Afford Anything - Ask Paula: Escaping a $100K Tax Nightmare

Episode Date: September 10, 2024

#539: An anonymous caller feels trapped. She owes $100,000 in back taxes on earnings she had to give up as a result of a lawsuit with her former business partner. What should she do? Saul and his wife want to retire in Mexico but they don’t want to give up the ability to continue investing in US stocks. Can they buy a primary residence that doubles as a short-term rental? Nina and her partner are eager to start a $500,000 renovation on their home but they’re still three years away from saving enough. How can they bridge the gap without risking too much? Former financial planner Joe Saul-Sehy and I tackle these three questions in today’s episode. Enjoy! P.S. Got a question? Leave it at https://affordanything.com/voicemail For more information, visit the show notes at https://affordanything.com/episode539 Learn more about your ad choices. Visit podcastchoices.com/adchoices

What do you do if you love where you live, but you're not sure you can afford to stay? What would you do in that situation, Joe? I'd buy a tent and I would camp in somebody's front yard until they kicked me out that I'd go camp in somebody else's front yard. No, that's not what I'd do. I don't know what I'd do. That'd be tough, wouldn't it? It would absolutely be tough. And we are going to tackle that question at the end of today's episode.

But before we get to that, we're going to talk to an aspiring expat who is going to retire in Mexico, but for a few reasons, he also wants to maintain residency here in the United States. What should he do? And we're going to kick off with a question. Actually, I'm not even going to spoil the first question. So those are the three questions we're answering today. Welcome to the Afford Anything Podcast, the show that understands you can afford anything, but not everything. Every choice carries a trade-off. So what matters most? This show covers five topics. Financial psychological, increasing your income, investing, real estate and entrepreneurship. It's double eye fire. I'm your host, Paula Pantt. I trained in economic reporting at Columbia,

and I hope you focus on what matters. Every other episode, I answer questions that come from you alongside my buddy, former financial planner Joe Salci. Hi. What's up, Joe? It is a super day to be here with you, Paula, and we've got some great questions. Amazing questions. Let's hear the first, which comes from Anonymous. Hi, Paula. I'm finding myself in a tax bind, and and I was hoping that you and or Joe could give me some advice on what to do with my situation. So the last several years of my professional career, I've been a 1099 contractor working in a business and helping my ex-business partner to grow the business. I never knew how much I was going to make, so I never paid estimated taxes. In my first year, I made $90,000, second year, $160,000, and in my

third year, about $360,000. So because I knew my revenue was going up in the business, and me being a profit share of the business, I never really paid estimated taxes so that I could just wait till the end and pay in a lump sum. Well, long story short, the business partnership went super sour. There was a lawsuit involved and essentially a lot of the money that I was paid was retracted and I was asked to give back a lot of it. So I do not have money for a lump sum payment and I owe something like $70,000 for federal taxes, $20,000 for state taxes, and $10,000 for city taxes. Those amounts continue to increase in both the interest penalties and fees. And so I don't really know what to do from here. Is there anything like tax abatements or something? Do I talk to a tax professional to do those

things? Just in a bind. Thanks for your help. Anonymous, first of all, I am so sorry to hear about that. That is a incredibly stressful situation and I can hear in your voice that you are handling it well. You sound calm, you sound collected. You are willing to face it. Let me give you accolades. A lot of people when they are faced with a tough tax situation, do not face it. A lot of people will try to ignore it in the hopes that it might go away. I have done that. Joe, you have done that. You shared a story recently about how you've done that. So anonymous, I'm going to give you a name in a second, but before I do, I want to first commend you for the fact that you are facing this head on,

which requires so much courage and strength and bravery. Yeah, I think there's a lot to unpack here. The good news is, is there is a light at the end of this tunnel and it's not a train, which is awesome. Because it feels like a train right now. I know it feels like a train. I know it feels like a train. Of course it does. So we're going to give her a name first and then we'll get on this. Yes, Joe, do you have any name inspiration? Well, you and I were having a wonderful, wonderful discussion about a creator that I love, an author named Jenny Lawson. Jenny is hilarious. She's written some awesome books. I just recounted a story about Jenny to you, which people can dive into her because there's so many

funny Jenny Lawson stories. I highly recommend all of her books. She's a wonderful blog. If you want to get to know her, she was known originally as the bloggest. She was the queen of all blogs, which is hilarious on its own, not as egotistical as you think. What I like is how she talks about being brave. And Jenny has had to be brave, Paula, around some things that are kind of everyday things because she really struggles with anxiety. And the fact that she's been so open about that, she's empowered so many people. So we're going to talk a lot today about being brave.

So I think we should call her Jenny. All right. Anonymous, your name is Jenny. I think the first thing she needs to do, Paula, is do what I did. not because I did it, but because it worked. And that is, number one, find a good CPA. Yes. Who can A, help you with this mess, because it is a mess.

Yeah. And then B, can also help you negotiate with the IRS. Because the big thing you're going to want to do right away is come clean with the IRS, tell them exactly where you are. Because, as was the case in my situation, the people at the IRS were the most helpful. And every day that you delay, the more the penalties are just going to keep getting worse and worse and worse. So coming clean with them. But the second thing the CPA might be able to do.

And this is where my former role as a financial planner versus a CPA, which is what you really need, allows me to know what question to ask, but not to know the answer. This is the question I would ask because I didn't ask it. And I didn't even realize I should have asked it until much, much, much later. And I worked with the great CPA. But can you restate what you earned during those years? Or is there a time lapse that's been too long? Maybe for the first year, it's too long. But certainly for last year when you made $360,000, assuming that was last year, you may still be able to refile that income tax return at a lower number because you'd be paying tax on money. that you truly didn't make, right? If you had to give back these earnings because your earnings were misstated, then I think there may be a case there. I don't know if there's a case. And I also don't know. This is the other thing I don't know. I don't know, Paula, if you give me money

and then you ask for it back, if then that means that I didn't earn it in the first place because I did earn it. And then I give the money back to you, or is there a way that I can just 1099 you back for that money that I had to give back? You know what I mean? I'm not sure what those mechanisms are, but I know that if I give you money, I've got to show the government that somehow. So there may be a bunch of this tax that you don't even know. Right. Exactly. So that was my first thought as well. Because there are a few ways that this would go. Number one, you can file, you should definitely talk to a tax professional, but you can file an amended tax return within three years. So up to three years after you have made a tax filing, you can file an amended return. Now,

what the parameters of that amended return are, that's a question for a tax professional. But one possibility, as Joe said, is that you may be able to restate your income retroactively. Yeah. That's one possibility. And again, you need a tax professional to confirm whether or not that is available to you. Another possibility, you mentioned that this is a business partnership. Now, I don't know the structure of that business partnership. For example, is it the case that you yourself were an independent entity and your partner was an independent entity and the two of you had a joint venture together? If that's the case and you had a joint venture but you yourself are structured as your own

entity, then it may be the case that you showed gains in those previous years, but now you show losses this year, right? I'm thinking about an LLC that receives money in the year 2021, 2021, 2022, 2023, but then loses money in the year 2024. Oh, I see. So she, let's say, gained $360,000 in 2023. Right. At 2024, she pays back $100,000 has no income. So she shows minus $100 in the following year. Right. Exactly. Okay. That's another possibility, right? Because if she is structured as her own business, then that business would have taken, would have shown a gain in 2023, but would show a loss in 2024, meaning ultimately over the long term it would net out. Those are two. And again, I want you to go to a tax professional because they will understand all of the nuances of your structure, your payment arrangements, et cetera. And they'll be able to advise very specifically all Joe and I can do as members of the financial media. is give you broad 30,000 foot view education on what types of questions you should ask a professional. And that's specifically what we would highlight.

Now, beyond that, Paula, the best option, I don't know what the overall best option, but probably what will happen. And this is more for everybody else listening, is that you will enter into agreement with the IRS where you're on a payment plan. And there will still be penalties, but however, this will help minimize those. It will help minimize the interest. The IRS will work with you on that. And you will fill out a bunch of forms, a bunch of online forums to determine how much the IRS thinks you can afford to pay every month. Now, what the IRS says you can afford every month and what you think you can afford every month are going to be two things. And I just want to let you know you will not be in charge.

The IRS is going to be in charge. They're going to give you a couple options, pay it, off quicker, pay it off slower, but then you're going to sign an agreement. And if you don't stick to that agreement, it's going to get really, really, really, really, really, is that enough for release? It's going to get very ugly. It hurt for me. It's going to hurt for you. It's going to be difficult, but it's not undoable. And what's great is the relief that I felt, once I knew exactly what the parameters of the damage was that I was facing. And the fact that every month it was getting better. And I got so excited about it, Paula, I paid it off early. When things started rolling,

I just, I want to get that behind me. Obviously, it was a huge weight off my shoulders mentally to get rid of that issue. And for those of you who missed it, if you want to hear the full story of Joe's personal experience in owing three years' worth of back taxes to the IRS, which Joe is something that you experienced in your late 20s, early 30s, you can hear that story. in episode 537. Affordanithing.com slash episode 537. You experience sounds like I was a bystander on the side of the road. Let's be clear.

I created the mess. I created a mess by not looking at it. So, yeah, just to be clear, I did not experience it. Yeah. I drove the car into the wall and then I had a bunch of people help me get better about it. Here's the next thing. What we just described, Paula, though, was looking in the rear of remeer. and fixing the issue. The bigger thing to do is to use automation to make sure this doesn't happen

again, right? So the key is, is how do I make sure that this doesn't happen? And there's one of two mechanisms you can use. The first one is the one that I recommend most people use. If you get 1099 money in, have a mechanism by which that money goes into an account that is not your main grocery account, travel account. You don't take money out of that account, except. to pay yourself. This is not your main account. And the reason is you want to monitor the amount of money that goes into that account so that once a quarter, you have enough money there to take out money for taxes. You can look every quarter at how much money comes in. I'll tell you what I had to do because of the fact that I have, and Paula knows this, a very ADD personality. And if I

see complexity, I just freeze. I hired a great accountant. I meet with her once a month. And And at the end of the quarter, I always have this reckoning of where we are. Now, I don't do the quarterly tax thing. I don't do it because there's a second thing you can do. And it's, by the way, there's no way to get away from the tax. This is not get away from the tax. For us, it's just ease of management. I'm in a two-income household.

And my spouse also works. And she gets withholding from her workplace. So what we decided is instead of trying to figure out how much money to withhold for one big quarterly check, we will take a lot extra out of Cheryl's check. So Cheryl gets these monster, monster withholdings, which includes withholding so that we don't have to do the quarterly tax return. If you're in a two-income household, you can try to figure that out with a good accountant. If not, then I like having money in an account. You're not going to touch. And once a quarter, look at how much money came in, send in the quarterly payment. It's 99% automated then.

You know, I should add, even if you're single or in a one-income household, as I am, if you set yourself up such that you are a W-2 employee of your own business, which is what I've done, you know, I use Gusto as my HR platform, and I have set myself up such that I am a W-2 employee of Afford- Anything LLC. And so as an employee of the Afford- Anything company, I receive a bi-weekly paycheck. And then you just jack up your withholding there to minimize the pain of that quarterly bill. Exactly. Yeah. So if you do set yourself up as an employee somehow, I love that. I like it for simplicity. I like it so that you never get to the end of the quarter and you go, uh-oh.

Because for me, back in the day, I always thought that I would make up for it next quarter. I'm not going to withhold it this quarter. I'll make up for it next quarter. And then you never do. There's always an emergency. So those are the two ways to do it, Paula, I think. Yeah. And systems were the answer for,

me. And I think systems, I don't think I'm a snowflake there. I think systems are the answer for most people. When you find some brilliance in your life, if you decide to cut out the Netflix bill, like we're busy high-fiving ourselves that we saved $18, $20 a month, whatever it is, take that $18 and add it to the amount you're putting in your 401k at work or the amount that you're putting into your emergency fund or the amount that you're like automated. So you don't just save $20 one time. You're saving $20 for. forever. It's beautiful. Whenever I find money now, I automate it. I lock it in. I automate it. Make sure that I replicate that savings over and over and over and over and over again. And you know

it's cool. Every time I set up more money to automated savings, I feel pressure on myself to never decrease it again. Right. So let's say I go and I decide I'm going to get Netflix later. In my mind, that money is being saved. I don't want to not save that money. So it's funny because you play these mental behavioral games with yourself to save more money than you thought you could. Yeah, exactly. But Jenny, to your situation, you absolutely 100% need a tax professional. Your situation has a lot of complexity. It has a lot of specificity. There is no way that you can or should get through this without a tax professional on your side. And it is so for most people, maybe not for everybody. I can actually only speak to my personal experience, but it's so calming.

It's so calming. To have that person in the room, the grown up in the room who's been through it. Yeah, who's not emotional about it. Right. The second out at her before, because she's so amazing, when I hired Sue, I walked out of that first appointment, having accomplished nothing yet just with my arms in the air. I slept so much better, knowing that we had a plan. Right. Jenny, that at least gives you a sense of what questions to ask the tax professional. Can you file an amended return? Can you restate your earnings? Can you claim this as a loss? What are the various ways in which you can get that tax bill down? And it isn't really even about getting it down. It's about how can you get the tax bill to reflect the reality of the amount that you were actually compensated? Because ultimately you were not compensated the full 360,000 that you received last year. I think that's the best news of all. I don't think you owe that tax. Yeah, I think there must be ways of getting your tax filing to reflect reality. And a good tax professional will help you find exactly what that is. So that's one piece of advice.

The other piece of advice, Paula, is Jenny could move to a country that has no extradition. Just let it go. Well, technically, you can't be jailed for being a debtor. You can for committing tax fraud and you can for not filing, but you can't be jailed for being a debtor. Well, there you go. So extradition is not even a relevant question when it comes to fleeing the country. Okay. I take advice number one.

I take door number one. Don't go with door number two. The reason Joe is talking about fleeing the country is because the next question that we are going to answer comes from a caller who wants to move to Mexico. He and his spouse are five to seven years away from retirement. They want to move to Mexico. But by virtue of doing so, they lose access to some of the things that they're able to do that require having U.S. permanent residency. And so they're wondering if they can have a primary residence in the U.S. while also being expats in Mexico. We're going to talk through that situation right after we take a moment to hear this word from the sponsors who are. allow us to bring you this show at no cost to you. The holidays are right around the corner and if you're hosting, you're going to need to get prepared. Maybe you need bedding, sheets, linens. Maybe you need servware and cookware. And of course, holiday decor, all the stuff to make your home a great place to host during the holidays.

You can get up to 70% off during Wayfair's Black Friday sale. Wayfair has can't miss Black Friday deals all month long. I use Wayfair to get lots of storage. of items for my home, so I got tons of shelving that's in the entryway, in the bathroom, very space-saving. I have a daybed from them that's multi-purpose. You can use it as a couch, but you can sleep on it as a bed. It's got shelving. It's got drawers underneath for storage. But you can get whatever it is you want, no matter your style, no matter your budget. Wayfair has something for everyone. Plus they have a loyalty program, 5% back on every item across Wayfair's family of brands. Free shipping, members-only sales, and more. Terms apply. Don't miss out on

early Black Friday deals. Head to Wayfair.com now to shop Wayfair's Black Friday deals for up to 70% off. That's W-A-Y-F-A-I-R.com. Sale ends December 7th. Fifth Third Bank's commercial payments are fast and efficient, but they're not just fast and efficient. They're also powered by the latest in-payments technology, built to evolve with your business. Fifth Third Bank has the big bank muscle to handle payments for businesses of any size. But they also have the fintech hustle that got them named one of America's most innovative companies by Fortune magazine. That's what being a fifth third better is all about. It's about not being just one thing, but many things for our customers.

Big Bank muscle, fintech hustle. That's your commercial payments of fifth third better. Our next question comes from Better Call Saul. Hey, Pauline Joe. This is Sol as in Better Call Saul, C-high. My wife and I currently live in Virginia, and we are both 48. We are planning on retiring in Mexico in the next five to seven years, where we already own a fully paid home and can live pretty much comfortably with about

$4 to $5K a month. I know that I can set a foreign address on my fidelity accounts, but that brings some consequences, such as the inability to buy new mutual funds or open new accounts if needed. Because of this, my wife and I were thinking about selling our primary residence and rental property in Virginia, which, by the way, makes no money. It just covers the current mortgage payment. And the proceeds of those sales, we would use to purchase a primary address home in either

Houston, Texas, or Las Vegas, Nevada, since both locations would be no income tax states. And we plan on purchasing this home outright without any mortgage. So my question is, can we legally have a primary resident? be a short-term rental as well, such as an Airbnb. Do you know if this varies by state or maybe even neighborhood? Paula, I believe you lived in Las Vegas before, and now while my wife and I don't plan on living at this place for maybe more than three months at a time during most likely the winter months,

I would like your opinion and maybe thoughts on this. Thank you and love the show and what you do for the community. First of all, I can't believe with the name like song, Saul, see hi. Why he wouldn't just move. If Houston, Saul is only five hours away from Texarkana, you're still in Texas. You can still get the tax break on housing that you get in Houston. Why move to Houston versus Texarkana?

Come on, Saul. I was just explaining to someone this morning that Texarkana is Texas, Arkansas, Louisiana. Texarkana. Yes. Arcana. It's an amalgamation. An amalgamation. A portmanteau.

A portmanteau sounds like a good wine, doesn't it? It does. It does. I'll have the portmanteau, please. And Joe will serve you a portmanteau if you move to Texarkana. Absolutely. We can be neighbors. That's all I'm saying.

We'll get to your answer. But yeah. The Saul brothers. I think that's where it is. Why don't I get out of the way on this one, Paula? I just have one thing for. the larger audience, which is you do really want to be careful when you become an expat because a lot of U.S.-based financial companies have difficulty working with you because of the Patriot Act.

So what Saul's trying to do for people that don't know what he's talking about is really make sure that he is able to use U.S.-based accounts and still be a U.S. citizen and have U.S.-based financial institutions while he's living someplace else. And it is a very fine line. You've got to be careful. There were times that my clients would move overseas. And all of a sudden, with that, unbeknownst to me, by the way, the clearing firm that we used, which was kind of the middleman between me and my clients, where the things are held so I can't do a burning made off situation and handle all their money myself. The clearing firm would all of a sudden just cut me off for my client. I would go, what happened? They go, oh, they live in Israel. Okay. So, they're like, yeah, it's a

big so. We can't work with somebody who doesn't live here. Wow. They would just cut you off right away. So Saul's trying to avoid that situation. I actually have a phone call scheduled later this week with a representative from Gusto, which I mentioned in the last question is the HR platform that I use. I'm having a conversation with the people at Gusto because Gusto Global does not include Pakistan. And so it puts me in a bind in terms of how to onboard. a new team member who lives there. And so we have a call scheduled to try to figure that out. So there's a lot of complexity that comes from being based overseas or doing business with people who are based overseas.

And even when you use services that seem to be set up for that, like gusto Global is designed, as the name implies, designed to be global. It's not uncommon that you find that you're in the one country or the small handful of countries where things don't work. You should just call them out on that, Paula. I think during the call, you should call them out on and go, I think you just need to change your name to Gusto kind of global. Yeah, Gusto semi-global. Right. Sudo-global. Because as you're proving through this phone call, you're not really global yet, are you?

Right. Maybe Gusto hoping to be global. Yes. Call it that. But, Saul, to address your question, in order to maintain a primary residence, you need to live in that location for 184 days per year. So that's six months and one day per year. Now, you mentioned that you're planning on coming back for about three months. That would not be sufficient.

But are you and your wife willing to come back for six months and one day? which is a total of 184 days per year. So that's 365 divided by two plus an extra day. Are you willing to come back for 184 days per year? If so, then we're talking. If not, then it would not qualify as a primary residence. So that's the first question that I want you and your wife to discuss with one another. The second piece of it, you asked if you could Airbnb your primary residence.

Yes, you can. As long as the specific municipality that you live in does not have Airbnb-related restrictions. So, for example, in the city of Las Vegas, the restriction is that you must have a permit to be an Airbnb host, and they will not award permits to residences that are within a certain distance from one another. They want to adequately space out the distance between Airbnb's. And so these permits are first come first served. They've all been gobbled up. They're exceptionally hard to get. If you had a condo, for example, inside of the city of Las Vegas, only one residence per

floor on a given condo can be an Airbnb. So on the ninth floor of a condo, there's only one unit that can be a short-term rental. On the 10th floor, only one unit. 11th floor, only one unit and so on. If it's a single family home, there's also minimum distance requirements. So those would be the restrictions. The restrictions would not be tied to usage of the home as a primary residence because Airbnb or short-term related restrictions do not care whether your usage of that home is primary

residence versus second home. It's kind of irrelevant to them. Exactly. Yeah. As long as the residence that you purchase is in an area that does not have short-term restrictions or is a residence that has a permit that can be passed from seller to buyer, then you'll be fine to short-term rented out. Now, all of that said, you could skip the short-term hassle and go with medium-term rentals. And a medium-term rental is something that has a

duration that's longer than 30 days, but less than a year. That would circumvent the need to get a short-term rental permit. Yeah, much, much easier, the medium-term rentals. And I think that that also, doesn't that vary municipality by municipality what the definition is short-term is, like when they're? Generally speaking, it's 30 days or less. It's 30, yeah. 30 days. Yeah, that's more or less standard. There might be one or two municipalities that have some variance in it, but I would say 98% of the time, you're going to see 30 days as the barometer. I think, there are a lot of people that aren't in this market that I think we'll still find it fascinating, Paula, why there are so many restrictions on Airbnb. I mean, we could kind of guess, but it's actually

cases of things that happened, municipalities being behind. I know that one of the early cities to embrace Airbnb's, Lisbon, Portugal, ended up with a horrifying circumstance where literally nobody, nobody lived downtown. And Lisbon, the officials were horrific. terrified because they inadvertently stripped the culture of people living in a place from the place. Right. And so Lisbon had to do a lot of backtracking. And I think other cities then very quickly went, oh, we've got a problem here. Yeah. But it was much more a case of backtracking than it was forward thinking. Right. Of looking at what had happened in some at the time, forward thinking, oh, cool. We can just put more tourists downtown. And oops, we filled downtown completely with

tourist, which is also why we're getting backlash in some places like Barcelona now as an example. Right. There were protests in both Barcelona and Marseilles around tourism. And, you know, in Las Vegas, in the building that I lived in, I lived there for five years, we had the problem where in the morning, there would be parents getting their kindergartners ready to go to school and you'd have drunk people coming home from the casinos. Oh. Right? This is a residential building where we're all taking our kids to school and putting on our dry cleaned suits to go to work and just trying to live our lives. And you've got people vomiting in the hallways. So you can only have so much of that before the residents just start to rebel.

Oh, I thought you're going to say, we just got to teach the kids what reality is. Not at all the right lesson. The other thing, Saul, that I want to address is that you mentioned that your rental property in Virginia breaks even when it comes. to cash flow, but is not cash flow positive. That does not give me any information as to whether or not it is a good rental, and by good, I mean, has a strong cap rate relative to its risk profile. So the wealth that you are gaining currently through the rental property that you hold comes from principal payoff, which those tenants are paying down the principal on that mortgage. It comes from property appreciation. It comes from tax advantages. There's a lot of wealth accumulation that happens

from a rental property outside of cash flow. And in fact, many rental property investors will aim for a cash flow of $100 per door. So if you're breaking even and there are other people whose goal is to be positive $100 per month, realistically we're talking about a difference of $100 a month. That's one trip to a restaurant per month. We're not really talking about a big number. But why do rental property investors shoot for $100 per door in positive cash flow? We know that particularly in the beginning, positive cash flow is not how you make money on a rental. That comes later. In the beginning, the wealth accumulation that comes from a rental comes from these other mechanisms. And so the way to assess whether or not a rental is performing is not based on

monthly cash flow, especially in the early days, but rather based on the cap rate of the property. And so that's what I would want to know before you sell that property. What is the cap rate? How good is that cap rate? Because the cap rate is functionally the unleveraged dividend that you are earning from the property. And once we know what that unleveraged dividend is, we add that to the rate of appreciation. and now you know the unleveraged total return. And you can then compare that to alternative investments. And for those of us in the audience, Paula, that don't do a lot of real estate investing, just for them, what does cap rate mean?

So cap rate, as I said, it's unleveraged dividend. And what I mean by that is that any asset makes money in two ways. There's the asset going up in value. And then there's the dividend or the income stream that it pays out. So a share of Coca-Cola stock ideally rises in value. And that same share of Coca-Cola stock also pays a dividend. Those are the two ways that that share of Coca-Cola stock makes money. A house does the same thing.

A house makes money in two ways. It ideally goes up in value. And it also pays a dividend. Now, that dividend is measured as a percentage of what you paid for it. Percentage of the purchase price, yeah. Exactly, a percentage of the purchase price of the property. And so what you do to calculate cap rate is you take your gross rent, you subtract out your operating expenses, repairs, maintenance, management fees, vacancy, things like that. You do not subtract out your debt servicing because that's financing, so that's a different ballgame. So you don't subtract out the principal and interest payments that you make on the mortgage, but you do subtract out the property. taxes and the homeowners insurance because those are all part of the operating costs. So you take that gross rent, you subtract out the operating costs, and you are left with a number that's referred

to as the net operating income. Now that net operating income divided by the purchase price is your cap rate. And that cap rate is your dividend. So then you take that dividend, add it to the rate of appreciation on the property, and that is your unleveraged, meaning without a loan, that is your unleveraged total return on the property. So once you see what that number is, you can then compare it to, let's say, a share of Coca-Cola stock or a share of VTSAX,

because then you'll know, hey, what kind of total return without taking lending into consideration? Because you're not borrowing to buy VTSAX, right? So let's just leave that off the table for now so that we can compare apples to apples, leave the lending off the table. How does this total return compare to just buying a share of VTSAX?

There are two things I'm thinking. The first one is I would imagine what most new real estate investors don't think about Paula is the vacancy part. Like you said vacancy, but then we kind of washed it. I think a new person doesn't think about the fact this might be vacant for two, three, four months. And I need to make sure that that is, that's a piece of the puzzle. On a long term rental, typically that's less of an issue.

On a short term rental, which is what he's talking about, vacancy is a much bigger issue. And so that's another concern, Saul, that I would have for you if you decided to go the short-term rental route. Not only would you need to be in a neighborhood that has permitting for short-term rentals, you would also want a really good assessment of what the vacancy rates on other short-term rentals in the area are. And then the second thing that I think about is do you think that owning a single property, if I'm comparing it to owning the total stock market index, like you said, or share of Coca-Cola, I think of a single property ownership as being risky in a few more ways. I have to be personally involved.

I've got just a tiny neighborhood where Coke on its own is distributed globally. There's a ton of people working on Coke versus me and maybe one or two other people. Is there what we call a risk premium on that where I need to see that I'm making more money on this? So if I compare it with VTSAX, let's say a VTSAX 10% versus this returning 10%, I would think I should go with VTSAX because, heck, I could just put my money over there, sit back with my hands behind my head and not do anything. What's interesting about Saul's specific predicament is that he is comparing a rental property in Virginia that would be held purely for the purpose of its function as an investment. Right. With a hypothetical new property in Texas or Nevada. Yeah.

Which would serve the hybrid purpose of providing him and his wife with a place to live for ideally 184 days a year. He's just comparing New Place to Old Place. Well, it's not an apt comparison of New Place to Old Place because New Place serves hybrid modality while Old Place has one specific usage, right? New Place must be that Venn diagram intersection of personal consumption and viable investment, at least minimum viable to cover the holding costs during the six months of the year when he's not there, versus Old Place is being held purely for the sake of an investment. So it is apt to compare the Virginia property to VTSAX because both the Virginia property and VTSAX would be held. purely for the sake of holding an investment. But by contrast, the Nevada, Texas property would be

held for a hybrid reason in which personal use is 51% of that reason. It's funny because, and this is maybe getting a little nerdy, I still love the comparison game because while it's not a risk premium, now it's like a usage. You know what I mean? Like, I'm going to accept a discount on my rate of return on the Houston property. And is that a fairer? amount of discount based on how I'm going to. Yeah, so it's not a usage premium. It's a usage discount, essentially. Yeah. Still fascinating. I think it's still a great measure to have to think is this worthwhile or not. Right. But all of this Saul hinges on whether or not you and your spouse are willing to live in this property for 184 days per year. I don't know about Houston,

but Texarkana, yeah. Probably. Las Vegas is a great place. It does get brutally hot in the summer. Do not go there in the summer, but the winters are nice. January can get a little bit cold. Like right around the holidays, New Year's, it gets a little bit cold. But February is spectacular. I think February is the best month of the year to be in Las Vegas. People think of the casinos, but it's a beautiful area. Really, you're living in southern Nevada. You're living in. canyons and mountains and camping and hiking, gorgeous desert. And knowing a few people who live in that region, frankly, when you live there, you're never at the strip. Yeah, not unless you work there, yeah. Yeah, never. And what's cool is that city for people that haven't been there, been there only briefly

to go to the strip, that city truly is built around the strip to isolate it. Right. You know, New Yorkers never go to Times Square. It's the same thing. Yeah. Just as New Yorkers don't go to Times Square, people in Las Vegas don't go to the strip unless you work there. Or unless you want a buffet. So thank you, Saul, for the question.

And congratulations on having a fully paid off home in Mexico and on being five to seven years from retirement. Great work. High five. Yeah, absolutely. And I do encourage you to spend 184 days a year in Las Vegas or in southern Nevada because it is a beautiful place, the mountains, go to Lake Mead, go to Mount Charleston. Those mountains are spectacular. And Saul, by Las Vegas, Paula means Texarkana.

That's what she means. She can read between the lines. TXK. All right, we will take one final break to hear from the sponsors who allow us to bring you this show at no cost to you. And when we return, we will hear from Nina, who loves the neighborhood. that she lives in, doesn't think that she can afford to buy there. What should she do? Get you and your crew to the big shows with Go Transit. Go connects to all the main concert venues like TD Coliseum in Hamilton and Scotia Bank Arena in Toronto. And Go makes it affordable

with special e-ticket fares. A one-day weekend pass offers unlimited travel across the network on any weekend day or holiday for just $10. And a weekday group pass offers the same weekday travel flexibility from $30 for two people and up to $60 for five. Buy yours at gotransit.com slash tickets. Our final question today comes from Nina. Hi, Paula and Joe, this is Nina. I'm a relatively new listener of Afford Anything, and I'm just setting off on my personal finance learning journey.

Your podcast has been hugely helpful for me. My partner and I live in San Francisco, an obviously very high-cost city. About four years ago, at the age of 29 and 30, we pulled the trigger and bought a small home here with the 10% down Jumbo loan. As soon as we were able, we refinanced with a 15% down loan with fixed interest of 3.25% and we've just passed the 20% down mark. We love our home and especially our community and couldn't imagine living anywhere else,

but with one child already in hopes of at least one more in the near future, our two-bed, one bath, very outdated home, is quickly feeling small and cumbersome. We plan to build an upwards addition to add two beds in one bath, in which case I think we would happily live here at least 10 more years. That said, building and renovating it will cost a whopping $500,000, inclusive of a buffer for unforeseen needs. We bought our home for $1.36 million, and it has appreciated in value a couple hundred thousand. It would cost more than an additional $500,000 to purchase a new four-bedroom home in the

neighborhood, and we likely wouldn't get a 3.25% interest rate for a long time, so we still feel it makes most sense to build versus buy. So my question is, are there any financial programs or loans we should tap into as we begin this addition? We plan to take out a HELOC in case of emergency, but I have the 500K and cash ready. That said, we will need to wait three plus more annual bonus cycles to get there and I would love to begin this process as soon as possible. Are there any building resources that we don't know of? For additional context, we currently have about 150,000 in investments in a diversified portfolio. We also have about 60,000 in rainy day funds, mostly in high-yield savings account, which wouldn't be included towards the 500K. My husband has

200 in retirement. I have 180,000, and we have a 20,000, about 20,000, and a 529 for our toddler so far. I make an annual salary of $200,000 with a possible 10% bonus, and my husband makes $210,000 with 50% bonus. We're fortunate to live to make an amazing living, but given the high living costs here of our mortgage, property taxes, daycare, an IVF journey, etc., the majority of our savings are coming from our annual bonuses, which have just increased significantly this past year. would love any advice you have on how to wisely build and renovate as soon as possible, or if you think this is a bad idea, would love to hear that as well. Thank you so much. It's funny, Paula, the second that she said, a whopping $500,000. My very first thought was, you live in San Francisco.

That does not sound whopping to me. Don't get me wrong, in Texarkana, that is a big, big house. But knowing a lot about San Francisco prices, 500,000. is frankly. And then when she said the value of the entire house, like $500,000 seems spot on or even inexpensive, frankly, if you're adding that much more living space. Right. To answer her question directly, because she asked about construction resources, there are construction loans that, Nina, that you could tap. And with construction loans, typically you need 20% down. Many people mistakenly only think about construction loans when they're dealing with new construction. But fun fact,

you can also use construction loans to finance a new addition. They are for what are known as stick-built houses, meaning that you, if you wanted to do something like build a straw-bale home, you might not qualify. But if you want just a conventional stick-built house that has all of the proper permitting, that has an architect, that has engineers, you know, if you're going through all of the proper mechanisms and building a conventional home, that is what construction loans are for. and that sounds like exactly what you're aiming for. Banks do these all the time. They're 100%. Competent, comfortable with it, you'll very easily go through the process. They will want to check a bunch of boxes that make sure that your house is what you say it's

going to be, that the addition is going to be what you say it's going to be. But it is not a big deal. Yeah. So a couple of distinctions between construction loans versus mortgage loans or home equity loans. So if you take out a mortgage or if you take out a home equity loan, that loan is made as an upfront lump sum payment. But if you take out a construction loan, that construction loan is paid in phases as work is completed. So once you hit certain milestones in the construction, that is when a phased payment will be made. And you can pay then your contractors in a timely manner.

everybody gets paid and you avoid unnecessary interest on a huge amount of money all at once that's just sitting there that you're losing money on every month. Yeah, exactly. So their interest rate is a little bit higher on a construction loan, but it's not too out of the woods. It's going to be like maybe a percentage point or so higher than the prevailing traditional mortgage interest rate on a 30 year fixed. What I love most about this, Paula, she already knows how they're going to pay

it off. I mean, her goal would be to pay cash, but she knows that three more bodice cycles, she has the 500,000 ready. And she knows it's devoted to that. I'm not at all opposed of starting it now like she wants to. Yeah, I think that's a great idea, because the value of any given home is a combination of the value of the underlying land and then the value of the structure that sits on top of the land. And when you are in a high cost of living area, as Nina, you are, The value of the underlying land is where most of that home value comes from. The structure itself, some cement and some lumber, I'm being a little flippant, you know, obviously there's more that goes into a home than just that. Love, love.

You know, some drywall and some copper, some gutters and downspouts, asphalt shingles and flashing, right? Yeah, you know, there are materials and they depreciate. and they're worth something, but the value of the underlying land is worth so much more. That's why is there such a distinction between the cost of a home in San Francisco versus Texarkana? It's not because the cost of lumber is wildly different between the two locations. Sure, there's going to be some minor variation in the cost of lumber or copper or cement between Texarkana and San Francisco, but that does not even begin to account for the distinction in home values. it's the underlying land.

So the sooner that you can capitalize on any underlying land that you have, the better, because the structure is the cheap part. One thing I found from our old real estate podcast that Crystal Hammond and I did is that there are, she asked about programs and what's available. That is going to be city by city specific. And I do know that if you're in some sort of historic district, historic area, the city of San Francisco may have some programs. that could be beneficial to look into.

And often they prefer it to be, for the same reason we talk to Saul about Airbnb, if you are going to be a primary resident living in this house, they may want to help you improve the neighborhood. So we don't know enough about your neighborhood. I don't know enough about San Francisco specifically. But different municipalities have, every municipality has a program.

Texarkana has programs for people, even in my small city, four houses that they're going to live in. It might be worth your time to see if there is a program that could help because as my partner on the stacking deed show, now stacking adventures, talking travel, but then talking real estate, Crystal found out surprisingly, Paula, she was able to score some great deals just by looking into what the city of Chicago offered. Right, exactly. So no promises, but I think it's worth looking into, don't you? Oh, absolutely, absolutely. And I agree with you, Joe.

a lot of incentive programs come from municipalities. They happen at the local level. Because what type of program is a bank or any major financial institution going to offer? It'll have various loan packages. But it'll make sure that they get to Cheching. Right. Yeah, exactly. So sure, you can talk to a lender about different types of loan packages. You can talk to a mortgage banker or a broker about some of those options that are available to you.

But fundamentally, it isn't the major financial institutions that are going to be offering incentive programs. I would just make that extra stop. I would go to your municipality, see if there are any programs for homeowners, quickly go through those programs. I would say there's a 85 to 95% chance that there won't be. That doesn't mean I wouldn't look there first. And then I would head to the bank and do the construction loan that Paula you're talking about. Yeah. I do have a question. This popped up in my mind when I heard Nina's question. What is the plan B if she were to lose her job prior to the next three annual bonus cycles?

That's a great question. You know, because so much of the plan hinges on the next three annual bonus cycles that what happens if either she loses her job or if the company goes out of business or if they change their annual bonus structure? You know, what happens if this thing that we are banking on does not come to fruition? And that doesn't mean, Nina, that we wouldn't do it. But certainly the plan B might be, well, then we still have this loan. It's long term. and without the bonus and on one income, we can still make the payment. So we'll just have a payment for longer and we're okay with that.

That's okay. But I love the idea of what if something goes wrong. Because you know what? Paula, you've done some construction before. Stuff goes wrong. Oh yeah. Absolutely. Well, and not just that, but what I have learned the hard way in my financial life is

whatever your most bedrock assumptions are, those are the things that are going to be your downfall. They really are. And I'm laughing not because it's funny, but because it's so damn true. It's so true. Yeah, exactly. In the words of Homer Simpson, it's funny because it's true. Whatever are your bedrock assumptions, those will be the downfall because those will be

the things that you don't protect against. I worked with someone who was an engineer for the highway department in the Michigan Department of Transportation was an engineer. They're always building new highways. and as they're looking at expanding a road or highway, she told me that before they start building, the first thing these engineers will do is make a list on a whiteboard, Paula, of all the things that could go wrong before they build. What are all the things that could go wrong? And then, once they know what their plans are around everything that might go wrong, then they start building.

Yeah. And I think that's the case here. It's a great exercise. The issue with it is the thing that's not on the whiteboard. Well, and that's what you got to be paranoid about, right? Right. Yeah. And this is why if you've people that aren't in your immediate family are emotional about it, because while you're emotional about it, everything's going to go great. And you bring up a few things.

Your brain brings up a few things, but your brain is so excited about it. And so to bring in somebody who's not emotional, man, we said that about the accountant earlier for Jenny. Jenny. Yes. I think that applies here too. Yeah. Having not emotional people help you with that whiteboard.

Good idea. Absolutely. You have to be, I've learned this throughout my life. You have to be optimistic to make money and paranoid to keep it. Well, and I like being pessimistic in your planning so that whenever anything goes right, you high-five yourself, right? And then you have more gratitude when things go right versus, man, we eked out the plan because we were so optimistic in our financial plan.

Yeah. So in Nina's question, she asked, hey, you know, if you think that this is not a good idea, I'd like to hear that too. So, Nina, what we're saying is we both think that this is a good idea. We both like the idea of building, but we encourage paranoia. We encourage a heavy think on plan B. What happens if you get sick in the next three years? What happens if your company goes under in the next three years? What happens if the annual bonus structure shifts? What happens if the home burns down and you end up in an insurance quagmire where they are delaying and dragging their feet on making. the insurance payout. I mean, we encourage sitting and thinking through what's my plan B, my plan C, my plan D. But the reason we encourage that is because we like plan A. It's only when you like plan A that you think about contingency B, C, D, D, E, F. But Nina, sounds exciting. Yeah, absolutely. Congratulations on the growing family. Yeah. On the great position that you're in, the wonderful job in

the wonderful city and now this dream home. Yeah, finding a neighborhood you want to live in is so important. Exactly. You know, Paula, part of why we moved back to Texarkana is because we love our friends here. You know some of my friends here. I do. Your friends are fun. We love the people here, which is great.

It's so cool because I've lived and you've lived in places where your neighbors aren't that fun and they can make or break your life experience. So being able to stay in that for a cool. half million dollars. Exactly. It's a weird day when I get to say $500,000 ain't that much, but it's San Francisco.

Exactly. Well, congratulations, Nina. And please call back and keep us updated as the plan unfolds. Joe, we've done it again. That's fabulous. What a great group of questions again. And I love the idea, you know,

we've talked about this many times, Paula, that there is a theme running through the episode and in two of our three questions, having people at the table with you who are not emotional and can help you through that. A lot of the financial geeks focus on that person being a CFP or fee only. I just think if you've got some smart friends, you know, just surrounding yourself with smart people who aren't emotional about your goals is a big key to winning. Right.

You need a personal board of advisors. Totally agree. But you also, in the right circumstances, need. licensed professionals. So to our first question, anonymous Jenny, she a thousand percent needs a licensed and certified tax professional. But for Nina, it could totally just be a group of smart friends. Right. Exactly. So Joe, tell us about what's happening on the Stacking Benjamin's podcast. Man, we have a fun week this week. Last week was the greatest hits week. We take a week off

and we play some of our favorite episodes from the past many years that we've been doing. this. But this week, we kick off a new eight weeks yesterday with the NFL season started this last week, Paula, and is celebration of the first Monday night football of the season. Brandon Copeland, former NFL star, a guy that actually went to Penn, and it is now a professor at Wharton, helping teach 101 finance to people. He's talking about winning the Super Bowl, getting ready to go pro with your money. We kind of line up the NFL start of the season. So we do that.

And then tomorrow, we have three dads who have worked with teenagers on a special roundtable. Wednesdays, we usually don't do roundtables. We save those for Friday. but John Acuff, who is an internationally known speaker and author, John Lanza, who has the Art of Allowance podcast and myself, who have two nearly 30-year-olds that launched. We've all worked with teenagers. Three dads talk about our fears, teaching kids about money, what we did that worked, what we did that didn't work.

So we have a very special roundtable on tomorrow's episode. Oh, that's wonderful. John Acuff has been a guest on this show as well. He's so fun. Yeah, he's a wonderful guy. Well, thank you, Joe, for bringing your wisdom as a former financial advisor to this round of questions. Always fun, Paula, of course. And thank you for tuning in.

If you enjoyed today's episode, please do three things. Number one, most importantly, share it with a friend or a family member or a colleague or a neighbor, your dog walker, your babysitter. Share it with the people in your life. Number two, please subscribe to this podcast. on Apple Podcasts and Spotify and go to YouTube, subscribe to us on YouTube and hit the notification bell. And number three, sign up for our newsletter, afford anything.com slash newsletter. We have a course on how to get a raise. So if you're listening to this going, wait a minute, I don't get a big annual bonus.

Well, maybe you could. Maybe that's in your future. So if you want to learn how to ask your boss for more money successfully, how to get that raise that will help you keep up with higher costs, higher inflationary costs and those costs of living. We're opening that course up for beta testers the week of September 23rd through 27th. September 23 through 27, mark your calendars. That's the week that we will open the course up to a beta test round. Now, at the beta test round, you will be able to access the course for way, way, way, way, way, way cheaper than it will ever cost ever in the history.

history of this course. The trade-off is it's not going to be as polished. It won't have the fancy graphics, kairons, images, you know, it won't have the bells and whistles and pizzazz, but you will be part of that founders group that helps shape it, that gives feedback that says this part ran long, you can cut it, or this part didn't adequately explain this concept, please elaborate. You will be part of that founders group that helps build it. And you will be part of that for life and you'll get the benefits of that for life. So come join the beta cohort, September 23rd through 27th. Thank you so much for tuning in. This is the Afford Anything podcast. I'm Paula Pant. I'm Joe Salcci. Hi. And we will meet you in the next episode.