Unfortunately, I have to give in a bit on the concept of frugality. You see, as I look for places to house\u00a0hack<\/a> around the DC-Metro market, I\u2019ve come to realize I inherently understand that living frugally is a\u00a0key part of the wealth building formula, no matter how much I hate to admit it.<\/p>\n Even though I\u2019m giving in to the concept of frugality, I view it somewhat differently. I prefer to find ways\u00a0to minimize my big ticket expenses rather than cutting back on the morning latte. I strive to follow the\u00a0Pareto Principle<\/a>, where 80% of my savings will come from 20% of my effort. By forcing myself to avoid\u00a0my latte, I save maybe $20 a week or $80 a month\u2014the effort is not worth the savings, to me at least.<\/p>\n On the other hand, I can dedicate 20% of my week to finding a great multifamily property that will\u00a0reduce my monthly housing expenses. Do you know how much it costs to live in DC if you have a car (a\u00a010-year-old beater car at that)?<\/p>\n You may not, so let\u2019s break it down: $1,300 in rent, $150 in utilities, $150\u00a0in parking, for a total of $1,600 every single month. Oh, and I have a roommate, so the above is only my\u00a0HALF of our total expenses. Compared to my city colleagues, I\u2019m actually on the cheap side! Yikes.<\/p>\n If I\u2019m able to find a multifamily where the other units can cover my mortgage, I can reduce my living\u00a0expenses monthly by $1,600 or annually by $19,200. That\u2019s relatively little effort, for massive savings\u00a0and accounts for a big chunk of my annual expenses.<\/p>\n I\u2019m a CPA, so naturally I have to talk about taxes. Taxes are likely the largest expenditures any one of you\u00a0incurs each year, aside from housing. Wealthy individuals understand this concept and constantly consult\u00a0with tax advisors to minimize their tax burden. They view professional fees as an investment rather than\u00a0an expense, and one that will provide returns in the form of drastically reduce their tax bills.<\/p>\n Ben Leybovich wrote a great article several weeks ago<\/a> about personal \u201cburn rates.\u201d The burn rate is the\u00a0rate at which an enterprise spends money. You\u2019re not treating your personal finances like a business?\u00a0Shame on you! Track your monthly income and expenses just like any business would and see how much\u00a0you are cash flowing. If you aren\u2019t doing that yet, it will be eye opening.<\/p>\n Anyway, taxes significantly add to the burn rate, and those people who break out of the low or middle\u00a0classes and into prosperity truly understand how to minimize their tax liability. Those people take\u00a0deliberate steps to reduce their taxable income, and do you know what step one is? Getting rid of the W-2 income. An example below illustrates my point.<\/p>\n I\u2019m going to illustrate the differences between those who understand that a high paying job is not the\u00a0best long-term wealth building route to take and those that do not.<\/p>\n Sarah has done quite well. She\u2019s in finance and only four years out of college. Her salary is an impressive\u00a0$110,000, she lives in a city, and she is proud of how successful she is. She contributes 6% to her\u00a0employer 401(k) and has a solid health plan. Her friends envy her lifestyle and success, yet they don\u2019t\u00a0see the whole picture. The problem is Sarah\u2019s burn rate.<\/p>\n To be close to her job, Sarah rents an apartment in the city that costs $2,100 per month with utilities\u00a0coming in at around $200 per month. Sarah spends annually $27,600, none of which is tax deductible.\u00a0Additionally, because Sarah rents, she neither has property taxes nor mortgage interest.<\/p>\n Let\u2019s look at the taxes: Sarah makes $110,000 and contributes $6,600 to her 401(k), which will reduce\u00a0earned income to $103,400. Sarah has no other income sources and is phased out of deductions, so\u00a0$103,400 is also her AGI. Sarah cannot itemize, mainly due to the fact she rents, so her standard\u00a0deduction of $6,300 and personal exemption of $4,000 further reduces her AGI to $93,100, which is her\u00a0taxable income. Her tax liability based on this income is $19,251.<\/p>\n Related:<\/strong> 5 Habits of the Wealthy That Helped Them Get Rich<\/a> Additionally, a commonly overlooked\u00a0fact is that Sarah will also pay payroll taxes of 7.65% on her $110,000 salary, or $8,415. This brings her\u00a0total tax liability to $27,666.\u00a0Between taxes and rent\/utilities alone, Sarah\u2019s annual expenses are 50.2% or her annual salary, or\u00a0$55,266. That\u2019s a very high burn rate, and we haven\u2019t even factored in basic living expenses, such as food!<\/p>\n Sarah is therefore left with $54,734, including her 401(k) contribution, to spend how she chooses.<\/p>\n Now let\u2019s switch gears and look at Tom. Tom is also four years out of college and spent the first three\u00a0working for corporate America. Tom works in the same city as Sarah. Tom found BiggerPockets early on\u00a0in his career and decided that the key to wealth building and lifestyle design is that it\u2019s not about how\u00a0much you make; it\u2019s about how much you keep.<\/p>\n So Tom purchased a property using his corporate W-2 to obtain financing. Because he decided to look\u00a0around the city rather than in the city, Tom found a reasonably affordable 4-unit for $350,000 which he\u00a0decided to owner-occupy. Tom put 3.5% down, and his monthly payment comes out to be about $2,300,\u00a0which includes that pesky mortgage insurance.<\/p>\n Luckily for Tom, with the knowledge he gained from his\u00a0time spent on BiggerPockets, he figured that each of the three units will rent for $900, and he was right.\u00a0So Tom actually earns $400 per month for living in his property. He also has utilities, though his tenants\u00a0pay for their share, so Tom only pays $200 per month, leaving him with a net $200 cash flow per month.<\/p>\n With the massive decrease in housing expenses, Tom was able to quit his corporate job and open up his\u00a0dream business. He provides services to clients, and during the year, he nets $55,000. Great for the first\u00a0year in business; poor compared to Sarah\u2014right?<\/p>\n Not really. Tom understands taxes are painful and has sought out a good CPA. The CPA set him up with\u00a0an S-Corporation, and Tom is able to pay himself a salary of $22,000. The remaining $33,000 is taken as a\u00a0shareholder distribution, which is not subject to payroll tax. Tom, like Sarah, also contributes 6% of his\u00a0salary to his 401(k)\u2014although his CPA advised him he can contribute significantly more with employer\u00a0contributions.<\/p>\n Let\u2019s look at the taxes: Tom\u2019s salary is $22,000, and he contributes $1,320 to his 401(k). His real estate\u00a0income and expenses net out to $0 for tax purposes. He also has $33,000 of taxable income from his S-Corporation taken as a distribution. Tom\u2019s AGI will be $53,680. Tom is able to itemize as he pays\u00a0mortgage insurance and property taxes, which pushes him over the standard deduction threshold. His\u00a0itemized deductions come out to $9,180, and his personal exemption is $4,000, reducing his AGI to\u00a0$40,500, which is also his taxable income. His tax liability based on this income is $4,969.<\/p>\n Additionally,\u00a0Tom must pay both the employer and employee halves of payroll taxes of 15.3% on his $22,000 salary,\u00a0or $3,366. This brings his total tax liability to $8,335.<\/p>\n Remember, Tom\u2019s net income for his multifamily property was $0 for tax purposes, but Tom actually\u00a0cash flows $200 per month, which is essentially tax-free. How does this happen? Depreciation!<\/p>\n Taking into account Tom\u2019s taxes and living expenses (or lack thereof), Tom\u2019s annual expenses based on\u00a0these facts alone is 26.9% or $5,935 ($8,335 – $2,400 of tax free rental income). This leaves Tom with\u00a0$49,065 to spend as he chooses.<\/p>\n Please note that this example is purposefully not using like-kind variables. Life is full of variances and the\u00a0two points I\u2019m attempting to drive home are: (1) it\u2019s not about how much you make and (2) thinking\u00a0strategically about your finances can drastically change your entire life.<\/p>\n Honestly, I don\u2019t know. I don\u2019t know how much Sarah works compared to Tom. I don\u2019t know how much\u00a0they enjoy their particular situations. But if I had to guess, I\u2019d say Tom is better off for several reasons.<\/p>\n First, many of Tom\u2019s everyday expenses can now be strategically written off as legitimate business\u00a0expenses. This will provide Tom with savings that are unachievable to a W-2 employee such as Sarah.<\/p>\n Additionally, Tom runs his own business and is his own boss. There are pros and cons to this of course,\u00a0but based this article that claims 52% of employees are unhappy at work, I think the odds of Tom being\u00a0happier is higher than that of Sarah\u2019s.\u00a0As a business owner, Tom\u2019s earnings potential are unlimited and can be tied directly to his efforts and\u00a0implementation of business systems. Compare that to a W-2 employee whose earnings are tied to\u00a0annual performance reviews and how well they can negotiate with HR.<\/p>\n Tom has also mitigated his risk of income loss by having multiple income streams. If Tom doesn\u2019t get\u00a0paid, he won\u2019t be facing an eviction or even a foreclosure since his tenants are paying his mortgage.\u00a0Sarah on the other hand will be in trouble if she is fired.<\/p>\n From a tax standpoint, you can clearly see who is better off. Tom can strategically implement tax plans\u00a0to reduce his business income and payroll taxes\u2014strategies which are unavailable to those who hold\u00a0W-2 jobs.<\/p>\n The moral of the story here is clear: Business owners and real estate investors have a massive advantage\u00a0over everyone else. This can be further substantiated by examining how the world\u2019s wealthiest people\u00a0earned their wealth (hint: it wasn\u2019t from that W-2 job).<\/p>\n Evaluate where you are now and where you want to be.<\/p>\n Start with looking at your personal income statement and statement of net worth. If you\u2019re not tracking\u00a0these, then you should start today. Heck, shoot me an email and I\u2019ll send you my templates.<\/p>\n Once you are tracking your expenses, you\u2019ll notice that you spend more money in a few key areas over\u00a0all others. For most of us, the top two will be living expenses and taxes. Your job is to figure out a\u00a0strategy parallel to your goals to reduce your top expenses.<\/p>\n I understand that you may not be in a financial position to take down a multifamily property. My\u00a0challenge to you would be to do whatever it takes to get to such a position. If it\u2019s simply impossible,\u00a0consider picking up a single family home and renting out the rooms\u2014same idea, but just sharing the\u00a0same space.<\/p>\n I also understand that many of you have families and owner occupying a multifamily is not an option.\u00a0Can you make the bonus room above the garage rentable? Do you have a detached guest house on your\u00a0property that you don\u2019t need? Can you downsize and use the excess cash to pick up a couple of rental\u00a0properties? Get creative here.<\/p>\n Related:<\/strong> The Pain-Free, Proven Way to Achieve a 200% ROI, Build $1.5M in Wealth & Earn $300 Per Hour<\/a><\/em><\/p>\n I hate paying taxes, which is ironically why I love the specialization so much. Anything I can do to legally\u00a0reduce my tax liability I want to take full advantage of. It has become clear to me through helping clients\u00a0and extensive readings\/research that business owners and real estate investors are not held hostage to\u00a0the tax code, rather the tax code is their friend.<\/p>\n So my next challenge to you is: figure out how to get out of the corporate world and into business for\u00a0yourself. This can be a real business or just managing your rentals. Of course, this is easier said than\u00a0done.<\/p>\n To mitigate the financial risk, build a side business while you maintain full-time employment. You don\u2019t\u00a0have to quit your job tomorrow; you can be smart and strategic about the timing of jumping into a side\u00a0business full-time. If that means waiting 3, 5, even 10 years, that\u2019s okay.<\/p>\n Everyone should try to generate side income. You have unique skills that others don\u2019t. Figure out a way\u00a0to monetize them.\u00a0From purely a tax standpoint, working for someone else is simply too costly. You may love your job,\u00a0which is great. But that song Jennifer Lopez wrote: \u201cLove Don\u2019t Cost a Thing<\/a>\u201d is a huge lie\u2014at least that\u2019s\u00a0what my parents tell me.<\/p>\nThe Pareto Principle<\/h2>\n
![\"\"](\"https:\/\/www.biggerpockets.com\/blog\/wp-content\/uploads\/2016\/06\/tax-savings.jpg\" "\\"\\"")
<\/p>\nTaxes Are Likely Your Largest Annual Expense<\/h2>\n
Higher Earner vs. Smart Investor\/Business Owner<\/h2>\n
Sarah’s Story<\/h3>\n
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<\/p>\nTom’s Story<\/h3>\n
![\"invest-while-work-full-time\"](\"https:\/\/www.biggerpockets.com\/blog\/wp-content\/uploads\/2016\/09\/invest-while-work-full-time.jpg\" "\\"\\"")
<\/p>\nWho Has it Better?<\/h2>\n
What Should You Do?<\/h2>\n
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<\/a><\/p>\n