Afford Anything - Ask Paula: Sooo … I Quit My Job. What Type of Business Should I Start?

Episode Date: January 6, 2020

#235: Anna has made the leap to self-employment … but what’s next? She lives in the Bay Area and she’s trying to choose between five business ideas; she needs to make enough money to stay in her high-cost area. Doug recently won $9,000 from an online poker side gig and is wondering how best to use the funds: pay off high-interest student loan debt, or keep it to increase his poker earning potential? Alex and his partner want to househack a single-family property with a mother-in-law suit. What should they consider as far as zoning goes? Darrell is on track to retire in two years at age 55 and wants to know what he should do with his primary residence. Should he rent it out? Or should he sell it and use the profit to invest in rental properties? Or use the profit to buy his retirement home? Mara is curious about 1031 exchanges. She has equity in a rental property that she’d like to harvest, but she wants more information before making the move. Michael and his wife are struggling with competing goals. They want to invest in real estate, but they also want to move into an apartment closer to work to reduce their long commutes. Should they sell their home and invest the equity into a rental property, or should they take a HELOC on their home instead? For more information, visit the show notes at https://affordanything.com/episode235 Learn more about your ad choices. Visit podcastchoices.com/adchoices

You can afford anything, just not everything. Every choice that you make is a trade-off against something else, and that doesn't just apply to your money. It applies to any limited resource in your life, like your time, your energy, your attention. And so that leads to the questions, number one, what's most important to you? Not what does society say should be most important to you,

but what actually is a priority in your own life? And number two, how do you align your day-to-day decisions to reflect that, even if that means making choices that are unconventional. Answering those two questions is a lifetime practice, and that is what this podcast is here to explore. My name is Paula Pant. I'm the host of the Afford Anything podcast, and today I'm answering questions that come from you, the community. Here's what we're going to cover. Anna has made the leap to self-employment, but what's next? She's trying to choose between five business ideas. Meanwhile, Doug recently won $9,000 playing online poker. How should he use

this money? Should he pay off high-interest debt? Or should he keep it in his poker bankroll? Daryl is on track to retire in two years at the age of 55. He wants to know what he should do with his primary residence when he retires. Alex and his partner want to house hack in a single-family residence that has a mother-in-law suite. What do they need to know? Mara has equity in a rental property that she'd like to harvest. Should she process a 1031 exchange? And finally, Michael and his wife have competing goals. They want to invest in real estate, but they they're also contemplating the possibility of moving out of their current home and into an apartment that's closer to both of their workplaces. If they move into this apartment, should they sell

their current home and use the equity to purchase investment real estate? Or should they stay in their current home and borrow against that house in order to buy their first rental property? We're going to answer all of these questions right now, starting with Anna. Hi, Paula. Longtime listener, first time caller. I just want to say I've read everything you've written, listened to every podcast, and I love how inspiring you have been in my life, so inspiring that I've decided to take the leap this week into self-employment. I quit my day job in marketing, and I want to know what next. I am 33. I have $150,000 in investments, $50,000 in cash, and zero debt. However, I do live in the big. I do live in the big. I'm in the

area and the living expenses out here are no joke. Therefore, what I do next, it's very important that it become profitable as quickly as possible so that I can sustain my rent out here. So given that, I have a few options that I'm contemplating and I feel like this is very much an afford-any-thing question because I'm going to need to focus my time and intention 100% on one business initiative. So I'm not spreading myself then and perhaps not. making money doing anything. The first business concept is obviously I do online digital marketing and consulting as my day job and I've been doing it as a side hustle as well for many years. So I could build out that business. I know the ropes. It's not my top passion, but I do

know that it can be profitable and I'm good at it. So that's probably the most practical option. The second option would be to build a blog. I love writing. I've heard that that's a passion project and it can take six months to a year at best to become profitable. The third option would be to explore a product business, whether that's selling these paleo cookies I make that are a huge hit and packaging them and trying to get in-store space and going on Shark Tank or whether that's an Amazon fulfillment situation with Rave Gear, where I sell on Amazon. Those are two things I'm considering as well. And then finally, I'm also contemplating, expanding out an e-book business that I've already been running.

I'm an author of multiple books that I've self-published online. And while that does bring in revenue, so far not enough to support myself. So I just would love to get your insights and opinion on what the best path to choose to be as financially responsible and continue to be self-employed for as long as possible. Thank you so much. I can't wait to hear your answer. Anna, first of all, congratulations on quitting your day job, on having the courage to take the leap into self-employment, and on starting that journey from a position of strength. You're already on really good financial footing. You have $50,000 in cash. You have no debt. You have another $150,000 invested. I assume that that's for long-term retirement. So that's great. You're starting strong. Now, of the options that you've outlined, as I see it, priority number one, is for you to get stable, steady income coming through the door immediately. As you said, you need enough money to be able to support yourself, to be able to stay in the Bay Area.

So the first priority is the practical choice, which is the side hustle that you've already been running, online digital marketing and consulting. You have a background in marketing. That was the day job that you quit. You've been running that side hustle for many years already. You have connections. You have a network. You can build this out as a full-fledged business, as you said.

And I know that that's not your passion, but at this moment, the immediate need is for you to bring in enough money every month to be able to support yourself. And so what I would recommend is it looks like online digital marketing and consulting is the path of least resistance. That is the fastest road to you being able to bring in enough money every month that you can pay your bills. So what I would do, if I were you, since it sounds like that's not ultimately what you want to do, I would first focus on building up that business up to the point to which that business can cover your cost of living. Now, if during the time that it takes to do that, you end up dipping into that $50,000 in cash that you have, what I'd like to see you do is build up the digital marketing and consulting business until you've replenished that $50,000. emergency fund, because you might be drawing down from it right now. So build it up until you've replenished $50,000 in your emergency fund and have enough money coming in consistently every month that this business can support you. It doesn't have to be super lucrative. It doesn't have to

bring in enough money that it supports your best life, but it should at least bring in enough money that it supports a satisfactory life, that it satisfies your needs and allows you to stay in the Bay Area. Now, once you've done that and you have that solid foundation of income coming in, then spend the rest of your time turning your attention to one of the other four ideas that you proposed that excites you the most. So you also proposed either blogging or selling paleo cookies or selling rave clothing on Amazon or selling more self-published books on Amazon. One of those four ideas probably excites. you more than the others. And only you know which one that is. But whichever one of those four ideas is a deep passion and is ideally the business that you would like to see brought into the world, pursue that one. But pursue that only in the remaining time that you have after you've first tended to your digital marketing and consulting business because that's what's going to put food on the table and keep the lights on. In essence, you can almost think that's, you can almost

think of this as the self-employed version of having a day job and a side hustle, in which your day job is as a self-employed digital marketing consultant, and then your side hustle is your passion project. And that passion project is whichever of those other four ideas you find to be so interesting that you have the energy to work on it at night or early in the morning or in the margins of your life. You have the energy in those margins of your life because you're that excited about the idea. So in essence, you'll still have the approximation of the day job that pays the bills and then the side job that fulfills a passion. And over time, hopefully, if all goes well, that side job that fulfills a passion will grow and grow and

grow to the point to which you can then get rid of the day job that pays the bills. You'll notice that I'm calling this a day job even though it's still in the world of self-employment. And that's because even in the universe of self-employment, there are the gigs you take because you love them. And then there are the gigs you take because they pay the bills. And in your case, the approach to that would be to develop two separate businesses in parallel. By the way, if you are interested in running an Amazon business, Steve Chu is a fantastic resource. We interviewed him in episode 34. You can find that at afford anything.com slash episode 34.

He has a wealth of information about how to build profitable e-commerce businesses, specifically on Amazon. Final thing I'll say is that what I just described, this running of two separate businesses in parallel, this is exactly how I built afford anything. I had one business called Catalyst Content Marketing, in which I provided content marketing services to a variety of clients. Small accounting firms or fintech startups or small financial planner or registered investment advisor. services, very small businesses that weren't big enough, didn't have enough of a staff to be able to have somebody in-house who handled their content marketing, they would contract with me. And so I had a small team and we provided content marketing services to these small businesses. And for many years,

that was where the bulk of my revenue came in. And while I was running that, I was also building afford anything on the side. And they ended up feeding into each other really well. Afford anything became a lead generator. It caught people's attention, and it was from that that I got a lot of my clients for the catalyst content marketing business that I was also running at the time. And then eventually it hit a point where I realized

I couldn't do both. And so one by one, I just started dropping my clients and I killed off all of the content marketing services so that I could focus full-time on afford anything. But it took years to get to that point. But what was great about that approach, There's this great quote by the author Elizabeth Gilbert in the book Big Magic, in which she says, quote, don't burden your creativity with the responsibility of paying for your life.

Keep your creativity free and safe. And so what's great about the approach of running these two businesses in parallel is that you can pursue designing rave clothing or making paleo cookies or writing either blog posts or books. you can enjoy that process and that creativity and you can enjoy building that out without unduly burdening it with the responsibility of paying for your life before it's ready. If you do that and you continue to grow it, then there might one day come a time when that creativity is ready to be able to pay for your life. But your art has a better chance of survival when it doesn't start life with that burden. When your other business, your digital marketing business, can pay the bills. So thank you, Anna, for asking that question. And congratulations again on quitting your job and being in a strong financial position at the time that you're starting self-employment.

Our next question comes from Michael. Hey, Paula. This is Michael. Really enjoy the podcast and when to get your advice on something. My wife and I make about $143,000 combined income, and we live around Chattanooga, Tennessee. We have around $100,000 in equity in our home, and I'd like to invest some of that equity into our first rental property. Both of our families live outside of Knoxville, Tennessee, and we've discussed moving back closer to them in the next several years. Our combined commute time to work is about an hour, and I've suggested selling our house and renting a luxury apartment three minutes from my work and 10 minutes from hers. This would give us more time with our nine-month-old daughter, free up our equity to begin investing in rental property, and make life a lot simpler because we'd be downsizing from our 2,800-square-foot house to a 1,200-square-foot apartment. Plus, we'd be selling the house if we moved to Knoxville in a few years anyways.

My job can transfer to Knoxville, but my wife's wouldn't. She makes about $63,000 right now. We plan on having more kids and talked about her working part-time or even staying home full-time if we ever moved back. I told I'd like to get started with rental properties now, while we both made great incomes, so we could at least replace a small amount of her lost income with passive income. However, my wife isn't thrilled with the idea of selling our home and renting downtown because there are a few inconveniences with moving to an apartment, which we experienced our first two years of marriage,

such as having to walk our dogs instead of letting them out in our fenced-in yard, having to carry bags and groceries more than just a few feet away from the garage, and just general problems with neighbors above and below you. Our mortgage is $1,400, and the apartment rent is around $1,800. However, once I factored in all the costs for yard, garbage, pests, et cetera, our housing costs equal around $1,800 too. My wife asked why we can't just stay in our current house and use a he lock to invest in rental properties. We're trying to weigh the pros and cons of all these decisions, and I just wanted to get your opinion.

Thanks so much and keep up the good work. Michael, I love this question. First of all, as you mentioned, your combined commute time to work is about an hour. Now, I don't know if you mean that your combined commute time is an hour each way or if it's an hour round trip, but either way, the two of you are spending either one hour a day or two hours a day commuting. That's an incredible, regardless of whether it's one hour or two hours per day. That's an incredible amount of time. And as you said, if you could reduce that time down to a combined 13 minutes each way or 26-minute round-trip, I mean, wow, that would free up so much time for you to be able to spend with your nine-month-old.

And the fact that you have the opportunity to do that for exactly the same price that you're paying right now. You're paying 1,800 in total housing costs right now, and it would cost you 1,800 to live so close to work that you with your reduced commute time will be able to spend significantly more time with your 9-month-old. I love that idea. I absolutely love that idea. Thinking through this, let's assume that your combined commute time to work is an hour. hour each way, so that's two hours roundtrip. And if you make this move, your combined commute time is 26 minutes round trip. You've just saved, combined, an hour and a half a day with no additional cost to you. You're paying 1,800 a month for housing either way. Now, granted, it's true. The 1,800 that you're paying on the home that you own, a portion of that goes to principal,

and so it continues to build equity. And so to that extent, yes, there will be. and impact in terms of the portion of your monthly housing payment that goes towards building your net worth. But that's getting really in the weeds because it's not going to affect your monthly cash flow. Your monthly cash flow stays the same and you have an extra hour and a half a day, which is plenty of time to bring the nine-month-old with you as you're walking the dogs. The whole family can take a morning stroll or an evening stroll because you don't have a commute anymore functionally. So within your question, I hear several questions or several issues inside of it. First is the question of whether or not your wife would agree to this move. Because setting aside,

let's just set aside for right now, the question of rental properties, the question of sell our home in order to capture the equity versus take out a HELOC, let's set all of that aside right now. the basic first question that we need to ask and answer is, will your wife agree to move into this apartment or not? Because if she really doesn't want to live there, if she really doesn't want to make this move, then all of the other questions become moot because if she wants to stay in the home that you're currently living in, then you can't sell it. So first and foremost, the two of you need to address that. Where are you going to live? Now, hypothetically, assuming that you both agree that you would both like to live in this apartment that's close to work, then step two is that now you have the opportunity to decide what to do with your current home. Because once you're living in the luxury apartment, you then have the opportunity to decide if you want to sell that home and use that money to invest in a rental. or if you want to hold onto that home, turn that home into a rental,

and also take out a he lock on it so that you can capture even more money, which you could use to buy a second rental. Both of those options are on the table, but only if the two of you move into the apartment that's close to work. If you don't move there, well, then there's really no decision to make. Because if you continue living in your current home, then the only way to get money out of that home would be to either take out a hellock or take out a cash-out refinance.

One way or the other, you'll be borrowing. against the equity in the home if you continue to live there. Now, if your wife is reluctant to move into this apartment, one option, one possible option might be to hold on to your current home, at least for the first year, operate that home as a rental property, and also borrow against it in order to buy a second rental property. Given the fact that both of you are still working and both of you are still earning an income, this is the best point in the near foreseeable future for you to qualify for a loan, given the fact that you have more income now than you anticipate having in a few years. And the other benefit of this approach is that if you hang on to your

current home, then the decision to move into an apartment is a reversible one. So if you move into this luxury apartment, you spend a year there, and you really don't like it, or your wife really doesn't like it and she doesn't want to stay beyond one year, well, as long as you've held onto your current home, then the decision is reversible. At the end of your lease, you can always move back into your home. So even if your current home isn't a fantastic rental property, meaning even if it doesn't have a wonderful cap rate and the types of returns that you would hope for if you were to search for a rental from scratch, there is still value in holding on to it as a rental during that one-year interim period in which you decide whether or not you might

want to move back there. And having that escape hatch, having that exit strategy from living in a luxury apartment might ease the transition. Sometimes it's if there's a place that you don't necessarily want to move to and you're reluctant to move there, it can be easier to know that if you move there and you don't like it, you always have the option of returning back to your current home. So that could be a possibility that would allow you to have two rental properties, get some experience under your belt with the world of managing rentals and managing tenants, and maximize your options. Now, the final thing that I'll say is that you mentioned that at some point in the future, your wife may transition to either working part-time or

staying at home full-time. My recommendation would be to begin adjusting your budget right now such that you're mimicking what that experience would be like financially. Now, of course, with one parent staying home, some of your current expenses will decrease. For example, some of your current child care expenses could decrease with one parent staying at home. But with the exception of those items, adjust the rest of your budget to reflect or mimic or practice the experience of living on just one income. And do this in stages. It's hard to rip off the bandage all at once. So incrementally, month by month, readjust your lifestyle so that you start capturing the experience of living on one income. And that's going to do two things.

Number one, it'll influence all of the decisions that you make between now and when your wife transitions her work. You'll be less likely to purchase big ticket items. You'll be less likely to upgrade your car because you're already practicing the experience of living on one income. And in addition to that, practicing living on one income while you still have two allows you to rapidly build savings. And those savings could be the down payment on a home if you moved to Knoxville. Or it could become a bigger emergency fund or more retirement contributions. You know, you can decide what to do with those savings, but those savings will be a side effect of practicing a single income lifestyle while you're still dual income. Again, with the exception of child care expenses.

Thank you for asking that question, Michael. And best of luck with the decision on whether or not to move into this apartment close to work, the decision about whether or not to hang on to your current home. And ultimately, the decision of whether or not to move. in Oxville. It sounds like you have some great things ahead, so congratulations, and thank you for calling. We'll come back to this episode after this word from our sponsors. 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,

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Our next question comes from Daryl. Hi, Paula. Longtime reader of your blog and I love your podcast. Great production, great content. Thank you for what you give to the community. In a little under two years, I'll be 55 and thanks to my military service, government pension, and my investments, I'll be able to retire. My question is what to do with my current house. When I retire, I'll have about 20 years left on the mortgage.

My principal is $400 a month, interest is $430 a month, and my tax and insurance is $320 a month. I pay $105 a year for homeowners' dues. I will owe approximately $150,000 on the mortgage, and the house will be valued at $325,000, so I will have approximately $175,000 in equity. The value of my home is a little less than the median value. for the area. Homes in my area of similar size and style rent for about $16 to $1,700 a month. I am debating if I should keep this home as a long-term rental, or if I should sell it and take the equity and use that to invest in one or two rental properties or to purchase my retirement

home. I'm assuming utilities would be paid by the renter. So in short, I am contemplating the opportunity costs. I do not plan on living in this home during retirement. Thanks again for a great podcast and all you give back to the community. Daryl, first of all, thank you. And congratulations on your upcoming retirement. Retiring at 55 is the dream for so many people. So thank you for sharing your story. Congratulations. And in answer to your question, you are absolutely correct. This is a question about opportunity cost. You made three suggestions. you're definitely going to move out of your current primary residence in two years when you retire. So with that established, there are three suggestions around what to do with that primary residence.

In no particular order, number one, you could hold the property and use it as a rental. Number two, you could sell the property and use the equity to buy one or two other rentals. Or number three, you could sell the property and use the equity to buy your next personal residence. So the first question, as we go through these three suggestions as we weigh the relative merits of each one, my first question to you is, if you were to use this property as a rental, or if you were to sell it and use the equity to buy another rental, where would the money come from for your next personal residence, the home that you will live in after you move out of this current one? I assume you have some sort of a plan for that, but that's the first question that I would want to be clear about. Would you be able to come up with the money to buy yourself a different home without unduly compromising other areas of your budget? Meaning without rating an emergency fund or without drawing down too much from an investment portfolio, would you be able to cash flow manage buying an alternative property for yourself as well as using your current.

property as a rental or using the equity in your current property to purchase another rental. Assuming that the answer is yes, assuming that you could do both, then from a lending perspective, it makes the most sense to take out a mortgage for a personal residence and either hold your current property or sell it and use the $175,000 in equity. It'll actually be a bit less than that because there will be closing costs, real estate agent commissions. Those expenses will be deducted from the net equity that you receive at closing. But from a lending perspective, it makes the most sense for you to take out a mortgage on your next personal residence and then either hold the current property or use the equity that you get from the current property to either buy a rental property in cash or make a large down payment on a rental property. such that you have a smaller mortgage on that property because the lending terms that you're going

to get on your primary residence are going to be much, much, much better than lending terms that you'll get on an investment property. So bias your equity, bias your money towards that use, assuming that you have enough to be able to do both, to buy a place for yourself and to have a rental. And so with the assumption that you have enough to do both, then the next question becomes, do you hold onto your current residence and use that as a rental property, or do you sell it? Now, your monthly expenses, your monthly PITI mortgage plus homeowners association dues on your current property comes to a total of $1,158.75 per month. That's $830 for principal and interest, $320 for taxes and insurance.

and then you mentioned that your homeowners association is $105 a year, which sounds incredibly cheap. So I wonder if you meant per month, but I'm just going to take at face value what you said in the voicemail, which is that it's $105 a year, in which case that's $8.75 a month. So you're paying $1.58 for PITI mortgage plus HOA, and you could rent the property for between $1,600 to $1,700 per month. So the spread would be somewhere between $441 to $541. So let's say it's about a $500 spread. Assuming, as you said, that the tenants pay all of the utilities, your major operating expenses are going to be repairs, maintenance,

major capital expenditures, property management if you choose to hire it out. And of course, we want to adjust for vacancies, because occupancy is never 100%. Once you adjust for all of that, your net cash flow right now will not be some amazing astronomical figure. I can't predict exactly what it will be because I don't know the condition of the property, but the momentary net cash flow might not be that great at the moment,

but bird in the hand, you know this property very well. You know its condition extremely well because you live there. So you can anticipate major CAPEX, major capital expenditures, with greater accuracy because of your degree of familiarity with the property. That's worth something. You're also, because of the fact that you live there, you're clearly comfortable with the profile of the neighborhood. And so all of those factors, a neighborhood with a risk profile that is a good fit for you,

plus a property that's in good condition and in which you can anticipate what the major KAPX will be in the next five years, because it's your house, so you already know how soon the roof needs to be replaced, how soon the water heater needs to be replaced. You know all of that really well already because you live there. and that degree of knowledge and risk profile fit, that can be quite valuable, particularly when you're in retirement. So the argument in favor of keeping your home is that even if the cash flow, the net cash flow right now, is not spectacular, that cash flow will improve every year as gradually rent climbs higher and higher with inflation, but your fixed-rate mortgage stays the same.

And once you reach the age of 75, so the later half of your retirement, and that $830 principal and interest payment goes away, then this can be a very good income stream for that later half of your retirement. So that's the argument in favor of keeping the home. But alternately, let's explore selling the home and then using the equity to buy an alternate investment.

The questions that I would ask then is, in terms of some alternate rental property that you would consider, what's the cap rate on that property, and how does that cap rate compare to the cap rate on the current home if you were to keep it, and what's the risk profile, the neighborhood profile, of that alternate property that you might buy? How much crime is in the neighborhood? How much vacancy slash occupancy do other homes in that neighborhood have? what is the age and condition of the property, since, of course, a property that is older or in poor condition or has a lot of deferred maintenance, that increases the risk of major CAPEX and

just higher ongoing operating expenses in the form of higher repairs and maintenance. So those are the questions that I would ask if I were looking at some alternate investment. What is the risk profile and the returns of that alternate investment? How does it compare to the current home? And even if that current home has a lower cap rate, does the reduction in risk offset that lower cap rate? Because there is wisdom to getting a slightly lower return in exchange for lower risk, especially during retirement. So if you start comparing the returns on your current home to the returns on some alternate investment, don't let a low cap rate or low immediate cash flow scare you off if the difference in risk profiles

justifies that difference in returns. Because the last thing that I would want to see a person do is to take on excess risk in an effort to chase potential returns during their retirement years. Retirement is a time of risk reduction. And if you think of risk as something that exists in multiple dimensions, right, you have leverage risk, which is the risk that you accept

when you take out a mortgage or take out debt for a property. You have neighborhood risk. You have condition of property risk, right? So you have a risk that exists along these multiple dimensions. And if you're going to dial up the risk in one dimension, then it makes sense to dial down the risk in other dimensions. So given the fact that you will be holding, I assume, at least two mortgages during retirement,

one that's for your personal residence, the personal residence, the new one that you move into after you retire, and the other that's for the rental property, given that you're holding two mortgages during your retirement years, there's something to be said for dialing down other forms of risk, such as neighborhood and property condition risk. That said, if you can sell your current home

and pay cash for a property, that changes the equation because all of a sudden, now you don't have any leverage risk on that property, which means you can take on more risk in terms of neighborhood profile. So think about risk existing in these multiple dimensions, and as you dial, as you move along the spectrum on one of the dimensions of risk, then dial it down on some of the others. Thank you, Daryl, for asking that question, and congratulations on your upcoming retirement. Our next question comes from Doug. Hey, Paula, my name is Doug. I'm calling from Maine. I've been listening to the show for quite a while now and have learned a lot. So first of all, thank you for everything that you do. I have a question today about how to allocate some funds I recently received. So I work full time as a software engineer. And I have a side hustle playing online poker. I put a lot of hours into it and I love it. And it's been fairly profitable lately. And recently I had a big score, at least for me, of $9,000. That's a huge outlier.

way more than I generally make in two to three months with the side hustle. I'm thinking about two options for how to allocate it. One, I have a 7.15% high interest personal student loan that I took out to go back to school, sitting at about 7,500. So option one is to pay that off with most of the 9K. Option two is to hold on to the money and add it to my poker bankroll, which would allow me to play higher stakes, diversify, play more games, things like that, which potentially would lead to higher earning potential with my side hustle going forward.

I'm leaning towards paying off the debt just because that would free up almost $500 a month that I could start automating into index fund investments. To give you a little more context, I am 31. I have a negative net worth. I've made pretty poor decisions in the past, but I'm really dedicated to turning that around and I'm saving as much as possible. And I'm probably about 10 years away from retirement at least, maybe 15. So thank you very much.

Hey, Doug. First, congratulations on all of the steps that you're taking to turn your financial life around. Sure, you made some poor decisions in the past. We all have, but the past is the past. And now you're proactively trying to grow your net worth. You want to pay off debt. You want to invest in index funds. You're thinking about retirement.

You have a side hustle. So congrats on all the steps that you're taking to put yourself in a really good position in the future. So with this $9,000, pay off the debt. Flat out, plain and simple, pay off the debt. Your debt has a high interest rate, 7.15%, and it eats $500 a month out of your monthly budget. So pay it off, your net worth will improve, your monthly cash flow is going to improve, and really, that's going to occupy the entirety of the money, because you said the balance on that debt is $7,500. Your win was $9,000, I assume, and I don't know about $10,000. taxes associated with gambling earnings, but I assume that that's taxable income. In which case,

once you pay off the $7,500 and then spend another $1,500 on taxes, that's the entire $9,000. Now, once you pay off that loan, you'll have an extra $500 a month. If you wanted to use part of that to add it to your poker bank roll, I don't see any problem with that, assuming that you don't have any other debts. So assuming that you're debt-free and you want to use a portion of that $500 a month that you've just freed up to add to your poker bank roll so that you can play those higher stakes and then use a different portion of that to invest in index funds so that you have some diversification, that makes a lot of sense to me. That's the approach that I would take. And just so you understand my reasoning, paying off this loan is a risk-free 7.15% return.

So when it comes to positive expected value, I mean, there is nothing that's more plus EV than paying off a high-interest loan. Plus, as you know, in poker there's this concept of risk of ruin. Debt increases your risk of ruin in the game of life. So when you pay off debt, you reduce your risk of ruin, which means you can handle greater variance. You're more equipped to handle the downswings in life. So for all of those reasons, I'm happy to hear that you're leaning towards paying off the debt, and I will 100% confirm that, yes, pay off the debt. And then with the extra $500 a month that that frees up, I don't know if you have any other debts,

but if you do, then pay off those other debts first with the exception of a low-interest mortgage. But other than your mortgage, pay off any other high-interest debts that you might have first. And then once those are paid off or assuming that those don't exist and that this is your only debt, then you can split that $500 a month between your bankroll and index funds. So thank you for asking that question, Doug, and best of luck. We'll come back to this episode in just a minute. But first, our next question comes from Mara. Hi, Paula. I love your podcast.

Thank you for sharing the framework that you use to think about a variety of issues along with the outcome of that process. My question is regarding 1031 exchanges. I'm planning to maybe harvest the equity that I have in a single family home. If the tenants do not want to renew the lease, I think I might plan on selling it, harvest the equity, and putting it into a quad. And I was wondering whether you have any recommendations for books on the subject. I searched the podcast and the website, and I only found episodes where the subject is touched, you know, very in a tangent way.

So if you can make any suggestions, I would really appreciate it. Thanks. Mara, thank you for asking that question. So you're absolutely correct. We've touched on 1031 exchanges tangentially on this podcast, but we haven't really dug into it. So first, let me take a moment for the sake of everyone who's listening and define what a 1031 exchange is and explain some of the basics around it. A 1031 exchange is a section of the IRS code which allows you to not pay capital gains tax on the sale of real estate investment property if you use that money to purchase other like kind property. and if you do it, if you execute the whole transaction in a very specific way, which I'm about to outline next. As additional background as to why this matters, if a person sells their primary residence,

assuming that they have lived in that primary residence for two out of the last five years, then that person does not have to pay capital gains taxes on the equity gains that they've made through the sale of of their personal residence up to a certain limit. And so that makes capital gains from the sale of a personal residence or a primary residence very attractive. By contrast, if you sell an investment property, which Mara is exactly what you're doing, since you mentioned there are tenants who are living there, you do have to pay capital gains tax on that sale.

The 1031 exchange is a vehicle that allows you to indefinitely defer that capital gains tax as long as you use those gains to buy a different like-kind property. And so, Mara, the suggestion that you made of selling a single-family residence and using that money to buy a four-plex, that definitely fits the bill for what the IRS would consider to be a like-kind property because both single-family residences and four-plexes are residential real estate. So that is as like-kind as it gets. Now, when you execute a 1031 exchange, you need to use a qualified intermediary, which is a third party that will hold the cash after you sell your property and then use that cash to buy the replacement property on your behalf. So once the sale of your property occurs, the qualified intermediary will receive the cash.

You yourself, Mara, you cannot receive the cash or it will spoil the 1031 treatment. That must go to the qualified intermediary. Now, if you execute a 1031 exchange, there are two important deadlines that need to be at the forefront of your mind. First, within 45 days of the sale of your property, you must designate replacement property in writing to the intermediary, specifying the property that you want to acquire. You don't have to narrow down your selection to the final option. The IRS allows you to designate up to a maximum of three properties as long as you eventually close on one. of them. So within 45 days of the sale of your property, you have to name three properties that you are considering buying, and then you have to buy one of those three. Or if you have

enough cash, you can buy two of those three, or all three. Designating those three up to three properties within 45 days of the sale of your property, that is the first deadline to keep in mind. And the second deadline to keep in mind is that you must close on the new property within 180 days of the sale of the old one. And those two time periods run concurrently. So if you designate replacement property exactly 45 days after you've sold your holding, you have a remaining 135 days left to close on the replacement property. Now, myth buster moment here. You do not need to buy a property of equal or higher value. That is a huge misconception. That is a huge misconception. about 1031 exchanges, and many people have unnecessarily paid capital gains tax that they did not have to pay

because they intended to buy a property of significantly lesser value, and they thought that they could not 1031 the sale of their former property because of the fact that the new replacement property would be of significantly lesser value. And so this myth that you must have to be a new replacement property. And so this myth that you must buy a property of equal or higher value has caused a lot of damage to a lot of people. So I want to bust that myth right now. If you buy a low-cost replacement property and you still have cash left over after the intermediary acquires that replacement property, then the intermediary will pay the leftover cash to you at the end of the 180 days. This cash is referred to as boot. and this portion of the cash will be taxed as partial sales proceeds from the sale as your property.

So this partial remaining sliver of cash that's left over will be taxed as a capital gain. But the other portion of your money that you used to buy a replacement property of lesser value, that will still be deferred from capital gains taxes. So never, ever, ever, ever listen to somebody who tells you that you have to buy a property that's the same value or higher, they are wrong. That is only true if you are trying to defer capital gains on the entire portion, but you can always defer capital gains on a partial portion and then simply pay capital gains taxes on the leftover boot.

So that is the background of 1031 exchanges. And now you know. So what are the issues related to a 1031 exchange? Well, there are several. One is that you've got some very tight deadlines. You have to identify the replacement property, or at least you have to identify your final list of candidates for the replacement property within 45 days. That's not a lot of time. And so there's a risk that you sell one property only to buy a mediocre replacement one, right? Like you might trade one mediocre property for another because of that tight time restriction. So the risk of ending up with a property that's kind of meh that you're not really excited about, it's not the right fit, it's not what you would have bought if you had more time, but you just rush to buy it because you've got these tight deadlines that you have to adhere to. That's one of the major risks and the major drawbacks of executing a 1031 exchange. Another major risk slash drawback is that sellers, home sellers, are often tougher negotiators when they know that the buyer is executing a 1031 exchange. oftentimes sellers will demand higher prices or offer fewer concessions.

So for example, if you submit an offer for less than asking price and a seller knows that you're executing a 1031 exchange, that seller might respond by sending a counteroffer demanding full asking price. Or if you ask during the due diligence period, if you send in an inspector who looks at the property and finds some unexpected problems or issues with the property, and you ask for those repairs to be made prior to closing, or you ask for a cash concession that is equivalent to the cost of those repairs or that compensates for some of those repairs,

well, it's entirely possible that the seller is just going to say no, because they know that you're under a tight timeline, you're under pressure, you've got to close quickly, if you're past the 45-day mark, you've only got a total of up to a maximum of three properties that you could possibly buy. So that seller is going to be a tough negotiator. And to that extent, you may end up paying a premium for the property that you're acquiring.

So that's another drawback of 1031 exchanges. And then finally, you mentioned tomorrow that you want to buy a fourplex. Foreplexes are great. I love them. But there's smaller inventory, smaller deal flow. There are simply fewer fourplexes out there than there are single family homes or even duplexes. And so when you have smaller deal flow combined with a tight timeline, you've created a situation in which you take what you can get. You might not be buying the optimal property.

You're buying the property that you can find that's good enough that you can get in this very tight deadline space that you're in. So that is 1031 101. Now, in terms of resources, in the show notes, which you can access at afford anything.com, slash episode 235. I have linked to several articles about 1031 exchanges as well as a book about 1031 exchanges that was written by a former IRS tax examiner who is also an accountant and an attorney. I've linked to all of that in the show notes and you can access the show notes at afford anything.com slash episode 235. That's episode 235. Thank you, Mara, for asking that question. And good luck with whatever you decide to do.

Our final question today comes from Alex. Hi, Paula. This is Alex from Denver. Quick shout out to being a fellow CU buff. I started listening to afford anything from the very beginning just three short months ago, and I just got caught up on your current episode. Wow. I can't even tell you how helpful your framework and approach to thinking about personal finance are. So I'll just say thank you sincerely. I've spent the last three years working my tail off to dig my way out of nearly $45,000 in credit card debt.

I sure did make some poor decisions in my 20s. I'm better educated now and feeling very empowered to build the life I want. I can't wait to call back in down the road with an amazing success story like so many of your other listeners. Okay, here's my question. My partner and I are considering an opportunity to house hack into our first rental property. Instead of a duplex, though, we're looking at a single-family home with a full mother-in-law suite in the basement. We would live upstairs and rent out the basement as an apartment, and the plan would be to hold on to it long term to eventually rent out both halves. What should we consider from a zoning perspective?

I'm also a newly licensed real estate agent, and I'm wondering where I can find out more information about any limitations this kind of a setup may face. might we need to seek a zoning variance to make this house an income producing property? Because I assume that may be difficult and could be a showstopper. Thanks for everything you give to your community of listeners. Bye. Alex, it's great to hear from a fellow CU buff. And congratulations on paying off $45,000 of credit card debt and turning your financial life around. That's amazing.

Hey, Steve, could we please get a sound effect here? All right. Now, Alex, to your question, great news, this is not a zoning issue. So a zoning ordinance specifies how property can be used. So, for example, zoning ordinances specify whether zones can be used for residential or commercial purposes. And zoning ordinances regulate the size of lots or the placement of properties or density or the structure height. Now, in your case, you're renting out the mother-in-law unit to a lot. You're long-term tenant. So you are not operating a short-term rental, and most municipalities define short-term rental as 30 days or fewer. In your case, you're operating a long-term rental with long-term leases of six to 12 months or more, and you're not running any other commercial establishment. You're not serving food or offering any other commercial services. So you are complying with the usage, which is residential. So this is not going to be a zoning issue, but it might be a permitting issue. The only question is whether or not you need a license or a permit

in order to operate a long-term rental. Some municipalities require this and others don't. But it's not a zoning issue. It's simply an issue of finding out whether or not you need a permit or a license. And if so, applying for one. Now, the only potential complication that I can foresee is a complication that might arise if the mother-in-law unit that you're referencing was not legally constructed, right? Because in your case, you are moving into a property that already has two autonomous units. You're not constructing an addition. You're not retrofitting a single-family residence to become a two-unit dwelling. You're buying a property, as I understand it, you're buying a property that already has two units in place, one of which is the main house and the

other of which is the mother-in-law unit. So as long as that mother-in-law unit was built legally with proper permitting, then you're fine. If it wasn't, then a new crop of questions arise. Illegally built additions are sometimes grandfathered in if they've existed long enough, but that's something that you would want to find out. And so to get that information, check the public records in your county. And the most accurate way to check public records is by using the parcel ID number of the property. So use the parcel ID number. Go to your county website, check the public records to see if anyone pulled a permit to build that mother-in-law suite. If it's permitted, it's legal. Another quick and easy approximation is, is there separate

electricity going to that unit? Are there separate meters, one of which meters the mother-in-law unit and the other of which meters the main dwelling? If it's separately metered, you're fine. If it's not separately metered, you might still be fine, but you'd want to double check. So thank you for asking that question, Alex. And congratulations on getting your real estate agent license and on starting your first house hack. I want to share two really sweet comments, both beautiful heartwarming comments. This first one comes from April. Hi, Paula. It's April from Los Angeles. I'm listening to the emotional resilience episode and just burst into tears because I'm starting a new business and I am afraid. and I really just wanted to call and say how much your podcast means to me and how wonderful it has been in my life and how many new ideas it's introduced me to. And I hope you have a fantastic holiday.

I know it's not the best time in your life right now. But thank you anyway for taking the time to make so many lives better. And I hope you have a fantastic new year and are looking forward to the many things that will come in your career and in your personal life. Just adore your show and adore you. Thank you. April, thank you so much. The episode about emotional resilience, which for anyone listening who hasn't heard that one yet, that's episode 230. It was our interview with Dr. Susan David. She is a Harvard psychologist who specializes in emotional agility.

April, I'm glad to hear that it resonated with you because I often interview the guests who are speaking about subjects that I myself want to learn more about. And emotional resilience emotional agility, that matters throughout life. As you know, starting a business is scary. And even once it's up and running, maintaining a business, wondering at the beginning of any given year if you will do as well or better than you did last year, living with that uncertainty, that's scary. It requires resilience. It requires agility. It requires grit. And that is everything that I've just mentioned, pertains to a person's work life, but when that is compounded with issues in your own personal life as well, it to me drives home the idea that all of these conversations that we're

having around money and investing in financial planning and cap rates and 1031 exchanges and helox, none of that matters without a foundation of core emotional awareness and strength. and there is no such thing as business development or successful personal financial management without concurrently also working on your emotional health. And so I'm glad that episode connected with you. I'm glad this podcast as a whole connects with you. And thank you so much for calling in. Thank you for the kind words for the compliment.

Thank you. I want to share one other comment and this comes from Caroline. Hi, Paula. This is Caroline, and I'm such a long-time listener that I actually started listening to podcasts because of you. I was reading your blog already, and I wanted to start listening to your brand-new podcast. I'd heard of podcasts, but I wasn't totally sure what they were. So you got me started on that. Thanks. I've never felt like I should call in before. I mean, I've been self-employed as a musician and music teacher since I was 12, and I'm on the path towards FI, but I don't really have any questions at the moment. but after hearing you talk about divorce and the accompanying life changes on your podcast a couple of times,

I wanted to share my experience. When I was 23, I married the guy had been dating since my second week of college. We divorced when I was 25, and I'm 32 now. It totally sucked, and I'm still sad about it from time to time, but fortunately, the experience helped me figure out what I actually want out of life and out of a partnership, and allowed me to recognize the awesomeness of my current partner when he showed up in my life. Also, Paula, your encouraging words about FI, self-employment, and the benefits of many retirements allowed me to say yes when he proposed that we quit our jobs, sell his house, buy a sailboat,

and travel full-time for the next three years. I honestly don't know if I would have agreed to it without your example. You're a shining beacon of living life to the fullest, and I'm so grateful for you. People always say they're sorry when they hear you've gotten divorced, but you and I both know that's not the whole story. A really good, solid marriage, one worth fighting for, doesn't just end in divorce. And Paula, we both deserve something better. So this probably sounds really dumb right now, but I'm sorry to hear you've gotten divorced. And also, congratulations

on getting divorced. Take care. And thanks for everything. Caroline, thank you for leaving that message. Thank you for sharing your story. Thank you for relating and connecting. You articulated it really well. Doing the thing that is ultimately the right decision. sucks in the moment. The thing that's right is not always the thing that's easy. And as you said, I've learned a lot about what I want, who I am, what I have to offer, what I'm looking for, what I will and will not accept, my vision is much more clear now than it was two years ago or three years ago.

And so that greater sense of clarity and much stronger sense of confidence, those are two of the positives that have come out of this thing that in many ways is the hardest thing I've ever done or the hardest thing I've ever had to deal with. So thank you for leaving that voicemail and thank you for sharing your story because it's nice to hear from people who have also been there, people who have also experienced it. and people who can report that it gets better, as I know it will. And I'll also say that this is what I love about the Afford Anything community. Having a community by my side is a profound experience. I do not know how to put into words how much it means to me to have this community of support. So to everyone who is listening to this, thank you. Thank you for being part of that.

That is our show for today. Please remember to hit subscribe or follow in whatever app you're using to listen to this show so that you won't miss any of our future episodes. We've got some great episodes lined up ahead. We are giving away a free ebook called One Tweak a Week that outlines 26 actionable steps that you can take. One step per week for the first 26 weeks, the first six months of the new year. You can download that at Afford Anything.com slash 2020 kickoff. Again, that's afford anything.com slash 2020 kickoff. And we will send you an email once a week with one simple action that you can take that week that takes less than an hour.

Some of them take less than five minutes that will improve your financial life. We are also giving away five books for free. You can enter our contest at Afford Anything.com slash book giveaway. We are giving away stillness is the key by Ryan Holiday, emotional agility by Dr. Susan David. letters from a stoic by Seneca, debt-free degree by Anthony O'Neill, and Brooke Millennial takes on investing by Aaron Lowry. We're giving away all five of those books to one lucky winner,

and you can enter that contest at afford-anything.com slash book giveaway. The contest closes on January 10th at midnight. A shout out to the sponsors for today's episode, Grove Collaborative, Radius Bank, Billy, and Policy Genius. Most of our sponsors offer special deals, discounts, coupons, free trials, things like that, the special offers. And if you'd like a complete list of all of those deals and discounts, you can find all of that at afford anything.com slash sponsors.

That's afford anything.com slash sponsors for a complete list of deals and discounts. Thank you so much for tuning in. My name is Paula Pant. This is the Afford Anything podcast. Happy January. Happy kickoff to 2020. It's going to be an amazing year. And an amazing decade.

It's the roaring 20. I'm excited to see what's in store in the coming year and the coming decade, and I'm thrilled that I get to spend that with you. So thank you for being part of this community. Please join us in our one-week-a-week challenge, and I will catch you next week. So my lawyer says I'm supposed to give you a disclaimer. So here we go. This is for entertainment purposes only. This is not intended to be advice.

And please do not consider me to be an expert, or a grown-up or in any way worthy of even really being considered an adult. I'm just some random person who has access to the internet. So anything I say is purely for the sake of entertainment, you can just think of this as the least funny comedy show that you've ever heard. This is the Afford Anything Unfunny Comedy Hour. Before you make any financial moves, please check with a real grown-up and a real expert. That means check with a financial planner, check with a tax advisor, check with an attorney, check with somebody who actually has credentials and who knows what they're talking about, because that's not me.

So please, give me the same level of respect that you would give, me, maybe a house cat? And please regard this entire show as nothing more than your source of entertainment. All right, you've been warned.