Christian Ramsey, Financial Planner Newletter

In This Issue True Net Cash Flow

Next Class: Contra Costa Association of Realtors Friday July 18th 9:00am-11:00am

"Land Rich, Cash Poor" This easy to read book explains over 12 techniques to sell a highly appreciated property and control when and if you pay capital gains taxes.

Christian Ramsey is a Financial Planner and Estate Planner that specializes in tax deferral and gifting strategies for property owners and business owners. He is also the author of "Land Rich, Cash Poor". Please feel free to forward this email to anyone that might benefit from the information. ARTICLES PRESENTED ARE NOT GHOSTWRITTEN! - These are actually live case studies that were interesting to the author. This month I am cheating a little bit and not providing an actual case study, instead I want to share some of the actual match behind determining profitability an investor experiences when owning property. This is crucial for a guy like me in making formal recommendations to buy or sell real property. Why is this important for you? My hope is that it gives each of you some extra leverage when meeting a prospective buyer or seller. I hope you enjoy this examination of True Net Cash Flow! Christian Ramsey Financial Planner Smith Mottini Financial Advisors 916-797-1020 office

True Net Cash Flow Many people invest in real estate for the opportunity for long-term appreciation and current net cash flow. The good news is that many real estate investors have experienced appreciation on their properties. The bad news is that some real estate investors have not sought opportunities to maximize the net cash flows from their properties and in many cases do not know what their True Net Cash Flow is. It is important to understand that True Net Cash Flow has nothing to do with Net Taxable Income. Although these two items sound alike, they are completely separate calculations used for two separate reasons.

Net Taxable Income is the amount of income you must report to the government on your income tax return. Net Taxable Income is generally calculated as follows:

$ (1) Gross rent income received -$ (2) Less all currently deductible expenses -$ (3) Less depreciation and amortization -$ (4) Less currently deductible repairs = (5) Net Taxable Income

Net Taxable Income must be reported to the IRS based on the above formula. But Net Taxable Income is not necessarily the only way to analyze the net income efficiency of your property. In some cases, Net Taxable Income will not provide a fair representation of the True Net Cash Flow a real estate owner is receiving for the following reasons:

1. The property owner might be paying a large amount of principal in each mortgage payment. The interest portion of the payment is a tax-deductible item, but the principal is not. If a property owner pays a monthly loan payment of $1,500 ($18,000 per year) and has deductible mortgage interest of $10,000, it means that the True Net Cash Flow is overstated by $8,000 per year. This overstatement is due to the fact that the property owner has cash outflow for the mortgage of $18,000 but is only able to deduct $10,000. This means that Net Taxable Income would be $8,000 higher than True Net Cash Flow.

2. The property owner might have $25,000 in capital improvements that must be made. The repairs must be paid for now but the expense must be depreciated over the life of the building, a period of up to 39 years! In addition to tax write-off delay, there is also a huge hit to True Net Cash Flow because the $25,000 must be accounted as a deduction against True Net Cash Flow.

The bottom line is that True Net Cash Flow, the actual amount of cash flow available after all cash outflows from the property, is often not considered. Other examples of this happening would include the following:

A property was only rented out for eight (8) months during the year due to current tenants moving out and new tenants moving in. Monthly total cash outflows for the property total $1,750. The property owner paid the $7,000 of out of pocket costs during the four (4) months of vacancy but still stated that for the year his net cash flow was going to be $600 per month, the same amount it had been in each of the last five (5) years when the property was rented out for all 12 months a year. In reality, instead of $7,200 of True Net Cash Flow for the year, the property owner only had $200 in True Net Cash Flow for the entire year simply due to a four (4) month vacancy. In some cases we have seen property owners pay for expenses related to their properties out of their own pockets without accounting for them against True Net Cash Flow. We spoke with a couple who had invested in real estate for more than 20 years. The husband stated that they had a $72,000 net cash flow from their commercial building because the property management company had given him an annual accounting that stated this. In discussing their property with them, we discovered that every year the wife paid for the real estate taxes, the property insurance, and miscellaneous costs out of pocket, without going through the property management company, in the amount of $60,000. This means that their True Net Cash Flow was actually $12,000 per year not the $72,000 per year they originally thought. True Net Cash Flow Defined

True Net Cash Flow is what a real estate owner has in his/her pocket after all expenses and cash outflows are accounted for. Although many don't realize it, True Net Cash Flow is an important aspect of real estate ownership. True Net Cash Flow from real estate is:

(1) Gross rent income received -$ (2) Less all tax deductible operating expenses -$ (3) Less additional cash outflows -$ (4) Less repairs -$ (5) Less the amortized cost of capital improvements needed over the projected holding period. = (6) True Net Cash Flow

Many real estate investors understand, and account for their net cash flow, based on numbers (1), (2), and (4) listed in the formula above. But they might not understand, nor account for their True Net Cash Flow, based on numbers (3) and (5) listed in the formula above. In other words, if you were to ask many real estate investors what their net income is, they will often give you an answer that is calculated based on their gross rent minus their monthly expenses, ignoring both additional cash outflows and large repairs and capital improvements.

Additional Cash Outflows

A prime example of an additional cash outflow that can decrease True Net Cash Flow is when any principal is paid down on a mortgage. Any amount that a property owner pays to decrease the amount of debt owed, termed principal pay down, is not accounted for in computing Net Taxable Income and must be accounted for in calculating True Net Cash Flow. If a property owner pays down their mortgage by $10,000 this year, it basically means that they have decreased their True Net Cash Flow by $10,000.

Large Capital Improvements and/or Repairs

What we have found is that when a real estate owner has to pay for large capital improvements and/or repairs, the real estate owner pays for these costs out of his/her pocket, has not set up a reserve account to pay for such expenses, and does not treat these large expenses on their real estate True Net Cash Flow calculation as a decrease to True Net Cash Flow. Here is an example: if a real estate owner receives $2,000 per month in gross rent, and then pays out $1,200 of monthly expenses, the owner would state he/she has an $800 net cash flow.

If this same owner had to pay $10,000 out of pocket for a new roof, in almost all cases the owner would state that up until now he/she has received $800 per month in net cash flow and that for the next several years projects that he/she will continue to receive $800 in net cash flow. The owner would also never state that he/she had a $9,200 Net Cash Flow Loss in the month the roof was paid for.

After thinking about this, it is very easy to understand that the real estate owner in the example above either really did not have $800 in net cash flow up until this time or will not have an $800 net cash flow from this time period into the future. This is because the $10,000 new roof expenditure must be accounted for somewhere. It can either be saved for each month by establishing a "Reserve Fund" for capital improvements, which reduces the True Net Cash Flow up until the expense is incurred, or it can be accounted for afterwards by decreasing the future True Net Cash Flow we think we are receiving by the total cost of the roof being amortized over some time period. Bottom Line: Real Estate Related Financial Planning can often work to increase True Net Cash Flow to 8%-10% in a tax-advantaged fashion upon the sale of an appreciated property.

Feel free to visit www.realestatestrategy.net for more information on the special class of financial and estate planning services I can provide to real estate professionals and investors. You are welcome to call anytime to discuss a particular scenario. Sincerely, Christian Ramsey Registered Representative of, and securities offered through QA3 Financial Corp., Member FINRA(www.finra.org ) / SIPC (www.sipc.org). Investment Advisor Representative of and services offered through QA3 Financial, LLC, an SEC Registered Investment Advisor. Smith Mottini Financial Advisors and QA3 Financial Corp Are Non Affiliated Companies. Licensed to offer Securities in the State of California.

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