There is a reason why the wealthiest people buy and/or hold their wealth in real estate. It’s a way to transfer current cash to future generations without risk of inflation. It’s a way to create cash flow. It’s a way to participate in appreciation and it’s a great way to get tax breaks. There are also some derivatives that you can make money with. One of these is mortgage notes.
An easy way to think of derivatives is to think of the grape and wine. Wine is a derivative of the grape. So it jelly and grape juice; I just happen to prefer wine.
When you buy a mortgage note, you are buying a stream of income. Often you’re buying it at a discount. For example, let’s say there is a note with a balance of $80,000 with $700 per month (principal & interest) on the note. You pay cash now for $65,000 to get the loan.
The worst thing that happens is you end up with a piece of property, assuming your mortgage is in good position (and not a 3rd or 4th mortgage on the property). Best case is you get paid back. That means you have bought a stream of income, with interest, for less than you’ll be paid back.
That is the background for a question I received at USTaxAid.
“When buying or selling mortgage notes either performing or non-performing outside my Roth, is there any tax advantage in using borrowed funds vs your own funds?
If you buy a discounted note do you pay tax on the interest portion as you receive it?”
Answer: If you borrow money to buy the notes, the interest on that loan is considered investment interest. It can only be deductible against investment income. So if you don’t have income for some reason, (guy stops paying) you can’t take a deduction. As a CPA, I wouldn’t recommend that.
If you buy a discounted note, like in my example above, there is income that is prorated along with the payments you receive. So, every payment will have some of that discount that is income and interest that is taxable.
The key is to know how good the underlying collateral is. If you don’t get paid, that’s what you’ll get. If you’re in 3rd or 4th position, you’re going to have pay off a lot of other loans before you can get to it. Take all of that in account before you buy a mortgage note.
On March 19th – 21st, I’m going to have a 3 day focused event in Reno, NV dealing with real estate strategies for more money & less tax. There are just a few seats left (only 3 left as of Feb 12th), so if this is a good fit for you, don’t wait. Information available at: https://www.ustaxaid.com/shop/3-day-focus-advanced-real-estate-tax-loopholes/