Personal Finance

Couple Will Retire Early on $250K/Year Through Real Estate Investing—Here’s How

Expertise: Personal Development, Personal Finance, Mortgages & Creative Financing, Real Estate News & Commentary, Business Management, Real Estate Investing Basics, Flipping Houses
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Middle-aged people wearing sunglasses. A man and a woman together. Happy adult couple.

This case study is about real people who’re ongoing, long-term clients. They came on board with me around eight years ago. This is their story up ’til now.

Around 2011, I agreed to meet Brick and Carm for lunch here in San Diego. We’d first spoken on the phone when they liked one of my BiggerPockets posts, and called me.

Brick is an advertising sales exec, on the road much of the time. Carm’s been an elementary school teacher for over 20 years and really enjoys it.

When we met, they were both in their mid- to late-30's and flush with enough cash to immediately acquire some real estate. In fact, they'd already dipped their toes in the real estate investment pool before we met, as they lived in one of the units of a fourplex fixer upper they’d purchased.

Their total housing costs back then were easily under $700 monthly. They lived in coastal SoCal.

Retirement Income Goals

They’d always lived relatively frugally, allowing them to save at least $5,000 a month—sometimes much more. In fact, these days they’re saving a lot more.

I immediately spotted the fourplex as a prime candidate for a tax deferred exchange, as the value they’d already added through fix-up was impressive to say the least. But that turned out to be a personal thing with them. Since they’d done most of the work themselves, they were somewhat emotionally invested and wouldn’t even consider moving at the time—regardless of how much closer it’d get them to retirement. (More on that later.)

Brick was the one driving the retirement date, as he’s not as into his job as he once was. He wants a minimum of $100,000 a year in passive retirement income.

Seasoned Attorney

The Initial Investment Strategy

They’d saved $190,000, over and above cash reserves, to begin retirement investing.

It was pretty simple at the beginning. I recommended they buy a couple brand new Texas duplexes.

This is where their high income and frugal lifestyle came in handy. Ever heard of cost segregation? It's nothin' more or less than a different approach to depreciation.

For those new to real estate investing, depreciation is merely a “paper” loss—translation: not a real life loss. Most investors used the normal depreciation to as a tax shelter for the property’s cash flow. Any leftover is then applied to the investor’s own ordinary (job) income. The schedule most investors use when depreciating their investment income property is usually 27.5 years for residential income property and 39.5 years for office, retail, and the like.

However, cost segregation (CostSeg) is an entirely different approach.

Instead of merely subtracting the land value from the purchase price, then dividing the remaining value by 27.5, CostSeg uses much shorter lives for every single system or factor involved in its construction. An example would be all the appliances, which generally speaking, can be written off in five short years—much less time than 27.5. The electrical, plumbing, roofing, A/C, and the rest are all treated likewise, virtually always with far shorter useful lives.

Here’s the bottom line result of using CostSeg as your depreciation approach: Compared to the normal straight-line approach, the depreciation dollars per year is virtually doubled! In the couple’s case, that meant their per duplex annual depreciation would jump from around $10,000 to $20,000 annually.

Now, that sounds too good to be true, right? Turns out in one critical way it is. See, our dynamic couple easily makes more than $150,000/year, adjusted gross income, or AGI. Here’s the problem with that.

When your AGI travels from $100,000 to $150,000, the IRS slowly but surely eliminates your ability to use any extra depreciation leftover after sheltering cash flow against your ordinary income. In other words, the fact your AGI exceeds $150,000 means all the time you own that property, all leftover depreciation is shunted off to the sideline to gather dust, with one cool exception in their case. Why? Cuz you make too much money at work!

But there’s a real-life happy ending to this story.

woman in maroon shirt and yellow sweater talking on a cell phone while going over notes on a notepad

Discounted Notes Secured By Real Estate

Fast forward a few years, and they now own four Texas duplexes. The total cash flow varies, but it stays in the range of $20-25,000 annually, all of which is tax sheltered.

They’ve been cussing and discussing my advice to branch out into discounted notes. The market was offering nice discounts, as 30 percent wasn’t uncommon. They pulled the trigger, spending roughly $85,000 on a total balance of roughly $118,000. The cash on cash return was just over 12 percent per year, with income at around $10,300.

As of earlier this year, they acquired another $400,000 +/- in discounted first position notes, secured by real estate. Their updated, current note income: just over $54,000/year.

Note: The leftover depreciation each year was used against the interest generated by the notes. This resulted in making all their note income tax-free. They’re now saving roughly $90-100,000 yearly.

Related: 3 Feasible Ways to Escape a Soul-Crushing Job, Reclaim Free Time or Retire Early

Tax Deferred Exchange

They'd become comfortable with the idea of executing a tax deferred exchange (IRC Sec. 1031) on their fourplex. They'd come to understand the huge long-term benefits of exploiting the impressively increased equity they'd created over less than three years.

We got it sold, and we took the net proceeds to Texas. They ended up with half a dozen brand new duplexes in the Austin market.

As I’d forecast a year and a half earlier, this one move turned out to be incredibly beneficial. How much so?

Less than five years later, they were able to refinance all of ’em to the tune of $500,000 in cash—all of which was tax-free by IRS definition. Fast forward a few more years. They’ve now amassed approximately $1 million in cash, over and above their handsome cash reserves.

Wait just a second here! How’d they manage that? It’s simple everyday math.

They saved a minimum of $5-6,000 monthly, then grew that savings to $8-10,000 monthly. Add another $10,000/year from tax-free note income. Then there’s the monthly cash flow from,—count ’em—10 duplexes, which historically ended up being $50-60,000 annually. Again, this was after taxes.

Two of their original Texas duplex purchases on which CostSeg was executed were sold. Between the taxes not paid on the note income and the leftover depreciation of almost five years, they essentially offset 85 to 90 percent of what would have been their tax bill, net net. Cash proceeds easily exceeded $250,000.

They had a glob of savings and purchased an impressive portfolio of roughly a dozen more discounted notes. Their cash on cash on this purchase has proven to be about $50,000, or 12 percent.

The best thing? This new portfolio of notes sports an overall loan to value of roughly a cheeseburger less than 50 percent!

Their current annual savings rate at this point has now reached approximately $130,000 yearly.

A couple years later, they decided to invest $400,000 in one of my investment groups. They continue saving money like crazy.

Fast forward to today. The first profits are imminent, as development of a lot zoned for multiple housing and a commercial space is now up for sale. The return on investment to the investors will exceed 10 percent—likely more.

They’ve now accumulated another $1 million of investment capital. The idea is to take a touch more than half and put it into another investment group that’s also developing income property. The balance will be directly put into partnering in acquiring their own stuff in the same project as the group.

The cash flow on these two  investments alone should result in at least $100,000 annually. Remember: That was their initial retirement income goal.

Young business people shaking hands in the office. Finishing successful meeting. Three persons

More Tax-Free Income

I won’t bore you with a bunch of insurance mumbo jumbo here. Suffice to say, one of the key members of my team, David Shafer, insures a minority of my clients for the primary purpose of producing a stand alone source of tax free income in retirement.

In Brick ‘n Carm’s case, this retirement income would begin in around 20 years (age 65) and fall into the range of $70-80,000 yearly, ’til age 89. I’m putting my own kids and their kids into this product.

Actual and Projected Cash Flow in Retirement

Here I’ll be using the actual known cash flow whenever possible. Otherwise, the low end of the cash flow range will be employed.

Current annual note income: $60,000. The interest income is still sheltered, but that shelter is now reaching its limits. If they buy more notes in the future, some (if not all) of that new interest income will be taxable. The current interest income, however, is still sheltered.

It’s important to understand something about these notes. They’re like bunnies. Keep ’em warm and fed, and pretty soon ya gotta whole bunch more bunnies. What’s better is that they come with plans B and C, if needed. But that’s another post altogether.

Current annual income property income: $20,000. This used to be nearly triple that amount. But since the decision was made to refinance all of ’em for just over $500,000 tax-free, cash flow took the hit.

Bottom line? They now have all their initial down payments and closing costs back working in other investments, while only selling 20 percent of the properties.

Group investments: Currently they’ve contributed $1 million into a couple investment groups, over half of that just this month. The first group is now about to distribute some attractive profits to their investors.

From 2020, and for the next several years, the cash on cash for both groups should easily hit $100,000 yearly. Some years will be less; some years will likely be embarrassingly more.

EIUL: This will begin at age 65, though it can certainly be sooner or later at Brick’s and Carm’s discretion. We’ll use the lowest range amount, $70,000 tax free annually.

Notes: $60,000   Income property: $20,000   EIUL: $70,000 tax-free   Investment groups: $100,000

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Total: $250,000 annual income in retirement

This assumes rents never rising, never making profits on notes, note payments never increasing, and group investments never doing better than 10% return.

None of those numbers factor in the roughly $400,000 they’re about to put into new nightly rental properties to be built in another state. The conservative projections say the cash on cash should easily be 9.6 percent, likely north of that.

By Christmas of 2021, my personal equity in the same project will be roughly $3-6 million. Walkin’ the talk, right?

Oh, and their cash reserves are approaching $200,000—a sensitive subject with me.

Related: 3 Lessons I Learned Surveying 851 Current & Aspiring Early Retirees

Takeaways

Brick and Carm have always lived their lives frugally, though not like monks in any sense. They’ve always been huge savers, eschewing the impressive cars and lavish vacations. Combine that lifestyle with the use of multiple well-planned strategies all designed to reduce risk, and these results are what’s possible.

In fact, the not so conservative numbers on all their investments will, more likely than not, end up with them retiring on far more than shown here. They took advantage of what the market gave 'em and never tried to control the market—a circus act for clowns if there ever was one. They weathered a recession, no problem.

Oh, and about those notes. By the time the EIUL comes to fruition, the note portfolio will have grown tremendously, even after tax. The income will, of course, follow that growth.

Four stand alone sources of income. It’s now likely that Brick will retire on or before his 50th birthday.

Are you conservative with your spending? Are you saving? Are you investing? What’s your retirement plan?

Tell us your story in a comment below.

 

Licensed since 1969, broker/owner since 1977. Extensively trained and experienced in tax deferred exchanges, and long term retirement planning.
    Nathan Richmond Rental Property Investor from Visalia, CA
    Replied about 1 year ago
    Love it! That’s what I’m talking about!
    Rob K. from Encinitas, California
    Replied about 1 year ago
    Good thing they did not 1031 their San Diego duplex out of state in 2011
    Ben G. from Boston, Massachusetts
    Replied about 1 year ago
    Brushing over the costs, fees and other issues of EIUL, while having it account for 25-30% of yearly income seems like a problem. My understanding of these products is that they’re great to sell, but not so great to buy. That said, the real estate component of this is pretty impressive. Do they ever have to pay the deferred taxes after cost-seg to 1031? How are they planning for this future cost?
    Jeff Brown from San Diego, CA
    Replied about 1 year ago
    Ben — Indeed, the fees are all front loaded, making the first 10 years worth a whole lotta not much. However, from the 15th year on EiULs are freakin’ stars! My clients care about results, and stellar results is what every single client has experienced from the EIULs they have.
    Blane Morgan Rental Property Investor from San diego, CA
    Replied about 1 year ago
    Eerily similar to the path I am on! Loved the Article! Note investing can be intimidating for novices.
    Jeff Brown from San Diego, CA
    Replied about 1 year ago
    Hey Blane — Note investing done by the the DIY approach is often a real life tragic/comedy. You’re spot on. They should ALWAYS have an experienced pro taking care of the purchase or sale of them.
    Eric Carr Real Estate Broker from Los Angeles, CA
    Replied about 1 year ago
    Once in a while someone will write something so dense, so packed full of experience, that it’s worth every letter in gold
    Jeff Brown from San Diego, CA
    Replied about 1 year ago
    So very much appreciated, Eric. Thanks!
    Justin M. Rental Property Investor from Denver, CO
    Replied about 1 year ago
    Great information here! I’m working on my REI portfolio and growing that, but would love to have another stream of income. Notes seem to be another great option as … noted here 🙂 I’ll have to dig into that more and see what options I have. Thanks!
    Tim Coffey
    Replied about 1 year ago
    I think this would read differently if I was more seasoned, but I honestly couldn’t follow. I appreciate all the keywords to search on though! Going to use them to build my knowledge.
    Ryan Buckmaster Rental Property Investor from Redondo Beach
    Replied about 1 year ago
    Very impressive! Glad to see a real estate broker with financial planning and tax skills!
    Mark S. Rental Property Investor from Kentucky
    Replied about 1 year ago
    Since they are used to living so frugally, what will they do with all that income (other than reinvest)? Are they charitably-inclined? I think it’s awesome what they’ve built, but I’d rather do it all and enjoy some vacations and nice cars (within reason) and still “retire early” comfortably but not with “too much income” by sacrificing early years.
    Jeff Brown from San Diego, CA
    Replied about 1 year ago
    Hey Mark — Living frugally is relative. Frugal to one is impossible for the next person. They simply are close with the dollar. Since he travels for work so much, he likes to stay close to home when he has a week or two off. Trust me, they don’t save used paper towels. 🙂