Money, Debt and Taxes

It is no secret that in general, I think it is best to be totally debt free. Just take a look at my series on Debt Free Forever. However, there are times when credit is necessary, and even if you are on a cash basis, there are times when a good credit score is important.

Here are a few tips from the Federal Reserve System for improving your credit score.

1. Get Your Free Credit Report

Don’t listen to the catchy jingles and the hype. There is only one place you should go to get your free credit report and that is www.annualcreditreport.com. This is the free credit report site authorized by the Federal Reserve and you wont’ need to sign up for anything to get your free report. By law you are entitled to one free credit report from each of the three major credit reporting companies. You don’t need to get them all at once. Spread them out throughout the year and you can keep close tabs on your report.

Once you get your free credit report, then check it carefully to make sure it is correct. If you find anything that is incorrect, or you disagree with, contact the credit reporting agency and they will tell you how you can correct the mistake, or at the very least, add a comment to your credit report stating your side of the story.

2. Don’t Miss A Credit Card Payment

Not only are missed or late payments damaging to your credit report, they are costly! Late payment fees of $29 or more can add up quickly. Through your bank’s automatic bill pay set up an automatic payment for at least the minimum payment on your credit card. Set it to send the payment a week before it is due. That way you know you won’t be late on your payments, and you can always send in extra payments if you want to pay your credit card off more quickly.

3. Don’t Max Out Your Credit Cards

Staying well below your limit not only avoids costly over limit fees, it also improves your credit score. Companies like to see that you have plenty of credit available. It shows that you can control your spending. If you have a credit card that is close to the limit, quit using it and make an effort to make more than the minimum payment and pay down the balance.

Just three simple steps to improve your credit score. It won’t happen overnight, but the results will be worth it.

Once again the IRS has extended the First Time Home Buyer credit and now is a great time to buy a house!

What I find really exciting is now you don’t have to be a first time home buyer to get a modified version of the credit.

Here is the scoop. If you are a long time homeowner, defined as someone who has lived in their current home for at least 5 consecutive years, you can now qualify for the long time resident credit and get a tax credit of up to $6,500.

Here is how it works. For both the first time home buyer tax credit and the long time resident tax credit you must enter into a binding contract by April 30, 2010 and have closed escrow by June 30, 2010. Miss the deadlines by even a day, and you miss the credit.

You can claim the credit when you file your 2009 or 2010 tax return, or if you don’t want to wait, for homes purchased in 2009 you can amend your 2008 tax return.

The credit is 10% of the purchase price of the home, up to $8,000 for the first time homebuyers credit and $6,500 for the long term resident credit. The new home must be your principal residence for 3 years, or you have to pay back the entire credit.

There are some limits, the purchase price of the home must be less than $800,000 and a taxpayers modified adjusted gross income must be under certain limits. Just how much depends on when you purchase the home. For homes purchased before November 7, the credit starts to phase out at $75,000 MAGI, $150,000 for joint filers, and no credit is allowed for persons with Magi of over $95,000 or $170,000 for joint.
For homes purchased after November 6 the full credit is available for persons with MAGI of up to $125,000 ($225,000 for joint) and no credit is allowed for taxpayers with MAGI of over $145,000 ($245,000).
Find out all the details on the Home Buyers Tax Credits at the IRS site.

Now here is where I think it gets really interesting.

Make Tax Free Income From Your Personal Residence

Rich Dad, Poor Dad: What the Rich Teach Their Kids About Money–That the Poor and the Middle Class Do Not!”
Robert Kiyosaki, of the Rich Dad, Poor Dad fame, said in his books that your home is not an asset. However, that was before the IRS made owning a home so attractive. Using a combination of the Home Buyers Tax Credits, Mortgage and Real Estate Tax Deductions, and the Tax Free capital gains from selling your home, it is possible to make large sums of tax free income from your home. Here is an example of how it might work.

You, as a first time homebuyer, buy a home for $80,000 on January 1, of 2010. You put 10% down ($8,000) and take out a 30 year fixed rate mortgage for $72,000 at 5%. Your monthly mortgage payments will be $386.51.

The first year, when you file your tax return, you get the $8,000 tax credit, in other words, the IRS just paid your down payment. You will have paid around $3,300 in interest, and maybe another $1,000 in taxes, giving you a tax savings of about $1,000. ( I am using round numbers here just to make it easy.) That is a total of $9,000 you didn’t need to earn, and $9,000 you don’t need to pay taxes on.

Years two and three are not very exciting, you still get the tax deductions and save around $1,000 per year.

After 3 years you decide to sell your home. Let’s assume the market has made a recovery (which is not an unreasonable assumption for 3 years out) and your home has increased in value 25%, to $105,000. Let’s play with the numbers.

First lets see how much cash it took to live in your home. (I don’t include insurance here, because even if you are renting your should be paying for insurance, and renter’s insurance and homeowner’s insurance cost about the same.)

Cash Out

If we add up the down payment ($8,000), the total monthly mortgage payments ($14,000) and the estimated property taxes ($2,400) we come to a total of $24,400 cash out of pocket to live in our home. But then we get to subtract the tax credit ($8,000) and tax savings ($3,000) to come up with a net out of pocket cost of $13,000. Not bad for three years of housing!

Now let’s see how the cash flows when you sell the home.

We sell the home for $105,000, but we have to pay the costs of selling the home ($8,400) and we have to pay off the mortgage ($68,000). That leaves us with cash in pocket of $28,600. Nice! Subtract from that the $13,000 cash out and you are left with $15,600 your don’t have to pay taxes on. Working a job and paying income taxes and social security taxes you would have to earn almost $20,000 to have the same amount of cash.

So by using the tax laws to your advantage you have lived in your house for free for 3 years and gained over $5,000 per year in cash flow.

In my book, that makes my home an asset!

I started my first business during a recession, and now, during this recession I am starting another one.
I think recessions are the best times to start a new business, especially a service business, and I am going to quickly tell you why.

#1. Rents are cheap.
You can tell yourself all you like that your clients don’t mind that you work out of your home, but I have found I get more respect, and more money from my clients when I have a professional business office. Right now commercial vacancies are high, and you can find good office space at bargain prices.

#2. Help is cheap.
Sometimes you just can’t do it alone. With unemployment at an all time high, it is easier than ever to find talented, qualified people to help you out. They are also willing to work on a temporary, contract basis, so when I don’t need them, I don’t need to pay them.

#3. It seems that everyone is willing to bargain.
I hate paying full price for anything. But often, vendors will say the price is the price. Recently I have been getting discounts on software and services just by asking. I try to give something back, and nothing talks like cash! My favorite line: Will you take $X for this if I pay you cash right now?

#4. You Have the time!
I was laid off from my job 3 months ago, and with unemployment over 11% where I live I probably won’t be getting a new job any time soon. It doesn’t take long to look and see that there are no new jobs I can apply for. So now I am using my considerable amount of spare time to get the new business rolling.