How Debt & Taxes Make the Rich Richer and the Poor Poorer

28

In my last article, “The Twenty-Something’s Guide to Financial Stability,” I discussed some of the common financial mistakes that are often made by young folks. But it is true that you can be broke at any age. For me personally, I’ve been both rich and poor. I was raised by a working, single mom with six kids on government assistance, and today, I’m considered an accredited investor.

What I didn’t go very far into last week is the impact of debt and taxes, especially on one’s ability to access capital or build wealth.

How to Purchase Real Estate With No (or Low) Money!

One of the biggest struggles that many new investors have is in coming up with the money to purchase their first real estate properties. Well, BiggerPockets can help with that too. The Book on Investing in Real Estate with No (and Low) Money Down can give you the tools you need to get started in real estate, even if you don’t have tons of cash lying around.

Click Here to Download

Access to Capital

One thing that I recognize is that income inequality and the wealth gap are growing in this country between the rich and poor, while the middle class is shrinking. If I were to narrow it down to one of the biggest reasons for this, it would be one’s access to capital.

Related: Americans: If You Can’t Build Wealth Today, You Should Be Scared. Here’s Why.

The difference is that poor folks just don’t have very much access. Just think about when you try to get a loan; it’s often based on your credit, income, and assets. Also, they often have to work for or earn all of their money, and then they’re usually taxed the most (as a percentage of earned income).

Maybe the real struggle is getting out ahead of these things. I remember listening to Jim Rohn tell the story about how you can be a good guy, work really hard, and still never get ahead.

It wasn’t until I understood the different types of money and how they’re taxed, along with the various tax breaks available, that I realized the true path to wealth.

As much as debt and taxes made poor folks poorer, it also made rich people wealthier. So, why is that?

finance-software

How the Rich Utilize Taxes to Build Wealth

When I was young, an old real estate developer I was working for pounded into my head, “It’s not what you make; it’s what you keep.” It’s so true.

Even if you’re a high income earner, like a doctor, you’re probably taxed the highest. In Pennsylvania, you could be handing over close to half of your earned income, and I’m sure in California it’s much higher.

But as a real estate investor, if I had $1 million of rental income, my taxes would be much lower, especially with all the write-offs made available in the tax code. A wealthy real estate investor could then turn around and use the earned $1 million to purchase a $4 million apartment building (utilizing debt, leverage, and tax breaks).

This investor would come out much further ahead, especially since passive income (and portfolio income) is much more favorably taxed than earned income.

Most less well-off individuals just don’t have many deductions, and on top of that, they have the most highly taxed type of income. All the government tax breaks seem to be given to those who benefit society more by providing jobs, housing, or by running things like nonprofits.

How the Wealthy Use Debt

When it comes to using debt, I also see a big difference. Wealthier folks are using things like private equity, government grants, and bank loans. They also have the best attorneys, accountants, and entity structures, as they are always considering the tax implications of everything they do.

For example, if the $4 million apartment building I mentioned before appreciates in value to $5 million, the investor might borrow against that new equity via an Equity Line of Credit and then use that capital to buy a cash-flowing asset or invest at a higher rate than their interest payment. This access to capital is also tax-free because it’s a loan.

The lower income folks often fall prey to using bad types of debt. By this I mean debt used to purchase something that goes down in value or doesn’t throw off any additional cash flow. They often spend more money than they make, and they pay excessive rates and fees for things like insurance, bank loans, and credit cards due to poor credit or because they are considered a higher risk. The poor and middle class may need more student loans than wealthier students, too.

multiunit-vs-sfr

Related: Personal Finance Software: 7 Top-Notch Tools to Help You Grow Wealth

I remember my early struggles when attending to a more affordable state college. I was commuting for the first two years since I couldn’t afford to live on campus, and I was working four to five nights a week. While my wealthier friends had more time to study or have fun, most of my free time was spent commuting and working. It was much harder to get good grades with all of the financial stress.

At the end of the day, it was and still is all about access to capital.

As the wealth gap and income inequality continue to grow, just be sure to think about how you’re making your money, how it’s taxed, how much you get to keep, what your plan for the money is, and how that use of capital will be taxed.

Today, I’m living proof that, it’s not about what you make, but what you keep.

What do YOU think? Are debt and taxes big contributors to the wealth gap?


Leave your comments below.

About Author

Dave Van Horn

Dave Van Horn is President at PPR The Note Co. - an operating entity that manages several funds that buy/sell/hold residential mortgages, both performing and delinquent. Dave has been in the Real Estate business for 25 years, starting out as a Realtor and contractor and moving onto everything from fix and flips to Raising Private Money.

28 Comments

  1. There is offense and there is defense…when it comes to money. Like Dave Van Horn said, “It’s not about what you make, but what you keep.” Offense is what you earn and defense is what you keep. Think of pro athletes or celebrities that earn a ton of money, but have no money. And then think of those penny pinching folk that earn modest incomes but are millionaires in a few decades. I fully agree with Dave.

  2. Mike McKinzie

    Dave
    While your information is accurate, it does fall way short of the complete picture. Let me give a few examples. My mother’s dad was a Missouri Sharecropper, and moved to California during the Dust Bowl era. He started picking nuts and fruit in the Central Valley of California and when he died in 1978, there were six Cadillacs following the hearse (he had six children, my mother being the youngest). His four sons served in WWII, and after the war, one became a Policeman, one became a Moving Company Franchise owner, one got into sales eventually ending up in Real Estate and one became a true Con Man, holding fake baby pageants. Yet, all of them got wealthy. When I was in Grade school, my parents had to raid my college fund to buy groceries and pay the utilities. While debt and access to capital are good points, if most people had access to capital, they wouldn’t have a CLUE what to do with it! Therefore, I think before that, you have to look at two very important things, EDUCATION and DISCIPLINE. In 1998, I was a single dad with sole custody of two boys, sleeping in my car and then renting a room in a house, owning 3 rentals, all negative cash flowing (my parents took them over), all due to a bad divorce. But because of EDUCATION and DISCIPLINE, by 2001, I had a new career, bought a house to live in and basically started over again. How? For starters, instead of renting a $1,200 a month house, I rented a $700 a month mobile home with burnt lemon shag carpet. That $500 savings a month turned into $9,000.00 after 18 months, enough for a down payment on a house. DISCIPLINE. I bought used cars, lived on Hamburger Helper and Top Ramen (NEVER going out to eat). We didn’t go to movies, we didn’t go to any amusement parks and we sure did NOT have any cell phones! And because of that DISCIPLINE and EDUCATION, I retired in 2010. As a final story to make my point, at my new job that I started in January, 2000, I made several friends. One of them had a horrible motorcycle accident and got some financial compensation. He came to me and asked what he should do with it. I told him to either pay off debt or buy a house. What did he do? He bought a new guitar, amplifier and other music equipment. Like I said, even IF they have Capital, they have no idea what to do with it. Today, we are still friends, he still works for that same company making six figures a year, rents a house and pays 16-18% on his car loans! He has NEVER owned a house in his life and he is almost 50 years old.

  3. Dave,
    Nice article and very nice to see yet another “rags to riches” story. This is why America is great.

    Another reason that the lower classes have a difficult time doing as you did is the lack of financial education. As you stated, when you were a “young” real estate investor “it’s what you keep” was pounded into your head. This is financial education.

    As a private lender, I am currently working with a newb on his first transaction. This investor has nothing except some drive and experience swinging a hammer, his access to capital is me. He understands the building side, but not the money. You are correct that no bank would touch this loan, so his access to money is limited, but he found it.

    I also grew up without a lot of money, but in slightly better circumstances, If your mother was like mine, she explained money to you and the education that was not provided in school was given at home. It is amazing how many highly educated people do not understand money or just live for today. Before retiring, worked with many folks with two incomes bring in close or over 200K and they had a nice big house that the bank owned, boat, always eating out lunch and dinner, come to work with a purchased coffee and breakfast sandwich, and not happy at work but stuck making no plans to get out because they don’t understand money.

    To keep money you have to understand money.
    Kevin

  4. Tom Stout

    I agree with the comments above, also great article, you’re an excellent writer

    I have one thing to add. I think the biggest challenge people on the bottom side of the gap face is mindset. Many are told day after day they were born poor, and that’s how it is. If you have any desire to improve yourself, it’s a huge uphill battle in which you are undermined by the people you trust at every turn.

    • Dave Van Horn

      You’re absolutely right, Tom. Even with success, I still find myself defending the idea of investing to most people because the mindset most have towards it since it’s not the norm.

      On the flip side of the issue though, this is why I often give friends and family members articles and books like Kiyosaki’s to get them thinking and slowly start to change their mindset.

      Thanks for reading.

      Best,
      Dave

  5. Good article Dave. I hope more people read this article and decide to take some action. Even one cash-flowing asset will improve one’s tax status as well as financial situation. Once they can learn the concept, with time and discipline, quality of life is better.

  6. Rapy Narruhn

    What a great blog!! Thank you for taking the time out to share this information with the BP community Dave! Much appreciated!! Keeeeeeep ’em coming:)

    I agreed with what everybody said 200%. From Dave to Mike to Kevin. I’ll definitely reread this blog over a few more times over time just to make sure I imbed the information in my brain. The two main simple points I really liked were….

    “It’s not what you earn, it’s what you keep.” & of course by the great speak Jim Rohn, “you can still be a good guy, work hard, and still never get ahead.”

    Much respect to your story as well, I’m sure your mother and siblings are proud of you Mr. Van Horn.

  7. Michael Swan

    Following Trump’s American Dream!!!
    1 of 1 pages Following Reply
    Michael Swan
    118
    posts
    Right on Dave,

    I love all your stuff. It took me until I was 45 years old to figure this stuff out.

    I just left this message below in reply to a forum post recently. I thought I would share it with all here to document my path and to inspire others to follow a similar path and stay away from late night guru garbage, touting something for nothing, instant gratification, diseased mind thinking. Lately, I have been receiving phone calls and messages from members that need to get their financial house in order, before investing in Real Estate.

    Donald Trump did it with 1 million seed money and I used my own money. I only used $300,000 (refinancing personal residence, savings, IRA money, stocks etc…) of my own money to build up a modest 2 million in equity and soon to be nearly 6 million in Real Estate after ONLY 5 short years of real estate investing. Here is my story below. I am no Trump. However, I only make combined family W2 earnings of $80,000.00 at my 2 teaching jobs and my wife working part time as a special Ed assistant. If a lowly paid teacher can achieve sooooooooo much and be financially free after such a short time, then anybody can!! Here we go!! This is my Easter gift to you. Read it and live it. I did and will continue to do so.

    My path was to start with single family condos in San Diego that I purchased in 2011 and 2012 for less than 1/2 of what they were selling for during the peak. Dramatic appreciation happened from 2013 to 2015 and we started 1031 exchanging those condos for 8, 10, 12, and a 15 unit complex in Northeast Ohio. I basically traded in 4 condos cash flowing at about $6,000.00 each per year on 30 year loans for $15-$20,000 cash flow for each Apartment complex. The power of the 1031 exchange is amazing!!! I read Multifamily Millions by David Lindahl, listened religiously to Lifestyles Unlimited Inc. (LUI) podcasts on TUNEIN RADIO for 2 years and attended LUI’s 2 day seminar in Houston, Texas. On Day 2 of that seminar, I knew that eventually I will have Three or four 300-400 unit Apartment complexes. Right now our Tax deferred cash flow sits at $120,000 per year and in 10 years time, I will be sitting at $1,000,000.00 tax deferred cash flow coming in yearly. I still have 4 pricey rental condos here in San Diego that I expect to sell and 1031 exchange this summer when the current rental leases expire.

    Check this out!! I am currently fully executing my first purchase agreement for an Equity Partnership with friends. We are purchasing a 21 unit and my total doors will now be up to 78 front doors, with the 8 single family we also own in the same State as our Apartment complexes. In the equity partnership, I will be putting in 10% of the down payment and receive 20% of the cash flow and 20% of the equity for my connections, running the entire thing as the managing partner. The investors will be contributing 90% of the down payment.

    If a lowly paid teacher earning a combined family income, before taxes of $80,000 can do this. Anyone can!! If you change the way you look at things, the things you look at, change right before your eyes!! We are only limited by our self imposed limitations. I once read and discovered the secret of a fantastic book called Think and Grow Rich and it was pivotal to my success so far and into the future. Here is the secret discoverd by Napolian Hill back in the 1920’s!!

    “Whatever the mind can conceive and believe it can achieve.”

    I wonder if Donald Trump ever read this book. I read it 6 times and am reading it for the 7th time now!

    Swanny

  8. Jerome Kaidor

    Another advantage of Real Estate income – it’s considered “passive income” by the IRS and also
    by Social Security. If you happen to be retirement age, you can earn as much money as you want from rentals and still get your full SS check.

  9. sal adamo

    Your idea that the middle class is shrinking and the poor are getting poorer is due to access to capital is way off. Income inequality in this country is increasing due to ILLEGAL IMMIGRATION. If the demand for labor stays constant and the supply of labor goes up, the price of labor goes down.

    • Michael Swan

      If the price of labor goes down, us landlords profit again. Heads we win and tails you lose. I love that game. It is a game called Swanny always wins. You can play this game too!! If I can do this, anyone in the middle class can do so too.

      Don’t you agree?

      Swanny

    • Jerome Kaidor

      Um, there’s also offshore stuff. Silly me, I used to think that meant a factory on a barge anchored a few miles off shore. We moved all our factory activities to cheaper countries, and then we wonder why there’s no jobs. That’s the One punch. The Two punch is computers & technology. Which have eliminated a LOT of jobs.
      * Every business bigger than 1 or 2 employees used to have a guy in the back room called a “bookkeeper” who tallied up all the transactions for the day. My dad was one of those guys. Gone.
      * There are a lot fewer receptionists than back in the day. Instead, we navigate through phone menus ( essentially, audio websites ) for routine tasks, and poke around vainly trying to talk to an actual person. When we do get to that person, he/she may be in a cheap country.
      * Internet commerce is slowly but surely killing off the local retail stores. The other day, I needed an office chair. I could have hied myself to a furniture store and bought the chair I wanted for a grand. Instead, I cruised Ebay and Amazon, and found the same chair for around $500 in New York. I’m seriously considering
      Amazon Fresh – which would even keep me out of the grocery store!
      So. With factory jobs gone, retail sales jobs gone, so many jobs gone – how will we earn a living? Or, more specific to our own business – how will our tenants earn a living?

      • Kevin A Sapp on

        Jerome,
        All very good points that our society is using more and more technology. Many factory jobs have been destroyed, which is terrible and I agree that we need to bring these jobs back to the US, I live in NC and the textile industry here is dead when it used to be huge. With that said, the RTP (Raleigh, Durham, Chapel Hill) areas are huge tech hot beds employing tons of computer professionals, chemists, botanists, finance and all of the associated support staff that goes with this.
        Book keeping is still around, in away, many companies outsource their books, meaning they moved. Business partners of mine, outsource to their local accountant and his staff keeping the knowledge in the accounting staff not the rehab and flip business.
        Don’t forget every chair that you purchase online needs to be delivered, regardless of where it is manufactured. I, like you would prefer that this means USA but generally that is not the case. (political note, perhaps you should vote for a candidate that will bring jobs back to the US).
        The Ebay, Amazons, etc hire tons of tech workers, yes some are out of the US or immigrants.
        Healthcare is not outsourced (yet), I’m having a roof put on my house, it is not outsourced either, when I had my hardwood floors replaced, a local tradesman cam and did a fantastic job.

        The living wage is there, it’s moved and yes, to your point not as easy to find. But, you have to want to find or create it. Let’s be thankful for that!

    • Charles Morgan

      I agree that automation has eliminated many jobs but it has also created many. As far as illegal immigration what you need to remember is that most of those people are working in low paying jobs that most American citizens do not want or they could easily have taken them. Few company owners that I know would hire an illegal over a citizen for the same pay, simply because they don’t want immigration on their necks.

  10. Jordan Sangalang

    I love these kinds of stories. And reading comments on these stories. They are daily reminders on how having such successes like these are possible with anyone with the right mindset. It’s great to be here with like-minded folks!

    • Michael Swan

      Yes Jordan you are correcti If a lowly paid, middle class teacher can do this, the world is your oyster. Go get it. All that is stopping people is FEAR. That is false evidence appearing real. Reality is merely an illusion, albeit a very persistent one. I believe Albert Einstein said that. He also said, “common sense is 18 years of prejudices attained.” Throw common sense to the wind. Millions of people will be retiring poor and in a much lower tax bracket if they follow common sense and follow the masses. When I reached the fork in the road, I threw caution to the wind and took the road less travelled. You can too!! Do it! Do it!! do it!!!

      Swanny

  11. Dave Van Horn

    Wow, thanks for all the comments Swanny (and to everyone else on here who has participated)! Appreciate all the feedback. It’s really turning into the great debate on here!

    At the end of the day though, I think you’re right about the majority of people. It seems like mostly everyone is afraid of failure, when they really should be afraid of regret. I agree, go out and do it! Don’t be afraid to make it happen!

    Best,
    Dave

  12. Unfortunately the author of this article doesn’t understand tax law and has written an article that sounds great to sway people into buying real estate and has used taxes as a basis for his argument… but his facts are all wrong.

    I have to comment on this… As a tax professional and CPA I hate this kind of article. It’s well written and has an air of being accurate as whoever wrote it appears to be confident…but the article is critically flawed in regard to taxes. I do agree that it is hard for the “the poor” to have access to money….as it should be. Remember 2008? Remember foreclosures everywhere? Remember the fall of “Main Street”? That’s what happens when ANYONE can get credit. Not everyone should have credit because not everyone can or will use it wisely and the ripple effect is devastating to the whole economy.

    In regard to the notes about taxes the line about the rich paying a lower percentage of their income in taxes than the poor is complete nonsense in almost all cases. The rich can often pay upwards of 50% in taxes because of our graduated tax structure and all the new phase outs from the ACA as well as the additional taxes on both earnings from employment and from investments.

    In addition, rental income is taxed the same as earned income except without the social security and Medicare taxes…. It is not a preferred tax item like capital gains. Rental income also does not allow for additional expenses outside of those necessary for the maintenance of the property…there are no freebies. Rental properties also come with large risks and those risks should be rewarded.

    I prepare hundreds of tax returns a year and the middle class is squeezed no doubt….the poor get a free ride and end up paying no taxes and receive government assistance through the tax return….and the rich get taxed the most. They are taxed at a higher base rate…they pay more in capital gains taxes (20% vs 15%) and their passive losses are suspended and do not help them in the current year unless they also have passive income. They don’t get child credits, student loan interest, education credits for college, miscellaneous unreimbursed employee expenses, and must meet a much higher threshold for their medical expenses to count. And let’s not forget the curse of AMT! The wealthy also lose some of their itemized deductions and all of their personal exemptions. They get to pay additional taxes on their investment income and on their normal earnings.

    I have been in many business building seminars and workshops and it appears to me that most people there want to be considered wealthy one day. I hope they don’t think once they have hit the magic six figures (or multiple six figures) they are expecting a magic line of loopholes and tricks to suddenly appear. If so they are going to be in for a very rude awakening when they find out that an exceedingly large percentage of their income is about to be paid out to a government that seems to reward (at least through a tax return) those who are not as hard working or ambitious.

  13. Chris LaSpada

    This article is a different perspective on wealth building. I do believe it provides a broad overview about some tax advantages of having rental (passive) income as compared to earned income. The most common type of income is earned income which is taxed higher than any other type of income due to the social security and medicare tax. The article does not touch specifically on the current depreciation rules, cost segregation, like kind exchanges and real estate professional status. However I believe the intention was to point out that there are ways to pay less tax or defer tax. Therefore I don’t believe the article is factually incorrect. I agree that there should be not an expectation of loopholes or trick to appear at a certain income levels. Taxpayers need to work with their team of professionals to understand the best way to achieve their goals.

    As a CPA who works with small businesses and individuals, we encourage our clients when they read an article like this to discuss this with us to see how it may apply to their situation. While clients are still most interested in what their tax liability is, the trend that I see is increased focus on wealth building and retirement.

Leave A Reply

Pair a profile with your post!

Create a Free Account

Or,


Log In Here

css.php