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May 23, 2024 | read

41. Creative Note Investing, Reducing Taxes on Interest Income and More

Ben Isley

In this episode, we’re joined by Dave Van Horn, seasoned real estate investor and Note Investing Expert to discuss creative note investing strategies, tax strategies to reduce interest income, how Dave handles accounting and taxes, and more!

Dave began in construction and got his real estate license at 26. Soon after, he started buying properties and was executing a strategy similar to the BRRR method. As his portfolio grew to over 40 units and his portfolio value increased, he began using HELOCs and entering into private and hard money lending for rehabs. This is how he first began in the note business. Dave has since trimmed his personal portfolio and moved more into commercial deals.

What is a ‘Note’?

A note is just a promise to pay. Everyone is in the note business with credit cards, auto loans, and student debt. When Dave speaks about notes, he’s talking about residential mortgages on 1-4 unit properties.

Notes are another stream of income and be wisely used to supplement income. There are seller/owner-financed notes and institutional notes. By owning notes, investors are paid-off first or can buy the delinquent asset directly from the bank. The note investor has access to the property before anyone else. Buying the note is like buying the asset from the bank before anything else happens.

Beginner Tips and Flexibility with Notes

It’s important to get educated and build relationships with those who are already in the space. Even with these resources, it’s wise to play it safe and maybe even start out small. Nobody says it has to be a huge note to start off.

There are many online sources for investing in notes, such as online auctions and the note MLS, loan exchanges online, note funds (such as PPR), and brokers that sell notes.

Note investors have options available such as selling partial notes (selling the next 5 or 10 years of payments at a different interest rate), borrowing against the note, selling the note, and flipping the note.

Optimize for Taxes

With notes, you’re a bit more limited in tax planning compared to real estate, such as the absence of depreciation on a note. With notes, you generally have interest income and short term or long term capital gains. It is popular for investors to purchase notes in retirement accounts and tax-advantaged accounts such as a SD IRA, Solo 401(k), or Coverdell Education Savings Account.

Creative Strategies

Phantom appreciation is where the investor buys a note that is only partially covered with equity. If the real estate market surges, the asset value and note value surges.

There are some situations, depending on the real estate market trend, where your note may not actually lose its market value. Despite taking payments on the note for three of five years, the timing may be such that you can still sell that note for a price similar to when you bought.

Another popular strategy is to use the payments from the note to pay off longer term debt. For example, you could use a note to pay for student loans. You could buy a note on a $100,000 property for $30K-$40K, and the monthly note payments will pay for the student loan debt. If your investment in the note is worth less than the balance on your student loans, you’re paying off your student loans with a smaller total amount of money – maybe even as low as only 30% or 40% of the face value of the debt. This strategy can be used on any long term debt.

Another similar situation is when an investor uses a HELOC for an addition or renovation. With the leftover cash, the investor could purchase a note. That note is going to cash flow and pay back the equity loan. It’s important to think about your methods for paying debt. When purchasing a vehicle, you could consider purchasing a note instead, and the note will cover the monthly payments.

You can learn more about Dave Van Horn at https://pprnoteco.com/