Liabilities VS Assets
Today's topic is on the difference between assets and liabilities. Simply put, liabilities are property that take money from your pocket, and assets put money in your pocket. Your credit limit or the amount you can charge on your credit is not an asset because it is money you can use but have to pay back. It is a debt which makes it a liability. Simple right? Now here is where it gets a little more complex. If you are a homeowner, then you would think your house is an asset. Not necessarily. If you paid cash for the house and there is no mortgage then it is an asset. But if you have a mortgage, then it is a liability. Even if you have equity in the house it is still a liability because you are still paying a mortgage on the loan balance.
Now if you were renting the house and the rent is more than the mortgage then it becomes an asset. You can make your home into an asset by converting part of the house into a money making property for instance starting a home based business. Using part of your house for your home based business makes that portion of your home expenses into a tax deduction. So say you use one of the bedrooms as an office, and it is 25% of the total square footage of your house. Well 25% of your home expenses including utilities, insurance, taxes and interest for your mortgage are all deductible expenses that would reduce your tax liability. This decrease in taxes translates to more money in your pocket thus making your home an asset.
What else can you deduct? If you are a baker, and you use the kitchen 25% of the time baking goods that you sell, or you are a landscaper and you store your landscaping equipment in your garage, then you calculate those areas and the percent to deduct the respective home expenses. Better yet, if you have a 3 bedroom house, rent out one room for transients on VRBO or AirBnB. Then you not only have a huge tax deduction, you now have money coming in from the rental. These would all convert your liability into an asset.
The same goes for cars. You buy a car and finance it, it is not an asset. Only if you paid 100% cash for the car then it would be an asset. How do you turn your vehicle into an asset? Same as the house. By converting it into a business asset and using it for your business and documenting the mileage used for your business. Or better yet, if you have more than one vehicle, rent it on Turo. Both would make your car an asset instead of a liability.
Your investments for retirement that are in the form of a 401K or IRA or an annuity etc, these are all assets. If you are a private person and don't wish to share your house with a stranger, think about buying a duplex or triplex or quadruplex. But if you are a high income earner, 1 to 3 rental properties may not necessarily be good for your taxes. It may be good for your pocket and make you money but it doesn't necessarily translate to good for taxes which means it might not be good for your pocket after all. Which is the reason why you need a tax expert to help you make the right decision. All investments are not necessarily money in your pocket if you are taxed for capital gains. But of course you want to measure the return on investments before you invest in anything.
While there is a lot to think about, you now know the difference between assets and liabilities. So for starters, sit down behind your computer or with a piece of paper and make two columns. One column is for all your assets and one column is for your liabilities. This is how you measure your financial worth. If you have more liabilities than assets it is time to find ways to accumulate assets which is the way to accumulate wealth.
Until the next time, this is Dr. KnowItAli
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