Last week I wrote about how I paid off my first rental property. I was extremely excited to pay off my rental and I paid it off just a little more than three years after I purchased it. I was surprised how many people wondered if paying off the rental property was a mistake because I would lose the tax benefits of a mortgage payment.
I understand people who want to take advantage of any tax benefit they can, but sometimes I wonder if people lose site of the ultimate goal in order to get a tax break. The ultimate goal in my mind is making and keeping as much money as possible, not paying as little taxes as possible. If I make no money then I am not going to pay any taxes, but that definitely is not my goal!
Are people really afraid to make a lot of money because they will pay more in taxes?
I made a comment about this on another blog last week and was blown away by the response. I mentioned that a career as a real estate agent can lead to making a lot of money. The commenter said they weren’t interested in making big money, because they would have to pay too many taxes. I could not comprehend this thinking because either the fear of taxes had blinded this person to the ultimate goal or they were using taxes as an excuse not to try to make it big.
The realities of paying taxes
My theory regarding paying taxes is that I want to maximize the amount of money I put in my pocket. I consider what goes in my pocket as the profit I make either through investing, business or working minus the money I pay in taxes. In order to maximize that figure I have to make a lot of money through work, business and investing. I can also try to minimize the amount of taxes I pay, but in the big picture paying a lot of taxes means I am making a lot of money. The more taxes I pay the more money I am making and the more money I make, the better!
Looking at my paid off rental as an example
Now, I am no tax expert, but I will do my very best not to screw up this analysis. If I am way off base, please let me know in the comments. Let’s assume my principal and interest payment on my rental was $400 a month. At the start of the loan about $300 would be interest and about $90 would be principal on the loan. Assuming all of the payment would be tax-deductible (I’m not even sure if this is the case, I really should know more about taxes before writing a tax article). Lets assume I am in the top tax bracket and pay 35% taxes. Assuming all of the $400 is tax deductible and my tax rate is 35% that equals a tax savings of $140 a month.
When I paid off that property I gained $400 a month in cash flow that I no longer have to pay to the bank. A simple calculation leads me to the conclusion that $400 minus $140 in taxes equals $260 more that goes into my pocket.
Looking at making big money and paying big taxes
Looking at another scenario; Let’s pretend someone is making big money, is it worth it due to the taxes they will pay? I’ll use $500,000 as an example of making big money. Now our tax system has a scale for what percentage each person pays. The less you make the less percentage in taxes you pay. Those percentages don’t change for people who make a lot of money until they make over those amounts. Assuming someone who makes $25,000 a year pays 15 percent taxes, someone who makes $500,000 a year also pays 15 percent taxes on the first $15,000 they make. Even though a $500,000 earner may pay the top tax rate of 35% they won’t pay that rate on all their money just the money made over that maximum rate threshold.
Even if the $500,000 earner pays 35% on the entire $500,000, they would pay $175,000 in taxes. That leaves $325,000 in tax-free money in your pocket. Let me think about it, do I want $325,000 but I have to pay a hell of a lot of taxes or do I want to make $50,000 a year because people pay too much taxes when they make a lot of money? It’s an easy decision for me. As a bonus, I feel good about trying to help our government pay down the national debt or build schools for our children or maintain the roads I drive on so much with all those taxes.
I am not saying we shouldn’t all try to save as much money on taxes as we can. But I don’t think it is wise to sacrifice profit or making more money in the name of saving money on taxes. When I see a huge tax bill I feel awesome, because I know the reason the bill is so high is I made a lot of money, much more money than the tax bill.
I am really looking forward to having the tax experts chime in and tell me how horribly I butchered these scenarios!