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My wife and I returned from Denver with our two babies and a third on the way. Our home in Philadelphia had been rented while we were away. We wanted to renovate and add on more space for our growing family. I also wanted to develop a workspace where I could work from home that would be separate from the family space.

I called my old friend Bob Thomas, who was one of the two founders of Campbell Thomas & Company in Philadelphia. Bob was an environmentalist who rode his bike everywhere in all kinds of weather, He had been a Peace Corps volunteer in Micronesia who did not believe in wasting and was a hardcore recycle advocate. He and his partner developed most of the Fairmount Bike paths in Philadelphia as volunteers when they first opened up their architectural firm. They started their humble firm and gradually grew it to a nice sized company that is still going strong today.

Unforeseeable Issues

Bob designed plans that my wife and I both liked. We went to our banker and applied for a construction loan. Our tenant moved out the day we began demolition. We soon ran into many unforeseeable issues like carpenter ants in some of the walls and part of the roof. A structural wall that held up the house and carport was in early failure. We hit rock when excavating for the rear addition. We were forced to remove all the first floor exterior walls and temporarily support the entire roof structure. All could be repaired or replaced but not within our original budget.

We headed back to the bank to increase the size of the loan. Due to unforeseen issues and other changes, our original $150,000 construction budget was now almost $300,000. As work progressed, we decided to replace 90% of the plumbing, 100% of the electrical, and the large heating system was now redesigned and replaced with three heating and cooling zones so we could shut down the parts of the house that were not in use. Construction was booming back in the late eighties and getting good construction labor was tough. We hired two of the guys who worked for us in Denver, flew them here and they lived in the last room of the house that we had not yet gutted.

The job took about a year. We had to visit the bank for another bite at the construction financing apple and we were approved but the lender said don’t come back. This is the last increase that they would allow. We finished the construction and moved in. The home was purchased in 1980 for $130,000. We put in another $450,000 and had a home worth about $780,000. I earned about $200,000 in equity for the year since I did not draw down a paycheck. My wife was working full time and we were able to live off her income. If I took the $200,000 as salary we would have lost about $90,000 to federal, state and social security taxes because the taxed owed would have been at the highest tax bracket. By not taking a salary and leaving the equity in the house we would have $200,000 in new equity to borrow against if we came up with another healthy real estate investment. Talk to your accountant if that does not make any sense to you or to understand. You don’t pay income tax on borrowed money, only earned money.

Financial Benefits

Each of my children required an educational environment not offered in our public school system. The equity built up from renovating our home paid for many years of private school, uninsured medical issues, and other real estate investments. As the years went by and our home kept growing in value, we applied for a $250,000 line of credit for our children’s education and as a slush fund for investments. It also funded a construction company, roofing company, and a 13,000 square foot warehouse for storage for the construction company.

Pro Tip: If you purchase large or small real estate investments and you are able to perform some of the work, even part time, you end up with equity, or what I like to call forced savings.

These forced savings do not require you to pay income tax until you sell the property. For example, if you purchase a rental for $100,000, you put in $50,000 in improvements and you put in sweat equity by performing all the demolition, insulation, some of the drywall, all the painting and landscaping, and you save an additional $25,000 in labor, then if an appraisal shows that the new market value of the home is $225,000 and you only owe $150,000 in debt, your equity is $75,000. Most banks will allow you to borrow up to 90% of the market value of your home if you have acceptable credit. If you needed the $25,000 to live on, you would pay federal and state taxes at your rate and social security tax of around 7% of the $25,000 which would be around $8,500. You would take home about $16,500 net. If instead you borrowed against that same $25,000 equity and the bank said we will give you a 90% mortgage against your $25,000 equity they would lend you $22,500 for your next investment. It is kind of like borrowing your way to wealth.

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