THE IRS PAYS YOU TO BUY DEFAULTED PAPER

As you saw in the previous email, reinvesting your profits back into more defaulted paper (buying the note from the bank) can be extremely profitable.  The numbers from the previous chapter don’t take into account the taxes you will need to pay on your profits.

As an example, if you invested $10,000 in a $30,000 note and then convinced the homeowner to refinance his loan, even if you give him an incentive (reduce the payoff by $5,000) to refinance the defaulted mortgage, you would still have to pay taxes.  So from the $10,000 initial investment you received a payoff of $25,000 ($30,000 mortgage - $5,000 cash incentive to refinance).  Your profit is $15,000 ($25,000 payoff amount - $10,000 investment). 

So is your profit really $15,000?  On the surface it appears so, but what we are forgetting is that Uncle Sam (the IRS) always get their share of any money that you make.  Let’s say you are in the 39% tax bracket, what would be your tax?  Your profit was $15,000 times the 39% tax equals a tax payable to the IRS of $5,850.  The paid tax actually reduces your profit to $9,150 instead of $15,000.  Add the $9,150 to our original investment of $10,000, we now have a total of $19,150 to reinvest instead of the $25,000.  So now instead of being able to purchase approximately $90,000 worth of defaulted notes (assuming you purchase your defaulted mortgages at about 30 cents on the dollar) we are only able to purchase approximately $57,450.  We can only purchase $57,450 if we use the same percentages as the previous chapter where we pay approximately 33% of the face value of the defaulted mortgage.  If you remember, for a $30,000 mortgage we will pay approximately $10,000 or 1/3 of the value. 

Well, if we could reinvest our payoff of the $30,000 note, in this case the payoff is $25,000 (we gave Jack a $5,000 discount for him to refinance immediately), after you take the tax out of $5,850 we only have $19,150 left to reinvest.  Multiply the $19,150 by three and you get $57,450.  Going back to the example of purchasing $90,000 worth of defaulted mortgages, you give the homeowner an incentive to refinance their property and pay you off. The difference between the $80,000 payoff (it’s $80,000 instead of $90,000 because we gave Jack a $10,000 discount to refinance the property) and $57,450 (the amount available for purchase after taxes are taken out) is almost $33,000.  The reduced purchase amount means our possible future profit is reduced almost $33,000.  That’s a lot of money.   All this lost income because the IRS always gets their money.  Or do they?

Did you know the IRS allows you to purchase defaulted mortgages in your retirement vehicles?  How do you picture your retirement?  Will you be sipping a cold drink while relaxing on the balcony of your oceanfront home, secure in the comfort of your investments with defaulted paper that is paying you above average returns on your investments? Perhaps you'll be traveling through Europe while the monthly checks pile up at home. Or maybe you see yourself volunteering for your favorite cause. These don’t have to be dreams. Sooner or later most of us will face the prospect of getting out of bed one morning retired.  It's inevitable, and it will happen sooner than you think.

Will you have the money to live your dreams?  If you are not sure, read a little further and see how the wealth building strategies of Tax Deferred Growth or Tax Free Growth can lead to wealth you can't imagine.

Until next time...

Carpe diem,

Mike Warren