Good Debt vs. Bad Debt
webmanager • May 17th, 2023
Debt.
Is it all bad?
Is there really such a thing as good debt? (Or is that something people tell us to make us feel better.)
Is it financially smart to take on debt to undertake an investment or grow your business?
Or is it better to avoid debt altogether.
The short answer is yes – there is such a thing as good debt. And I’m going to break it all down for you in this blog post.
Let’s first define debt:
Any time someone borrows money from someone else, debt is created.
Debt can be used in so many different ways, and the difference between good debt and bad debt is in the way you use it.
Let’s look at a few examples.
An example of bad debt would be using a credit card to buy things for the office.
In this example, you owe money to a company, and your business is not financially improved or more positively positioned for the future.
In fact, the debt could come back to hurt you from an investor or financing point-of-view.
You may not have needed this items and they don’t add any value to you.
On the other hand, if you borrow money to increase your net worth, or promote and advance your business, it can be categorized as good debt.
As Robert Kiyosaki, the author of Rich Dad Poor Dad said,
“If debt produces income and put money into your pocket, it’s a good thing.”
Surprisingly, taking on debt is not actually a problem.
The problem comes from managing the debt, or bringing it under control.
In fact, as a business owner or investor, leveraging debt can be instrumental in growing your business and building your investment portfolio.
For example, taking an auto loan to buy a personal car – which decreases in value by 20% as soon as you drive it off the lot – is a bad debt.
But taking an auto loan to buy a car that you drive for Uber is a different story.
It now becomes your biggest income producing asset and is considered good debt.
Someone may argue that home mortgage is a bad debt, however I disagree for a simple reason.
Although your home doesn’t produce income, it does appreciate in value overtime. And the appreciation can generate a tax-free capital gain when you sell.
If you live in your home for two out of the last five years before you sell, and meet a few other conditions, you may be able to exclude up to $250,000 of capital gain ($500,00 if you’re married filing jointly).
This is tax-free money, making it good debt!
Although too much debt can hurt you, it’s not evil. And it’s certainly not something that you need to avoid at all costs.
The key is learning how to leverage debt and understand the role of debt in the financial system.
Hint: that’s what we specialize in as accountants.
Without debt we wouldn’t have an economy.
Like someone else I don’t know said, debt is nothing more than moving money from the lowest yield to the highest yield.
It’s how the banking system works.
You invest your hard-earned dollars in a savings account that may yield 1 or 2% (ridiculous).
The bank then turns around and lends your investment to someone who needs to borrow at a higher rate (4 or 5%), and the banks make a profit!
It’s leveraging debt.
As a business owner, taking on debt is sometimes necessary to grow your business.
And there are a few tax advantages that come along with it.
For example, the interest expense on a business loan can be tax deductible.
We recommend getting in touch with your accountant to find out which deductions apply to your unique situation.
There may be obvious ways to take advantage of tax advantages that weren’t previously there.
TIP: As a real estate investor, if you take a HELOC on your home (personal) and buy a rental unit (investment), this will convert your personal loan to a business one so that you can fully deduct the interest expense, not subject to TCJA limitation on the deductibility of home mortgage interest.
If you don’t have a good accountant, you can book a complimentary call with us anytime. We are here to help.
And we’ll leave you with words from Mr. Kiyosaki:
“Bad debt takes money out of your pocket. Good debt puts money in your pocket.”
Remember that!
Learn how leverage debt and manage it to increase your net worth and maximize your tax benefits.
Samy Basta brings you more than 20 years experience in tax, financial, and business consulting to his role as founder of Basta & Company. His focus is primarily strategic business planning, empowering clients to set priorities, focus energy and resources, and strengthen operations. In addition, Samy and his firm provide strategic counsel, and technical insight, on a wide range of needs, including tax saving strategies, tax return compliance, as well as choice of entity.
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San Francisco, CA 94111