplish the same goal by opening up a 'Solo 401(k)' designed for very small business owners.

04-14-2012, 02:57 PM   #32
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Join Date: Jul 2005
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Quote:
 Originally Posted by gauss I had always wondered, if our 401k plans became more restrictive, if I could accomplish the same goal by opening up a 'Solo 401(k)' designed for very small business owners.
I do have a Solo 401k (with E*Trade), and I can select many of the options. Not sure I have the ability to contribute after-tax money, but pretty sure I have in-service rollovers. However, DW is working and I'm not, so it's not doing me any good.

04-14-2012, 07:04 PM   #33
Thinks s/he gets paid by the post

Join Date: Mar 2007
Posts: 1,088
Quote:
 Originally Posted by gauss The \$ ends up in a Roth IRA as opposed to a taxable account --> no taxes on future growth under current tax law in the Roth IRA. Also, this technique allows up to \$49,000 of new money to get into the Roth IRA each year as opposed to the normal \$5000 limit for new contributions. If you can structure the transactions so that you can isolate the basis, you end up continuing to defer the taxes on the taxable portion, and just move the after tax portion to the Roth IRA, but this is the tricky part. Lots of discussions/analysis of this over at fairmark.com. See strategy 3 and strategy 4 at this post. I also found the online "withdrawal modeler" that was available at my 401(k) plans' site useful to confirm how my withdrawal would be treated (ie how the distribution will be allocated between pre-tax and after-tax dollars) before I executed it. DW's plan had a similar tool available. You might also want to do just a small amount the first year and then file the taxes the following April to confirm that everything goes as expected.
I'm sorry, I still don't understand.

First, you never answered my question about whether the IRA was a non-deductible IRA.

What I was saying is, why not directly deposit the money to a non-deductible IRA, then convert it to a Roth? Why do you need to go through the after-tax portion of your 401k?

Also, where do you get the \$49,000? I don't see that quoted anywhere in the Fairmark link.
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04-14-2012, 07:14 PM   #34
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Quote:
 Originally Posted by Animorph There is a big discussion now on waiting periods between contribution and conversion, so you might read up and decide what you're comfortable with.
Are there waiting periods?

I contribute to my tIRA then within a day convert to the Roth, I do this to avoid any possible gains on the contributions. Theoretically there is no tax due since I haven't made any gains.

I figure that is the best move to avoid tax consequences, but I haven't read or heard anything about suggested waiting periods.
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 04-14-2012, 08:15 PM #35 Thinks s/he gets paid by the post   Join Date: Aug 2011 Posts: 1,928 Finance Dave, IRA is Traditional - non-deductible in my case. Some, but not all, 401k plans allow after tax contributions. The IRS sec 415 limit of total contributions to a Defined Contribution plan such as 401k in 2011 is 49,000. It sounds like many 401k plans do not accept these after tax contributions however.
04-15-2012, 11:22 AM   #36
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Quote:
 Originally Posted by Ronnieboy Are there waiting periods? I contribute to my tIRA then within a day convert to the Roth, I do this to avoid any possible gains on the contributions. Theoretically there is no tax due since I haven't made any gains. I figure that is the best move to avoid tax consequences, but I haven't read or heard anything about suggested waiting periods.
There are no official waiting periods. I haven't read the discussions about them very closely. But I believe there is some concern about "intent", and the wait is supposed to help with that. Something I would study before jumping into a backdoor conversion.

Forbes:
"There’s still time to make an IRA contribution for calendar year 2011 through April 17, 2012. You can double up and make your 2012 contribution too. How long should you wait to convert? “It’s a grey area,” says Robert Keebler, a CPA in Green Bay, Wisc. He suggests a waiting period of six months, although other advisors say to convert the next day to limit the tax bite on the conversion."

WSJ:
"There isn't a tax deduction for the contribution, but the law allows owners to convert such accounts to Roth IRAs. IRA expert Ed Slott says there isn't an official waiting period; he suggests a couple of weeks."

So, not much information, just speculation on what the IRS might think about it.

04-17-2012, 11:00 PM   #37
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Quote:
 Originally Posted by gauss Finance Dave, IRA is Traditional - non-deductible in my case. Some, but not all, 401k plans allow after tax contributions. The IRS sec 415 limit of total contributions to a Defined Contribution plan such as 401k in 2011 is 49,000. It sounds like many 401k plans do not accept these after tax contributions however.
OK, I give up lol.

I have not suggested putting it in the after-tax portion of a 401k....I suggested putting it in a non-deductible IRA, then convert it to a Roth. You don't need a 401k at all.

Granted, that would have a limit of about \$6k/year...so that may be why you are doing it through the 401k....to get the dollar amount higher...I'll have to think about that.

Thanks Gauss.
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04-18-2012, 05:58 AM   #38
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Quote:
 Originally Posted by Finance Dave OK, I give up lol. I have not suggested putting it in the after-tax portion of a 401k....I suggested putting it in a non-deductible IRA, then convert it to a Roth. You don't need a 401k at all. Granted, that would have a limit of about \$6k/year...so that may be why you are doing it through the 401k....to get the dollar amount higher...I'll have to think about that. Thanks Gauss.
Correct! If you want to stay within the standard yearly IRA contribution limits then there is no need to involve a 401(k).

OP wanted to invest about \$4k/month. That was why I suggested this strategy if it was available to him.

Sorry about the confusion.

04-18-2012, 01:18 PM   #39
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Join Date: Mar 2007
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Quote:
 Originally Posted by gauss Correct! If you want to stay within the standard yearly IRA contribution limits then there is no need to involve a 401(k). OP wanted to invest about \$4k/month. That was why I suggested this strategy if it was available to him. Sorry about the confusion.
No problem Guass. I found a few articles on this...this was one of the better ones IMO for the items I was confused on.

http://www.paulweiss.com/files/Publi...10RothMemo.pdf

Here's another with more details.
http://hwcdn.net/v3n9d4a6/cds/alwp/a...5434967153.pdf

There are some "gotchas", such as the fact that you must be 59 1/2, which I am not. Also, if you take from pre-tax, it's a taxable event if you take pre-tax money (makes sense), so that minimizes the chance high-earners would do this while working. If you take after-tax, there are some complications around pre-87 vs. post-86 monies.

Still may be useful for some.

Dave
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 04-21-2012, 05:22 AM #40 Recycles dryer sheets   Join Date: Apr 2012 Location: Oswego Posts: 76 Well, I checked into doing this at work and its a no go So, i will have to use the backdoor IRA suggested above. I will get that going in the next couple of weeks, I belive its a 10k limit for married couples, so it will only be a small fraction of my plan. Thanks for all the great info folks. Steel __________________

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