Tuesday, March 9, 2010

Still another guideline....

Guideline #16: Budget for taxes, income that is.

Since we do not believe in "investing" in things that are
designed to lose money (see Guideline #25), profitable
investments create an income tax obligation. Prepare for it.

One of our youthful mistakes in investing was to believe
that all our investments should be paid off within ten years.
It is important to know that we typically put a little as
possible cash into the deal, financing as much as possible.
This was not some grand strategy. It was just a reflection
of the fact that we did not have a lot of cash. Most of our
early investments were rehab projects. Back in the mid-
1980's we found a niche that had been mostly ignored;
buying, fixing, and leasing older properties in the smaller
"county seat" cities around Ohio. Ignored niches often
offer significantly good returns on investment.

Anyway, back to the guideline. We financed several of
these early deals with ten year amortization, trying to pay
the debt off as soon as possible. We forgot, or more
accurately did not realize, that principal reduction gets
accomplished with taxable income. We put all of our cash
flow into reducing the debt, then had to borrow money to
pay the income tax obligation that the investment created.

This led us to Guideline #32 and to the decision to finance
our investments over a longer period of time.

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