I'm looking for some opinions on a way of personal accounting for the way I finance my properties. I currently only have a condo, but I'm going to try to buy a multi-family the next time I'm back in the States for more than a day or two, so I want to iron out some of the finer details on this system. Forgive me for the long post and perhaps a few creative terms as accounting is not my forte.
To finance my first property, I put 20% down on a traditional 30-year mortgage from a local credit union. To finance the 20% down, I used a line of credit secured against my personal investment account, which was far more convenient (and tax-effective) than liquidating a substantial portion of the account. Since I can draw and deposit as I please on this line of credit, I'm just paying it off as fast as I can to be ready to use on my next property.
For the sake of accounting, I had originally labelled the down payment as a cash investment. However, I've started to look at it as more of a loan to myself, separating my personal account from the property, at least on paper.
To do this, I essentially charged my property a standard monthly payment similar to a mortgage payment. I put an interest rate at 1% higher than what I pay for my line of credit, although I plan on experimenting with this number in the future. I set a payoff time frame for 90 months (1/4 of the mortgage size, therefore 1/4 of the time to pay it off).
The upside to this method is a simple way to pay myself. I personally make money by lending to my property business. At the end of the day, my personal salary is the interest.
The downside is that it kills my cashflow when I look at the property account. Seeing a lot of red on the spreadsheet isn't the best, but it doesn't matter too much at the end of the day since it is all internal to my greater financial network. This is all a way of drawing lines in the end.
How do some of you account for putting your personal investment into the property as a down payment? Have any of you used the idea of an internal loan or is it essentially an investment with the payout of controlling interest?
Basically, you're saying, "pay yourself first" no problem, it's a way of thinking, but accounting and tax wise, your money injected is a contribution to capital, real mortgages are a liability, don't confuse or mix the two schools of thought, you really don't have a loan to yourself, you have a forced, self imposed savings plan......that's fine. :)
The IRS wont allow you to charge yourself interest. Its all your money. You can do what you want on paper but you cant deduct the interest expense nor can you claim the interest income on your taxes.
If you have a business entity (i.e. LLC or Corporation), you can loan to your entity and charge a reasonable interest rate, just as you've described. I do this all the time (and was advised to account for it this way by my CPA).
If everything is in your name, then it doesn't fly with the IRS, but still works on paper as a way to pay off your loan and pay yourself first.
None of this is an actual loan, as some of you pointed out. I'm mostly figuring out the best way to actually measure my own profit and pay myself. At the end of the day, it's all just on paper, so I'm not too worried about any tax or legal issues. Just a mentality. I appreciate the feedback.
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