Today, we tackle your questions about renting out a property, buying a house, estate planning, and the home office deduction. We also talk about a new potential long term care insurance tax in California, much like the tax in Washington state. We also have one of our real estate partners on to update you about what is going on at MLG and to help answer a few of your questions.
I like this question because you're trying to do the right thing. And in general, the right thing is to put rental properties in LLCs. That does a couple of things. One, if state law provides this protection, it can provide both internal and external liability. Internal liability is something that happens at the rental property. Somebody slips and falls there, has a terrible injury, they say it's your fault. All they can take from you is your rental property. That is a big benefit. That's internal liability.
It can also provide external liability. This deals with if you get sued for a gazillion dollars and for some crazy reason it's successful and not reduced on appeal and you have to declare bankruptcy. In some states, getting assets out of your LLC is very hard. That creditor is limited to a charging order, meaning that they can only take money from that LLC. But since you control that LLC, you don't have to distribute any money. In fact, you can just send them the tax bill for their portion of the money that you never distributed to them. And what that does is it provides a heavy incentive for them to settle with you. That's a big benefit of having an LLC.
The problem is LLC law is very state-specific. Some states limit creditors to a charging order. That's more common on a multi-member LLC. The reason for that is they're trying to protect your partners in this LLC. Why should they be punished just because of something you did in your practice? They shouldn't be punished. They're an innocent party. That's why that protection is extended. It is less commonly extended in a single-member LLC. If I were in Maryland or in DC, the first thing I would do in this sort of a situation is learn whether my state or the District of Columbia extends those protections.
If you'll look at the White Coat Investors Guide to Asset Protection, you'll quickly learn that neither Maryland nor DC limits creditors to a charging order, whether it is a single-member LLC or a multiple-member LLC. Your LLC really provides no external liability protection, and that's unfortunate. But that's the way your state laws are. That makes this a little bit less valuable of a thing to do rather than just holding this thing in your own name and buying lots of property insurance and a big fat umbrella policy on top of it. You may opt to go down that route.
Now, will the LLC help with internal liability? It still should, but that's going to provide less protection in a single-member LLC than in a multi-member LLC. It just comes down to case law and the specific situation. Obviously, you want to keep that as separate as you can from your personal finances so you can argue that it's a separate entity, but that would be the only reason to go through the trouble of putting your property in an LLC in that state.
Onto your question about title insurance, I don't know the answer to this question. I think that the answer you're getting is probably what you're going to get from every title insurance company, at least in your state. I don't think they're just trying to rip you off and get you to buy a new policy.The good news is you ought to be able to maybe negotiate a discount on the cost of that new policy since it's coming from you and you've already got a policy in place, title insurance in place. I think they ought to give it to you a little cheaper than a normal one. But I guess that doesn't mean they will.Another problem people run into when they move properties from personally owned into an LLC is they always wonder about the mortgage. Do they have to call the bank and change the mortgage? My experience is that most people don't. They don't bother. The reason why is if they have to get a new mortgage, especially these days, they're having to get it at a new higher interest rate.
But even so, typically a mortgage for a non-owner occupied property is at a higher rate than one in which you're living in it. When you move out and you talk about changing the mortgage in any way, shape, or form, they usually want a higher interest rate on that. Don't be surprised about that. A lot of banks don't care if you go to them and say, “Hey this is now going to be a rental property and we’ll just leave this the way it is.” They're fine with that. But I think it's much more of a common situation where people are not asking and not telling, and I don't know that that's necessarily some huge deal. What's the bank going to come to you and say, “Hey, you have to pay off your mortgage instantly?” That's the risk. I don't hear that happening very often. Even so, that's no different than you having to go out and get a new mortgage right now when you move it into an LLC. I don't know if that should necessarily deter you from going down that route.
Dr. Jim Dahle:
Let's take the general view of this. He's talking about a real estate investment trust, but I think this can be broadened as well to just about any real estate investing opportunity. What advice would you give to Kyle about evaluating these and then what to do if one of them is not going so well?
The benefit of a REIT or a fund like MLG is the opportunity for diversification. I think as a general investing principle, whether it's real estate or stocks or anything else, unless you're a very specific expert in the field in which you're investing, diversification is a good rule to live by. And REITs provide that; so does a fund like ours. But I think what we're learning in the market right now, the next thing you should look at is a time-tested manager. There are a bunch of real estate companies that sprung up in 2016 through 2022 that all made a bunch of money for a couple years but had never been through a cycle. Many of those are the groups that are now having issues with their debt maturities and things like that. I would say it's important to be with a manager with a good track record and then evaluate the risk profile of the deal, as well. If you're an older investor looking to wind down your career, you're probably not looking for a bunch of development deals that have a higher-risk profile when there are opportunities out there where you can invest in already existing high-quality real estate that has existing cash flow. Considering the risk-return balance that you're looking for is important, too.
Dr. Jim Dahle:
Yeah, and there's more than just the risk of the real estate itself, right? Obviously, ground-up developments can be riskier than a Class A core holding that's already fully rented out. But the deal itself has got risk in it. How much leverage is being used? What kind of leverage is it? Is it short-term variable rate debt that's going to have to be refinanced halfway through the deal? There's a lot to walk through here. We put together an entire online course to help people evaluate real estate deals. But I absolutely agree with your first point, which I think is the most important aspect of investing, whether it's real estate or anything else. That's diversification, because diversification protects you against what you don't know. But it also protects you against what you can't know. When a deal inevitably goes bad, it sure is great if it's not a huge piece of your portfolio. If it's a tiny piece then, it's a whole lot easier to stomach the fact that it's not going so well. But let's say you're in a private deal and things have kind of turned south. What advice do you have for somebody that's in an illiquid deal that's not going well?
Unfortunately as an LP investor, there's oftentimes not a lot of control or things you can do once you're already in a deal. I would say probably the biggest advice I would give people is use it as a positive lesson to not make the same mistake again. Once you're in it, I think there are limited things you could do. There are some opportunities if you end up realizing a loss, those losses could be useful to shelter some gain elsewhere in your portfolio. Definitely worth a conversation with your CPA on that front. The biggest thing is don't make the same mistake again, but also don't be afraid of continuing to invest. There's always opportunity in the market. You just need to be with the right groups that can identify and still produce returns in a risk-adjusted way.
Dr. Jim Dahle:
That's the thing with most of these passive deals where you are a limited partner is your due diligence has to be done all up front because then you're along for the ride. It might be a year, it might be three years, it might be 12 years. You are along for the ride. If things go well, you're along for the ride. If things go poorly, you're along for the ride. I've had a couple of deals that I would describe as not going well. One of which was a fraud problem. The operator was actually fraudulent. The second of which was kind of an incompetence problem. In the first case, it's probably going to be a total loss for me. In the second case, it's going to be a significant loss of principal for me. This stuff does happen, and this is a reason why expected returns have to be higher—to make up for the fact that not all of these deals do well. This is one of the big reasons I think it's helpful to be in a fund rather than individual syndications. You get that additional diversification from multiple assets in the fund, but you still have one manager or one managing team. It's a good idea to also diversify between managers by using multiple funds, in my experience.
I agree with that. When you look at an individual deal vs. a fund, you should always expect a higher rate of return for an individual deal. For those who have spent some time in the actual models playing with the projections, you learn quickly that the numbers are very, very sensitive to minor changes. Even if an individual deal pencils to greater than a 20% IRR, even if you miss on your rent growth by $50, which $50 a month doesn't sound like that big of a deal in theory, it can have a huge impact on your total return. That's why, like you just said, in a fund, you can have some that outperform, some maybe don't perform exactly as planned. But you have a base of diversification; that matters a lot.
Dr. Jim Dahle:
The proforma is really pretty easy to make look good. It doesn't take much tweaking to do it. I've had some funds that have gone round trip or nearly round trip and 15 assets maybe in the fund, and in at least one they just mailed in the keys. They said, “We are not making any money on this property. We basically had a total loss in that fund.” Yet I still ended up with double-digit returns on the fund despite the fact that one of their properties was a total loss. Diversification is important. These deals don't all do awesome, and there's significant leverage involved. And that's risky.
I don't think there's any problem with splitting the space. The rule for the home office deduction is you have to be in business for yourself. You can't be an employee. But you have to be in business. You have to actually be running a business out of this space. But the rules are exclusive use and regular use. If you're using that space for anything else, that's not exclusive. If you use it once a year, that's not regular. The IRS has not necessarily defined regular, but in an audit, those questions would come up. The easy way to take this is just the standardized way, which is $5 a square foot up to 300 square feet. That's $1,500 a year, and you don't have to keep track of all the expenses of your house and divide it by the percentage of your house that is being used for this business and then add that to the basis when you sell the house later. The simplified deduction is the way to go for most people, just for ease of use. But for those of you living in expensive houses, especially if you have a pretty big home office, that's probably not the biggest deduction. You could probably get a bigger deduction by keeping track of all that, and only you can decide if it's worth it or not.
Does it have to only be used for one business? No, but I'll bet when most people report this, if they've got multiple business, they probably put it on one business. Does that break the exclusive use thing? I don't think it does if you're using this thing for business. If your kids are doing homework at that desk, that's maybe not exclusive use. If you're doing a bunch of other stuff at the desk—your volunteer work or something—maybe that's not exclusive use. But let's be honest, nobody is coming to your house and watching you 24/7/365 to see what that desk is being used for. There's a little bit of a spirit of the law here that we're talking about.
Remember, for corporations, the way to do this sort of a thing is to rent the space from your corporation. That doesn't necessarily help you tax-wise. It changes it maybe from one kind of income to another, but it doesn't necessarily help you if you're just taking a deduction on one side and then it becomes income on the other side. It might not be super helpful to you. The exception, of course, is if it's being rented for 14 days or less a year. This is what you talk about in your last question. You can take the home office deduction and rent the house out to your business. You can do both of those in the same year. That's not a problem. We do that here at WCI because the space I'm claiming for my home office is not the entire space that we use for our meetings. I think that's completely legit.
If you want to learn more about the following topics, as well as read the interview with Nathan Clayberg or MLG Capital, check out the WCI podcast transcript below.
Today we are talking with a doc who has hit a half-million-dollar net worth. He took our Fire Your Financial Advisor course and gained the confidence to take control of his financial life. He fired his advisor who was really just a salesman and started making big progress on financial goals.
The term financial advisor is tricky to clearly define because there is no legal definition. This leaves it up to interpretation and means that pretty much anyone who wants to say they are a financial advisor can when, in reality, they are often salespeople promoting financial products like mutual funds, annuities, and insurance. These salespeople often earn big commissions, which can create a conflict of interest. Being a financial advisor does not necessarily mean they are fiduciaries.
To ensure impartial financial advice, you should hire fee-only advisors. These advisors can be compensated through asset under management fees, annual fees, flat fees, or hourly rates. Asset under management fees can make sense when you have a smaller net worth, but as your assets grow, this becomes more and more expensive. As always, we recommend getting good advice at a fair price. Financial advisors can be a fantastic resource. Just do your due diligence to make sure you are choosing someone who will act as a fiduciary and not a salesperson. Our recommended tab is a great place to start if you want to find a trustworthy advisor.
In situations where you have mistakenly hired salespeople as financial advisors, know you aren't alone. It is important to make a detailed plan for a smooth transition away from that advisor as well as figuring out what you want to do with all of your assets. This may involve hiring a genuine financial advisor or developing a financial plan independently. Check out our “Fire Your Financial Advisor” course if you want to learn how to be your own financial advisor and create your own financial plan.
Laurel Road is committed to serving the financial needs of doctors. We want to help make your money work both harder and smarter, which is why we offer a 5.00% Annual Percentage Yield † on our High Yield Savings accounts. A Laurel Road High Yield Savings account comes with zero costs to open and no monthly account fees. † Whether you’re saving for an emergency fund or planning your next big purchase, you can keep building your savings and access your funds whenever you need them. For terms and conditions, please visit www.laurelroad.com/wci.
Laurel Road is a brand of KeyBank N.A. All products are offered by KeyBank N.A. Member FDIC. ©2023 KeyCorp® All Rights Reserved.
Transcription – WCI – 336
INTRODUCTION
This is the White Coat Investor podcast where we help those who wear the white coat get a fair shake on Wall Street. We've been helping doctors and other high-income professionals stop doing dumb things with their money since 2011.
Dr. Jim Dahle:
This is White Coat Investor podcast number 336 – Asset protection and real estate investing.
This episode is brought to you by Laurel Road for doctors. Laurel Road is committed to serving the financial needs of doctors. We want to help make your money work both harder and smarter, which is why we boosted the rate on our high yield savings accounts to 5.00% APY.
Laurel Road high yield savings account comes with zero cost to open and no monthly account fees. Whether you're saving for an emergency fund or planning your next big purchase, you can keep building your savings and access your funds whenever you need them.
For terms and conditions, please visit www.laurelroad.com/wci. Laurel Road is a brand of KeyBank N.A., member FDIC.
All right, welcome back to the podcast. I hope you're having a great fall enjoying football season and the cooler crisper weather. Maybe in a few parts of the country you're already experiencing some snow. I know it's starting to snow up at our ski resorts by this time of year most years.
But we're not done having fun yet. As you're listening to this, I've just finished doing a bunch of canyoneering trips to Southern Utah. So, I hope you're able to find a way to do something fun, as well.
QUOTE OF THE DAY
Okay, let's do our quote of the day first. Abraham Lincoln today. Everybody likes Abe. He said, “You cannot escape the responsibility of tomorrow by evading it today.” That goes for your finances as well.
As you listen to this, the day this drops is October 12th. That is the final day. So, I hope you are listening to this the day this podcast dropped, but today's the final day to register for WCICON24 at the early bird price. You can do that at wcievents.com.
It's going to be a great conference. I'm looking forward to meeting you there personally and to give you a chance to be inspired, to accomplish your financial goals, to become more financially literate, to become less burned out, and just to have a great time.
We're in Orlando this year. It's going to be awesome to be on the East coast for the first time. And I know a lot of people are combining this trip with a visit to some of the theme parks there. It's a great time of year to be down there. It's starting to cool off. Well, I guess it's starting to warm up by February when this thing runs but it's still very nice down there and perfect time of year to be in Florida. So, check that out, wcievents.com.
Okay. Another thing we're doing is we have a program where we try to give away a copy of the White Coat Investor's Guide for Students to every first year medical and dental student in the country. That's starting again. October 17th is the first day you can apply to do this.
And the way we pass these out is by the box, not by the individual book. It's just not cost effective for us to do that. So, we send a box. Actually it's usually like three or four boxes to a champion in each class, and they distribute the books to their classmates. It costs you nothing but a tiny little application to be a champion. All you have to do is be a student in good standing in that class and agree to pass out the books. That's it. You get a little bit of extra swag for you and you get to be everybody else's hero.
If you think about this, if on average someone who becomes financially literate saves a couple million dollars over the course of their career and there's 200 people in your med school class and half of them actually read the book and become financially literate, that's a lot. A lot of value that you have provided to your classmates. It might be the most valuable thing that happened to them during their entire time in medical or dental school.
So, sign up for that white coat investor.com/champion. We need one from every medical and dental school in the country. You have to be a first year, but you can start applying in just a few more days. Thank you for doing that. It is a great service to your classmates.
ASSET PROTECTION IN REAL ESTATE INVESTING QUESTION
All right, let's get into some of your questions that you guys have for us. We'll start with this one, which has to do with the subject matter of our podcast today about asset protection in real estate investing. Let's take a listen.
Serena Brown:
Hi, Dr. Dahle. My name is Serena Brown and I'm a family physician located in the DC area. I had a question for you about trying to rent out a property that I own. I'm transferring ownership of that property to my solely owned LLC for liability protection purposes prior to renting it out.
I wanted to add an endorsem*nt to my title insurance policy to add my LLC as a covered insured, but the title insurance company is stating that I need to purchase a new policy to have coverage.
The property is located in Maryland. And my question ultimately is has anyone successfully been able to add an LLC to their title insurance policy without buying a new policy at a significant additional expense?
I've been told different things by different lawyers who work at various title insurance companies, and so I'm at a loss of what to do. I'm just trying to make sure that I'm covering myself prior to renting out the space. Thanks for everything you do. I appreciate your time and thoughtfulness in trying to help me answer this question.
Dr. Jim Dahle:
All right, great question, Serena. I like this question because you're trying to do the right thing. And in general the right thing is to put rental properties in LLCs. That does a couple of things.
One, if the state law does so, if state law provides this protection, it can provide both internal and external liability. Internal liability is something that happens at the rental property. Somebody slips and falls there, has a terrible injury, they say it's your fault. All they can take from you is your rental property. That is a big benefit. That's internal liability.
It can also provide external liability, in that if you get sued for a gazillion dollars and for some crazy reason it's successful and not reduced on appeal and you have to declare bankruptcy.
In some states, getting assets out of your LLC is very hard. That creditor is limited to a charging order, meaning that they can only take money from that LLC when you pull money out of the LLC, when the LLC distributes money to you. But since you control that LLC, you don't have to distribute any money. In fact, you can just send them the tax bill for their portion of the money that you never distributed to them. And what that does is it provides a heavy incentive for them to settle with you. And so, that's a big benefit of having an LLC.
The problem is LLC law is very state specific. Some states limit creditors to a charging order. That's more common on a multi-member LLC. And the reason for that is they're trying to protect your partners in this LLC. Why should they be punished just because of something you did in your practice? Some real estate LLC with your partners there, they shouldn't be punished. They're an innocent party. And so, that's why that protection is extended.
It is less commonly extended in a single member LLC. If I were in Maryland or I would were in DC, the first thing I would do in this sort of a situation is learn whether my state or my District of Columbia extends those protections.
And if you'll look at the White Coat Investors Guide to Asset Protection, you'll quickly learn that neither Maryland nor DC limits creditors to a charging order, whether it is a single member LLC or a multiple member LLC.
Your LLC really provides no external liability protection and that's unfortunate, but that's the way your state laws are. So, that makes this a little bit less valuable of a thing to do. Rather than just holding this thing in your own name and buying lots of property insurance and a big fat umbrella policy on top of it. You may opt to go down that route.
Now will the LLC help with internal liability? It still should, but that's going to provide less protection in a single member LLC than in a multi-member LLC. Hopefully still works but that again, comes down to case law and the specific situation, etc. Obviously you want to keep that as separate as you can from your personal finances so you can argue that it's a separate entity, but that would be the only reason to go through the trouble of putting your property in an LLC in that state.
Onto your question about title insurance, I don't know the answer to this question. I think that the answer you're getting is probably what you're going to get from every title insurance company, at least in your state. I don't think they're just trying to rip you off and get you to buy a new policy.
The good news is you ought to be able to maybe negotiate a discount on the cost of that new policy since it's coming from you and you've already got a policy in place, title insurance in place. So I think they ought to give it to you a little cheaper than a normal one. But I guess that doesn't mean they will.
Another problem people run into when they move properties from personally owned into an LLC is they always wonder about the mortgage. Do they have to call the bank and change the mortgage? And my experience is that most people don't. They don't bother. And the reason why is if they have to get a new mortgage, especially these days, they're having to get it at a new higher interest rate.
But even so, typically a mortgage for a non-owner occupied property is at a higher rate than one in which you're living in it. So, when you move out and you talk about changing the mortgage in any way, shape or form, they usually want a higher interest rate on that. So, don't be surprised about that.
A lot of banks, they don't care if you go to them and say, “Hey this is now going to be a rental property and we’ll just leave this the way it is.” And they're fine with that. But I think it's much more of a situation where people are not asking and not telling, and I don't know that that's necessarily some huge deal. What's the bank going to come to you and say, “Hey, you have to pay off your mortgage instantly?” That's the risk.
I don't hear that happening very often. And even so that's no different than you having to go out and get a new mortgage right now when you move it into an LLC. I don't know if that should necessarily deter you from going down that route.
CALCULATING NET WORTH
Okay, let's take our next question. This one's about buying a house. Somewhat related, not necessarily investment related.
Eneil:
Hi, Dr. Dahle. Thank you for everything you're doing for us. I have question in relation to house buying. My current net worth is $800,000, for which $200,000 I'm saving up to buy a house. So essentially my assets will be $600,000.
I found a house on the market currently, which I see listed at about $400,000. [11:02 – 11:06 Inaudible]. So I would put $200,000 in cash offer, so then I essentially have to pay $200,000 more to pay off the house.
My question is as follows. One, how do I take the house into calculation for my net worth? Does it become $600,000 plus $400,000 of which $200,000 is already paid off? Or does it define it $600,000 minus $400,000? Or that’s $600,000 minus $200,000 because $200,000 is already paid off? I just do not understand how do I calculate the net worth with the house. If you could kindly explain this that would be really appreciated. And once again, thank you for everything that you have done for us.
Dr. Jim Dahle:
Okay, great question Eneil, I appreciate that. This is a much easier question to answer than the last one. This is pretty straightforward. When calculating your net worth, you add up everything you own and you subtract everything you owe. So once you buy a house, you own the whole thing. If it's worth $400,000, that is a $400,000 asset on the positive side. If you buy it with a mortgage, well, you've picked up an additional liability and that goes on the liability side of your balance sheet.
So, if you've got a $400,000 asset and you've got a $200,000 liability and that is everything you own in your entire life, well, you've got a net worth of $200,000. $400,000 minus $200,000. I hope that helps explain how to do net worth.
Now a lot of people also track a different number. Investable assets, sometimes it's called your nest egg, your retirement money, whatever you want to call it, which is different from your net worth.
I think the most common way to do this is you leave your house out of this calculation. You're just calculating your net assets, stuff that goes toward your nest egg, your number, the number you know when you're financially independent. And most people do not include either the house or the mortgage toward that number. It's just a number of positives. You add up all your retirement accounts and your taxable account and your investment properties. If you have investment properties, you would include the mortgages for those in that calculation. But as far as your net worth, you count everything.
INTERVIEW WITH NATHAN CLAYBERG OF MLG CAPITAL
All right, we've got one of our sponsors, Nathan Clayberg with MLG that I'm going to bring on. We're going to do an interview with him, and talk a little bit more about real estate investing and what we're seeing out there in the real estate investing world. He's going to help me answer a couple of your questions as well.
Nathan Clayberg, vice president of MLG Capital, now joins us on the podcast. Welcome to the podcast.
Nathan Clayberg:
Thanks, Jim. I’m excited to be here.
Dr. Jim Dahle:
I should say welcome back to the podcast. You've been here before.
Nathan Clayberg:
That's right. It's good to be back.
Dr. Jim Dahle:
How's life at MLG these days?
Nathan Clayberg:
It's good. It is an interesting world we're in right now. So, never a dull moment, but overall it's been a good year so far and have a couple good acquisitions in the pipeline to round out a nice year overall.
Dr. Jim Dahle:
Yeah, I think it's great anytime in 2023 that a real estate firm can say, “Hey, it's a nice year.” That's great to hear because I'm not hearing that from every real estate firm out there. They're not all saying it's a nice year, I assure you.
Nathan Clayberg:
Yeah, I can imagine that that's the case. We are thankful to be invested in a moderately levered fund right now, and it's a strategy that wasn't so sexy a couple years ago, but now it's paying off.
Dr. Jim Dahle:
Yeah, for sure. Warren Buffett is famous for talking about you don't know who's swimming naked until the tide goes out. And a lot of people in real estate were maybe a little over leveraged or maybe their operations weren't very good, or maybe all their debt or majority of their debt was variable. And they're struggling now. They're having a hard time. Rates have gone up 4%-ish in the last 12 to 18 months and that has a pretty serious effect on leveraged real estate for sure.
Nathan Clayberg:
Yeah, no doubt. And we have a couple floating rate deals in our portfolio. Thankfully we bought caps that are very much in the money at this point. But we're thankful that is primarily fixed rate debt. That is saving grace in times like this.
Dr. Jim Dahle:
Yeah, I've talked to people a lot in the past and not just about real estate investing, getting their own mortgages or refinancing student loans, that if you get a variable rate, you've got to be able to afford the worst case scenario.
Nathan Clayberg:
Yes.
Dr. Jim Dahle:
Sometimes people can't afford to run the interest rate risk themselves and they'll be paid to do that and most of the time it works out fine, but clearly in times like this where rates have rapidly gone up, there's some real benefits to having fixed debt.
All right. Well, let's talk about what's going on at MLG. First of all, for those who've never heard of it, how would you introduce MLG? How would you describe the firm?
Nathan Clayberg:
Yeah, we're a private real estate investment manager. We've been around for 35 years. We offer a series of funds, which we'll talk on our most recent offering fund VI. And then we also have some other tax deferred vehicles that we offer primarily via our legacy fund, which we'll hit on today too. But a long track record, a lot of success over the years, which is why investors like to continue to work with us.
Dr. Jim Dahle:
Yeah, 35 years is like forever in this space.
Nathan Clayberg:
Yeah, it's longer than I've been alive.
Dr. Jim Dahle:
Is there even anybody at the firm that's been there since it was founded?
Nathan Clayberg:
Yeah, in fact, the “M”, Mike Mooney in MLG still comes into work every day. He's in more of a chairman of the emeritus role at this point. But Tim Wallen, our CEO, joined the firm in 1989. The founding year was 1987. So he's been here for 30 plus years. And the rest of our principals joined in the early 90s. The leadership is still very intact from the last 30 years.
Dr. Jim Dahle:
Well, I'm invested in fund IV. These are closed funds that you come in, you raise money, and then you close the fund. They're not evergreen funds. Right now you're raising money for fund VI. What can you tell us about fund VI?
Nathan Clayberg:
Yeah, fund VI is a $450 million equity fund. With that we'll buy roughly $1.1 to $1.2 billion of real estate. Primarily what we invest in is multifamily. That's definitely the bread and butter of what we do. Typically, 80 to 90% of the fund is multifamily.
We mix in a couple different other asset classes. We like industrial a lot. It's hard to buy at scale, especially in the past few years with the competition in the industrial market. But we'll have a little bit of that in there. And then we look at retail and office very opportunistically. It has not been a significant part of our funds in the last three or four funds and will likely not be going forward.
But the idea is you get diversified across different asset classes, across geographies. It mitigates risk that way. Our investor base generally has made their money in life and don't feel the need to roll the dice anymore. So, our first and foremost goal is to protect their capital and if we can grow it in a responsible risk adjusted way, that's a win for us and for our investors.
Dr. Jim Dahle:
So, how much of the fund is raised so far?
Nathan Clayberg:
We are sitting at around $180 million raised today, just under $180 million. We've only been open for about 15 months in this fund so far. We have an either or end date, either when we hit $450 million or December 31st, 2024. At most we're still about 15 months left on the fundraise for this offering.
Dr. Jim Dahle:
And how long is the expected whole?
Nathan Clayberg:
Typically, our funds have a life cycle about 10 to 12 years. We expect to return all the original investor principle in roughly six to eight years, and then there's a profit share beyond that for the last four or five years or whatever it ends up being.
Dr. Jim Dahle:
And no anticipated liquidity in between that time.
Nathan Clayberg:
There will be occasional liquidity as we sell deals, but from an investor standpoint, it's kind of out of their control. It's whenever we're selling and whether that makes most sense. So, you go into it expecting six to eight years that cash is pretty much locked up.
Dr. Jim Dahle:
So if you were an investor, what range of returns would you expect from a fund like this over the next 10 to 12 years?
Nathan Clayberg:
We target annualized IRRs or an annual rate of return of 11 to 15%. Our prior funds over the course of our 35 year history, we've actually pretty significantly outperformed that, but we rather under promise and overdeliver and also just trying to be real with where the market is at. Market's become a lot more competitive in recent years and so we try and manage expectations that way.
But that's an 11 to 15% annualized rate of return. The way we get there is through a three tiered waterfall. I think it's worth hitting on just because we believe our return waterfall is very investor centric. The investor really gets the first two bites at the apple through an accruing compounding 8% preferred return.
What that means is that's the first stage when we pay. And our funds, typically we start off paying 4% or 5% distribution. The investor unpaid portion, the difference between the 4 and 8, the 5 and 8, accrues and earns 8% interest until we make them whole on that.
Our first obligation to investors is to get them current on the 8%. Once we've done that, we'll begin to sell some properties, return capital, but we don't get to share in any of the profits from sales or any of the investments until investors have the 8% annualized and all of their money back.
So, if the last asset in the fund doesn't perform as planned, that disproportionately impacts us relative to the investors to make sure we're incentivized to finish all the way through. And we only get to share once the investors have the 8% and all their money back.
Dr. Jim Dahle:
And what's the split above the 8%?
Nathan Clayberg:
Normally 70/30. That's our typical business deal. We have a special relationship with the White Coat Investor group. Once the group exceeded $5 million in fund VI, we amended that to 75/25, which we have hit that threshold. We're thankful for our relationship with the White Coat Investor group. Actually when you factor that in, the total expected return is probably something more like 12 to 16 as opposed to 11 to 15.
Dr. Jim Dahle:
Awesome. And you guys have something else going on that I've been noticing the last year or so, which I think is pretty cool. This is a little bit of a different fund, this Legacy Fund. Tell us what the Legacy Fund is, who’s it for and what to expect out of that.
Nathan Clayberg:
Yeah. The Legacy Fund is born out of a realization that the current tax deferred solutions available to real estate investors in the market were inadequate in our mind. The most common one you see people pursue is a 1031 exchange. You sell your property, you buy a like-kind property and defer the taxes that way.
But there are other options. You see Delaware Statutory Trusts or DSTs, it's called an UPREIT where you're contributing your property to a REIT. All of those for different reasons we felt like we're falling short of creating the best solution for those investors.
And so, we concepted the Legacy Fund. It began in early 2021 and the simple idea is that investors can contribute their property to the fund and a tax deferred contribution uses a different section of the IRS code. It's actually a 721 contribution, but they contribute their property to our fund in exchange for shares of the fund.
The benefits of course is first, it's a tax deferred contribution, but also they become passive and then diversified because the fund today has almost $1.2 billion in assets and they become a partial owner in that fund through their shares.
This product is perfect for those who are generally older, have owned their asset for a long time, typically a very low basis and a large built-in gain. The ability to relieve themselves of the day-to-day management and get diversified and protect their money going forward is a pretty attractive option. And it's been evidenced by the market. Like I said, $1.2 billion in assets in just over two and a half years. Markets responded pretty well to what we're offering.
Dr. Jim Dahle:
Yeah, so it's an exit plan for people who are direct investing and don't want to do that anymore.
Nathan Clayberg:
That's right, yes. And there's some tax and legal complexity with these types of deals. So, the minimum equity check in order to do a contribution with us is $3 million, but for those who have that situation, it's a great alternative.
Dr. Jim Dahle:
Yeah. Is anybody investing cash in this fund or is the only way to invest in it to roll property into it?
Nathan Clayberg:
You could invest cash in this fund. It is primarily Class A and multifamily in the Sunbelt and as a result it targets a little bit lower returns and has a little bit less in the way of tax benefits that it can offer investors. But you could in theory invest cash. I would say in almost every case it makes more sense to invest in our finite funds and you get a little higher return and more tax benefits that way.
Dr. Jim Dahle:
Okay. All right. Well, let's see if we can get to a couple of listener questions here. First one I think is a little bit about evaluating opportunities and particularly maybe what to do when things aren't going so well. Let's take a listen to that.
HISTORY ON REITS AND WHAT TO DO WHEN INVESTMENTS GO BAD QUESTION
Speaker:
Hi Dr. Dahle. I was wondering if you could give a brief history on real estate investment trusts, suggestions on what to look for before investing in a REIT and subsequently what options investors may have when REITs go bad.
I have about 10% of my investment set up for real estate, most of which is tied up in the peak housing REIT, which from my understanding you also have funds invested. At the beginning of August, they sent out a pretty depressing update and after some emails back and forth due to rising interest rates, bad decision making on their part and needing to pay off a preferred equity holder, it looks like of the $175,000 I have invested, I at best may eventually only receive about 40 to 60% of my investment back. Any suggestions? Thanks for all that you do.
Dr. Jim Dahle:
All right, this question from Kyle, let's take the general view of this. He's talking about real estate investment trust, but I think this can be broadened as well to just about any real estate investing opportunity. What advice would you give to Kyle about evaluating these and then what to do if one of them is not going so well?
Nathan Clayberg:
Yeah. Well, the benefit of a REIT or a fund like MLG is the opportunity for diversification. I think as a general investing principle, whether it's real estate or stocks or anything else, unless you're a very specific expert in the field in which you're investing, diversification is a good rule to live by. And REITs provide that, so does a fund like ours.
But I think what we're learning in the market right now, the next thing you should look at is a time tested manager. There are a bunch of real estate companies that sprung up in 2016 through 2022 that all made a bunch of money for a couple years but had never been through a cycle. And many of those are the groups that are now having issues with their debt maturities and things like that.
So, I would say it's important to be with a manager with a good track record and then evaluate the risk profile of the deal as well. If you're an older investor looking to wind down your career, you're probably not looking for a bunch of development deals that have a higher risk profile when there are opportunities out there where you can invest in already existing high quality real estate that has existing cash flow. So, considering the risk return balance that you're looking for is important too.
Dr. Jim Dahle:
Yeah, and there's more than just the risk of the real estate itself, right? Obviously a ground up developments can be riskier than a Class A core holding that's already fully rented out. But the deal itself has got risk in it. How much leverage is being used? What kind of leverage is it? Is it short term variable rate debt that's going to have to be refinanced halfway through the deal?
There's a lot to walk through here. We put together an entire online course to help people evaluate real estate deals. But I absolutely agree with your first point, which I think is the most important aspect of investing, whether it's real estate or anything else. And that's diversification because diversification protects you against what you don't know, but it also protects you against what you can't know.
And when a deal inevitably goes bad, it sure is great if it's not a huge piece of your portfolio. If it's a tiny piece then it's a whole lot easier to stomach the fact that it's not going so well.
But let's say you're in a private deal and things have kind of turned south. What advice do you have for somebody that's in a illiquid deal that's not going well?
Nathan Clayberg:
Yeah, unfortunately as an LP investor there's oftentimes not a lot of control or things you can do once you're already in a deal. I would say probably the biggest advice I would give people is use it as a positive lesson to not make the same mistake again. Once you're in it, I think there's limited things you could do. There are some opportunities if you end up realizing a loss, those losses could be useful to shelter some gain elsewhere in your portfolio. Definitely worth a conversation with your CPA on that front.
The biggest thing is don't make the same mistake again, but also don't be afraid of continuing to invest. There's always opportunity in the market. You just need to be with the right groups that can identify and still produce returns in a risk adjusted way.
Dr. Jim Dahle:
Yeah. That's the thing with most of these passive deals where you are a limited partner is your due diligence has to be done all up front because then you're along for the ride. And it might be a year, it might be three years, it might be 12 years. You are along for the ride. Things go well, you're along for the ride. Things go poorly, you're along for the ride.
I've had a couple of deals that I would describe as not going well. One of which was a fraud problem. The operator was actually fraudulent. And the second of which was kind of an incompetence problem. In the first case, it's probably going to be a total loss for me. In the second case, it's going to be a significant loss of principle for me. So, this stuff does happen and this is a reason why expected returns have to be higher to make up for the fact that not all of these deals do well.
This is one of the big reasons I think it's helpful to be in a fund rather than individual syndications. You get that additional diversification from multiple assets in the fund, but you still have one manager or one managing team. And so, it's a good idea to also diversify between managers by using multiple funds in my experience.
Nathan Clayberg:
Yeah, I agree with that. And when you look at an individual deal versus a fund, you should always expect a higher rate of return for an individual deal. For those that have spent some time in the actual models playing with the projections, you learn quickly that the numbers are very, very sensitive to minor changes.
And even if an individual deal pencils to greater than a 20% IRR, even if you miss on your rent growth by $50, which $50 a month doesn't sound like that big of a deal in theory, it can have a huge impact on your total return. And that's why, like you just said, in a fund, you can have some that outperform, some maybe don't perform exactly as planned, but you have a base of diversification that matters a lot.
Dr. Jim Dahle:
Yeah. That proforma really are pretty easy to make look good. It doesn't take much tweaking to do it. And I've had some funds that have gone round trip or nearly round trip and 15 assets maybe in the fund and at least one they just mailed in the keys. They said, “We are not making any money on this property. We basically had a total loss in that fund.” And yet I still ended up with double digit returns on the fund despite the fact that one of their properties was a total loss. Diversification is important. These deals don't all do awesome and there's significant leverage involved. And that's risky.
TAX SAVINGS IN PASSIVE REAL ESTATE SYNDICATIONS QUESTION
All right, let's talk a little bit about taxes. Our next question comes in from Eneil. Let's listen to his question about the taxation and where you can get some tax savings with some of these investments.
Eneil:
Hi Jim. I have a passive real estate syndication tax question. I'll give you a brief example. If I invested $100,000 in five different syndications over a span of one year and I got paper losses of around $300,000 for those five syndications. And in year two, one of the syndications got sold for a total profit of $100,000. Am I required to pay taxes on the gains that I got from that liquidated syndication? Or will my passive losses cover the gains that I got from the passive syndication?
The popular saying is that the more passive losses I accumulate, the less taxes I would pay. Also, if I keep accumulating passive losses over the next 10, 15 years, investing in more syndications and eventually die, would my heirs get a step-up basis? Thank you for your help.
Dr. Jim Dahle:
All right, lots of questions in there. Let's talk about taxation of real estate syndications and funds, etc in general and then see if we can answer his questions specifically.
Nathan Clayberg:
Great. Do you want me to jump in?
Dr. Jim Dahle:
Sure. Why don't you jump in and give your thoughts on taxation and then we'll try to get to his questions.
Nathan Clayberg:
Yeah. Well, in general, one of the biggest advantages of investing in private real estate, and this is more specific to a fund like MLGs where it's an LLC structure as opposed to a breach that's maybe one critical differential or differentiator.
But in a fund like ours, when it's an LLC, it's a pass through entity which allows for the pass through of the depreciation to investors. We use cost segregation studies, so we depreciate different component parts of the asset as opposed to the entire asset itself, which allow us to accelerate the depreciation.
And then the current tax law allows for bonus depreciation on top of that as well, which means if you depreciate in appliance or other five year property or seven year property. In the first year of your ownership, you can write off up to 80% of that in the first year.
What it creates is, like this investor mentioned, they invested $500,000, they got $300,000 of passive losses. If you have significant other passive income, this is passive ordinary losses, passive ordinary income, you can use those losses to offset and defer your passive ordinary income, which especially for highly taxed individuals is a powerful, powerful tool because many times people are paying 50% ordinary income tax rates on that income and to defer it both takes advantage of the time value of money.
And when the asset is sold, you realize capital gains, which are a lower tax rate. So you have permanent savings created by the difference between cap gain rates and ordinary income rates.
Now where it gets especially powerful is, like this investor mentioned, if you have suspended losses that you're carrying forward and you have a passive loss activity that's sold and entirely disposed of, you trigger a large passive capital gain, the losses associated with that gain when the asset is disposed of are then freed up and released into your tax picture.
But the beautiful part of it is they don't actually have to apply specifically to the gain that you realized in the sale. In fact, they can flow through to whatever income in your tax picture is taxed at the highest rates.
So, for a doctor, for example, if you have $100,000, let's say of suspended passive losses and you have a gain recognition event of a $100,000 triggering that much in passive capital gain income, those $100,000 of losses can even flow through and offset your W2 income.
And what we see happen is investors have withheld the entire year expecting a large W2 income and that's usually 45, 50% all in effective tax rate when you factor in federal and state.
But then the losses offset by that income and they end up just paying the capital gains tax. So we see people get a significant, significant refund on their taxes by capturing the difference in those two rates, which can be typically 15 to 20% depending on your tax picture.
Dr. Jim Dahle:
Yeah, and this is one of the most complicated aspects I think of private syndication LLC investing is just understanding all the moving parts because there's a lot of different categories of income. You've got your 1241 gains and you've got your ordinary income and losses and you've got your long-term capital gains and short-term capital gains and all that sort of stuff. It can be pretty powerful when you can start using those losses, not just to offset rental income that you might have from other investments, but also to apply it to other things when the property is sold.
And if there are capital gains, you can often also use capital losses you've piled up from tax loss harvesting. You pick up these losses as you go along and all of a sudden you're able to use them when you're selling your practice or when you're selling your house even, you can get long-term capital gains on your house. And so, it's definitely a good idea to keep track of the tax picture, understand all the different categories of income and how they can apply to your particular tax situation.
Most people, honestly, when you're getting into these sorts of investments, you're probably not doing your own taxes anymore. The K-1s are ridiculous, right? My MLG K-1, I don't remember, but I'll bet it was 50 pages. It was probably 50 pages.
Nathan Clayberg:
Sounds about right.
Dr. Jim Dahle:
And if you got a dozen of these sorts of funds or syndications, imagine plowing through all that on your own. This is a real cost of this sort of investing is you're going to be not doing your own taxes anymore. You're going to be hiring somebody else to do it. It's probably going to be a four figure fee you're paying every year to have your taxes prepared. And there's a good chance you're going to be filing in significantly more states than the one you live in.
But you've got to ask yourself, is that worth it for a little bit higher returns, some pretty unique tax advantages. And obviously in my case I've decided that is worth it, but reasonable people can decide, “Hey, I just want it as simple as possible even if it means I have lower returns or pay more in taxes.” But that's a decision you got to make on your own.
Anything else so we can add to the tax picture there?
Nathan Clayberg:
Yeah, I always just tell people to talk to your CPA, then there's so much nuance that depends on what's specifically going on in your tax situation. It's hard to cover it in a blanket statement, so talk to your CPA. If you have other questions specific to how it works, at least with MLG, we're happy to answer that on our end. But it can be very powerful.
I guess the last thing I'd say is don't invest in real estate just for the tax benefits. Do good deals first and then if you make money, which is the first goal, then you can do smart tax planning around it as a cherry on top.
Dr. Jim Dahle:
Yeah, that's good advice for everybody. The first thing that often happens to a doc, they go through residency, they go through fellowship, they think they're paying taxes. They're not actually paying taxes and then all of a sudden they've got a tax bill that's more than they made as a resident, maybe a six figure tax bill.
And the first question they ask, “How can I pay less in taxes?” Well, the best way is to make less money and lose money on your investments, you'll pay less in taxes. But that's really not the goal, right? Your goal should be to make the most money after tax, not just to pay less in taxes.
So, be careful of that because there's a lot of scammers and swindlers out there that will take advantage of that desire to pay less in taxes to ensure you indeed do pay less in taxes, but end up having less money despite doing so.
Thank you so much, Nathan Clayberg for coming on. He is the VP of MLG. He would love for you to come learn more about MLG. You can find out more at whitecoatinvestor.com/mlg and learn more about their excellent funds and what they can do for you and your portfolio. Thank you so much for coming on.
Nathan Clayberg:
Thanks Jim. Thanks everybody.
HERITAGE TRUST QUESTION
Dr. Jim Dahle:
All right, let's take our next question off the Speak Pipe. This one's about a heritage trust. So, let's hear the question.
Dan:
Hey Jim, my name is Dan from Texas. I was reaching out to you because my parents are working on estate planning with lawyers in the state of Ohio. And they were discussing the idea of a heritage trust, which was a name I hadn't heard before. I was initially a little bit skeptical thinking maybe a name that I hadn't heard on your website or heard do you talk about might be some sort of a marketing ploy.
But looking at the websites, there isn't a ton of information on it, but a couple individual lawyer websites for estate lawyers do seem to mention it as a type of trust where the trustee is the beneficiary and they manage all the assets, but there's a distribution trustee who manages all the distributions from that trust.
We're kind of in a situation with myself and two siblings and everyone's got a good head on their shoulders and no one's really struggling financially. And so, my parents are kind of considering a three way sibling heritage trust. I just wanted to see if you thought that that was a good idea or if you had any other information on the topic. Thank you.
Dr. Jim Dahle:
All right, great question. Wonderful to hear that you're in this fortunate position, your parents and siblings and you. Good job to everybody involved. People should be congratulated when they're successful to this degree. And so, good job to everybody.
Lawyers are funny and trusts are funny in that there's a lot of marketing involved there. It's a competitive business. There's lots of attorneys in a given state and they want your trust business. And there's only so many people that need trusts. There's lots of people that don't have that much money and only a few people that have enough money and concerns that they need a trust.
So you want to capture that business. And the way you do that is through effective marketing. And a particularly effective way to market is to come up with a new name for a trust.
And so, I'm always seeing new names for trusts. This one was new to me, a heritage trust. Well, I Googled it as well, just like you did and read up on what people were calling a heritage trust. And it's just another irrevocable trust, which are the ones that are used to ensure that your wishes are carried out after you're dead. It provides asset protection to you when you put money in an irrevocable trust because you can't take the money back out. But mostly it's an estate planning tool.
And I'm a big fan of estate planning, especially if you've got enough money that you have to start worrying about estate planning, estate tax issues, more so than just who's going to take care of your kids if you die young and who's going to get your stuff and you're putting together an “I love you” that goes to your spouse afterward. “I love you” will.
Maybe you don't need a big fancy trust, but for those of us who have enough to worry about estate taxes, for those of us who have complicated blended family kind of pictures or concerns with son-in-laws and daughter-in-laws, then you need a trust to deal with all that.
The definition I saw for a heritage trust was simply one, an irrevocable trust where you're trying to hose your in-laws if they get divorced. That you want your money to go to your grandkids, not that no good son-in-law, in the event that he leaves your daughter. That's a heritage trust. Well, that's an easy provision to put into any sort of irrevocable trust. Whether you call it a heritage trust or dynasty trust or whatever you want to call this sort of a thing, it's just putting your wishes into the irrevocable trust that you're leaving behind to your kids.
Now, trusts are governed by state law, so they're state specific. You need to see an estate planning attorney in your state. But as a general rule, the beneficiary and the trustee that controls distributions, not the investments, but distributions often has to be a different person.
For example, our irrevocable trust, it's particular flavor. It’s called IDGT, Intentionally Defective Grantor Trust. And a specific type of that is a SLAT, a Spousal Life Access Trust, or whatever it stands for. I think that's what it is.
Anyway, the point is this trust is an irrevocable trust. The beneficiary is my spouse. The investment trustees are my spouse and I, but there is a distribution trustee that is not a beneficiary. It happens to be a relative of ours whose job it is to determine the distributions. And then there's a trust protector you can put in place in case your trustee sucks and you can change the trustee.
But the bottom line is the distribution trustee could not be Katie or me. It had to be somebody separate. And it sounds like that's probably the case in your state with this particular type of trust.
But the bottom line, you go in, you talk to the attorney about what you want to happen, they tell you what's possible under the law, and you try to get as close as you can to what you want with what's possible. We all want this super flexible thing that costs nothing and is super easy to maintain and that's not always the case. But you do the best you can.
So, hopefully that's helpful to you. I wouldn't say a heritage trust, “Oh, you need to run. This is something terrible. Someone's going to scam you.” It's just another name for the provisions in an irrevocable trust.
HOME OFFICE DEDUCTION QUESTION
All right, the next question off the Speak Pipe. This one's going to be about the home office deduction.
James:
Hi Jim, this is James in Texas. I had three questions about home office deductions. My first question, does a home office need to be one continuous space or can it be multiple spaces? For example, if I have a desk in a bedroom that is used only for business, and if I have a large closet that I use only for supplies, but they're in separate areas, can that be part of the same home office?
Second question, can the home office be used for multiple businesses? For example, if I have a property rental business and I have an S Corp for patient care. And third, can I take the home office deduction and additionally rent out my house to my business for board meetings and the Christmas party? Thank you very much. I appreciate what you do. Have a nice day.
Dr. Jim Dahle:
Great questions. The first one, I don't think there's any problem with splitting the space. The rules for the home office deduction, you have to be in business for yourself, number one, you can't be an employee. But you have to be in business, you have to actually be running a business out of this space.
But the rules are exclusive use and regular use. If you're using that space for anything else, that's not exclusive. If you use it once a year, that's not regular. The IRS has not necessarily defined regular, but in an audit, those questions would come up.
The easy way to take this is just the standardized way is $5 a square foot up to 300 square feet. That's $1,500 a year and you don't have to keep track of all the expenses of your house and divide it by the percentage of your house that is being used for this business and then add that to the basis when you sell the house later. The simplified deduction is the way to go for most people, just for ease of use.
But for those of you living in expensive houses, especially if you have a pretty big home office, that's probably not the biggest deduction. You could probably get a bigger deduction by keeping track of all that and only you can decide if it's worth it or not.
Does it have to only be used for one business? No, but I'll bet when most people report this, if they've got multiple business, they probably put it on one business. Now, does that break the exclusive use thing? I don't think it does. If you're using this thing for business. Now, if your kids are doing homework at that desk, that's maybe not exclusive use. If you're doing a bunch of other stuff at the desk, your volunteer work or something, maybe that's not exclusive use. But let's be honest, nobody is coming to your house and watching you 24/7, 365 to see what that desk is being used for. There's a little bit of a spirit of the law here that we're talking about.
Remember, for corporations, the way to do this sort of a thing is to rent the space from your corporation. And so, that doesn't necessarily help you tax wise, it changes it maybe from one kind of income to another, but doesn't necessarily help you if you're just taking a deduction on one side and then it becomes income on the other side. It might not be super helpful to you.
The exception of course is if it's being rented for 14 days or less a year. This is what you talk about in your last question. And you can take the home office deduction and rent the house out to your business. You can do both of those in the same year. That's not a problem. We do that here at WCI because the space I'm claiming for my home office is not the entire space that we use for our meetings. So, I think that's completely legit.
FORCED LONG TERM CARE INSURANCE IN CALIFORNIA QUESTION
Okay, let's take another question. This one comes in and it's related to a blog post and an event that happened a couple of years ago in the great state of Washington. They had basically some legislation passed that forced everybody to either buy long-term care insurance or pay a tax. And if you didn't have much money, the tax wasn't very high. But if you had a lot of money, it turned out it was cheaper to just buy long-term care insurance than it was to pay the tax. And not to mention then you had long-term care insurance. Whether you needed long-term care insurance or not, you had to do one or the other. So, now this doc from California writes in.
Emailer:
I've been following you since med school. I've continued to do so as a practicing physician in the Bay Area. Your advice has saved my family and others lots of money. Thank you so much. I recently heard that California state may be closely following Washington state to consider mandating a statewide long-term care tax in California, and that it may be implemented as early as in 2024 without any warning for preparation. I was previously quite scared to learn about the disaster with the implementation of Washington state long-term care tax that many Washington state residents were scrambling to obtain private long-term care insurance. Assuming a physician family makes $600,000 to $700,000 annually and a minimum of 0.58% California state tax rate to fund the LTC program, the LTC state tax can mean an additional $3,600 to $4,200 in state tax a year.
I wonder if my family should consider buying private long-term care insurance that costs less than $2,000 a year for the entire family with a combined benefit of about $144,000 by the end of this year so my family can opt out of the state mandated LTC tax in the future. There can be options to just pay for 10 years for the private LTC benefit, but the three times higher premium than lifelong payments and we don't need to contribute afterwards.
However, it is hard to gauge the minimum total payout. I heard the current minimum for LTC insurance in California state is $3,000 per month for 12 months times two years per person equals $72,000 per person. Maybe I need to opt out of the tax as details have not been disclosed. Transferability to other states and termination flexibility or other issues that I'm not sure about.
I was originally planning to save enough so my retirement pools will cover long-term care costs, but it seems like the climate of California and other 10 states is pushing taxpayers to make less than ideal financial decisions. It also seems unfair to current California residents who may leave the state in the future for various reasons. Any insights and suggestions on this issue will be highly appreciated and valuable. Thanks in advance for reading. Give us advice. Please talk about this in a blog post or podcast.
Dr. Jim Dahle:
Well, we'll do it on the podcast. It's a hard situation. It was a hard situation for all these in Washington because things changed. What happened once this legislation started getting finalized is all the long-term care insurers left the market in Washington. So, you couldn't buy it. It became a problem. People had to pay the tax because they couldn't buy long-term care insurance.
Knowing that can happen, the safest thing to do, although it may end up causing you to spend money you wouldn't otherwise spend, the safest thing to do is to run out there and buy insurance now while you still can. I guess that's what you probably ought to do.
Now, you could cancel it next year if it has any sort of cash value in it, you could roll it over into another type of insurance or cash out of the cash that you have in it. But without knowing the details, what you buy might not meet the requirements.
So, there's some risk there. There's a lot of legislative risk that what you do won't actually work. It's a bit of a gamble. I don't know what to tell you without a functioning crystal ball, without sitting there in the committee meetings with the legislators, I don't know how likely this is to pass it all, number one. Number two, what it will look like. Number three, what the long-term care insurance market will do in response to it.
Also, you mentioned 10 other states. I couldn't even tell you what those 10 states are that are thinking about doing this sort of thing. I agree with you. It was a disaster in Washington. I thought it was a terrible rollout, the way they did this law. And if this starts becoming more commonplace, I think more people are going to struggle with exactly what you're struggling with right now.
Obviously, $2,000 beats $4,000, especially since you're actually going to get something for your $2,000. But it's not guaranteed that you'll have to pay $4,000. And once it is guaranteed, you might not be able to spend the $2,000. So, you're really in a Catch-22.
I feel bad for you.
Yet another reason maybe California should have fewer doctors than it has. High taxes, high cost of living, it sounds like you're making good money, but lots of docs aren't being paid all that well in California. And now this. Nevada, Arizona, Oklahoma, Texas, they'd love to have you. But if you're dead set on staying in California, there are patients that need you there and you'll have to decide what to do about this issue. I hope that advice is helpful to you.
Take a look at the column I did about Washington. That's whitecoatinvestor.com/washington-long-term-care-insurance-law. Read the comments section. It talks about docs and how they made their decisions and how things changed over time. So, it's really interesting as a kind of a case study of what happened in Washington, but there's no guarantee that your experience in California will be the same.
SPONSOR
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Dr. Jim Dahle:
Don't forget about WCICON24. Today is the last day for early bird registration. So, if you're just hearing this, go home tonight and register, wcievents.com. Yes, you'll still be able to register afterward if it doesn't fill up, but it's going to cost you $300 more. We're selling it for the same price we did the last two years. We haven't raised the price. You are paying more for everything else in your life, but not WCICON. We're keeping the price the same.
Now, I guess if we start selling out in two days, like we did at least once in the past, we may have to raise the price at some point, but for now, we think it's a fair price. We think we're putting together a great experience and we think it is well worth the money. So, please, wcievents.com. I’d love to see you there in person.
Don't forget to sign up for the Champions program if you are a first year medical or dental student, whitecoatinvestor.com/champion. You can get all the information about that. It's not a huge commitment and you'll be a hero to your class.
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All right, keep your head up, shoulders back. You've got this. We'll see you next time on the podcast.
DISCLAIMER
The hosts of the White Coat Investor are not licensed accountants, attorneys, or financial advisors. This podcast is for your entertainment and information only. It should not be considered professional or personalized financial advice. You should consult the appropriate professional for specific advice relating to your situation.
Transcription – MtoM – 139
INTRODUCTION
This is the White Coat Investor podcast Milestones to Millionaire – Celebrating stories of success along the journey to financial freedom.
Dr. Jim Dahle:
This is Milestones to Millionaire podcast number 139 – Academic pulmonologist has half a million dollar net worth.
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Welcome back to the Milestones to Millionaire podcast. We're glad you're here. This podcast is driven by you and what you want to talk about and your experiences and your challenges. We use your stories to inspire others to do the same.
Then we throw in a little bit of extra information. We added that this last year or so trying to boost basic financial literacy. But this material doesn't show up in the show notes we publish each week from the regular White Coat Investor podcast. The only way to get it is to listen to the Milestones podcast. So I hope you're enjoying that. The feedback we're getting on it is good. People like the extra information. So we're going to continue to do that.
We got a great interview today. Afterward, I'm going to talk a little bit about financial advisors and say some hard truths that if you're a financial advisor, it might not be all that fun to hear, but that if you are not and don't know how the financial services industry works, this is information you need to know. So, stick around afterward.
INTERVIEW
My guest today on the Milestones to Millionaire podcast is Ian. Welcome to the podcast.
Ian:
Thanks. Thanks for having me.
Dr. Jim Dahle:
All right, tell the audience what you do for a living, how far you are out of training, what part of the country you live in.
Ian:
I am an intensivist and I live in the Midwest and I'm about seven years post-fellowship.
Dr. Jim Dahle:
Seven years post-fellowship. Okay. And you've hit a net worth milestone recently. Tell us what milestone you hit this year.
Ian:
Yes. This year we hit in a sustainable way a half million dollar net worth. It was up and down a little bit in 2021 or 2022 rather.
Dr. Jim Dahle:
Yeah. Yeah. I think most of us experienced that as well. Okay. So, tell us about your net worth. What's it divided up into? Tell us about your assets to start with.
Ian:
So, it's about $480,000 in retirement savings which is mostly in pre-tax accounts with some smaller Roth and taxable space. And then maybe about $150,000 of home equity.
Dr. Jim Dahle:
Okay. And tell us about the liability side.
Ian:
We have one car loan and I have student loans, which are due to be forgiven via PSLF later this year.
Dr. Jim Dahle:
Oh, that's exciting. Later this year, there's another story right there. This is fascinating. In 2017 I had people coming to me going, “Nobody's gotten PSLF. The newspapers are reporting only 1% of people who apply for it are getting it.” And I had to really push people to say, “Hey, this is like a real thing. It's really going to happen. The reason no one's getting it is no one has done 10 years of payments yet.” And now we're seeing all kinds of people getting it all the time. Awesome. Good plan. I like your student loan plan.
Ian:
Thanks.
Dr. Jim Dahle:
You're in the Midwest, so it's not Bay Area prices, but what kind of house do you live in? Approximately what's it worth?
Ian:
Yeah. We bought the house for $360,000 when I was at the end of training. And it's appreciated some. It's probably worth maybe half a million dollars, but it's a comfortable sized house. We have four kids, two of them share a room, but I joke with my relatives, if we had a bigger house, we'd lose one of them. So, it works well for us and it doesn't stress our finances, which is really helpful.
Dr. Jim Dahle:
Very cool. It allows you to build some wealth. Okay. Is your spouse working?
Ian:
She is on hiatus. She worked up until our fourth was born, and has been home full-time with them and is interested in getting back into something within the next year or two.
Dr. Jim Dahle:
Okay. All right. Well, tell us a little bit about the income over the last seven years and what you guys have been doing.
Ian:
Yeah. When I finished fellowship training, I was making maybe about $150,000 or $160,000 as a base because I'm in an academic center and was doing some research and my wife made maybe $90,000. So our income was a little over $200,000 coming out of training.
And then actually during COVID, because we worked a lot more in the ICU, and I took on some extra work, our income was up over $400,000 for a year or two and now it's kind of settling in around $300,000.
Dr. Jim Dahle:
Okay. $200,000 to $400,000 range for that time period. Pretty typical. If I had to ask what’s a doctor income, $200,000 to $400,000 is what I tell people it is.
Ian:
Yeah.
Dr. Jim Dahle:
Okay. Tell us how you did this. You've been steadily building wealth. It's not like some crazy story that you're worth $2 million a year out of residency or something, but you've been steadily building net worth, you're moving in the right direction and now you've hit a significant milestone. How have you done this?
Ian:
Yeah. I think slow and steady is sort of the right descriptor. We worked with a financial advisor who was an insurance salesman for a couple of years before I sort of found your material and learned that I could take more control on my own.
And after doing that, we accelerated our savings rate from more like the mid to high teens to closer to 20%. And that's made a big difference in the last couple years. We've grown our net worth a lot more by just more aggressive savings.
Dr. Jim Dahle:
How'd you feel when you found out your financial advisor was really a salesman?
Ian:
I was frustrated but also motivated to learn how to do it by myself.
Dr. Jim Dahle:
That is a great description of how I felt in 2004 when the same thing happened to me. And I was mad. I was like, “Ugh, I'm taken advantage of. I'm never going to let this happen again.”
Okay. So, savings rate. That was the first time you calculated your savings rate, was when you fired your financial advisor?
Ian:
Yeah, 2021 was the first time I'd sort of built an Excel sheet. Now I have a nice Excel sheet where I can track everything. I'm kind of a data nerd.
Dr. Jim Dahle:
Very cool. Well, you work in an ICU, right? But you can certainly handle a spreadsheet about your savings rate and your net worth, no doubt about it, if you can handle intensive care medicine.
What'd you find out? You said your savings rate, the first time you calculated it was what? Mid-teens?
Ian:
Mid-teens. Mid-teens.
Dr. Jim Dahle:
And how'd that feel? Were you happy? You're like, “Oh, we're actually doing pretty good?” Or were you like, “Oh, that's all?” How'd you feel about it?
Ian:
I was happy that it was more than the single digits. And those things had been sort of slowly growing, but then I recognized that we had some need and opportunity to do more. We hadn't been doing back Roth IRAs and I have a 457 account at my work, which we weren't using, and now we're doing both of those things. And so, almost all of the savings happens in some sort of tax protected space.
Dr. Jim Dahle:
Tell me about some of the conversations you've had with your spouse about finances as you were kind of going through this financial awakening for lack of a better term.
Ian:
Yeah, I think the most useful thing is just focusing on our goals, which is “Hey, it would be really nice if when I'm in my late 50s or early 60s I can be choosing how much and how to work and if it's right for us as a family for me to stop working that we're in a position for me to do that. And if it's right for me to keep working, that's great and we'll just have more resources.
I think she's totally on board with a journey towards financial independence. She's not as in the weeds as I am, which is fine, but we're on the same page about our big picture goals for our family.
Dr. Jim Dahle:
Now you picked up a little bit of a side gig. Tell us what you're doing on the side.
Ian:
Yeah. I do also ICU telemedicine from home. It's sort of an offshoot of my main job and that's helped us grow our income also in the last couple years. And it's just new and different, which is fun at this point in my career.
Dr. Jim Dahle:
Where are the ICUs that you're working in via telemedicine?
Ian:
All over our state. Some quite far hours away.
Dr. Jim Dahle:
Little tiny towns mostly, or what?
Ian:
Yeah, exactly. Small places.
Dr. Jim Dahle:
So, who's taking care of these patients? This is a night gig for you, you mentioned. Who's taking care of these patients during the day?
Ian:
There's an ICU doc during the day and then then at night we work with a non-intensivist clinician at the bedside.
Dr. Jim Dahle:
Okay.
Ian:
We sort of work as expert consultants.
Dr. Jim Dahle:
They port you in with a video camera in the room and you can see the monitors.
Ian:
We can. Yeah.
Dr. Jim Dahle:
And you got access to the EMR and all that. Very cool.
Ian:
Exactly.
Dr. Jim Dahle:
Very cool. And which job do you like better? Obviously one of them is at night, so that's a big downside, but if there were both during the day, which one would you like better?
Ian:
For me, I love my bedside work mostly because I have built relationships with the nurses and the respiratory therapists and all the sort of team members that we work with in the ICU. And it's the people that are as motivating as the medicine for me to go into work. And the nights are hard. As I've gotten a little bit older and have a bunch of kids, it's hard to work at night.
Dr. Jim Dahle:
Well, I can definitely relate to that, especially as they get into activities that are in the evenings. You are missing those or whatever. Okay. So, tell us a little bit about your spending. What kind of spending do you guys do? How much do you think you spend in a typical year?
Ian:
Yeah, I was trying to figure that out in advance of this podcast. And I think we probably spend between $170,000 or $180,000 a year including everything. I think that the biggest chunk is maybe food, feeding all of our kids. And we have some unique desires amongst for their food.
Dr. Jim Dahle:
I talked to somebody yesterday, they make like six dinners every night.
Ian:
Yeah, exactly. We're certainly not living bare bones at all, but we also have reasonably frugal taste in our vehicles and on our vacations and things like that. And that has helped us not spend too excessively, I think.
Dr. Jim Dahle:
What do you driving into the hospital?
Ian:
I drive a Corolla Hybrid.
Dr. Jim Dahle:
Okay.
Ian:
And we have a minivan.
Dr. Jim Dahle:
Is that the one with a loan on it?
Ian:
Yeah. Those things are expensive.
Dr. Jim Dahle:
Yeah. Yeah. They add up for sure. Especially if you want a four-wheel drive one, which is what people look for around here.
Ian:
Yeah.
Dr. Jim Dahle:
Okay. Well, what advice do you have for somebody else? Let's say they're a couple years out of residency and they're like, “I don't really know what's going on with money. I'm not sure about this advisor I've got.” What advice do you have for that person?
Ian:
Yeah, I think my advice is just to not be intimidated, and like you say often, if you can figure out how to take care of sick people, you can figure out how to take control of your finances. And that's been really liberating for me and for our family to feel like we're in control. We're not beholden to somebody else in defining our goals and how we get there. So, I think you can do it is really the key.
Dr. Jim Dahle:
Cool. What lessons do you plan to pass on to your kids about money?
Ian:
I think just recognizing that there's always trade-offs involved. And if choosing to do one thing now, maybe you can't do something else later. Because that's been sort of I think the most important piece of this. Saving now so that later we have choices in life.
Dr. Jim Dahle:
Yeah. What's your next big financial goal?
Ian:
Well, getting the student loans forgiven. That'll be nice. And then saving up to just pay off the car loan so that our only debt is our mortgage.
Dr. Jim Dahle:
Very cool. Wouldn't surprise me if you knock both of those out before the end of the year.
Ian:
Yeah.
Dr. Jim Dahle:
Very cool. Well, congratulations to you on your success. You're doing great. You should be proud of yourself. Your kids don't know it yet, but eventually they'll be proud of what you're doing in these years of your life. So, thank you for coming on the podcast and using your experience to inspire others to do the same.
Ian:
Thanks and thanks so much for all that you do for our community. We really appreciate it.
Dr. Jim Dahle:
All right. I hope you enjoyed that podcast. We get so many people on here that are just absolutely crushing it. People that are millionaires two years out of residency or pay off their student loans in four months or whatever.
It's nice to have a regular doc on here every now and then that’s just doing it. That made a few mistakes, sure, but is saving money, is investing it in some reasonable way, is building wealth slowly but surely, is serving, working hard, in academics in this case, an ICU doc and just doing it.
This is what White Coat investing is all about. Going to work, taking care of patients, doing the best you can, making sure your finances aren't being totally screwed up and being able to focus on your spouse and your kids and your patients and your own wellness without having to worry about money.
I appreciate having what I'd call a regular milestone. I remember when we hit that milestone, it was a big deal to hit a half million dollars. When we recorded earlier, I think it actually runs later than this one. It was somebody who hit $250,000. I remember that milestone. It was an important milestone to us, and I'm sure it is to you as you tick them off as well.
FINANCE 101: FINANCIAL ADVISORS
Okay, I promised you we were going to talk about financial advisors. I do not hate financial advisors despite some of the things I've written about them and said about them.
However, I use the term financial advisor differently than most of the financial services industry. Basically, you don't have to do anything to call yourself a financial advisor. The term legally speaking means nothing.
And so, a large percentage of those who call themselves financial advisors are not what you think of in your mind when you hear the term financial advisor. What they are is representatives or agents or salespeople. And what are they selling? Well, they are generally selling mutual funds commissioned or loaded mutual funds. They're selling annuities, they're selling insurance, and they call themselves financial advisors. And maybe they even throw you a pearl or two of what could be called financial advice.
But the problem is they have this huge conflict of interest. How are they paid? They're paid on commissions. They're paid on commissions. When they sell you something, they get some percentage of what you use to buy it.
That's fine. I have no problem with commissions. I've had staff members that I pay on commission and if they can sell an ad, they get a percentage of it. When I buy a car, I buy it from a commissioned salesperson. I don't have a problem with them earning a commission selling me the car. It's fine.
But when I walk into that dealership, I don't expect that Toyota salesperson to give unbiased advice about all cars. They can help me choose between the models of Toyotas. They can help answer questions about what's available for that model year. But I don't go to them asking, should I buy a car at all? Much less which car should I buy?
And that's the way you should interact with salespeople. You should use them for what they are good for, but not mistake them for an unbiased advice giver, which is what you're looking for when you hire a financial advisor.
So, the easiest way to make sure you are hiring an advice giver is only pay for advice.
That means fee-only, not fee-based. Fee-based means you're paying commissions and the fee. But fee-only.
And fee-only means that you're paying them in one of three ways. The most common way is an asset under management fee. I'm not a huge fan of this. It's fine when you don't have that much in assets. If you're paying 1% of your $100,000 invested, that's only $1,000 a year. That's a fair price for good financial advice.
In fact, even if you're paying 1% on a million dollars a year, that's only $10,000 a year. That's probably a fair price too. But if you're paying 1% on $5 million, you're getting ripped off. As your assets go up, you've got to be negotiating lower fees with someone who charges asset under management fees, or you got to move on to a different advisor or even if you're getting good advice, you're just paying too much for it.
A couple other ways you can pay advisors. You can pay them an annual fee. Whether it's a fee for them to do financial planning and be there for you when you need them with questions or whatever throughout the year. Some sort of retainer or you're paying them flat fees for the project to help you draft up a financial plan. Or you're paying them on an hourly rate often, which is higher than the hourly rate you charge.
But that's okay because you're paying for advice. When you don't need the advice, you're not paying more. And that's the way you hire your accountant. That's the way you hire your lawyer. That's the way you hire your doctors. So, why shouldn't it be the way you hire your financial advisor?
It's a little harder to find people that charge flat fees. A little harder to find people that charge by an hourly rate. But the bottom line is you just need to calculate what you are paying. Is that a fair price? Am I getting good advice?
But a lot of us, including me, as I mentioned on the podcast, get into a situation where we realize we have made this mistake. We have hired a salesman, we have mistaken them for a financial advisor, and we now need to extricate ourselves from that situation.
I have got an online course called Fire Your Financial Advisor. And you can imagine that title was a big hit with our financial advisor advertisers. And we keep a list of recommended financial advisors, real financial advisors, not salesmen, real financial advisors on our recommended tab. You can go to whitecoatinvestor.com/recommended. You'll see all the professional services that we recommend.
But you get into a situation and you're like, “Okay, how am I going to get out of this?” And step one is not to make any huge change right away. Step one is to figure out what are you moving to. And that might be hiring a new advisor, a real advisor this time. And if that's what you're going to do, go do that first. Go hire them and have them extricate you from the situation. That's what you're paying them for. You might as well get some value for your fees.
If the answer is, “I'm going to try to do this myself”, I'd recommend our Fire Your Financial Advisor course. Not because it's specific to firing your advisor, in fact, the first module teaches you how to work with advisors, but because it will allow you to have a plan in place, and that's what you need is an overall plan. Whether you put that in place with an advisor's help, whether you use our course to do it, whether you go on forums and read books and figure it out yourself, you got to have a plan.
So, get that plan in place before you make the changes. Otherwise, you're likely to have to make changes multiple times. That's my recommendation if you got to move on from an advisor that maybe you shouldn't have hired in the first place.
And if the advisor works for a company whose primary job is selling you insurance, for example, a company that rhymes with “Shmorshwestern Putual”, you need to do this as soon as possible.
All right, that's the end of our podcast for today. I hope you're liking these podcasts. We sure enjoy making them for you. It is some work. It's mostly work for Megan though, and we appreciate Megan, our producer, and we appreciate Wendel who does all of our AV work, gets it up on YouTube, gets it up on the podcast services. They sure work hard on this podcast a lot harder than I work. They do three or four or five or six hours of work for every hour I'm doing in this, and I'm grateful for them just like I'm grateful for you and your work.
Keep your head up, shoulders back. You've got this. We'll be here to help. See you next time.
DISCLAIMER
The hosts of the White Coat Investor podcast are not licensed accountants, attorneys, or financial advisors. This podcast is for your entertainment and information only. It should not be considered professional or personalized financial advice. You should consult the appropriate professional for specific advice relating to your situation.
