Matching Expenses with Passive Income
In my past 2 posts, I shared how I spent nearly $200K last year and how I’m about to purchase a brand new fourplex in Indiana that should yield about $70K per year. Today, I’ll talk about how the fourplex fits into my goal of getting my passive income to match my expenses. Let’s see where I am today and how much work I have left to go!
The Goal
First of all, if I spend $200K per year, I must earn much more than that due to taxes. Using back-of-the-napkin math, assuming I pay a hefty 35% tax rate on all earnings, I’d need to earn around $300K to have $200K left over.
There are two ways to reach my goal: reduce my expenses or increase my passive income. Obviously, doing both will accelerate my timeline. I won’t dive into my $200K in annual expenses again, since I just spoke about them in a recent post. So let’s just dive straight into my passive income.
Passive Income
Right now, the vast majority of my passive income is generated from real estate. I earn virtually no interest on my savings accounts, since I prefer to invest as much as possible rather than hold cash. Outside of real estate, my only other passive income comes from dividends.
Dallas-area Single-Family Home #1
This is a new construction, single-family home that cash flows approximately $7,500 per year. This real estate investment wasn’t a bet on cash flow; instead, I am hoping it appreciates significantly.
Dallas-area Single-Family Home #2
Similar to the previous SFH (single-family home), this is also a new construction, single-family home that cash flows approximately $9,300 per year. Hopefully, this one appreciates significantly, too.
Promisorry Note
A couple of years ago, I was unable to find a buyer who offered enough for one of my properties. So I went down an unconventional route: I entered into a deal with a buyer who agreed to buy at my desired sale price, but only if I seller-financed the deal. As the buyer, I sell my property at my desired sale price; however, the seller puts little to no cash into the deal by requiring me to be their lender, rather than having to follow the rules typical of banks. Thus, I now hold a promissory note on their property at a 7% interest rate, where they basically pay me (their lender) their monthly mortgage payments. If, for whatever reason, they fail to pay after a couple of months, I could technically seize the property back. Lastly, the agreed-upon promissory note dictates that the note balloons in January 2028. This means the buyer must either renegotiate the terms or pay off the entire loan by then.
Anyways, long story short, the note currently yields $40,425 per year. But again, this passive income will likely disappear by January 2028, at which time I’ll have to figure out what to do with the lump-sum cash and how to make up for the lost passive income.
Fourplex (Missouri)
In 2017, I purchased a turnkey fourplex in Missouri. I’ll discuss this property in more detail in a future post. But for now, know that it cash flows approximately $17,300 per year.
Fourplex (Indiana)
As mentioned in my previous post, this brand-new fourplex in Indiana should generate approximately $70,260 in cash flow per year. The big difference in cash flow between this fourplex and the Missouri one is that this one was paid for in cash, whereas the Missouri one is mortgaged.
Dividends
Ignoring all retirement accounts, my individual brokerage accounts currently yield approximately $28K in dividends per year.
How Taxes Impact Passive Income
For the 2 SFHs I own in the Dallas area, they shouldn’t have any taxes, thanks to the various ways to write off expenses. Similarly, my Missouri fourplex racks up a good amount of write-offs, as well. Thus, for simplicity’s sake, let’s say the 3 rentals combined generate a total cash flow of $34,100 per year.
On the other hand, the promissory note is treated as interest income. Unfortunately, that means it’s taxed just like earned income. So conservatively, the cash flow of $40,425 comes down to roughly $26,000 per year.
Because my new Indiana fourplex has no mortgage, there’s a lot less to write off as expenses against its revenue. To keep things simple, let’s just assume taxes and some write-offs bring its cash flow from $70,260 to $50,000 per year.
Lastly, my $28K in annual dividends are largely taxed as “qualified dividends,” which means they are subject to preferential tax rates. For me, that likely means a max tax rate of 20%. Therefore, the $28K drops down to $22,400 for the year.
All in all, the after-tax passive income is $132,500. Not bad! But it’s also not nearly enough for my goal of matching our $200K in annual expenses.
Closing the Gap
$200K - $132,500 comes to $67,500. That’s how much I have to close the gap to reach my goal. Assuming my expenses won’t come down any time soon, my only choice is to earn more passive income. Here are some of my ideas:
Reallocate my investments from growth stocks to dividend stocks. Unfortunately, sacrificing high growth for stable, dividend stocks is one trade-off that can make a big difference. For example, if I shift $1 million into dividend-paying stocks that yield 2.5% per year, that’s another $25K. Subtracting 20% for taxes leaves me with $20K per year.
Trading my 2 Dallas-based SFHs for a better cash-flowing property is another option. The combined value of both won’t be enough for another Indiana fourplex, but it’d be close. Right now, the difference in cash flow between the two SFHs vs. the one Indiana fourplex is approximately $33,200 in after-tax dollars. That’s massive.
Lastly, I’m considering refinancing the million-dollar Indiana fourplex to give me $500K in cash to buy a second one. I haven’t gone through the numbers in detail yet, but I’ll do this in a coming blog post! Let’s find out together if the numbers make sense.
Options #1 and #2 alone would give me an extra $53,200 in passive, after-tax income. That would close the gap to just $14,300. Pretty darn close!
Do you have any suggestions for me to reach my goal? Let me know in the comments below!
