"A TALE OF TWO FAMILIES"

The Johnsons:

The Johnsons signed a one year contract on a 3 bedroom apartment and renewed a second year:
Rent = $700 per month
Combined annual income = $30,000
Increase in rent after first year = $725 per month
Increase in value of residence to Johnsons after two years = $0
Total amount invested by Johnsons in ownership of their residence over the past two years = $0
Improvements made to Johnsons residence in two years = none allowed

At the end of the two years the Johnsons decided to move back with their parents to save money. During the two year period they bought a new car, racked up credit card debt and were expecting their first child. The neighborhood wasn’t getting better and the landlord had decided to increase the rent again to $750 and they couldn’t afford that on top of all their other expenses. When they left their apartment they got their $200 deposit back.

Cash burned during two year period renting (rent)= $17,100
Cash received after check out = $700

Throughout their life the Johnsons didn’t think too much about their financial future. They were more concerned with going on vacations, having bigger and better entertainment systems and driving new cars. They believed that if they were good everything would work out. They eventually received an inheritance after the passing of Grandpa Johnson. Grandpa Johnson was a simple man who had worked a small farm his entire life and never cared that it had grown in value to over two million dollars. The old Johnson farm was sold and the Johnsons received over $100,000 as their share of the inheritance. They felt that they had been blessed. They paid off their debt and bought a home in a nice neighborhood. They noticed their new neighbor the Joneses seemed to have everything. The Joneses had a larger home on a larger lot with a pool. They also had several new vehicles and a boat, traveled often and had their children in private school. The Johnsons felt that they deserved these things as well and took out a second mortgage on their home so that they could purchase better things than their neighbors. Their debt situation grew very bad, but they believed that everything would work out. Unfortunately there were no more inheritances to be had. The Johnsons declared bankruptcy fairly late in life and eventually became dependant on their children.

The Joneses:

The Joneses bought their modest home for $100,000 with 0% down and a 30 year fixed 6.125% mortgage in 2004
Mortgage payment = $700 per month ($607 principal and interest+$50 property taxes+ $43 insurance)
Combined annual income = $30,000
Increase in monthly housing payment = $0
New value of Joneses home = $145,000
Total amount invested by Joneses in ownership of their home over the past two years = $2550.45
Improvements made to Joneses home in two years = paint, landscaping, tiling and new light fixtures. The Joneses did work themselves and spent less than $3000 on materials.

Cash burned during two year period owning= $14,324.95 (24 months interest on loan + property taxes + insurance)
Amount paid down on home during two year period = $2475.05
Cash received upon selling = $37,325.08

     At the end of the two years the Joneses decided to purchase a slightly larger home because they were expecting their first child. They sold their home for $145,000 and it sold in less than 2 weeks because of the improvements they had made. They only owed $97,524.92 by now and were able to walk away with $37,325.08 after paying approximately 7% to sell the home. Their tax professional informed them that if they lived in their home for two years or more they would be able to take advantage of the 1997 tax act which allows couples filing jointly to sell their home and keep the profits tax free up to $500,000.

     Encouraged by their success, the Joneses decided to buy, improve, and sell a home every 2 years and pocket the profits tax free until they hit the $500,000 limit. Their income had grown to over $50,000 and they found out from their financial advisor that they could save even more on their taxes by purchasing an investment property. They decided to buy a duplex and rent it to two families. They learned that they could not only continue to write off most of the mortgage expenses on this second property, but also all improvements and maintenance. Furthermore, they found that it was possible to write off depreciation on the building even as the land was increasing in value. The Joneses knew that all the while they could expect to be receiving rental income which would probably rise over time and would eventually be paying all their housing expenses and then some. Finally, the Joneses knew that when the time came, they would most likely be able to sell their duplex for much more than they paid for it or exchange it for a similar investment property using a tax benefit called a 1031 exchange.

     Their financial advisor had informed them that although they could not sell a rental property tax free, they could use a 1031 exchange to put off their tax bill on the sale of their duplex so that they could put the full profit down on another more expensive and profitable rental property anywhere they pleased. Over the coming years the Joneses traded up several times on both their residence and their rental properties and also had acquired several vacation homes which they also rented out through an agency. They were now living in their final home and enjoyed spending time with their new neighbors the Johnsons. After several years they were saddened that the Johnsons became more distant and seemed to fight a lot. Over the course of several months large trucks would come by and haul away the Johnsons things. First the motorhome, then the boat, then the dirtbikes, then the pool table, and finally most of their furniture. One day the Joneses called the Johnsons to see if they could help, but the phone was disconnected. The Joneses walked over and found that the house was almost empty and was for sale. They were polite enough not to ask why the Johnsons were moving, but still wanted to help. They asked how much the Johnsons wanted for their home so that they could help them sell it. They were shocked to learn that the Johnsons were asking $50,000 more than a nicer house down the street just barely sold for. The Joneses were even more shocked when the Johnsons told them that if the property sold at that price they would be taking a large loss. One day the Johnsons left and a new neighbor appeared. They assumed the Johnsons had sold the property and went to meet the new neighbor. They introduced themselves and learned that the new neighbor didn’t know who the Johnsons were and had bought the home from a bank. The Joneses were glad that even though they had debt, it was not for things which were decreasing in value.