The topic of finding a qualified tax professional is common in my mailbox. There is no pat answer for each request so I generally ignore them. Another common request is for a referral if I am too busy. It is true I only accept a small fraction of the requests for service, but the good news is I have more staff this tax season and have been accepting more new clients than last year. The bad news is that I don’t have someone to refer you to in your area.
Yesterday I received an email that touched me. Long emails usually die before I read more than three sentences due to time constraints. This email was different. The sender asked to remain anonymous and I will honor that request. He asked: How do I go about finding a good local accountant? He wants someone local he could shake hands and sit down with to discuss his tax and financial matters. I get it. He continued: I am hoping for an idiot-proof, step-by-step guide. I don’t know where to start searching, never mind narrowing the choices.
Finding qualified professionals is a difficult task. I wish it were as easy as an idiot-proof guide, but there is no such thing. My goal today is to share ways to increase the odds you have a good tax professional on your side.
Good tax professionals are a busy group, especially this time of year. The industry has consolidated over the last few decades and many top notch accountants have retired. Making matters worse is fewer people entering the field. CPAs frequently seek employment in government and large corporations or large accounting firms. The small and mid-sized accounting practice is a dying breed. These are the same firms serving the average American family’s tax preparation and planning needs. Finding an awesome tax professional to work with you is getting harder by the day. I have a few ideas to help you land a good one, but you might not like what you here.
The Initial Search
You need to build a list before you narrow it. The phone book or an internet search will give you a long list of local tax professionals. However, there is no way to determine quality with such a shotgun approach.
The first step I would take in searching for a tax professional is talking with friends and co-workers. Business owners tend to find average or above avaerage tax/accounting firms if they are in business any length of time. You don’t want average, but building a list that excludes as many dudes as possible reduces the winnowing process.
Second, know the difference between a CPA, attorney, enrolled agent and unenrolled preparer. A CPA is an accounting professional who might focus on taxes. Attorneys are legal professionals. Many attorneys take tax preparation work. However, they tend to farm that work out and add a fee on top of the real preparer’s fee without adding additional value. Some CPAs and attorneys are good tax professionals; others, not so much.
Enrolled agents are licensed tax professionals. EAs sometimes handle payroll, bookkeeping and other accounting issues as well. Unenrolled preparers are anyone who hangs a shingle.
CPAs, attorneys and enrolled agents can represent you before the IRS.
There is another group of semi-professionals in the tax field: those in the Annual Filing Season Program. These folks have limited representation rights, but are required to take 18 hours of continuing education each year and pass a test. This program has been in flux the last several years as the IRS works to improve the tax profession, while the courts knock it down because the IRS has no authority to regulate tax preparers at that level. It is a voluntary program as a result.
I am an enrolled agent so I am biased. In my search for a tax pro I would consider EAs and CPAs first, then attorneys (based on cost and because most farm the work out anyway), then preparers in the Annual Filing Season Program. I would avoid non-licensed tax people. The worst riff-raff is usually avoided once a professional designation is attached to the professional.
There are two places to look for a list of generally qualified tax professionals: professional organizations and the IRS. (Yikes! The IRS! Yup.)
The National Association of Enrolled Agents has a Find a Tax Expert page. Plug in your ZIP code and you get a list of EAs in your area who also happen to be members of the NAEA.
I am not a member of any professional organization so my name will never show up there. These organizations are expensive and the annual dues do not provide enough benefit for my investment. However, the enrolled agents you find at the NAEA site not only have a professional designation, but also have a commitment to their professional development by belonging to the NAEA. I undertake different activities to earn my credentials. That is just me and should not reflect poorly on the fine people on the NAEA registry.
A complete list of tax professionals can be found at the IRS. I like the IRS site better because it has a complete list of all tax professionals with any sort of designation. If the best tax professional for you doesn’t belong to the NAEA or the organization you are searching you will miss out. The nice thing about the IRS site is you can limit your search to a specific professional designation, like enrolled agents.
Making a List and Checking It Twice
Now armed with a fist full of names, it is time to shorten the list. There is no simple way. You need to pick up the phone and call.
I am writing this as tax season is starting. If you are starting your search for a tax pro now, shame on you. And your job is 100 times harder, too. As a tax pro with over 30 years under the belt I can say with absolute accuracy, tax professionals don’t have time now to discuss your search for a tax pro.
Not all is lost. The earlier you start the better. During the off tax season is the best time to build a relationship with a tax professional. The initial consultation is probably free, except during tax season. Too many tax pros are like me: swamped. We have paying customers lined up with cash in hand. Free consultations have no place in the schedule until May. A quick phone conversation might do the trick, but getting the accountant to give you more than a few minutes is unlikely if they are good, because if they are good they are swamped.
There is another way. You might not like it, but it will get you much better results. Pay for the service. Tell the accountant up front you want a paid consultation where you expect solid information as it relates to your tax situation. Make it clear you are also looking to hire her if you feel it is a fit after the paid consultation.
During the off tax season I would talk to a few additional tax pros. If it is tax season before you even look, expect to hire the first competent tax pro you can find if they even accept new clients.
The Most Important Step
You did your research and found three or four potential tax professionals that could work for you. Now you need to have a short meeting or phone call with the tax pro. Truth is you will know in 10 minutes or less if it is going to work. In some cases you will know if it will not work in less than 30 seconds. If it isn’t going to work, save both yourselves time and say it. Move on to the next name on the list.
People calling my office tend to ask two questions: How much do you charge? And are you taking new clients? They ask in that order. The answer to the first question is it depends what work I have to do. The answer to the second question is I am always taking new clients, but selectively. Depending what the kind of work you have will determine if I will take the account.
And those two questions are the wrong ones to ask! The guy you call could be dumb as a hammer and all you want to know is what he will charge you and if he will honor you by charging you. There is a better way.
Whether you have a short phone conversation planned or a one-hour paid consultation on the schedule, you want to ask the right questions. Remember, the tax pro is interviewing you too. They want to know if it is a good fit. Tax pros don’t want problem clients.
Think about how you plan on presenting your tax situation. If it is a mess, be honest. Many tax offices have people inside the firm and outsourcing options to get your paperwork in order. It will cost extra, but the option is available.
Be clear in what you expect. The tax pro needs to know if you are the kind of client who needs handholding or will show up once per year with maybe a phone call or two over the summer. Don’t try to guess what kind of client the tax pro wants. It’s not going to work if you play that game. I fire clients every year who do not fit my preferences. It is not personal. Better yet: it’s not you, it’s me. If you don’t fit the corporate culture, best we know up front. I can still help with consultations in most cases, even if another firm prepares your return.
The last questions you should ask are, in this order: After reviewing my account, are you willing to take me on as a client? With that attitude I will want to do just that. It will hurt if I have to take a pass. Good, professional clients are always my favorite. And the last question you should ask is: Now that you reviewed my tax situation and are able to take me on as a client, how much will my tax return cost to prepare? See the difference? Most people ask the last questions first when I have no idea what it will cost or if I have time to prepare the return. Be a good client and you will get the best tax pros to say “Yes” and at a reasonable fee.
Paying for Service
Tax season is triage. I want your stuff and I want it done and out the door. Now is not the time for a consultation. I am more than happy to provide a short review of your tax return before filing it. Asking me how you can save taxes should wait until May or later in summer.
Many tax professionals offer a phone or in-office consultation during the off tax season without fee. This is a mistake. I know the accountant it trying to be nice, but think about the mindset. If I am not going to charge a fee, I will not prepare. We will jawbone for an hour without digging as deep as we should. A well planned consultation will allow the accountant plenty of time to research your tax return for ideas and it should be a paid consultation to encourage the tax pro to perform.
In some situations the tax pro will say there is not much to discuss so there will be no fee. I get it. But the consultation should be more than just taxes. For the accountant to do an awesome job, she will need a deeper discussion on your financial goals. Now is the time to work on retirement goals and how you can reduce taxes while you save and invest. Education planning for the kids might be a topic. A planned major purchase run by the tax pro can give you insight from a third party with your best interests at heart.
Taxes are only the first step when working with a tax pro. Before you hire the accountant, make sure they are versed in the areas important to you. If maxing out retirement accounts is an issue for you, make sure the accountant understands that part of tax law. Not all do.
There is no fool-proof method for success when searching for a tax professional. Here are the things we discussed that will increase the odds you find a good one:
- Ask friends or trusted business owners who they use for an accountant.
- Search NAEA, the IRS or other tax professional organizations to build a list of potential tax pro candidates.
- Stick with an enrolled agent or CPA unless you need the specialized services of an attorney.
- During tax season a 10 minute call is about all you will get when determining if you will hire the tax pro.
- Outside tax season be willing to pay for an in-depth tax analysis.
- Ask quality questions pertaining to your situation. Focus on areas outside taxes, too, such as, personal finance, home purchase, retirement planning and education funding. Make sure the tax pro handles areas of concern to you.
- Save the discussion on fees until the tax pro knows what work she is expected to do.
- Be willing to pay for our professional advice.
- Be nice. We really, really want to help you, but we get really tired at times from all the hours in front of a computer. We love you guys and want to help, but we are only one person.
- Give your accountant a hug. She needs one after a long day.
There it is. As fool-proof a method if ever there was one for finding the tax professional of your dreams. Remember, communicate. The more your tax pro knows you, the better job she can do.
The most dreaded words a salesperson can here are, “I need to talk it over with my accountant.”
Accountants have a reputation for breaking deals. Behind the scenes we are actually called ‘Deal Breakers’ as a derogatory term. But the name isn’t fair. What we really are doing is protecting our clients.
The investor or business owner already thought of all the things that can go right. Accountants throw cold water on the deal by examining the numbers. They don’t always stand up to the hype.
And then there is my last blog post where I play a Sad Gus with robo-investing and Betterment. I think a lot of people really believed the tax benefits were much higher than they really are. There are real benefits, just not as many as some would have you believe.
That is where accountants shine. If you are going to serve your client you had better have the stomach for laying the truth on the line, even if the client doesn’t want to hear it.
The most common deals I review involve real estate. Multi-million dollar commercial properties or multi-unit residential properties need a second look by a trained eye before signing your name. Over half the deals I review get a thumbs down. All the work to get to that point is wasted. At least the money is preserved.
Usually the client accepts my analysis and cancels the deal. The sales agent thinks nasty things about me and my parentage. They dread the next deal I review.
Then there are the times the client goes forward anyway. In a few years I am hired to clean up the mess. And quite a mess it is. Money is lost. Lots of money. It is rare for an investor or business person to beat the odds when they are against them.
The numbers don’t lie. My goal is to help the client make a good decision. Too often, small business owners and investors see things with rose-colored glasses.
Once or twice every decade I am proven wrong. It happens. But two deals working after I raise serious concerns does not trump the 100 deals that sour. Accountants are sometimes wrong, but it is rare. Investing and business ownership is all in the numbers.
Business as Usual
Business owners and potential business owners have it worse. More real estate deals get my approval than existing business purchases. Business owners want too much too often when they sell. So I break the bad news to my client.
You would be surprised at what I find upon review of the books. Business owners think they can hide certain things, but there are ways to ferret out the facts. The seller wants to get top price, but wants to use her books instead of the tax return where she didn’t report all the income. Too bad. We use the tax return and verify it was the return filed.
Buying a business has problems all their own. Sometimes clients leave. Sometimes there is a learning curve for the new owner. It isn’t easy picking up where someone left off. Nothing is more common than the new owner of a business pissing away a profitable enterprise.
Investments are the worst of all. Even good ideas can turn bad. It has happened even to your favorite accountant. When you think you are smartest is when you get your head handed to you.
Affiliate programs change your view of a product no matter how honest and honorable you are. I am not immune. This blog needs to turn coin to pay the few bills blogs have and compensate me for my time. I could be doing something else, you know.
Payment changes how we think. A client paying me to review a piece of real estate or a business will get a thorough review, even better than I might review my own deals. In fact, reviewing my own deals is when I take the greatest risk. I am not better than you or any investor or business owner. I am just as capable of self-delusion as the next guy.
Bloggers have offers pour in as their traffic rises. Most offers are pure junk. Fortunately, I have a sizable nest egg to live off of if all goes south. A younger—and poorer—version of me might be tempted. Or worse, totally deluded. Except, older does not mean wiser. I am just as human now as I was twenty or thirty years ago. I am only slightly less prone to delusion than I was years ago due to experience.
A Gift for You
And then the gifts show up. I am a sucker for t-shirts. Love’em! I’d live in t-shirts 24/7 if I could. A few days a year I wear a dress shirt just to remind me I am supposed to be a professional.
If my research works out I’ll be using a new product in my office to handle a facet of my business. Then I will share it with you guys. Of course, an affiliate program will be involved. They sent me several t-shirts. So, how do I tell if I am doing it because of the affiliate program or because it really is the right thing to use? My policy is to always review the product as if it was for a client and I am paid to conduct the review. Then I use the product in my practice and if it still passes the sniff test I will present it to you.
So far I haven’t been invited to a company’s headquarters where they can put the heavy sell on. Other bloggers might accept what they see and hear. The accountant in me believes everything is bullshit until proven otherwise.
The last few years business owners have come to me wanting to organize as an S corp because they saw me on other blogs doing just that with great success. They come to this blog and read more of what I offer. I can hear the disappointment in their voice when I tell them they are not ready for an S corp or would be better served by a different strategy.
Selling My Soul
Sometimes I am disappointed in the financial results of this blog. My traffic is good and growing, but as a good accountant, I record everything. The numbers don’t grow fast enough at times. The Wealthy Accountant turns a profit because there are no real expenses to speak of. Unless you consider my time. Then it is a big, fat bust.
I spend a lot of hours writing this blog. Like any business, it takes time to hit a critical mass. Where the blog kills it is new tax clients. There it is a resounding success. Affiliate revenue, not so much.
Writing is something I do regardless so writing this blog is no big deal. No matter how big the numbers get, I will always review and examine the results. I am a hands-on type of business owner. It’s not about money. It’s about the game of business. The scorecard is money. The wealthier you are the more you will understand what I just said.
It also requires caution. When my accounting practice started I tracked every detail of the business. Still do. Budgeting and goals are not for me. My goal each year was to beat last year. That’s all.
It sounds simple, but after a few decades those numbers become daunting. Stuffing more business into the same building gets harder each year. Expanding to multiple locations was never in the cards for me. I like things just the way they are.
But never underestimate the ingenuity of a country accountant. I found ways to expand the business without hiring half the county’s tax professionals or opening new locations. I added payroll and bookkeeping to the mix. Now I am selling those departments of the business. I found a way to grow without doing more work myself or expanding the structure of my practice.
Now The Wealthy Accountant is on the scene. I can leverage the entire business like never before. The ability to grow the practice while staying put in one location is possible. The contortions I must go through to manage this feat is entertaining at best.
And then I start thinking. If I were to review this idea for a client, what would I say? I’m afraid to ask.
Sophisticated investors have been harvesting losses manually for decades to acquire tax benefits. Betterment and Wealthfront made harvesting losses easier and more efficient than ever since 2008. Betterment alone has reached $5 billion under management.
Personal finance bloggers tend to love tax-loss harvesting without much mention of risk. A few bloggers have expressed doubts over the whole process, but their numbers are few and their voices drown out by the scream of the crowd. Betterment’s affiliate program has caused concern positive reviews are biased. Betterment’s affiliate program has tightened for bloggers investing with the company and with published reviews due to recent SEC rule changes. As a result, many bloggers must end their affiliate relationship with Betterment or take down their reviews of the company.
The truth about TLH is not as clean cut as some would have you believe. Taxes and performance are two issues every investor needs to consider prior to investing with any company engaged in TLH.
How TLH Works
Tax-loss harvesting is when you sell a security at a loss for tax purposes. The IRS knows this strategy can be used to generate substantial phantom tax losses by taxpayers. There are rules to prevent doing just that.
Sales of a security at a loss are not deductible if you buy a substantially identical stock/security within 30 days of the sale. This includes the purchase of options to purchase a substantially identical security. Disallowed loses from a wash sale are added to the basis of the purchased substantially identical security.
Wash sales in a traditional IRA are lost forever! Using Betterment or other similar programs increase the risk you will have a wash sale. When Betterment sells a security at a loss and you buy a substantially identical security in your IRA unwittingly, the wash sale loss is disallowed forever. The taxpayer’s basis in the IRA is not increased by the amount of the disallowed loss. Understand now? No? Then you either must allow Betterment to handle all your investments or don’t use them at all. It is the only way to steer clear of this pitfall.
Using the Harvested Loss
Capital losses, including harvested losses are applied first against other capital gains. If all gains are used before the losses, up to $3,000 can be deducted against other income. Most states follow the federal rule. However, Wisconsin only allows $500 per year against other income.
Long-term capital gains taxes reach 20% for taxpayers in the 39.9% tax bracket. The alternative minimum tax has a 22 ½% LTCG rate. (AMT issues will need to wait for another post as the issues surrounding AMT are massive.) If you are in the 10% or 15% tax bracket, LTCGs are taxed at zero and harvested losses are worthless. In lower brackets you want to gain harvest to increase your basis while paying little or no tax.
The Net Investment Income Tax may add 3.8% to the LTCG tax bill of high earners. There is a possibility this could change in the near future. (I am writing this in early 2017.)
Excess capital losses must be deducted (yes, there is a very limited opportunity to avoid this, for the tax accountants reading) up to $3,000 each year until used, even if it provides no benefit. When a capital loss is carried forward, it is applied to capital gains first again. If excess still exists, up to $3,000 is deducted. (Example: If you only have $1,000 of loss left over then you only get to deduct $1,000.)
Investors in Prosper, Lending Club or similar investments have an added issue. Loan defaults in the micro-lending arena are treated as capital losses. As you will see shortly, larger capital losses carried forward can cause nasty tax problems. Later collections are treated as capital gains.
The $3,000 deduction against other income is at your marginal tax rate. Since the $3,000 comes off the top, it comes off at your highest tax rate. Therefore, a $3,000 deduction for a taxpayer in the 33% tax bracket will see her tax liability drop $990. State taxes may allow for additional savings.
TLH reduces your basis. Later, when you sell, your gains are taxed at the LTCG rate (assuming you held the investment more than a year). Even in the 20% LTCG bracket, you still pay 13% less than what you saved. The good news is you get a tax break now and pay later at a discount. The problem? It only applies to $3,000 per year.
The tax savings on the above example is $130 max. It seems like a lot of horsing around for such a small real gain.
Disclosure: I am not an affiliate of either company. If I am asked to be an affiliate I might agree, but as of this writing I have no intention of pursuing that course. I also do not have any investments with either company.
Technology has brought Modern Portfolio Theory front and center. Back in the 1990s when I was a securities guy, we talked about the efficient frontier and Modern Portfolio Theory a lot.
Modern Portfolio Theory entered our world in 1952 when Harry Markowitz published a paper called “Portfolio Selection”.
Betterment and Wealthfront can now automate the entire process, balancing the investment and taxes for maximum results. There are fees connected to the service, of course. The fees are generally small, but they do reduce the value of the tax benefit.
First, broad-based index funds may outperform the TLH platforms. This is because Modern Portfolio Theory doesn’t have you in one broad-based investment. My experience with clients is that in up markets TLH underperforms a bit and in down markets outperforms a bit. It could be my small sample group giving me this worldview, so take it with caution. Since the market is up more than down, there is something given up for the smoother ride and the access to harvested losses.
Second, harvested losses vary a lot. Usually the early years provide the biggest benefit. As the basis drops, so do the tax benefits. It is not unusual for the first full year of the investment to produce harvested losses near 10% of recently invested capital. Harvested losses decline as the years go by unless you add more capital
TLH in Retirement
Here is where it gets tricky. What starts as a good idea ends up working against you when your taxable income declines. As you accumulate wealth by investing income, your marginal tax rate tends to be higher. Therefore, you benefit from the TLH.
In retirement, early or late, your income declines to about what you spend, maybe lower. Social Security is only partially taxed, if at all, depending on your other income. Withdrawals from non-qualified accounts are not all taxable gain as some is return of capital. Traditional retirement distributions add to income. People around here tend to live a frugal lifestyle. That is how they built a large portfolio. Therefore, they have low taxable income in retirement.
At this time you don’t want to harvest losses because they hurt you! Now you want to do the opposite. A low tax bracket means your LTCGs are very low or even 0%. Harvesting gains doesn’t have wash sale rule problems, either. You can sell at a gain and buy back the exact same security a second later without tax basis consequences. You claim the gain at the low or 0% tax rate and get the higher basis. If you sell in the future you will have a smaller gain which is good if your income has increased. Tax gain harvesting is free or close to it and doesn’t require a platform, like Betterment.
Married People and Wash Sales
As if wash sale rules weren’t hard enough to account for, married people have an added risk. The 30-day rule applies to your spouse’s account too. Like above, this means if you have a wash sale, even your spouse cannot buy a substantially identical security in her qualified or non-qualified account during the 30 day window.
If a traditional IRA is involved the basis is lost forever, again.
The only way around this is to have 100% of your investments with the same platform for you and your spouse. If not, you could run afoul of the wash sale rules without knowing it. And if the IRS finds out . . .
Who Owns the Loss? Where You Live Matters
Capital losses have one last problem to consider. Losses follow the person they belong to. If you have a capital loss and you die, the loss dies with you. Your spouse does not inherit the loss for use on her tax return.
In marital property states (https://wealthyaccountant.com/2017/01/23/avoiding-the-gold-diggers/) non-qualified accounts are considered owned 50/50, where each spouse gets half the loss applied to his/her account. In equitable distribution states (most states) the loss belongs to the person named on the account. It could be a joint account, but if it isn’t the loss only follows the person named on the account.
The $3,000 capital loss deduction is per return, not per person.
When a spouse dies and in a divorce, it is important to account for which spouse gets what amount of the loss carry forward. Marital property tax states are nice because it is usually a 50/50 split; one of the few benefits of working as a tax pro in Wisconsin. Equitable distribution states require some work to properly allocate the loss.
Would I Recommend Betterment or Wealthfront?
Actually, I have. Recently, at a Camp Mustache in Florida, I offered consultations. For some reason I ended up recommending Betterment to over half the people I consulted. The percentage was high so I started to feel concerned. No one answer is right for everyone.
After plenty of thought I felt comfortable with my recommendations. Betterment offered a quality service which would reduce the client’s taxes. The client was unlikely to do any TLH themselves, so it made sense to recommend.
What I don’t have control over is when the client will need to flip the process. You see, if they are in a 33% tax bracket now (saving $990 per year) and retire with a lower bracket where LTCGs are taxed at 0%, the best possible outcome for my clients, they need to reverse the process and start gain harvesting.
I don’t recommend Betterment or any TLH program for everyone. I recommend selectively if the numbers add up. The tax savings are nice, but small for most people.
Wash sale rules are complex and easy to mess up. A qualified tax professional is required for most people when they engage TLH programs.
Betterment (or other TLH platform) needs to manage all or none of your investments to assure you do not run afoul of wash sale rules.
TLH is just one tool to reduce your tax liability. I personally do not use any TLH platform, but periodically do some TLH manually. A large capital loss carried forward will not benefit my spouse if I die. Of course, Mrs. Accountant would get a step-up in basis if I kicked the bucket.
High earners benefit the most from TLH. High income also means there is probably less time available to work this stuff manually.
Young people also have more time to accumulate tax benefits. Remember, the real benefit is the $3,000 allowed against other income. Netting a $500 – $1,000 annual tax reduction is nice, but you need several years of benefits for the amount to become meaningful.
We can continue the discussion in the comments section below.
During the 1980s and 90s I owned a lot of real estate. It started slow and exploded into a 176 building pain in the ass. To be fair, most of the investment properties we owned were either single family homes or duplexes. A few multi-family buildings, a boarding house and a storage facility rounded out the mix.
With so many properties running through my personal accounts and a partnership with dad and brother, I learned a few things along the way. One hundred seventy six buildings is a lot of buildings. Good thing I didn’t own all of them at the same time. Mistakes were sure to happen.
By the early 2000s the real estate empire was gone. I was burnt out and sick of working with tenants. Countless property managers helped us over the years, but it was not enough. Managing over a hundred units much of the time over a footprint covering most of NE Wisconsin took its toll. To complicate matters, I also ran my accounting practice with double the employees I have today (during tax season).
Starting slow was my greatest idea. It felt good to see the passive income filling the checkbook. Our teams of contractors allowed us to buy fixer-uppers and increase the property values significantly. Our best deal was the purchase of an upper-lower duplex in my hometown for $8,000. Hard not to make a profit on those.
The Pain of Gain
The first 10 properties were fun. I still remember the first one. (Isn’t that true for most things?) 833 E North Street in Appleton, Wisconsin. A beautiful front-back townhouse. Bought it from the bank for an even $50,000. The combined rent was $980 a month without a day of vacancy and the rents rose rapidly. Ah, those were the halcyon days. Two years later I sold it for an even $75,000.
The first 10 were easy so I managed them myself. But with profits like this, I decided to make hay when the sun was shining. Before North Street was even sold we were buying up to 10 new properties a month and selling 2-3 per month. The last business day of the month was almost always spent at the title company, where we handled all our closings.
More properties over a larger geographical area required property managers. And so we did. I went from managing properties myself to managing managers. That was fun at first, too.
Finding good property managers is just as hard as finding good tenants. They are out there. Back in the 1990s they were harder to find in my area. Most property mangers back then handled large apartment complexes only. The few who handled stuff like I had were not always connected with real estate firms (where I found most good managers to exist).
The weight of too many properties took me away from what I loved most: taxes. The fun was sucked out of the whole process. Now I spent the last day of the month at the title company selling more houses than we purchased, and soon we were only selling.
Today I do not consider myself in real estate, but still own close the seven figures in RE value with only $111,000 in mortgage on my farm. It is not fair to say I am a landlord. I rent my commercial property to my practice, which is an S corporation. I have one property sold on land contract where I hold the paper and the farm, 10 acres of respite in the backwoods of NE Wisconsin.
The Itch is Back
I have been out investment properties now for over 10 years. Part of the reason for selling way back when also included my realization rents were not keeping up with real estate values in my market. Sometimes it pays more to take a profit and go home. Coupled with burnout, it was a no-brainer.
Itch or no, I have to review mistakes I made decades ago and review how the investment property environment has changed over the decades before diving back into the investment property markets
Mistake #1: I managed too many properties on my own to increase margins. In hindsight, my profits would have been higher if I would have hired all the management work done and focused on the financials only. When they said—Jack of all trades, master of none—they were thinking of me. Now you know.
Mistake #2: I got addicted to owning real estate. Younger and with a larger ego, I enjoyed the stroking I received when people mentioned the amount of property I owned. Toward the end I was buying properties that did not have the potential of earlier investments. My goal no longer focused on quality properties, but volume. Dumb, dumb, dumb! With rents stagnant, margins came down. Too much work sucked the fun out of the whole project; lower profits killed any love I had for more real estate.
Mistake #3: I stayed close to home. I bought almost all properties within 100 miles of home base. No properties were purchased outside Wisconsin. The NE Wisconsin market was no longer a great place to invest. Only the rare prize would make an investment locally worth pursuing.
After all these years the itch is back. I want to add real estate into my investment mix. Next I am going to show you how I plan to make these investments. Having learned from my mistakes I may end up with investment properties the rest of my days. You can use my template as a guide. You have to decide how you will handle your investment properties. Learn from my mistakes and successes. Real estate is a great way to build a steady flow of passive income. A small amount of money invested in the right properties can allow you an early retirement. More to the point: $100,000 invested in five good properties ($20,000 down each) could be enough to retire in some areas. If you do it right.
You have to buy right for this to work. Never chase a property and never rush. My second mistake above was I started to rush the process and it showed.
There is a lot of advice on how to buy properties floating around. They are not my concern. My accountant mindset thinks differently. I don’t care about the 1% rule for rents or, fingers-crossed, potential appreciation of the property or tax advantages. These things are used by real estate agents so it is easier to sell the property. Just because rents are 1% of the purchase price does not make it a good buy. Future appreciation is hope and I have an adage about hope: Hold out both hands. Wish in one and shit in the other and see which fills up first. Sorry to be blunt, but you never consider any appreciation in the property value when buying an income property. (Okay, there might be a few instances. You are on your own in those cases. Leave me out of it.) And tax advantages are a stupid reason to buy a property. If you want to buy for tax deductions, I have a bridge I would like to sell you. Cheap!
Rule #1: When I calculate the profitability of a property, I do so as a no-money down deal even though I will put money down. Here is why. If I put enough money down any property will turn a profit. But what about your investment? My rule is simple: My investment must return at least as much as the cost of capital. If the bank has a 4% mortgage rate, then my investment sure as hell better do at least that good.
Therefore, I use a mortgage payment as if I financed the whole darn thing for my illustration.
Rule #2: Allowances must be made for vacancies and repairs. The market the property is in and the property’s condition will determine the vacancy and repair allowances.
Rule #3: The cost of a property manager must be included in your expenses. If you don’t you are valuing your time at zero. Stupid! As you will see below, I will never manage investment properties again. My time is too valuable for me to do something I really don’t like doing.
Example: Let’s run some numbers to see if we can add a certain property to our portfolio. I live in a part of the country where you can buy a small home in livable condition for under $50,000, so play with me.
You found a nice 4-plex (multiunit buildings usually have a lower cost per unit, making it easier to cash flow) for $120,000. A 15-year mortgage at 4% gives you an $888 per month mortgage payment. In Wisconsin we have high property taxes so we will say this property owes $3,600 per year in local taxes. Rent is $500 per unit.
Time to plug some numbers (per month):
Mortgage Payment: $888
Property Tax: $300
As you can see, the 1% rule would be a disaster in most Wisconsin markets for several reasons, property taxes being the most notable. $1,200 in rent would not cover the most basic cash flow needs.
Now we add other expenses. Some of them are non-cash most months, but significant when they show up. Vacancy rates, maintenance costs and property management fees are generally low in my area.
Repair Allowance: $200
Vacancy Allowance: $50
Property Management Fee: $50
Of course I picked a deal that would work. If my mental math is right, I’ll make $437 per month on a no-money down deal with a property manager doing the day-to-day work. Any down payment will increase the cash flow and the expected monthly profit. Certain expenses (repairs and vacancies) could be higher or lower.
This illustration is not to show you what to buy, but rather, the mechanics of the accounting I do prior to buying. Yeah, I know, most properties don’t make the cut.
Rule #4: Your local market is almost certainly not going to be the best place to invest! It sucks, I know. But on a brighter note, if you buy in a different market you will be more motivated to hire a manager.
For now I would stay within your own country to keep things simple. If you educate yourself, you may consider properties in world markets. The tax preparation surrounding most investment properties is generally small, even when you own in multiple states. The worst market in the U.S. is New York City for preparing taxes. Any rent controlled cities are also more problematic from a management perspective.
Dirty Little Secret the Wealthy Accountant Knows
As an accountant I see what works and what doesn’t. Of all the bankruptcies I see in my office, the most come from landlords. Landlords are also one of the wealthiest groups of people in my office. What gives?
Investment properties have risks many people ignore. They think it is all easy money. Seminars around the U.S. charge massive sums to teach people how to flip houses with no work and zillions in instant profits. It ain’t so. Good investment properties take time to find. Not every property fits the bill and flipping is a tough game. When you flip a house you make a quick profit, but an investor will hold the property for years, collect rent, watch the property increase in value and pay less in tax than the flipper. And don’t start with the like-kind exchange BS. If I buy a property for $100,000, collect $200,000 in rent over the next 10 or so years and sell the property for $220,000, I will make more than the pittance you made flipping.
Flipping is the mindset of losers! Not that I never flipped a house when the price was right, but short-term thinking is not the path to riches. In over 30 years as an accountant I never once had a client with a consistently high income flipping house. Many declared bankruptcy, however.
Now my landlord clients, they are a different story. Some of those guys went broke too, usually because they leveraged too much. I also have numerous success stories of clients hitting it out of the park that owned and managed investment properties. A steady stream of passive income beats a quick lump of cash any day. In the end my income stream beats the tar out of your flipping and while you are hunting for the next flip, I am reading a book at the beach (if I did that sort of thing).
Buying the property right is the only way to win the investment property game. But buying is only a small part of the process. Now that you own the property you need to manage it. The temptation is to save a few dollars and manage the thing yourself. With the many rules ever changing, I recommend against doing it yourself. You can remind me I am a hypocrite in the comments below. But my days of busting tail doing it all alone are over. I learned my lesson. The question now is: Will you learn from my mistakes or experience the same groin kicks I did?
Rule #1: Get a property manager. The rules are different is every community. A property manager does this stuff for a living and has all the forms in-house. They also have a steady stream of potential tenants. Besides, when you buy income properties, are you looking to create a job for yourself or an income stream? Good. Then hire the manager.
Property managers are everywhere. Good ones usually work in a Realtor’s office. Many states require property managers also be licensed real estate agents. Those ladies already work this stuff every day and know what they are doing. Let them do it! They are worth every penny you pay them. They also know the right rent to charge. Do you?
Property managers usually work this way:
They rent out the property, collect rents and the security deposit, pay the mortgage out of those funds, handle necessary maintenance, pay all other expenses out of funds received, subtract their fee and deposit the remainder in your bank account. Now you know how people retiring early can travel the world while owning investment properties. The biggest issues are buying right and management.
Note: If a major expense arises (roof, furnace replacement) you will need to provide funds to cover those costs as the monthly revenue will not be enough. Might I suggest paying these expenses with a credit card that has a large cash back bonus?
Property managers don’t want extra work, either. Good managers keep on top of maintenance issues so you can plan accordingly and they don’t have to field late night calls from tenants.
Real estate is like any other business today. Only the crazy people (anyone thinking perhaps of a crazy accountant from Wisconsin) handles every facet of the process themselves. You’re the investor! You buy the properties right. Let the management pros do their job. They are better at it.
Now you can start looking for the next awesome deal or maybe travel a bit.
(Final recommendation: I would consider keeping the repair and vacancy allowance in a money market account. Then you will never be short when the need arises. The more properties you own, the easier it is to spread costs around. If your finances can easily handle any repair expense then you can disregard this suggestion.)
More Wealth Building Resources
Credit Cards can be a powerful money management tool when used correctly. Use this link to find a listing of the best credit card offers. You can expand your search to maximize cash and travel rewards.
Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?
Side Hustle Selling tradelines yields a high return compared to time invested, as much as $1,000 per hour. The tradeline company I use is Tradeline Supply Company. Let Darren know you are from The Wealthy Accountant. Call 888-844-8910, email Darren@TradelineSupply.com or read my review.
Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.
QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.
A cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.
Amazon is a good way to control costs by comparison shopping. The cost of a product includes travel to the store. When you start a shopping trip to Amazon here it also supports this blog. Thank you very much!