Monthly Archives: October 2018

So You Want to Flip Homes?

Buy a house, put in a few improvements, and then sell it for a much higher price. Do it again and again. It sounds so simple, but here are a few pointers to keep in mind if you want to succeed with house flipping:

Experience: If your experience in real estate is performing repairs on your home during weekends, then you do not have the required experience. Ideally, you should have experience in both residential construction and real estate sales.  Experience as a general contractor will help you to determine the amount of time and costs to improve a potential flip, while experience in real estate sales will help you to locate a property, determine the market characteristics, and eventually sell the property.  Both are extremely important because you want to maximize your profit by investing your time and money in the right house and the smartest improvements. If you do not have this experience then you need to spend the time to learn as much as possible before purchasing a flip to minimize costly errors.

Know your costs and potential selling price: Before purchasing a property you need to estimate your cost of purchasing the property, the necessary improvements, and carrying costs such as real estate taxes, loan payments, utilities, and insurance. Just as important is the estimated selling price. If you underestimate your costs, overestimate the selling price, or underestimate the time to improve and sell the property, then your chance of profit will be greatly decreased. The formula is simple, but not always easy to accomplish; profit = the selling price minus all costs. With this in mind you want to make sure that you leave enough wiggle room to make a profit in case your estimates are off.

Capital: If you don’t have the necessary capital to purchase a fixer upper, make improvements, and pay the carrying costs, then you need to either obtain a loan or partner with someone who has the necessary capital. Make sure that you have a cushion just in case your estimates are wrong.

Time and opportunity cost: Let’s say that you are a contractor and are looking to flip a house. Make sure that you estimate that you will make more money on the time spent with your flip than during your regular construction activities. The same goes for anyone else trying to invest their time and money in a flip.

Start small: If just starting out then make sure that your first slip does not have the potential to decapitate you financially. Just think back to what happened to many house flippers about a decade ago.

Taxes: Most likely your profit will be taxed at ordinary income tax rates and possibly self-employment taxes vs. long-term capital gains rates. This is due to the fact that you are usually considered to be a dealer with the intent to buy, improve, and sell a home in a short time frame.

Alternatives: An alternative and close cousin to house flipping is to rehab a rental property, rent it out, and hold it for the long term. It is not as exciting as house flipping, but it can be very worthwhile, while also carrying less risk.

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5 Financial Truths

There is a lot of information out there about finances, and it’s hard to figure out what is exactly true or not true. Always seek the truth, especially from someone that is not trying to sell you something. Here are some examples:

College: We are led to believe that all of our children must go to college to be successful and make a lot of money. While I am a big believer in education and college, it is not the only route and it is not for everybody. With the high cost of college, the decision to attend college should not be automatic. There are alternatives, such as becoming a tradesman, learning a special skill that does not require college, starting a business, sales positions, military or government positions that do not require college, stay at home parent (yes, this is a vocation), etc.

Retirement savings: Saving for retirement is a good thing, however, it should be balanced with both short and mid-range needs. For example, if you allocate virtually all of your savings towards retirement accounts and ignore having a cash cushion, then your risk of financial catastrophe increases. If a financial crisis arises or a large purchase needs to be made, then you will have to withdraw from your retirement accounts, which is one of the worst financial decisions to make due to both income taxes and penalties on the withdrawals. Furthermore, if you do not have withholdings taken from your distributions, then you will probably end up with a tax problem once you file your return. The prudent action is to have a cash cushion of 3 to 6 months of expenses for emergencies and to save for mid-range goals, such as a house purchase.

Debts: Debt truly is a double-edged sword. There are some who advocate staying away from debts at all costs and others who encourage you to leverage yourself to make more money. The truth is that debt should be used wisely and sparingly, if necessary and as a last resort, and it should not cripple you. If you are able to avoid debt, then that is excellent, as debts increase your risk and they also encourage risky behavior and increased spending in many cases.  To prove this point, why do you think McDonald’s started to accept credit cards, why do auto loans have 7 year terms, and why can young adults take out massive loans for college?  It is to get you to spend more than you would have otherwise.  As you mature financially you should seek to decrease your debts.

Most people would not be able to afford a house without obtaining a mortgage, and if they waited to purchase a house and rented instead, then they would most likely be worse off financially over the long term. Also, some businesses may need to incur debts to purchase expensive equipment, inventory, or improvements that would not be possible if they did not incur debts. To emphasize, it should be used wisely and sparingly.

Expenses, income and savings: Most likely your expenses are way too high. If you are able to save 15- 20% of your income and have no debts then spend whatever you want. Otherwise, set aside money towards savings to steadily increase the percentage that you save each time you get paid. This way you will spend whatever is left over. If you are not able to do this then you need to take a serious look at decreasing your expenses and increasing your income. The truth is that it is really not that hard, but most people have a hard time doing this. As Yogi Berra said, “Baseball is ninety percent mental. The other half is physical.”

Home and health = wealth: In the quest for success, don’t ignore your most valued relationships or your health. Nothing can cripple your finances as quickly as health or family issues, such as divorce. With either of these issues your expenses increase exponentially while your income suffers at the same time. Make sure to prioritize.

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A Few Tax Scams to Be Aware Of

The IRS posts a list of tax scams each year that you should be aware of:

Phishing: This is when fake emails are sent claiming to be from the IRS, however, the IRS never initiates contact with taxpayers via email about a bill or tax refund. You’ll see more of these during tax season.

Phone scams: I have even received some of these calls on my cell phone. Criminals, many times calling from overseas, will state that they are from the IRS and then threaten that you will be arrested, deported, etc. if you do not immediately pay a tax balance. By the way, the IRS will not do this, and they especially will not ask you to purchase gift cards from CVS or to wire them money to take care of your balance.

Identity theft: You usually find this out when your tax return gets rejected because it has been filed already. This is because your identity was stolen and criminals filed a return using your social security number to obtain a fraudulent refund. Always try to protect your personal data when you can to help to minimize this risk.

Fake charities: The IRS says that fake charities may even have similar names as national organizations. Make sure the charity is legitimate, and you can even check out the status of a charity at the IRS website. By the way, when I first started my practice years ago, I came across someone who started a fake charity and solicited donations to help people after 9-11. Supposedly, they used the money to pay for expensive vacations instead. Know your charities.

Abusive tax shelters: These are schemes that are promoted to avoid paying taxes that are illegal. If it sounds too good to be true, then it probably isn’t true.

Other scams include: return preparer fraud, inflated refund claims, excessive claims for business credits, falsely padding deductions, falsifying income to claim credits, frivolous tax arguments, and offshore tax avoidance.

Most of these scams can be avoided just by using a competent and trusted tax preparer.

 

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Where Are all of the Young CPA’s and Why Should You Care?

I was at another continuing professional education seminar recently, which is very often as CPA’s are required to have 120 hours of continuing education every three years. One of the observations that I make each and every time is that I am one of the youngest CPA’s in the entire room. This is true now and was true 10 plus years ago when I became a CPA. Unfortunately, I have been jumped past the young man status, so it has nothing to do with being a “young” CPA. Why does this matter and why should you care?

Some details: When looking around the room this time and every time, It appears that approximately 5% of the CPA’s are younger than 50 years old, with the majority being older than 60. Could it be that older CPA’s attend the seminars that I happen to attend or is this true throughout the profession. When digging deeper, I found out that according to the AICPA, approximately 75% of CPA’s are expected to retire in the next 15 years, so my observation applies throughout the entire profession, and not just Bergen County.

More accountants, less CPA’s and CPA firms: Studies are showing that although there are more accounting graduates, less are becoming CPA’s. There are numerous reasons why including greater education requirements, time requirements, and the expense of taking and studying for the exam. Also, although I do not have a statistic on the age of CPA’s that own small firms, I do not know, even casually, one CPA firm owner that is younger than me. Just to reiterate, I am not a spring chicken anymore.

Negative impact on clients: CPA’s are the main business and tax advisors to small business owners and many individuals, so who will fill this void? I can only make several guesses to the alternatives, which are not very good for clients. Alternatives include: using non-CPA business advisors and preparers (whom generally lack the education, expertise, and training of CPA’s), using larger firms (along with much higher prices and less attention to the “little” guys), and doing everything yourself (ie. QuickBooks, however you need to be an accountant to actually get the numbers correct, along with not receiving guidance that saves business owners more than they actually pay their CPA). Another negative aspect is that there will be less CPA’s to collaborate with as peers. As a side note, the CPA’s that I know have been the most generous, helpful, and supportive people to me professionally.

General trends: There has been a generally trend for less people to start their own businesses, which has been the case for decades, according to a 2017 report by the Kauffman Foundation, titled, “The Entrepreneurship Deficit.” Several reasons are cited, including demographic changes, technology, and geographic changes. It appears that the CPA profession is not immune to these general trends, and as a result there are less small CPA firm owners.

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