Posts by Keith Taxguy

Do You Need an Investment Adviser/Financial Planner?

Your personality determines your investment success. Understanding your relationship with money can make the difference between outstanding and sub-par results.

Your personality determines your investment success. Understanding your relationship with money can make the difference between outstanding and sub-par results.

Once again we see the market throwing a temper tantrum. On the way up it was tempting to handle your investments on your own. Now with the horizon less clear and a modest correction in the books as I write, you wonder if professional help might be worth the extra expense.

Those most knowledgeable about money resist the advice of commissioned (or fee-based) professionals. As everyone know, fees have serious consequences over long periods of time. The lower the fees the more you’ll have 10 years down the road.

But when the market gets schizophrenic confidence in one’s abilities declines. Worse, you can make serious mistakes well in excess of what you would pay a financial professional.

The stereotypical financial planner or investment adviser is history. Commission based compensation still exists but on a much more limited scale as fee-based planning has taken over, hitching the client’s performance to the adviser’s income. Annual fees typically run around 1% of assets per year. While this fee is lower than many mutual fund expense ratios from decades ago, 1% annually starts to add up. And remember, you not only lose the 1% fee, but all the future gains that 1% would have earned.

Readers of this blog generally forgo advisers since they are well versed in the details of money management. Some readers apologize when they call me for a consulting session as they pay investment management fees to an adviser. It doesn’t bother me if you use an adviser because there are good reasons to hire an adviser which we’ll cover shortly.

Normally people in the FI (financial independence) community would want to pass on an article suggesting you might benefit from a financial adviser. This should be the exception. After careful consideration I decided to share 3 reasons a financial adviser could be a good idea for you.

Actually, I personally believe there is only one true duty of a financial professional. Don’t cheat and skip ahead. There are other minor duties a financial planner should provide should you decide to hire one.




Broken Confidence

Before we begin I want to share why I’m writing this post. This blog has a presence on several social media platforms. I also follow several groups and pages in the genre on Facebook. Recently a few people confessed they were willing to sell because the pain was too great since they lost maybe 10% or so of their portfolio value from the market top a few months back.

This confused me since these same people exuded tremendous confidence in their personal investing habits without the help of a professional. How could a run-of-the-mill correction have people screaming? How would they react in a real down market? A bear market?

Further digging showed many were investing in individual stocks such as Apple, which is down is bit more than the broad market averages.

Of course selling after the decline is in full swing is rarely a good idea. The time to sell is when the market is up, not after it drops 10% – 25%.

People comfortable spending less than they earn and investing the difference consistently do fine when the market is climbing. But when the ride gets bumpy or a bear market growls loud, these same people consider making the largest mistake of their financial life: selling at a market low.

I see this whip-sawing with clients all the time. It breaks my heart to see a client bust her tail to build a sizable nest egg only to lose money in one impetuous panic trade.

And that is where professional help comes in. While fees are always a concern since we know it hurts long-term performance, we need to weight the costs against real world results.

So here are the 3 things a financial planner or investment adviser must do to earn your business:




3. Asset Allocation

Index funds get all the press, but index funds are not the answer to every problem. (Have halitosis? A healthy dose of a Vanguard index fund will clear that right up! If only.)

Index funds are an important part of almost every financial plan. A financial professional should help you (or keep looking until you find one who does) determine how much should be in bonds, equities and cash. (If the adviser recommends Bitcoin, commodities, options, or other esoteric investments, especially if commission based, run like the wind while you still have a chance. And hold your wallet tight as you run!)

A financial planner should understand you and your goals with consideration for your investment temperament. The only investment that works is one you stick with. Here are the tricks financial professionals use to win the money game.

A financial planner should understand you and your goals with consideration for your investment temperament. The only investment that works is one you stick with. Here are the tricks financial professionals use to win the money game.

My personal portfolio has very few bonds. I certainly don’t follow the traditional investment philosophy of subtracting your age from 100 and having that much in bonds, or some such advice. (Yeah, I know I mangled that. The point is I don’t follow traditional investing advice.)

This brings up an interesting point. Your portfolio will look different from mine even if we are exactly the same age, in the same health, and have the same amount of money! The reason is that your personality will be different from mine. I’m willing to ride out any storm (for real!) while you might lose sleep at night if your investment/s decline temporarily.

When the market drops I start licking my chops. Where some people get scared and want to sell to protect from additional declines, I’m thinking about—and usually carrying out—purchases of more shares of companies or index funds.

Down markets are where the real money is made! The same applies to an individual stock if it is a quality company in most cases. (Apple is down hard recently and may drop more. I added a small amount to my portfolio and if the decline continues I’ll add more. Apple is a well run company with superb management. Temporary setbacks are part of investing and usually a time to invest in more shares of great companies and always a good time to buy broad-based index funds.)

A good adviser/planner will help you build a portfolio that allows you to sleep at night. For some it might be all cash, ie. bank deposits. (I actually have a neighbor who has it all in the bank and is happy as a clam in his retirement. He sleeps at night! No index fund gains would be worth the loss of security to him so it is the right thing to do. . .  for him.)




2. Goals

The financial professional is more than a product pusher. The professional will know his client (that’s you) before making any recommendations. If an adviser prescribes before diagnosis, walk. Keep looking until you find an adviser who wants to work for you.

Investing isn’t about “more money”. Well, not completely, at least.

Investing needs a reason, a purpose, for it to be something you’ll be consistent with. Financial independence can be a solid goal since once you reach FI it opens your view to the horizon rather than working a job because you must. You may stay working in your current environment if you enjoy the work after reaching FI. There is nothing wrong with that! You might want to start a business or explore an idea. That is good, as well, as that is where all progress comes from.

Early retirement is an honorable goal. So is building a nest egg so you can work less and spend more time with family is a goal that motivates. Growing your portfolio to leave an adequate legacy is also an important consideration. So is growing your portfolio so you have the resources to fund philanthropic causes dear to your heart.

Goals are endless. An adviser or planner must be willing to listen to your goals, even help you formulate clear financial goals that will serve your needs.

Often times we don’t even know what we want. Just wanting more money isn’t reason enough! With only a vague, undefined goal, that SUV looks mighty tempting fast. Only goals you fully subscribe to will keep you on course and fill you with joy.

So, advisers and planners need to understand who you are and what makes you tick and work with you to discover your real financial life goals. It might sound like a detailed job; it is.

When I work with clients I practically give them a tax and financial proctology exam. You might be laughing now over my choice of words, but I’m dead serious. I need to know my client when dealing only with taxes. My advise is based on what I discover about my client and her goals. If it’s important with taxes; it’s tremendously more important when it involves your financial plan.




1. Panic and Greed

Two very important traits a financial adviser must have before you work with them is they must understand who you are and how it affects your asset allocation and a determination to help you reach your financial goals. But those traits are nothing compared to what I consider the only true value a financial professional has: dealing with your emotions: fear and greed.

It might seem like a total waste of money to pay a financial planner 1% of your portfolio annually when all the money is tucked safely into index funds. The whole low-cost benefit of index funds is partly removed with the advisory fee. So how can it be worth it to hire a professional for such a simple (and appropriate, I might add) investment portfolio?

On the surface the fees might seem like a waste until you remember how we entered this post: people freaking out on social media over a mild market correction.

If a 10% correction has you running for cover you made the wrong investment! Or at least you didn’t adequately prepare yourself for the reality of your investment choices.

Do you have the right financial plan? The right investment adviser can help you create, set up and implement the appropriate investment strategy for success and then work with you to stay the course.

Do you have the right financial plan? The right investment adviser can help you create, set up and implement the appropriate investment strategy for success and then work with you to stay the course.

And this isn’t a blame game either. Most people have no idea how risk adverse they are until the proverbial manure starts hitting the fan. Then Katy-bar the door, boys. It’s about to get real.

And for this reason a financial professional can earn her keep.

People who build a large portfolio do so by ignoring short-term market moves. It’s easier said than done. Most people need a steady hand to see them through. Enter the investment adviser/financial planner.

If the current market volatility concerns you then you either made the wrong investments for your personality or you need a professional to smooth the emotional peaks and valleys, maybe both.

The same applies to bull markets. If you’re tempted to use margin (borrowed money) when the market is hot you need a professional to talk you down.

My decades of experience makes it clear to me many people need professional help with their money. Everyone wants to go it alone because we all think we’re smarter than we really are, and as the market rises (as it usually does) it masks our deficiencies. Blue skies lull us into a false sense of security. Then the storm arises.

If you are considering a financial professional after reading this then I want you to do it right. Interview several financial professionals. If they aren’t interested in you, really want to know and understand you, move on. The adviser you hire (you’re paying them so you are hiring them so they darn well better do their job!) must take an interest in your goals. In fact, they should naturally gravitate toward questions bent to learn about you and what most motivates you.

Make it clear to any adviser you consider that you want a steady hand, not exotic investments. She must help you deal with the emotions in a down market so you don’t crush your financial dreams with impetuous trades; she must hone your desire to take a flyer when the world is getting rich in FAANG stocks.

A good adviser does those kinds of thing because they are responsible and looking out for you, her client. Anything less and you’re better off with the security of a bank.




A Parting Story

The mid and late 1980s were an incredible time to be invested. A long-time client with experience managing his own money added religiously to his portfolio. From 1982 to 1992 the market churned out an annual return well into the double digits. It was a good time to be invested in equity mutual funds.

During this decade my client invested in Fidelity’s Magellan Fund. During a good portion of this investment period the legendary Peter Lynch managed Magellan. Returns were in nose-bleed territory.

My client was a steady investing hand. An up market didn’t turn him greedy. He added funds steadily as he earned them.

Mild downturns were also okay for my client. But the 1987 stock market crash turned him into a sleep-deprived zombie. He couldn’t take the market volatility so he sold. At the bottom! Then the market recovered and blue skies returned so he moved back into Magellan.

Then in 1990 the market once again declined. Not nearly as bad as 1987, but enough to shake our good friend. As you may have guessed, he sold. A short while later when the market returned to new highs he felt safe enough to push all his money back into Magellan.

During this period the Magellan Fund was up an over 20% per year on average if you never sold. Our hero managed a measly 2% because he sold twice in decade out of fear, less than money market funds would have earned back then. Our hero went from mouth-watering investment returns to performing worse than money market funds over two stupid decisions.

Moral of the story: It only takes one or two stupid investing mistakes to sabotage your financial goals.

Now be honest: Do you need a financial professional to see you through the storm clouds?

Now for the bad news. If you do, they are as hard to find as a good under-priced stock.

Good luck.

 

 

More Wealth Building Resources

Credit Cards can be a powerful money management tool when used correctly. Use this link to find a listing of the best credit card offers. You can expand your search to maximize cash and travel rewards.

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Side Hustle Selling tradelines yields a high return compared to time invested, as much as $1,000 per hour. The tradeline company I use is Tradeline Supply Company. Let Darren know you are from The Wealthy Accountant. Call 888-844-8910, email Darren@TradelineSupply.com or read my review.

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

PeerSteet is an alternative way to invest in the real estate market without the hassle of management. Investing in mortgages has never been easier. 7-12% historical APRs. Here is my review of PeerStreet.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregations studies work and how to get one yourself.

Amazon is a good way to control costs by comparison shopping. The cost of a product includes travel to the store. When you start a shopping trip to Amazon here it also supports this blog. Thank you very much!

 



Is Staying Fully Invested in the Market the Right Move?

Should you always be 100% invested. It depends on your circumstances. Sometimes cash is the better investment. Cash can also grow your long-term investment returns.

Should you always be 100% invested. It depends on your circumstances. Sometimes cash is the better investment. Cash can also grow your long-term investment returns.

Most of the time the stock market is climbing north. Interspersed between bull markets are those times when rookie investors act as if the sky is falling.

Long bull markets turn normally intelligent investors into casino gamblers; they even use gambling terminology: we’re due for a bear market or as they say at the casino, “Red is due after 8 black spins” at the roulette wheel; as if the ball has a memory. The odds of it coming up red are the same as it was last spin, in case you were wondering.

Of course, long moves in the stock market sets off our sixth sense that this can’t last forever. Before long you’re not fully invested (a religious mantra of many investing circles) which smacks of market timing.

This brings up a good question: Should you always be 100% invested in the market?

If only it were as simple as a yes or no answer.

The truth is many people should NOT be fully invested in the market and some people SHOULD be and it has nothing to do with market timing. The trick is to know when to be fully invested and if not, by how much.

It boils down to your personal situation: where you are on your journey to financial independence, how close to retirement you are (or if you are in retirement), spending habits and viable alternative investments.




Investment Levels

Whether you should be fully invested or have cash in money market accounts includes many variables. The easiest decision is when you are starting out.

Under $100,000: When your net worth (this should probably be liquid net worth) is under $100,000 and you are a good distance from retirement age you should be fully invested at all times.

This is the time to super-charge your tax benefits by funding retirement plans to the max. Employer contributions (if available) are an added bonus.

With time on your side you have to stay fully invested. Markets declines will come and go, but the risk is being out of, rather than in, the market. Riding out the storm of a bear market is only a minor speed bump in the rear view mirror so fully invested you should be.

Fully invested requires some explanation. Fully invested applies to your retirement and non-qualified accounts. These funds are earmarked as long-term investments and should be where they have the greatest opportunity for gain: broad-based index funds. You still need an emergency fund or at least some liquid assets easily accessible should your employment situations change or a major expense arise. We don’t want to be in a situation where we are forced to borrow at unfavorable terms or sell an index fund at market lows. A modest amount of liquidity is necessary and has nothing to do with market timing.

Your level of cash involves several factors. If you own a home and have access to a line of credit, it might be better to keep everything invested always and use the LOC if the need arises. This allows your savings to be working to your advantage. As the economy and business grows, so does your wealth.

In any case, when you are young and just starting out, the more you keep invested the better. Dividends and corporate profits keep climbing with only modest, short-term declines. You need the out-sized returns of the market to reach financial independence in a reasonable amount of time. The broad market averages 10% per year (some years more, some years less) while money market and bank accounts barely keep up with inflation if at all.

Investing can feel like a balancing act. Should you invest in the market or keep some in cash? There are good reasons to keep cash instead of investing.

Investing can feel like a balancing act. Should you invest in the market or keep some in cash? There are good reasons to keep cash instead of investing. Please share on Pinterest.

$100,000 – $1,000,000: The first $100,000 is the hardest. You earn every dime to get your account value up. The higher the account balance, the easier it is to get it compounding with meaningful numbers.

As your net worth climbs, having more cash can be beneficial, especially if you invest in individual stocks or have real estate investments.

When starting out it is important to invest in less risky investments. While the stock market does go down, the long-term gains are enviable for those with a modest amount of patience.

As your account balance rises you may consider alternative investments. Income property comes to mind. So does Peer Street and similar types of investments. (Most alternative investments should be a minor part of your portfolio.)

Retirement accounts will remain fully invested unless you are in or entering retirement where about 2 years of living expenses should be in a money market account.

Non-retirement accounts are a different story. The higher your liquid net worth the more likely you will keep some money in cash. High net worth individuals have more opportunities to invest than low net worth people. (Consider this an incentive to grow your account values.)

With a higher net worth you are either closer to retirement than those starting out or in retirement. A long-term investment horizon makes index investing almost a necessity. However, once retirement pops above the horizon or is your current lifestyle, more cash needs to be held in liquid money market accounts to satisfy normal (and sometimes abnormal) living expenses.

As your net worth grows you tend to learn how to ease up on traditional labor. Ample money allows you the freedom to choose between more time at work or more time with family; most people choose more family time. Because you now have the resources to spend less time in a formal working environment, you will need liquid funds to cover expenses wages may not.

Over $1 million: Even index funds keep a small percentage of their assets in cash to cover expenses and for withdrawals. Now that your liquid net worth reached seven figures you need to consider the same strategy.

Millionaires start to see their income get lumpy. This means you don’t see a steady income, but larger chunks from sales of assets or from your business or commissions, rents, dividends and interest. While wages can still make up a sizable part of your income, other passive forms of income generally dwarf your earned income. (The stock market gaining an average 10% in a year on a $1 million account yields a $100,000 unrealized gain and $20,000 in dividends at a 2% dividend yield.)

More alternative investments tend to show up now that your stash has climbed to million dollar status. The easiest way to invest a small sum is in an index fund. With a larger pile alternatives play a potential role.

We preach index fund investing a lot around here, but everyone I work with that has at least seven figures of net worth has accumulated several alternative investments. Once you begin investing, opportunities abound. Just be careful it isn’t a scam; they abound, too.

There is a difference between a few dollars and a million plus. With a million dollars you now spend more time allocating assets: how much real estate should I own and where, do I own bonds, individual stocks, gold (please, no), micro lending investments and so forth.

Most of the people I work with that have a large net worth tend to keep a small pile in cash. Five percent of a million dollars is $50,000. It sounds like a lot, but a small amount compared to the whole. $50,000 sounds like a lot until you realize circumstances could require you to need this liquid cushion. Remember, income tends to gets lumpier when your net worth gets reasonably high (and even worse when unreasonably high).




Business Owners and Side Gigs

Readers living off business income have a unique set of challenges. Businesses need working capital so uninvested money needs to be easily accessible for operating expenses or opportunities to expand the business or spike profits.

Businesses must have an adequate cash reserve! Every business owner enjoys surprise opportunities unannounced. Some of my best money-making opportunities were the result of having cash available when competitors didn’t.

Cash is king! 100% invested all the time can hurt your investment return. Find the right balance between cash holdings and index fund investments.

Cash is king! 100% invested all the time can hurt your investment return. Find the right balance between cash holdings and index fund investments.

Side gigs are really micro businesses. The same opportunities fall in the laps of side gig purveyors.

The type of business determines the amount of cash needed. In my tax practice I generally keep $50,000 liquid with a $100,000 line of credit. Small opportunities do not require the risk of waiting to sell an asset or borrowing money; I can write a check. As strange as it sounds, there are times when they sell dollar bills for 82 cents a piece. (Well, it seems that way. I use multiple bank offers with this working capital, snagging thousands of dollars annually in bonus interest. I also can buy assets or invest in a new business venture connected to this blog or my practice without funding concerns.)

As you approach retirement you also need to consider more liquid funds because there will be a need in a few years or less. (Index fund investing should have a 5 year time horizon minimum.)

Short-term funds must always remain liquid to prevent a market decline forcing you to sell at a loss! As I stated, money needed within 5 years should be in a bank product or money market account. This applies to everyone at all net worth levels. Nothing guarantees a market decline better than dropping short-term funds in the market you’ll need in six month or a year. It’s almost like God is punishing you for being stupid (or greedy). (Yes, I’m speaking from experience.)




Retirement

Retirement changes everything. As you are growing your nest egg you are also bringing in outside cash from work and/or income properties, et cetera. When you are in retirement you are earning less (or nothing) so you need the income stream from investments to cover daily expenses.

You annual spending habits and investment values determine how much you will need to keep liquid.

If your net worth is really high and spending level low you can keep all your money invested in index funds and live off the dividend stream.

For everyone else it is a good idea to keep around 2 years of living expenses in cash (money market accounts). If the market keeps climbing you can sell enough of your index fund to pay bills. When the market declines you can live off the money market funds. If the market decline is steep you can divert dividends to the money market account rather than reinvesting dividends.

The goal is to a void a cash crunch when the market is down significantly. Small declines ( a correction, defined as a 10% decline from a recent market top) are no problem as you’ll still sell part of the index fund for living expenses (if dividends don’t cover the bills). What I’m worried about is the 2008 type decline of 50%. I don’t want to sell in that environment no matter what. It’s a buying opportunity if anything.




Market Timing

As my net worth grew over the decades I noticed I keep more and more money in cash when valuations become stretched. While this isn’t technically market timing (buying and selling to capture small market movements), it is done with the expectation of investing at a later date at a better price.

Currently I’m at a high cash position. Money pouring in over this year I’ve kept in money market accounts (I still invest automatically in my Vanguard index fund, but the money coming in is always more than the baseline I automatically invest). For a while I invested in Peer Street and made a few other modest investments. I tried to get out of investing in individual stocks, but I had to invest more in Altria when the world was coming to an end and the dividend yield jumped over 6%. I also added to my Facebook and Apple holdings modestly when their stocks declined significantly.

Another reason I keep more money liquid now is that I want a ready pile of cash for an emergency investment. The economy is humming right now, but the day always comes when a piece of real estate shows up 30% below market value for a fast sale. And I’m just the guy to make a fast sale to because I don’t need a loan; I can close this afternoon.

Liquid funds have a low rate of return until you can pull the trigger on a deal like no other in zero time! Businesses and individuals frequently have fire (or should I say FIRE) sales for a variety of reasons. I enjoy getting first dibs because the seller knows I can close the deal fast.




Bonds

Interest rates also play a key role in how  much you should have in equity index funds. When interest rates are high it’s easier to keep more liquid funds as your money market pays stock market returns.

We haven’t seen high interest rates in well over a decade. That doesn’t mean those days will never return. In the early 1980s you could buy a 30-year Treasury with a 14% coupon (the bond paid 14% interest annually for 30 years) and the interest was state tax free. Regardless of what the stock market did, I would not have had hurt feelings if I had money in Treasuries for 30 years at 14%. That is about the best risk-free investment there ever was.

If Treasury bonds climb to 7% or higher I will probably keep some money in bonds. If you are starting out you still need to ride out the stock market storm as you need the compounding effect of growing businesses to build your nest egg. If your stash is a bit bigger risk-free bonds might be at home in your portfolio. (For the record I currently hold one, that is 1, Treasury Inflation Protection Security (TIPS) of $1,000; my entire bond portfolio.)

If interest rates ever climbed to double digits there is nothing wrong with dumping a large portion into Treasuries, especially if you are retired. You can throw the 4% rule out the window when the U.S. government is paying more than 10%.




Wrap Up

Reading personal finance blogs might lead you to think holding cash is a sin. It Isn’t! Having plenty of cash ready to jump at a moment’s notice is a powerful wealth building tool. Warren Buffett keeps large amounts of cash at his firm, Berkshire Hathaway. He keeps the cash handy for potential claims from his insurance business and for opportunities to buy good businesses at a good price. You and I should be no different.

If you buy and sell the market hoping for a quick gain you are market timing and you will eventually get you head handed to you (if you already haven’t). Every client I ever had who *traded* the market had sub-par results and most took a bloodletting.

It might seem like a fine line between market timing and what I’m suggesting here. It isn’t. Money I keep to the side for potential investment can stay in money market accounts for years for all I care. If I don’t find a super deal for the money is plods along earning 2.3% (the rate as I write). It may never get invested. If, however, the market declines I’ll allocate more of these liquid funds to the index.

And if Apple decline more or Facebook drops (or gets better management) or Altria stays at these levels (or buys Juul, I think it’s a god fit) I’ll be exchanging more of that cash burning a whole in my pocket for pieces of those businesses.



More Wealth Building Resources

Credit Cards can be a powerful money management tool when used correctly. Use this link to find a listing of the best credit card offers. You can expand your search to maximize cash and travel rewards.

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Side Hustle Selling tradelines yields a high return compared to time invested, as much as $1,000 per hour. The tradeline company I use is Tradeline Supply Company. Let Darren know you are from The Wealthy Accountant. Call 888-844-8910, email Darren@TradelineSupply.com or read my review.

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

PeerSteet is an alternative way to invest in the real estate market without the hassle of management. Investing in mortgages has never been easier. 7-12% historical APRs. Here is my review of PeerStreet.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregations studies work and how to get one yourself.

Amazon is a good way to control costs by comparison shopping. The cost of a product includes travel to the store. When you start a shopping trip to Amazon here it also supports this blog. Thank you very much!

Regaining Motivation When You Have No Debt

What happens when the thing that motivated you most of your life is removed? Here is how you can bring meaning and purpose back to your life.
What happens when the thing that motivated you most of your life is removed? Here is how you can bring meaning and purpose back to your life.

What happens when the thing that motivated you most of your life is removed? Here is how you can bring meaning and purpose back to your life.

The literature is largely silent on what you should do once you attain financial independence(FI). Plenty has been written about building wealth and how much is needed to reach FI and how much you can safely withdraw each year in retirement.

Plenty of debate has also revolved around paying off the mortgage — any debt for that matter — versus plowing the excess payments into investments that pretend to offer a return greater than the interest rate on your debt. While investments can provide outsized returns, the return isn’t guaranteed; the interest on the debt is.

As much as we preach about eliminating debt as part of a smart wealth building program designed for FI, there are some benefits to having certain kinds of debt. Risks are always present, but the advantage may be worth the risk. Buying a home without debt ever would mean most people would never have a chance at home ownership. And you can forget about income properties if you can’t use leverage to start your real estate empire unless you inherited from a rich uncle.

A mortgage (all debt) does have one powerful advantage most people overlook. Debt is the #1 motivator when it comes to getting people to sacrifice time with family and friends. Debt motivates you to work harder than you ever would if debt demands were not hanging over your head.

So if debt is so caustic to financial success a prime goal should be to remove debt from your life except for only the rarest of cases. But then what?

If you pay off your debt and build a sizable nest egg, a primary motivation to keep producing declines! How will the economic engine of progress ever survive? (I’m being facetious here.)

People will take a second, or even third, job just to pay for prior sins, plus interest. Families are destroyed; health ruined; children neglected, just to make good on your obligations. You did give your word and you’re a person of your word.

 

And then you had a come to Jesus moment. Maybe you read a blog or had a serious talk with a councilor or your accountant. Debt became enemy #1. And then the debt finally disappeared and cash kept accumulating in your investment accounts until money was no longer a reason to work; money is only a tool now.

A once powerful motivator in your life is gone. You either took an early retirement, did the traveling thing you always wanted to or started a side gig from a childhood dream. And it didn’t take long before you asked: Is this all their is? Is there no more?

Travel became dreary as it was nothing more than a replacement for the old job. Life on the road isn’t what you hoped it would be. Travel is wonderful in modest gulps, but inhaling the elixir sends it down the wrong pipe and you end up coughing it back out.

Early retirement left you with long days and nothing to do. The fellowship from the work environment is gone and you miss it.

The side gig fills some of the gaps, but still something is missing.




Finding the Meaning of Life and Motivation

While debt can be a thorn in your backside motivating you to action, it is a cruel taskmaster at best. Better the drudgery of excess travel, days of boredom or a side hustle that doesn’t completely fill the gaps of emptiness. Debt can do more than motivate; it can destroy. Best to keep the debt where it belongs; in the past.

Use the secrets wealthy, successful and happy people use to achieve anything.

Use the secrets wealthy, successful and happy people use to achieve anything.

A mixture of options can improve the attitude. Some travel is a great thing. Time off to read, think, reflect and enjoy family time is important and something to cling tenaciously to. And side hustles can be a lot of fun so why give that up.

If you really think about it, traveling, more free time and side gigs are not the problem! The problem was created by debt and you’re still suffering the consequences even when it’s gone.

For the first time in your life you can do something truly meaningful. In the past you were so focused on paying the bills you never learned how to make a real difference in the world that juiced you to the max. You were too busy helping Wells Fargo meet analysts expectations for the quarter.

The travel, family and free time and side gigs are good things to have and do. But too much of a good thing is bad. (Sounds crazy, doesn’t it? But can you imagine me connected to the hip of Mrs. Accountant? I’d have a rolling pin beside the puss by the second day! There is such a thing as too close.)

So now we need to add meaning back into our lives; something that makes us excited to get out of bed and charge into the day.

Before I share what I consider the best motivational tool any FI individual can have, let me share a few other ways to bring viva! back into your life:

  1. Plan: You may have heard retired people saying their more busy once they retired than when they worked. It’s true! I see it all the time. And it was because they had a plan. They planned retirement before they got there: the travel ventures, entertainment choices, how much family time and with whom, how much time to dedicate to a hobby. If you plan you will find more than enough meaningful stuff (a purely technical term, I might add) to fill your day; more than enough to motivate you to get out bed exited daily. Too many people think they will retire and do one thing like travel or golf. That ends up the new job and drudgery. Variety is the magic potion.
  2. Turn your side hustle into a real business: A side gig can occupy a portion of time each week. Depending on the depth of your side gig determines the time and enjoyment involved. However, a side hustle doesn’t contain the drive necessary to really push. (You don’t have to do it if you don’t want to.) If you really enjoy your side hustle, consider going all-in. A full-blown business takes work, but if the work is pleasurable it becomes a powerful motivator. A business provides much more to a community than a mere side gig. Not only will you provide more valuable goods and services for your community, you might even create jobs. Best of all, when you run your own business you are the captain. You can make real changes; solve real problems perplexing society.
  3. Challenge yourself: Of course travel and side gigs have challenges, but I’m talking about something more. Using travel as an example: you can take a tour or strike out on your own. Striking out on your own have various levels. Consider an extended stay in a country, learning their language and culture on a deep level. Since many reading this blog are younger, consider mountain climbing or similar challenging tasks. It takes time and dedication to learn serious climbing. It could take years or decades to reach a level on competence. (You will not climb El Capitan in Yosemite the first week. Not if you want to live long enough to get your motivation back, at least.) Striving for excellence in a large goal will have you jumping out of bed each morning early to meet the day.
  4. Set personal goals: This pertains to what was said above. Business is filled with goals; planning is a form of goal-setting; undertaking (remember we used mountain climbing as an example so the pun was intended) a massive challenge (learning a new skill to a level above mere competence) will bring motivation back into you life. Not all goals need to be grandiose. If your life is consumed by one all-encompassing goal it can cost you in other areas of life. Notice I said “personal” goals. Goals must include family and friends and should include many short, easily attainable goals. Business and rock climbing are major goals. That isn’t what I’m talking about in this point. Numerous smaller goals of things you think you’ll enjoy is what I’m suggesting. It’s all about enjoying the process and feeling motivated and alive each day.
  5. Take on a large project: Turning a side hustle into a full-fledged business is a “large” project. What I’m suggesting in this point is a bit different. The large project I’m suggesting straddles the business and personal world. For example: get a college degree in a field that interests you (history might be a poor degree choice, but now you have the time and money to really dig in). Now is the time to write that novel you always promised yourself you would write. Maybe start a blog and share your adventure from subsistence to abundance.

The whole idea of these ideas is to give you one big thing to do with your life with multiple smaller goals to keep you active and motivated. Any of these endeavors will fill a good portion of your day and provide motivation to keep moving forward.

The key is to choose something important, that makes a difference in the lives of others. Hedonism will only take you so far. When you do something that benefits others your life is filled with meaning and purpose. That is the birthplace of motivation.

And that brings us to the last and most powerful way to gain motivation, meaning and purpose in life when you’ve reached the safety of financial security.




The Meaning of Life is to Give

I work with numerous wealthy individuals in my practice. What I see in private I also see in the news: wealthy people like Bill Gates and Warren Buffett giving large chunks of their net worth to charity.

The happiest people in the world have a reason to get out of bed each day. Learn the lessons the wealthy use to do the impossible.

The happiest people in the world have a reason to get out of bed each day. Learn the lessons the wealthy use to do the impossible.

It goes beyond mere financial donations. Peter Lynch, the great mutual fund manager at Fidelity Investments’s Magellan Fund from 1977 to 1990, volunteers his time and experience to charitable organizations. Bill Gates not only donated a massive chunk of his wealth; he started and funded the foundation he runs, changing the world for the better. Gates’s experience allows him to make a serious difference.

You also have skills and experiences many organizations can use. There is no greater satisfaction or satisfying job than to work with people of a common cause doing good. 

Listen, we hear all the bloggers bragging about their exotic travel and early retirement bragging. After a while the selfies get old. It must be depressing to spend so much time in self-aggrandizement.

We can do better! Let’s use the 5 points above to illustrate what I’m suggesting:

  1. Plan your giving: Each gives what each has. Maybe you have loads of money so you spend time reviewing the best organizations to fund. Maybe you’re good at helping raise money for organizations. (You’ll be in higher than demand than you can imagine if you are.) Maybe you love working with your hands. Perhaps Habitat for Humanity could use someone with excellent construction skills.  You have limited time and resources so you need a plan on how to give wisely.
  2. Experience: People tend to enjoy what they are good at. Familiarity bias is something we can use to our advantage. I work with a non-profit connected to Goodwill helping people with serious money and/or tax problems. It’s what I’m good at; it’s what I enjoy, so it is where I can do the most good. Take an inventory of the skills and experiences you have and match it with the things you most enjoy doing. Satisfaction of a job well done and demand for your skill sets will leave you massively motivated, satisfied and enjoying every day to the max.
  3. It ain’t easy, but it sure is darn fun: Life is most enjoyable when challenged. Charitable organizations are designed to deal with challenges. The work can be hard at times, even frustrating, as you try to achieve goals that make the world a better place. Working with like-minded people is one of the most pleasurable things you can do.
  4. Pace yourself: Don’t turn your good nature into drudgery. Set limits (read: goals). You can’t solve all the ills plaguing our world alone. The nice thing about FI is you can pace yourself. One day of challenges at a time instead of overwhelm is just the ticket to living the good life post-debt.
  5. Service: Serving your community is a large project by definition. Remember, you can help more than one organization. But don’t spread yourself too thin. The goal is motivation.

People are happiest when they give. (Read that again.) Giving is the meaning of life.

You spent a lifetime fighting to retire debt obligations. Now that you buried the debt-demons and built a mighty financial fortune, it’s time to find a reason to live another day.

There are so many things you can do to feel alive each morning.

I get up early; I always have. I’m excited about life. Deep down I kept a mortgage around way to long, knowing it was a powerful tool to motivate me. (You can check the links at the beginning of this post to read more about my mortgage/wealth adventures.)

Debt is a stupid way to stay motivated.

I knew once I retired my mortgage a serious motivation pillar would be removed from my life. My net worth is well above the FI threshold.

No more than the mortgage was gone and I noticed the loss of drive to set more appointments or even write so much on this blog. The nice thing about FI is you no longer have to do anything anymore; it is also the greatest problem.

It doesn’t have to be that way. You can live a life filled with excitement and adventure; you can live each day knowing there are people who really need you.

Find what motivates you. Sit down and really think about it. Write your thoughts out.

The world will be a better place if you do.

 

 

More Wealth Building Resources

Credit Cards can be a powerful money management tool when used correctly. Use this link to find a listing of the best credit card offers. You can expand your search to maximize cash and travel rewards.

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Side Hustle Selling tradelines yields a high return compared to time invested, as much as $1,000 per hour. The tradeline company I use is Tradeline Supply Company. Let Darren know you are from The Wealthy Accountant. Call 888-844-8910, email Darren@TradelineSupply.com or read my review.

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

PeerSteet is an alternative way to invest in the real estate market without the hassle of management. Investing in mortgages has never been easier. 7-12% historical APRs. Here is my review of PeerStreet.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregations studies work and how to get one yourself.

Amazon is a good way to control costs by comparison shopping. The cost of a product includes travel to the store. When you start a shopping trip to Amazon here it also supports this blog. Thank you very much!

 

 



The Benefits of Having a Mortgage

Paying off the mortgage is the American Dream and the first step toward retirement; it’s harder to retire with a mortgage payment blowing a hole through a fixed budget. Owning your home is the foundation of any vibrant financial plan. Until your home is unencumbered (without a mortgage) the bank still owns it in a manner of speaking (and they’ll remind you of it if you miss a payment).

Still, a home mortgage has its benefits. The traditional reasons to carry mortgage debt are bad reasons to carry the liability, but there are still a few good reasons.

We will review the traditional reasons for borrowing against your home and why the benefit is perceived rather than real. We will finish with the three reasons a mortgage can help you build wealth.




Revolving Mortgage

The debate is legend: should I pay off the mortgage faster or invest the extra instead? I recently finished that personal debate permanently.

In Accounting 101 they teach students how leverage (borrowed money) spikes investment returns. It all makes sense.  If I pay cash for a $100,000 home and it increases in price by $3,000 the first year I managed a meager 3% return on my investment (assuming you feel your primary residence is an investment). If instead you borrowed $90,000 and only invested $10,000 of your own money, the gain jumps to 30% ($3,000 increase in value divided by the investment of $10,000).

A mortgage is a powerful financial tool to build wealth. It also carries risks that can harm. Learn how to use a mortgage to build wealth.

A mortgage is a powerful financial tool to build wealth. It also carries risks that can harm.

They also teach of the risks of leverage in the classroom, but it doesn’t feel as real as the real world will make it. Leverage is wonderful animal when your assets are increasing in value. When the inevitable decline happens real pain begins.

In our above example the 30% gain is an illusion. If you have a mortgage against your home you will pay interest and that reduces the actual gain. Let’s assume a 5% interest rate on your mortgage. This equals $4,500 in interest the first year without consideration for the principle payments on each monthly payment. Your 30% gain went south darn fast, taking a $3,000 gain and turning it negative!

But if I invested the $90,000 (assuming I didn’t need a mortgage) and earned a return there I once again should be popping some mouth-watering returns. Maybe.

We’ll return to this in a moment.

Understanding how leverage can spike investment returns, I always subscribed to holding a mortgage. I bought my first home in 1986 and had a loan against it. It was paid off when the home was sold. (I’m embarrassed to say it was a mobile home, but in my defense I was single and enjoying life to the max. I was retired at the time (turned out to be gap years only) and immersing myself in an endless supply of books.)

From the mobile home I moved into a three bedroom ranch in town (1989); full mortgage in place. Opting to invest every dollar I had, the mortgage was never paid a penny sooner. Then I bought the farm (sounds morbid, doesn’t it?).

The farm is my final resting place and — embarrassed as I am to say it — was used as an ATM since 1995 when I took ownership. The farmhouse was unlivable, but I wanted a traditional barn and the 10 acres also appealed to me. I coughed up a $120,000 hairball with a $100,000 mortgage. I handled some remodeling on my own to make the farmhouse livable until I was ready to seriously remodel with an addition.

A few years later (somewhere around the year 2000) the mortgage was down to $40,000. It was time for a serious upgrade.

My 900 square foot farmhouse swelled to 3,000 square feet and cost close to $200,000 to remodel and expand. (I still swallow hard when I think of that. Not to be outdone, the bank (Farm Credit; they have awesome terms and interest rates for farmers) allowed me to borrow 80% of the value of the finished home; $400,000. That means I was able to grab another 80 grand and drop it into the market.

By 2008 the farm mortgage was under $100,000 again as I paid extra in spurts. The market tanked and good credit came to the rescue; I was able to take another quarter million. Into the market it went.

Of course I look like a hero because the timing of my remortgages coincided with market declines. This wasn’t an accident. When the market died I wanted to add to the account and the ATM was cheap money. (You can read the prior article linked above for more. The ends do NOT justify the means so the increase in investment value is a poor reason to toot my horn.)

I tell you this story for a reason. I struggled with paying off the mortgage for decades as many readers also do. I had the funds to retire the debt a long time ago, but chose to keep the mortgage anyway. Until last month.

At the beginning of this year I had whittled down the mortgage to ~$100,000. I didn’t want to sell assets/investments to pay the mortgage, causing a taxable event. Hyper-frugality set in. By June the mortgage was down to $57,000 and the sickness set in. It was time to kill the mortgage forever!

And I did it! On October 5th I made a special trip to the bank to put the final nail in the mortgage. (Mrs. Accountant came with to experience the magical moment. Either that or she didn’t trust me and was worried I might chicken out and drop it all in an index fund.)




Traditional Benefits of a Mortgage

Mortgages have been touted for a variety of reasons with promises of helping the economy, providing liquidity to the housing market and offering tax advantages to some. We’ll now run down many of the most popular traditional mortgage advantages and why it’s best to avoid the boondoggle.

 

Real estate is a known way to create and build wealth. Turn your property into a cash cow using the right financial tools.

Real estate is a known way to create and build wealth. Turn your property into a cash cow using the right financial tools.

1.) Tax Advantages. This is the most popular reason given for having a larger mortgage. Banks and other financial institutions have a vested interest (pun intended) to get you to borrow more. You know the advertisements: Mortgage interest may be tax deductible. Consult your tax professional. Rarely do people consult with their tax professional and the bank is counting on it. All people hear is mortgage interest is tax deductible.

Why this is bad advice. 

Every lie has a grain of truth to it. Mortgage interest is deductible. Unfortunately many will not benefit from the deductibility of the mortgage interest they pay because they don’t itemize. Also, paying the bank $10,000 in interest just so the IRS might give you up to $3,000 back is a really stupid move.

 

2.) You can afford more house. Yes, the more you borrow the more house you can buy. If every home was required to be purchased with cash the price of homes would drop precipitously.

Why this is bad advice.

Just because you can dig a deeper hole doesn’t mean it’s a good idea. Dig a deep enough hole and it’s called a grave.

 

3.) You can invest the difference for a higher rate of return. Fair enough. If you borrow the maximum you free up capital for other investments.

Why this is bad advice. 

This concept is fine as long as you don’t take on more house than you can afford. And you have to actually invest the difference. After 35 years in the tax profession I can count on one hand with fingers left over of people who invested money earmarked for additional mortgage payments into an investment account. Sure, some may have invested the money without a formal accounting. But my suspicion (gather from decades of experience) is that people tend not to save the money; they just increase lifestyle spending. All is fine until storm clouds appear.

 

7 ways to use your mortgage to build wealth.

7 ways to use your mortgage to build wealth.

4.) You don’t have to sell assets triggering a tax event to put more down on the house. Once again, fair enough. I used the same philosophy when paying my home off faster (fast!). Selling assets to put more down on a property can cause a serious tax issue. A larger mortgage (temporarily) makes a lot of financial sense.   

Why this is bad advice.

The larger the mortgage (the more leverage) the larger the risk something can go wrong. The investments you didn’t sell could decline in value. Selling to have a reduced mortgage means you forgo future gains on the sold investment. By keeping the asset and acquiring a larger mortgage you take on market risk while paying additional interest to boot.

 

5.) Investment gains. I hear it all the time, “The market goes up 10% a year while I’m only paying 5% interest.” It is true the market averages gains of about 10% per year on average. Some years the market increases more; other times the market gets cut in half! 

Why this is bad advice.

As we noted at the beginning of this article, leverage seems like a great idea. . . until you look under the hood. It might be easier to see with an income property.

The choice is to pay cash for the property or mortgage it to the hilt. If you mortgage the property you can invest the difference.

Let’s assume you purchase a $120,000 property for cash. If the value increases 3% the first year your net worth has increased $3,600, plus any profits from renting the property. Sound good, but the real estate agent introduced you to his banker friend and he says you can borrow $100,000. This means you can buy more properties (now you know why the agent recommended his banker) or keep the money in an index fund or other investment.

A good banker can make the numbers look compelling and this banker is gooood. You decide to borrow $100,000 for 15 years at a fixed 5%. We’ll use simple interest to keep this easy to follow. The value increased the same 3% as above (and also a common annual increase in value for real estate). The value of the property increased $3,600; the mortgage interest amounted to $5,000!

Yikes! You actually lost on the deal!

Maybe not. The property in a vacuum with the mortgage appears to have lost $1,400 the first year. Hopefully you didn’t invest in 5 more properties with the same mortgage deal because then you are hurting. The $100,000 you left invested earned, let’s say, the average 10%, or $10,000. Added together you made $8,600. It seems the mortgage was a good deal after all.

Buuuut. . .  You have to assume a good market (or a pretty good return on whatever investment you made) to justify the out-sized mortgage. If the investment under-performed, or, {gulp!} declined in value, you not only suffered a loss on the investment, the property has interest expenses in excess of the gain in value, increasing the total loss from the investment.

 

 

The above traditional advantages are not bad in and of themselves. Most people don’t decide between paying cash or a mortgage; they don’t have the money to pay cash so a mortgage is the only choice. Home ownership, especially as you begin your financial journey, almost always requires a mortgage.

Now we turn to non-traditional reasons to have a mortgage; reasons that might actually make sense.




Good Reasons to Have a Mortgage

Real, or good, reasons to have a mortgage are few. The risks of leverage are higher than most people anticipate. The odds are virtually 100% the economy will decline one or more times during the lifetime of a mortgage. Job loss or disability further add to mortgage risks. Rare is the person who doesn’t have a few times when the mortgage payment is a challenge.

All the negatives of the mortgage doesn’t mean the liability is totally worthless. There area a few reasons I can think of to have a mortgage, reasons worth their weight in gold.

 

There are good reasons to have a mortgage. Tax benefits are the smallest benefit. A mortgage can do a whole lot more when used properly.

There are good reasons to have a mortgage. Tax benefits are the smallest benefit. A mortgage can do a whole lot more when used properly.

1.) Free up capital. Leverage entails risk; no working capital can be a greater risk! If you pay cash for a property and have no working capital to deal with maintenance, insurance, property taxes or other expenses you can find yourself in just as deep as if you have a large mortgage.

Landlords should be acutely aware of this issue. Vacancies early in property ownership can cause serious financial harm. Without a mortgage the landlord should have a really good cash flow. But, you need a maintenance fund and resources to cover insurance and taxes should the property refuse to rent early in the ownership cycle.

The same can be said for those buying a primary residence. Without any emergency fund, a minor unexpected expense can create hardship.   

Solutions to potential problems. 

Up till now I’ve used the all-or-none approach. Taking out a small mortgage can free up capital to deal with any of the problems listed above.

Another very low-cost solution is a home equity line of credit (HELOC). For a couple hundred dollars you can secure a line of credit against the property. If things go well you have no additional mortgage expenses; if cash gets tight you have a resource to manage the bumps.

 

2.) Working capital. In business, investment properties and even your personal life, working capital is necessary to achieve your financial goals. Being property rich and cash poor means you have to pass on obvious opportunities for financial gain.   

Solutions.

When I bought my office building I didn’t want a mortgage. Profits are really nice when you don’t owe anyone anything. However, the seller wanted to spread his taxes out so I accepted a land contract (7 year amortization; seller allowed me to make a final lump sum in the fifth year).

But owning my office building requires ~ $200,000 of my net worth to be tied up in real estate. If an opportunity comes along I might have to pass and that would bother me. (It really would!) So I’ve always had a line of credit in my business. Originally it was attached to the building; now I have an unsecured line of credit. This allows me to smooth out the lumpiness of my business income (spring is good; year-end not so much).

I haven’t used the LOC for a few years so the only cost in $150 per year. Still, if I ever needed funds I can dip into the LOC for a very short term. This allows me to invest excess capital more quickly without fear I’ll need it before the good times return the following tax season.

 

3,) Motivation. This is the reason I wrote this post. I knew from the beginning if I ever paid off my mortgage, to be totally debt-free top to bottom, I would no longer have a financial motivation to get out of bed. And just as I predicted, I’m feeling the slump.

Financially I had the money to pay the house off decades ago without even a minor hardship. My logic was that I invested the extra money I borrowed so it was okay to keep the spur of a mortgage in my shorts.

Don’t worry too much, kind readers. I still roll out of bed around noon and put in an hour or two before calling it a day. (I’m joking, guys!)

Financial independence is different from debt-free! A mortgage always focused my attention. It helped me push my frugality (defense) while encouraging more income growth (offense). The frugal part has been good since the mortgage is gone; good habits continue on.

However, I find myself thinking more and more about how much I don’t have to do now that I’m mortgage free. I need $2,000 a month to live without a mortgage payment (a bit more during the winter heating season; a bit less in the summer). The nice thing about a mortgage is I needed lots of income to fully fund retirement accounts, add to non-qualified accounts and then pay extra on the mortgage. Without the mortgage money is no longer a driving force even on a minor scale!

 




And this is where we stop for now. My next post will deal with finding motivation when money is no longer an issue. Debt creates (or at least should) a crisis environment. As my good friend Mr. Money Mustache says, “It’s not a debt emergency; it’s a DEBT EMERGENCY!!!

I used a DEBT EMERGENCY to prod me in the past. Now I need to grow up and find motivation from other places. While debt can focus one’s attention, it is a poor way to achieve a goal! I used it way too long.

Debt is a tool with serious risks. Debt in and of itself isn’t bad, but it can create the illusion it is making things better when all it is really doing is increasing risk. We can do better than that.

Paying off my last liability has been liberating. I’m glad I did it. There are many ways to refocus attention so you can continue to create value in the world around you and in your life.

I think you’ll enjoy the answers I publish next week.

Happy Thanksgiving, American readers!

 

More Wealth Building Resources

Credit Cards can be a powerful money management tool when used correctly. Use this link to find a listing of the best credit card offers. You can expand your search to maximize cash and travel rewards.

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Side Hustle Selling tradelines yields a high return compared to time invested, as much as $1,000 per hour. The tradeline company I use is Tradeline Supply Company. Let Darren know you are from The Wealthy Accountant. Call 888-844-8910, email Darren@TradelineSupply.com or read my review.

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

PeerSteet is an alternative way to invest in the real estate market without the hassle of management. Investing in mortgages has never been easier. 7-12% historical APRs. Here is my review of PeerStreet.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregations studies work and how to get one yourself.

Amazon is a good way to control costs by comparison shopping. The cost of a product includes travel to the store. When you start a shopping trip to Amazon here it also supports this blog. Thank you very much!

 



How to Retire Happy with Lots of Money

What is the secret to a happy retirement with lots of money? Here are a few who actually did it.
What is the secret to a happy retirement with lots of money? Here are a few who actually did it.

What is the secret to a happy retirement with lots of money? Here are a few who actually did it.

When I started this blog a primary goal was to share the worldview from my side of the desk. Over the years I’ve seen things I would never have seen if I were not in the profession I am in. And now I’ve seen things in the early retirement community I can no longer keep secret.

Many secrets have been shared over the last few years while new secrets have emerged as I sit smack-dab in the middle of the FIRE (financial independence/retire early) community. In many regards I represent an anti-FIRE philosophy. I espouse frugality while venting disdain for travel and anything that echoes of retirement.

As an odd apologist for the FIRE community I watched on as Suze Orman set the community on fire when she exclaimed she HATED! the FIRE movement. While card-carrying members were up in arms I muttered under my breath, “I know what you mean.”

Yes, you heard that right. I actually agreed with Orman on something, a rare occurrence. Orman’s insistence you need $5 million to retire is absolute rubbish. But there is something deeply disturbing about the FIRE community and it has the power to rip it apart.

To make matters worse, I may be the only one in the community who understands what is happening under the surface. And how I know this is due to my unique position in the community.

As readers may know (and they will now if they didn’t), I prepare taxes or advise a number of A-list bloggers within the FIRE community. I also consult with several people each week from this blog. And a concerning pattern has taken shape.




Feelings of Failure

It didn’t exactly start with Mr. Money Mustache, but the FIRE community solidified around Pete and his work. Pete retired at the ripe old age of 30 and set a new standard in early retirement.

News feeds have a litany of stories of 30-somethings living the good life as they travel abroad. Coupled with the stories of people paying off a gazillion dollars in debt in four and a half minutes and it starts to look easy.

Except it isn’t that easy! It’s actually damn hard. Personal circumstances play a vital role. Where you live, your health and education opportunities determine at least a part of the outcome.

I’ve been consulting with members of the FIRE community for close to 5 years now. At every personal finance (PF) conference I’ve attended I conducted consulting sessions. Tuesdays and Thursdays are consulting days at the office and I’m usually booked months in advance. (Okay! Sometimes I get caught up because I say “no” for a few months to every request.)

You would think consulting sessions with a “wealthy accountant” would focus on taxes. Au contraire. Personal finance issues and retirement are front and center as well.

People pay a lot of money for what frequently turns into a therapy session. Fully half of all consulting sessions start with an apology that sounds something like this: “I’m 37, but I haven’t retired yet.”

WHAT!

Your 37 and and haven’t retired? The inhumanity. But I have to take their words seriously! The words come out as contrition. These people feel like complete failures because they were still gainfully employed the day after their 30th birthday.

The steady stories of early retirees living the good life, traveling the world and loaded with cash has warped the worldview of many young people.

Another 15% or so of consulting clients already reached financial independence and partook of early retirement. Traveling grew old or they didn’t care for running around any more. They need guidance to get back into life.

Which leaves at best a third of my consulting clients who ask what I would consider normal questions of a tax guy.




Tears in Heaven

On more than one occasion it came to tears. Earlier this year a young man needed a consulting session bad. He started the session with an apology; he was 32 and still was working out of necessity. His voice broke and then the tears came.

This is why I felt somewhat the same as Suze Orman said she HATED! the FIRE community idea of frugality and early retirement. There is more to it than that. Some people take it to heart and experience depression when the extraordinary doesn’t come to pass.

Orman is wrong on many levels. She is too much of a self-promoter for me. But she does get it right often enough. That is why she reached the position she has as a trusted (by many) financial resource.

Orman is also right on a few things. A singular goal of early retirement smacks of narrow-mindedness. Exactly what do you plan on doing with all that time if not engaged in creating value? (Now you know why I’m an outlier of the FIRE community. Many stay far away due to my opinions concerned they may rub off. A recent visit to the doctor confirms I’m contagious.)

But if a community causes depression in some people it might be time to rethink the mantra. I’m only one guy and I have only so many therapy session time slots. There has to be a better way.

 

Publicly Speaking

A few weeks ago I was talking with Pete (Mr. Money Mustache) when I shared these facts with him. He was aghast. He had no idea people were experiencing these kinds of negative emotions due to the FIRE movement and his work.

Family, friends and loved ones are the true meaning of a happy and joyful life. Money and wealth don't make for an incredible retirement; you do.

Family, friends and loved ones are the true meaning of a happy and joyful life. Money and wealth don’t make for an incredible retirement; you do.

But it’s not Pete’s fault! Like many people Pete had the opportunity. Unlike many people he went for it and succeeded! His story resonated and for a reason. The MMM story provides a template for how it can be done.

Saving hard and investing gives you an advantage. If others are distressed it isn’t your fault!

I wish I had an easy answer for people struggling with FIRE community concepts. If you reached your 40th birthday, or God forbid, 50, before you retire there is no shame! Even if you retire at 70 or older there is no shame.

But the older guys are not the problem. When a 70 year old asks for a consulting session he doesn’t worry about early retirement; he wants guidance on financial issues, legacy planning, investments, taxes and medical problems. The pressure to retire early left the station long ago. And thank God for that. Pity is not a good place to begin a PF plan.

For the younger guys feeling the weight I need to convince them retirement isn’t the issue; financial independence is. Clients in their 20s want a firm game plan to reach the finish line no later than their 30th year. It’s an insane request.

Up to this point I just said what needed to be said, but the only way to get the message across is with an allegory. And I start with a joke so their minds open to options.

Here is what I say:

I’m not afraid of public speaking; I’m afraid people might actually believe what I tell them.

Public speaking is the number one fear for most people. People would prefer a root canal than to speak before a group.

Not me. I’ve never had an issue with speaking to a group of any size. I guess I’m weird that way.

What does scare the living bejesus out of me is that someone in the crowd may actually listen and take my words to heart. And that too is a bit strange. (It seems your favorite accountant is often half bubble off center.)

 

Easy Peasy

From the inception of this blog to today I’ve worked hard to outline where I failed and how I dealt with the issues. But no matter how hard I try people seem to think it was easy for me.

History seems preordained to future readers. The same applies to me. Readers know the outcome even when reading the struggles I faced and anguish I felt. There was no chance of failure. The outcome was known.

It was never easy and it certainly wasn’t a sure thing at the time. The nights I lay awake in bed in a cold sweat trying to figure out what to do did not guarantee an acceptable outcome. There were a few times when I thought I was finished for good. Business can mete out some bloody lessons.

And that is why public speaking doesn’t scare. I faced far worse deaths than dying on stage.

But what about my fear that people might take my words to heart?

That is where the real fear lies. When I accept a podcast or speak to a group (or even when speaking to a client in a consulting session) there is no guarantee my best advise will work. Like everyone else, my past is littered with good ideas that went bust!

My concern when working with any client is to prevent further harm. A victim of assault (yes, I’ve had a few sessions where personal safety was the primary issue) needs good advise, but the risks already exist and it is imperative I weigh my words carefully to prevent further harm.

Even when it comes to business, money and taxes I take great care. The mistakes I’ve made over the years are legend and a reminder of how fallible I am . Yes, a tax professional with my experience can get it wrong. (I know, it blows my mind, too!)

But it happens. The best laid plans often go awry. Standing in front of a group of people doesn’t cause the fear. The fear is later when I realize some of the attendees will take my words and use them. Using history as a guide I know some of those concepts will not work as designed.




Lots of Money

By now alert readers will point out the title of this post promised a happy retirement with money; lots and lots of cash.

I didn’t forget my promise and it wasn’t a click bait title either. Before I could deliver on the promise I had to expose you to the riptides under the surface of the FIRE community; a riptide even the fearless leaders of the community are probably not aware of.

Then I needed to share an allegory to illustrate the problem the leaders of the community face. The winners have a jilted view. They made it happen. They saved, invested and it worked. It is hard at times to see what is happening on the ground floor when sitting at the peak

There are many with serious medical issues not so lucky. Educational and business opportunities also play a key role.

Still, nearly anyone (I leave room for the possibility some have little to no chance of living the FIRE fantasy) can reach the goals espoused by the FIRE community.

Suze Orman was wrong to HATE! the FIRE community when she later admitted she didn’t fully understand the movement. (I think Suze Orman is a very smart lady and knew exactly what the FIRE community stood for. She also understands human psychology. She said exactly what she wanted and the FIRE community promoted her most recent book better than $100 million of advertising. We need to be smarter than that FIRE community and not be so easily baited.)

She did get one thing right. The FIRE community leaves many feeling empty when the bar is set so high that only a few can reach it (retire by 30 that is, not financial independence which is attainable by the vast majority).

The pursuit of financial independence and attaining said goal at any age is awesome! Feeling bad because some 30-something has his/her picture in the news feed enjoying another adventure around the world is the wrong impression to take.

Remember who I am! I consult with many of these people and speak with them periodically even if they aren’t clients. More than you think return to a “normal” job or start their own business after the shine comes off the bauble of early retirement.

So how do you reach financial independence? How do you get the loads of money I promised?

As my old friend Doug Nordman once said, “Your net worth is a product of

  1. your savings rate,
  2. investment fees and
  3. time.”

It’s as simple as that. The more you save and invest the better off you are, just give it a little time. The larger the percentage of your income you invest in low-cost index funds mixed with time determines your net worth. To reach your goals you only need to plug in the numbers and wait a bit.

If you want to retire sooner you have to increase your savings rate. The earlier you start the earlier your reach financial independence. Then you can toy with retirement until it gets old and you decide to start creating value again.

Of course your income will also plays a role. The higher your income the easier it is to save a larger percentage of your income. A good six-figure income can take you from zero to FI within 10 years. Minimum wage will take longer.




Retire Happy

The most viewed post of this blog was published years ago in April of 2016. In that post I share how I met Mrs. Accountant and how our relationship grew. I concluded the best way to have a rich, happy life (the best kept secret of early retirees, the wealthy and happy people) was to have a nurturing relationship with the one you love for life. In other words, I stayed married for over 30 years now (to the same woman, if I need to point that out!). This one fact is largely responsible for my level of wealth, happiness and contentment with life. (Every morning I wake and feel stunned by level of awesomeness my life has been. That same moment every morning I realize the relationship with the woman sleeping next to me is the most valuable asset I have.)

Early retirement gets all the press, but how you retire is what really matters. Retire to the life you will love at any age.

Early retirement gets all the press, but how you retire is what really matters. Retire to the life you will love at any age.

Money is the easy part! This blog and many others provide plenty of ideas to get rich. Even when I speak to a group and I fear someone might think I actually know something, I still utter a few golden nuggets you can use to have a better than even chance at knocking the ball out of the park.

Happy is the hard part because people don’t listen to what I say. There is no fear on my part when I explain what has made me happy in life.

And it’s more than happiness! Happiness is an event and fleeting. Winning the lottery or having a child or achieving early retirement at age 29 (eat your heart our mustachioed man) will bring happiness. Happiness creates a giddiness. And it is fleeting. Once the newness of the experience begin to fade, so does the happiness.

Instead, I encourage joy. Joy is much more than happiness and not dependent on an external event. Joy comes from in here (pointing to my head and heart) not out there. I imagine I will feel joy on my deathbed as I say goodbye to my children, family and friends. This isn’t happiness. I’ll miss the people I love and dying doesn’t sound like fun. But I will feel joy.

Joy is a more powerful emotion. In a world where people are brought to tears over a delayed retirement (delayed to some age less than 50 especially) it is important to spend less time on happiness (retiring at 30 brings happiness for a while) and more time experiencing joy. You can feel joy in any situation in any location. The choice is yours because joy is internal.

Joy is contentment, a coming to terms with oneself. Joy is gratitude for the gift of life. Even if it means a life of hardship and poverty.

Pete did a good thing when he set a goal of retiring by his 30th birthday and reaching said goal. His example can provide us with tools to achieve our own goals. (All those young people in the news feeds telling their story of early retirement provide the same material: a blueprint to help us design our own goals. Our goals; not their’s.)

If for some reason you manage to retire by the time you live 30 years on this planet I’m sure you’ll feel happiness. At least for a little while.

If you want to know the secret of happiness then you need to feel gratitude for whatever life has dealt you. Then you feel something even more powerful than happiness: JOY!

And nobody can take that away from you.

 

 

More Wealth Building Resources

Credit Cards can be a powerful money management tool when used correctly. Use this link to find a listing of the best credit card offers. You can expand your search to maximize cash and travel rewards.

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Side Hustle Selling tradelines yields a high return compared to time invested, as much as $1,000 per hour. The tradeline company I use is Tradeline Supply Company. Let Darren know you are from The Wealthy Accountant. Call 888-844-8910, email Darren@TradelineSupply.com or read my review.

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

PeerSteet is an alternative way to invest in the real estate market without the hassle of management. Investing in mortgages has never been easier. 7-12% historical APRs. Here is my review of PeerStreet.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregations studies work and how to get one yourself.

Amazon is a good way to control costs by comparison shopping. The cost of a product includes travel to the store. When you start a shopping trip to Amazon here it also supports this blog. Thank you very much!

 



Micro Business and Side Gig Tax Guide

Enjoy all the tax benefits allowed for owning your own micro business or side gig.

The reason for starting a side business are legion. Maybe early retirement left you with more free time than you know what to do with. Maybe you took early retirement a bit early with the intentions of earning some side income. Or, personal or family issues limit the hours available for gainful activities.

Micro businesses are a great way to earn more money without a massive expenditure of time. You can enjoy the best of both worlds: reasonable income and freedom.

But there is one factor that causes more headaches than any other: taxes. Micro businesses/side gigs have special tax rules that can cause serious problems, or, if done correctly, virtually eliminate your tax bill.

I’ve published on this in the past, but new tax rules require I provide an entirely new guide. Several notable changes require your attention. A misstep will cost you hard-earned tax dollars; a well thought out plan allows you to keep most or all of your side gig income.

 




Highlights of the Changes

First we need to define what I mean by a micro business or side gig. For this discussion I consider a business micro if profits (not revenue!) are less than $30,000 annually and are expected to remain so in the future. This profit level is confined by economic and personal factors. You still have a micro business if you elect to remain small.

By eliminating businesses with over $30,000 of profits we also limit the choices when we plan for taxes. That allows for a detailed analysis of the issues without concerns for larger side gigs.

One of the large changes to the micro business environment involves hobbies. In the past (2017 and prior) hobby income was reported on the front page of Form 1040 with expenses deducted on Schedule A as an itemized deduction. Hobby expenses could not exceed reported income from Form 1040 and the expenses were combined with multiple other deductible items (job search expenses, safe deposit boxes, tax preparations fees, et cetera) and then 2% of adjusted gross income was subtracted.

Starting in 2018 hobby expenses are no longer deductible in any amount while income is still required to be reported. The revamped Form 1040 also means you need Schedule 1 to report hobby income (see inset).

Where to report hobby income on a tax return.

Where to report hobby income on a tax return.

 

The other big change for micro businesses comes from §199A, the Qualified Business Income Deduction. This new animal allows for a 20% deduction on certain business income (profits) without an out-of-pocket expense. We don’t have to worry about limitations since we are focused on businesses/side gigs with under $30,000 of annual profits.

 

While tax code changes didn’t affect LLCs, S corporations or regular corporations (the C corporation), there are considerations for micro businesses when it comes to entity formation.

 

The Hobby Decision Tree

Even without the possibility of deducting any hobby expenses, there are times being a hobby might be advantageous. Before we begin this part of the discussion you should review this article to refresh your memory of who can and cannot report income as a hobby.

Why would anyone want to report income as a hobby? First, you may actually have a hobby rather than a sole proprietorship (a small business for tax purposes). Second, there is still a possible tax advantage to hobby income over small business income.

Hobby income does NOT incur self-employment tax on the income. A hobby with few expenses will be taxed less as a hobby than over a sole proprietorship.

Enjoy all the tax benefits allowed for owning your own micro business or side gig.

Enjoy all the tax benefits allowed for owning your own micro business or side gig.

Example: Fred has a hobby building model ships. He sells a ship every 4 or 5 years without a profit motive; he just likes building model ships in his free time. He meets all the criteria of a hobby. If Fred sells a model ship for $5,000 and reports it as business income he will face income tax at ordinary rates (determined by his income level), plus a 15.3% self-employment tax. Reported as a hobby Fred would not pay around $750 in SE tax. He would still pay income taxes on the hobby income at ordinary rates.

Once the self-employment tax issue is understood (or experienced), smart taxpayers start pushing their tax professional to list income as hobby versus small business income. However, you are automatically considered a business by the IRS anytime you turn a profit in 3 of any 5 year period. 

There are ways around every problem. First, you don’t have to conduct the same hobby every year. If you report hobby income every year, but from significantly different hobbies you should be prepared to explain to Revenue your position. (I would actually explain it with an attachment to your tax return every year you report hobby income in 3 or more of any 5 years.)

Second, you can enjoy your hobby like Fred. Fred loved the process of fleshing out a detailed ship from times past. He would spend a year or more on each masterpiece. Fred doesn’t have to sell a ship every year. He can sell his growing cache once every 4 or 5 years. (His wife might require Fred to divest in his some of with hobby creations due to space limitations. She might get sick of cleaning the growing horde of ships decorating every corner of the house.)

Because Fred has few expenses (perhaps $500 or less per ship) most of his income from the sale is profit. However, since he is a hobby he avoids paying self-employment tax on top of income taxes.

How do new tax rules affect your hobby decision? While avoiding self-employment tax can be enviable, hobby expenses are no longer deductible, meaning your income tax will almost certainly be higher. Your other income determines your tax bracket. High earners might be better off as a business than a hobby once expenses are considered.

Finally, don’t succumb to temptation to cheat. The IRS watches hobby income and gets irritable when the line is crossed. Yes, if Fred had a model ship hobby where he completed and sold a ship every 5 or for more years for $80,000 he could avoid SE tax. But he better be prepared to explain why he isn’t really a business. Be sure to read the article from the link about to gather a better understanding of where the line is if you plan on reporting income from a hobby.

 




Business Deductions

Business deductions that are “ordinary and necessary” and that are reasonable are allowed. This is a very wide road to travel.

Your business structure doesn’t change what can be deducted. A sole proprietorship, regular corporation, S corporation and partnership can all deduct reasonable ordinary and necessary business expenses.

Let’s talk about common deductions first. Anything related to your business is usually deductible. Advertising, rent, utilities, office supplies and bank fees are just a start. A painting to decorate a wall at your business or home office is ordinary and necessary because it creates a better profit producing environment. (A Picasso would not be reasonable and would be disallowed for all but the largest of businesses and even then might be a problem. Remember the expense needs to be reasonable.) Desks, computers, chairs are also business expenses, though they may need to be depreciated over a number of years.

There is a sweet spot in business deductions, too! While cash going out is easy to record and deduct, non-cash deductions are easily forgotten. You may qualify for an office in the home. With the standard deduction much higher now the office in the home might be a way to benefit from some of your mortgage interest and property tax expenses.

Explore all the tax benefits of a side hustle with this Micro Business and Side Gig Tax Guide.

Explore all the tax benefits of a side hustle with this Micro Business and Side Gig Tax Guide.

Mileage is another expense without an easy correlation. The mileage deduction can exceed actual cost, creating an additional non-cash deduction.

Meals and entertainment offers a choice when traveling. You can use actual expense or a per diem. The per diem can exceed your actual outlay providing another non-cash deduction. The beauty of this method is that you can choose which method you use for each business trip. High meal expense trips can use actual expense and low meal expense business trips can use the per diem.

Bonus depreciation is 100% this year for most new assets. The de minimis election to deduct rather than capitalize tangible property with a class life of 20 years or less and with an initial cost of $2,500 or less also allows for faster expensing of most business assets purchased.

You can even estimate some expenses! If receipts are lost or destroyed you can use reasonable numbers for expenses, except for meals & entertainment, travel, auto expenses and listed property. Advertising, supplies and postage can be estimated if records are unavailable. Be sure to review the rules with the link at the beginning of this paragraph to avoid problems.

And here is a final deduction nugget frequently overlooked. If you have a customer appreciation event, Christmas party for the office or other business event at your home you can charge your business a reasonable fee (deductible) and not report it on your personal return (tax-free) if you rent out your home for 14 or fewer days per year. To determine “reasonable”, check around locally for the cost of renting a similar facility. As always, document ad nauseam.

 




Retirement Planning

Even the owner of a micro business can reduce or eliminate income taxes.

We turn now to deductions that amount to moving money from one hand to the other and receiving tax advantages as a result.

There are a host of retirement plans available to micro business owners unless the income is classified as hobby income.

SEP plans are probably not the best choice for a micro business due to contribution limitations based on income. (20% of a $20,000 profit is only $4,000).

401(k) plans, including solo plans, allow for larger deductions ($18,500 in 2018 and $19,000 in 2019) but can have higher fees than other options.

If other income doesn’t preclude an IRA contribution you then have a choice: Roth or traditional. The maximum contribution allowed for either is $5,500 in 2018 and $6,000 in 2019; folks 50 and older on the last day of the tax year can add an additional $1,000.

If the traditional or Roth IRA are not allowed or not enough for your needs you should consider a SIMPLE IRA. SIMPLE IRAs are just the way they sound: simple. They are simple to setup and maintain with low fees, if any. Investment houses like Vanguard and Fidelity will help you with the process if you have issues. The best part of SIMPLE IRAs is the higher contribution limits: $12,500 ($13,000 for 2019) with a $3,000 additional catch-up provision for those 50 and older on the last day of the tax year. Also, you can contribute 100% of your business profits up to the contribution limits! This means if your micro business earns $10,000 per year you can contribute the entire amount, avoiding income tax on your business income (SE tax is stilled owed on business profits regardless of retirement plan contributions).

 

§199A: The Qualified Business Income Deduction

This new and unique deduction is in the news a lot lately. The Code is vague on certain issues at it pertains to the §199A deduction. While vague may sound like a problem, tax professionals deal with vague tax issues all the time. It comes with the territory.

We can avoid many of the complicated issues because we limited our discussion to micro businesses of less than $30,000 of annual profits.

Owning a micro business/ side gig/ side hustle is rewarding and profitable. Use this guide to pay the least amount of taxes with your venture.

Owning a micro business/ side gig/ side hustle is rewarding and profitable. Use this guide to pay the least amount of taxes with your venture.

Real estate investors of income property can also benefit from the 199A deduction. (Generally an income property investor must meet the definition of a “trade or business” (undefined as of this writing) before taking the QBI deduction up to the level of profit or 2.5% of the original basis before adjustment, whichever is less.)

Regular corporations saw a massive reduction in their marginal tax rates, except for the lowest bracket which was increase from 15% to the flat rate for regular corporations of 21%. Unlike partnerships, S corporations and sole proprietorships, the §199A deduction does not apply to regular corporation.

Revenue issued some guidance on the QBI deduction. One thing is certain, the deduction is allowed for all business entities, except regular corporations. Partnerships that pay guaranteed payments to partners (the paycheck portion paid to owners of a partnership, in a manner of speaking) will reduce the QBI deduction.

Example: Sally and Mark form a 50/50 partnership to sell widgets. They have one part-time employee. The employee receives a weekly wage and a W-2 at year-end. Sally and Mark agree to pay themselves $100 per week. They do not get a W-2! Instead, their payments are considered guaranteed payments to partners. If profits are $20,000 after all expenses, including guaranteed payments to partners, they use $20,000 to calculate their QBI deduction of $4,000.

S corporations generally require more than $30,000 of annual profits to be a viable choice for tax reductions. If you have an S corporation you must pay reasonable compensation to owner/employees which reduces the QBI deduction.

Sole proprietors do not pay themselves a wage or receive a W-2. Instead, they take draws. QBI is generally the reported profit of the sole proprietorship without regard to self employment taxes. Once again, multiple by 20% and deduct.

The QBI deduction is not taken at the entity or business level. The deduction is claimed on page 2 of Form 1040, Line 9 (2018 tax forms).

Claiming the Qualified Business Income (QBI) deduction(Section 199A) on your tax return.

Claiming the Qualified Business Income (QBI) deduction(Section 199A) on your tax return.

Caution! My journals have some conflicting advice on reasonable compensation to S corporation owner/employees and guaranteed payments to partners. Before Revenue released guidance on August 8th some felt guaranteed payments to partners and reasonable compensation to S corporation owner/employees would be added back before calculating QBI. Sharp readers called me on this. The reason for the assumed (by some people) add-back before guidance was released is so high earners couldn’t play with reasonable compensation to qualify for the QBI deduction in certain service businesses. Guidance now indicates QBI is profit after reasonable compensation or guaranteed payments.

Planing tip! Because S corporations require reasonable compensation to owners/employees, micro businesses probably do better as a sole proprietor since there are no wages to the owner to reduce QBI.

 

Entity Selection

I preach LLCs treated as S corporations a lot. However, micro businesses rarely benefit taxwise from such a structure. In most cases S corporation treatment does not lower taxes enough to offset costs of organizing as an S corporation until profits consistently exceed $30,000. Even $30,000 is really low! I prefer to see $50,000 or more before deciding to switch to an S corporation and only if it appears profits will remain north of $50,000 in future years.

We are discussing micro businesses of under $30,000 of annual profits so organizing as an LLC is fine for legal purposes, but electing to be treated as an S corporation is a questionable move if taxes are the reason why.

Your S corporation may have started as something bigger and withered over the years as you downsized. Keeping the S corporation may be more convenient than moving to a sole proprietorship.  For these reasons we’ll touch on S corporations.

S corporations generally pass all their profits to the owners on Form K-1. The QBI deduction is not lost! Rather, as stated above, owner’s wages are added back with 20% of this higher total deducted on page 2 of Form 1040.

We already discussed partnerships above.

While I focus on tax considerations, entities serve a legal purpose as well. I encourage you to discuss the legal ramifications of entities with a competent legal professional.

While the sole proprietorship is easy to organize, it also pays the most tax of any form of conducting business. Sole proprietors also face a highest federal audit risk, around 4% per year. Corporations (regular and S) and partnerships are audited at well below 1% per year. For this reason  alone you may wish to organize even a micro business as an S corporation, regardless of the tax ramifications.

 

The Best Tax Choice

Here is a step-by-step guide to deciding how to manage your micro business:

  1. Are you a Hobby or business? It makes a difference. A hobby is by far the easiest way to report income. But no expenses are allowed while SE tax is avoided.
  2. Choose an entity structure. An LLC provides legal protections and takes on the tax flavor you want. A single member LLC defaults to a sole proprietorship and if there are two or more owners to the business, partnership is the default. These are called disregarded entities (disregarded for tax purposes only, not legal purposes.)
  3. Make sure you don’t miss any deduction.
  4. Take advantage of the QBI deduction.
  5. Consider retirement plans.
  6. Enjoy! It is a micro business for a reason. Your goal is a bit of extra money while engaging an enjoyable activity.

 

Note: Technical corrections were made to this article. The complexities of the Tax Cuts and Jobs Act have caused serious issues when tax planning. The IRS issued some guidance on August 8, 2018, but more issues remain. Tax professionals are encouraged to contact the author if they disagree with a statement here. I have attended several training programs this year on the new tax rules and there are areas of disagreement between programs. I’ll make additional technical corrections as they are discovered by readers (or me) or further guidance is provided by Revenue.

 

More Wealth Building Resources

Credit Cards can be a powerful money management tool when used correctly. Use this link to find a listing of the best credit card offers. You can expand your search to maximize cash and travel rewards.

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Side Hustle Selling tradelines yields a high return compared to time invested, as much as $1,000 per hour. The tradeline company I use is Tradeline Supply Company. Let Darren know you are from The Wealthy Accountant. Call 888-844-8910, email Darren@TradelineSupply.com or read my review.

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

PeerSteet is an alternative way to invest in the real estate market without the hassle of management. Investing in mortgages has never been easier. 7-12% historical APRs. Here is my review of PeerStreet.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregations studies work and how to get one yourself.

Amazon is a good way to control costs by comparison shopping. The cost of a product includes travel to the store. When you start a shopping trip to Amazon here it also supports this blog. Thank you very much!



Reduce Your Taxes to Zero!

Listening to an experienced accountant explain a tax situation sounds like easy work even when the words and numbers sound strange. It is rarely so easy connecting the dots, however.

The Tax Cuts and Jobs Act (TCJA) passed December 22, 2017 changed how you are taxed in ways we haven’t seen in over a generation. New opportunities to reduce your tax liability were opened, but the real advantages are hidden from plain view. It takes an experienced hand to ferret out the unexpected connections that can make or break your financial condition.

Today we are going to explore a thought experiment where we outline how the TCJA can super charge your tax savings. But first we have to tell a story.

A Chance Encounter

I spend my days researching the tax code for ways to help clients (that’s you, kind readers) reduce or even eliminate their tax liability. Some ideas are old and well-known. Others are somewhat unique in their application to the specifics of a client’s needs.

Our story starts with a longtime client and a real estate agent.

Wouldn't it be great to know all the tax reducing secrets of tax professionals? Now you can. Check out how accountants reduce their taxes to zero.

Wouldn’t it be great to know all the tax reducing secrets of tax professionals?

In my office there is a family limited partnership with several pieces of commercial property. One of their leases was coming up and I was unable to determine an accurate lease rate. Market rates are changing as real estate values climb.

Since it was my job to advise my client on an accurate lease rate I had my assistant call multiple sources around town to get an appraisal. My client was also interested in selling if the price was right.

After serious vetting we settled on a real estate agent with a history of success in the local commercial real estate market.

I was pleased the agent was wiling to provide a market analysis (a quasi appraisal) without fee. The agent provided the service and hoped to get the business if he did a good job.

My client also had a mini-mall with a vacancy. The current listing agent wasn’t able to sell or lease the unit in years. I convinced my client to get an assessment on this property as well.

The agent preparing the market analysis was fast, efficient and informative. The tenant of the first building we needed to update the lease with also wanted to buy. There was no need for the agent (or the fee) to sell or lease this property.




Good Luck

As luck would have it the tenant of the first building wanted to buy. My client was happy.

I felt it was fair to list the second property with the agent as a gesture of goodwill for his work assessing both properties. The agent did good work, followed up and was professional.

My client dragged his feet. The second building had one vacant unit with nobody working it now. I had to light a fire under my client.

After weeks (it was really a few months) of pleading my client finally relented and decided to let the agent offer the property for lease and sale.

The agent sent his assistant to pick up the paperwork the same day it was signed.

It Pays to Talk with People

It was getting to be 4:30 when the agent’s assistant showed up. I explained we sold the first building and didn’t need his services for that building. The assistant was good with that and understood our reasoning.

I then explained a unique tax strategy (a cost segregation study) that I shared with the buyer of said property. I mentioned to the assistant the buyer would save over $100,000 in taxes even though he was closing on the last business day of the year. These tax saving would be the result of a $300,000 first year deduction for owning the property a single day of the year!

People who know me understand how quiet I tend to be (dad, stop laughing). You can’t pry a word out of me.

Okay, I enjoy deep conversation that leads to massive results.

As I talked with the assistant I explained how the TCJA made it easier than ever to never pay income tax again. As we talked I kept building a bigger and bigger pyramid of tax savings strategies involving real estate. Many of these strategies would help the agent’s clients.

Needless to say, he took several of my cards. I reduced taxes for local businesses by several million dollars in less than one and a half hours. That short conversation opened a can of worms that will benefit this accountant’s communities for years to come.

And it was only possible because of the chance encounter with the agent. I knew all these things, but until that moment I hadn’t put the pieces together. Months of relentless research gave me the tools to excel at helping my clients in their tax matters as it pertained to the new tax laws.

And this is where you come in, kind readers.

The Gift that Keeps Giving

What I am about to share is merely a thought experiment. I will use large and round numbers because it is easier to understand that way. Many of these ideas will work for people with lower incomes. But in the end I will show you how you can have a million dollars in gains, pay no tax on said gain and end up with a $400,000 loss on your tax return you can use to offset other income.

Do I have your attention yet?

I hope so. This is new; this is novel, but it will work. The tax law is clear. What I am proposing can reduce your income tax to zero with extra deductions is case you have other income you need deductions against!

You will also seriously consider selling income properties you currently own to use this information. In fact, you may want to pass on like-kind exchanges (the old, and still usable, way to defer taxed on real estate) in the future. But I’m getting ahead of myself.




Step-by-Step Profits

The best way to understand my strategy is see it in action step-by-step. Because there are several ways to apply this strategy I will provide multiple solutions to the word problem.

Background:

Before we start I need share a few things that have changed in the tax code. Like-kind exchanges are a way to defer the gain on business or income property you sell by transferring the gain to a replacement property. While this tax strategy is still available for real estate, it is nixed in 2018 and after for business property. Capital gains from other investments are always taxable, until this year.

I sometimes get complaints that my tax strategies don’t apply to everyone. This is true. Not everyone can benefit from every strategy. The goal is to provide a framework that is understandable and modifiable for personal needs. While this works best for property owners with large gains, it can be tailored to lower incomes as well. It also assumes you have capital gains as that is our starting point. Wages and business income are not the driver of this strategy. If you want to reduce business income taxes you can read this. Wage earners should probably focus on retirement plan first as these provide significant deductions.

Starting Point:

We start with capital gains since real estate and the stock market have been climbing for a good decade now. The gains in these investments are huge and a real problem to diversify without incurring a large tax bill.

Real estate might seem easier since like-kind exchanges (sometimes known as 1031 exchanges) are still available. But a like-kind exchange requires a replacement property be identified within 45 days and closed within 180 days. And all your money stays in the replacement property to receive the tax benefit. (You can borrow against the equity of the replacement property after closing, but this costs you interest.)

It is easier than ever to reduce your income taxes to zero. Read how the wealthy and tax professionals pay no income taxes.

It is easier than ever to reduce your income taxes to zero.

With this in mind we need to deal with either large unrealized stock market gains or a piece of real estate with a large gain over basis (purchase price plus improvements minus depreciation).

For our example we will consider a stock investment (mutual fund, ETF, index fund, individual stock or other asset with an unrealized gain) with a $1 million unrealized gain and/or a piece of real estate with a large gain if sold.

The good news is that ALL capital gains are now super easy to avoid with a Qualified Opportunity Fund. I will not get into all the details of Opportunity Funds since I published recently on the topic in detail, available through the link.

For our thought experiment we can realize a capital gain from a real estate or investment sale and avoid reporting of the income currently. A million dollar gain can be deferred to 2026 and only 85% is taxed at that time with deflated dollars.

But Opportunity Funds are more than deferred taxes with a small tax reduction enhancer! All the gains within the Opportunity Fund (not the original gain, but gains on the capital gains invested in the Fund) are tax-free if held for 10 years or more.

Another benefit of Opportunity Funds over a like-kind exchange is how much needs to be reinvested. With the like-kind you need to buy a replacement property of equal or greater value to defer tax on all gains. Under the new rules only the GAIN needs to be reinvested in the Opportunity Fund within 180 days. The basis you can do whatever you want with.

Example: You have a duplex you bought for $200,000 and depreciated $50,000. You sell the property for $500,000. You can pocket your remaining basis ($150,000) and invest the taxable gain of $350,000 in an Opportunity Fund, avoiding any tax on the gain until 2026. (We will disregard depreciation recapture in this discussion so the examples don’t get muddy.)

Example: You bought $100,000 of Apple stock and now want to diversify without tax implication. Your Apple stock is now worth $1,000,000. You sell the stock, invest the capital gains in an Opportunity Fund and use the original $100,000 for whatever you want. Only 85% of the $900,000 capital gain will be taxed after 7 years and all the profit the $900,000 generates is tax-free after 10 years in the Opportunity Fund.

A Better Idea:

Selling your appreciated assets (investments or real estate) is only the starting point on your journey to tax-free freedom. Remember, you only deferred most of the gain. And if you have other income (business income, wages, dividends, interest or rental income) in need of deductions to avoid income taxes currently, you need another step.

Enter, real estate.

I assume you are not adverse to income property ownership in this stage of our game.

In our above examples we have large capital gains we deferred gains on and either $100,000 or $150,000 of basis we could do whatever we want with. I suggest buying a good piece of income property.

By good income property I mean a property that cash flows. You may need to buy something further from home base and utilize a property manager. This is probably a good thing regardless.

Without the necessity of replacing a property with an equal or greater value you have more choices. A half million dollar property doesn’t need to be replaced. Instead, with your basis from the sale, you can buy an income property that cash flows right out the gate and get more tax benefits.

Let’s jump to the cost segregation study again. You can read more with the link, including who I refer my clients to for a cost segregation study.

For a cost segregation study to work the property involved needs to have an original basis (generally the purchase price) of $300,000 without considering the value of the land.

The basis from the original sale in your pocket is perfect for a down payment on the property we are eyeing.

Example: Assume we buy a new income property (or properties) for $700,000. Under current tax rules a cost segregation study will turn approximately $300,000 of the purchase price of the building into a deduction the first year!

What this means: Think about this for a second. You sold a stock or rental property with a massive gain. You deferred/avoided tax on the complete capital gain by investing said gains in an Opportunity Fund. Then you decide to use the basis from the original investments as a down payment on an income property and conduct a cost segregation study. This equates to a $300,000 deduction on your tax return while avoiding tax on the capital gains! If you are a real estate professional or use grouping you can use this deduction against other income still being taxed.

But wait!!!

If you buy right now we will include this free pocket calculator. Keep it even if you return the product. It’s our way of saying. . .

Okay, I got carried away.

But I’m not done. there is even more!




Why You Want to Sell NOW!

Up till this point we played with big numbers with a focus on real estate. Deferring capital gains from any source is simple under current tax rules. A $30,000 mutual fund gain is easily deferred/avoided just as easily.

But what about landlords. If you own real estate now you might want to consider selling!

Remember our thought experiment above where we defer gains and apply cost segregation studies on new properties? If you already own real estate with gains you have an additional tax planning tip.

Cost segregation studies are possible on properties you held for years. The tax benefits are still tremendous.

However, unleashing gains on existing properties is a powerful way to spike cash flow!

More isn’t always better so I always recommend property managers for the day-today tasks of property management. Your job is to buy the right properties at the right price. Rinse and repeat. The manager/s should handle the rest.

Example: In this example we will start with three income properties you owned for 10 years. We’ll assume you have a combined basis of $500,000 on these properties with a market value of $1 million. A cost segregation study on each of these properties is inadvisable (each property is less than $300,000).

They say taxes are for the poor. No more. Keep your hard earned money where it belongs: your pocket. The rich have many ways to avoid taxes. Here are three you can use.

They say taxes are for the poor. No more. Keep your hard earned money where it belongs: your pocket.

If you keep the properties your cash flow grows only as fast as market rates for the three properties. You pay tax on all the profits after expenses.

Unless you sell!

That’s right. Sell the three properties. Invest the capital gains in a Qualified Opportunity Fund and use the $500,000 basis as the down payment for a larger value property where a cost segregation study will work well.

Assume we find a multi-unit complex for $1,000,000. The half million capital gain is in Qualified Opportunity Funds avoiding tax while the other half million is available for any use you want. Whether you use all the excess money from the previous sale or borrow more funds to purchase the complex, you will realize around a $400,000 deduction under current tax rules due to the cost segregation study. This massive deduction is available to reduce your other income property profits or income from other sources in many cases.

If the three income properties were throwing off $4,000 a month, the complex should be doing the same or more and the cost segregation study will generate a deduction to eliminate the tax on these profits. (Your taxes would be low or zero in this example if you had no other reportable income so other factors must be considered before you proceed.)

Example: Here is another example worth considering. Let’s say you’ve owned a property for decades and depreciated the property to the land only. The property is throwing off oodles of cash flow, but it is all taxed because there are few deductions (mortgage is paid off,too) and no remaining depreciation.

Capital gains from the sale would go to a Qualified Opportunity Fund to defer/avoid taxes once again. Buying another property to replace the lost cash flow opens the opportunity for a cost segregation study.

I didn’t use numbers in the last example for a reason. The idea is to provide a framework you can tweak to your personal needs. The idea is to keep cash flow pouring in while reducing or eliminating income taxes from any and all sources. The only way to do that is with a new piece of property.

Coda

Taxes are complicated and getting worse. Today’s thought experiment is not meant as a definitive guide to eliminate taxes. Rather, my goal was to help you think differently about taxes and strategy.

The tax code may seem straight forward, but the real benefits come from putting the pieces together. I asked my Facebook followers if they would like a program to reduce their taxes to zero. The response was overwhelming. I asked the same group what taxes they wished they could avoid taxes on this year. Capital gains came up often.

We didn’t cover every type of income or every income level. The idea is to plant a seed in your brain so it can grow.

The TCJA is a massive piece of legislation. The advantages are hard to grasp in the basics and putting the pieces of the jigsaw puzzle together in a way that benefits you is even more difficult.

What I provided above should have been a pleasant exercise. You can see how the new puzzle pieces have increased the opportunities to reduce your tax liabilities.

It might be a good idea to read this a few times and even save it. Share it with friends (enemies don’t deserve this level of tax savings). You might even want to use a highlighter on key points:

  • Sell with no current capital gains tax using Qualified Opportunity Funds and
  • Buy quality real estate where a cost segregation study works well to eliminate all other income taxes.

Below I include the regular list of additional Wealth Building Resources I attach at the end of posts over the last half year or so. You can find cost segregation links easily there from all current posts.

Finally, don’t be afraid to think outside the box when it comes to taxes. Now is the easiest time to reduce your tax liability in over 100 years. Use this opportunity to fuel your net worth.

These good times are unlikely to last forever.

 

 

More Wealth Building Resources

Credit Cards can be a powerful money management tool when used correctly. Use this link to find a listing of the best credit card offers. You can expand your search to maximize cash and travel rewards.

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Side Hustle Selling tradelines yields a high return compared to time invested, as much as $1,000 per hour. The tradeline company I use is Tradeline Supply Company. Let Darren know you are from The Wealthy Accountant. Call 888-844-8910, email Darren@TradelineSupply.com or read my review.

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

PeerSteet is an alternative way to invest in the real estate market without the hassle of management. Investing in mortgages has never been easier. 7-12% historical APRs. Here is my review of PeerStreet.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregations studies work and how to get one yourself.

Amazon is a good way to control costs by comparison shopping. The cost of a product includes travel to the store. When you start a shopping trip to Amazon here it also supports this blog. Thank you very much!

 



Opportunity Funds: Deferred and Tax-Free Gains

An Opportunity Fund can defer or eliminate capital gains taxes. Keep more of your money. #wealthyaccountant #capitalgains #taxes #investments #opportunityfunds
Jump for joy! You get to keep more of your money. Reduce or eliminate capital gains taxes with an Opportunity Fund. #wealthyaccountant #taxes #capitalgains #profits #opportunityfunds

Jump for joy! You get to keep more of your money.

The Tax Cuts and Jobs Act of 2017 brought several new opportunities to reduce your tax burden. A few previous options have been reduced or eliminated. First the bad news.

Like-kind exchanges are now limited to real estate. Capital gains in real estate can be deferred into a replacement property if complicated tax rules are followed. The same cannot be said for business property any more.

The good news comes to us in what is known as §1400Z-2 and §1016(a)(38) as added or modified by the Act. This might sound like a mouthful, but once you understand the implications your mouth is sure to start salivating. In a language normal people understand this means ALL capital gains can be deferred with some gains even tax-free at some point. It also means future gains (for a limited time only as we’ll discuss shortly) can be completely tax-free!

Your favorite accountant has received multiple requests to cover these new Opportunity Funds and Zones in detail due to the conflicting and limited information published elsewhere. In this post we will dig deep into the subject, unveiling the nuances you can use to take a serious bite from your tax liability.

We will also use multiple examples to illustrate available options in utilizing Opportunity Funds.




The Basics

Opportunity Funds were created by the Act to encourage investment in economically disadvantaged areas of the country. To encourage investment in these areas Congress provided for zones that would have special tax advantages.

There are two major advantages when investing in Qualified Opportunity Funds:

  1. Tax deferral: Taxes on capital gains invested in a Qualified Opportunity Funds are deferred while the funds are invested in the Fund.
  2. Partial tax-free capital gains: Some of the capital gains deferred become tax-free in some instances (discussed later).
  3. Tax-free growth: Capital gains on investments in a Qualified Opportunity Fund become tax-free if held for 10 or more years.

Point 3 above comes with caveats we’ll discuss below. Deferred gains of the investment used to fund the Qualified Opportunity Fund need to be recognized on December 31, 2026 (or when the investment is sold, whichever comes first) even while the gains from the Fund investment continue deferring to the 10 year anniversary where they become effectively tax-free. Examples below should clarify.

An Opportunity Fund can defer or eliminate capital gains taxes. Keep more of your money. #wealthyaccountant #capitalgains #taxes #investments #opportunityfunds

An Opportunity Fund can defer or eliminate capital gains taxes. Keep more of your money.

You are allowed one temporary election to defer gain. In other words, you can use a portion or all of a gain to invest in a Qualified Opportunity Fund, deferring the gain, and the remainder is reported as gain with applicable taxes paid in the year realized.

You self-elect. Revenue may produce a new form to report this election which is attached to your tax return when you file. You have 180 days to invest the gains into a Qualified Opportunity Fund. The act of investing these gains into a Qualified Opportunity Fund within the 180 day window is your effective election.  You will probably have a simple election button to click on your tax software to report the deferral instead of an additional form to fill out. Be sure to track your Fund investments manually if you change accountants or switch tax software.

The 180 day window to invest includes weekends and holidays. The Act is unclear on this issue, but it seems to indicate 180 calendar days rather than 180 business days, even if the 180th day falls on a holiday or weekend. There is no extension of the 180 window to the next business day.

Only gains are involved. Like-kind exchanges use a complicated formula to determine the amount required to be invested in the replacement property. With Qualified Opportunity Funds only the gains need to invested.

Example: You buy a piece of land for $100,000 and sell it in 2018 for $250,000. Only $150,000 of the sale is required to be invested in a Qualified Opportunity Fund to defer taxation on the gain.

 

Issues

Before we dig down into the details you should note there are several issues with the Tax Cuts and Jobs Act. In at least one section of the Code there is a reference to another section which makes no sense. We are left to assume what Congress meant if a reconciliation bill doesn’t correct the errors. The IRS will eventually write regulations on the ambiguous issues with the Tax Court determining the actual nature of the issues in question.

Another issues involves the IRS. Revenue promised clarification by late summer. As of this writing the IRS has not provided the form for self-certifying for those wishing to start their own Fund or additional guidance on how to handle many of these issues. The tax profession is left to determine the procedures with the risk regulations and/or the Tax Court may later determine differently.

I will note where the ambiguous issues reside as we review examples below. Taxes by nature have similar issues. Using Qualified Opportunity Funds to defer capital gains is something to consider. Just understand some details may change in the near future. Of course, the Tax Code can be modified at any time so stay tuned for updates.




Tax Benefits

The tax benefits from investing in a Qualified Opportunity Fund are significant with a bonus benefit.

  • Any capital gains invested in a Qualified Opportunity Fund within 180 days of a realized capital gain is deferred until the investment is divested or December 31, 2026, whichever comes first. There is no limit on how much can be deferred. Caution!  While the 10 year rule is still in effect, the tax deferral benefit ends December 31, 2026 and the original capital gain will be reported as income minus the basis adjustment discussed next. You are still required to hold the Qualified Opportunity Fund investment 10 years to receive tax-free status on the Opportunity Fund investment.
  • Investments held in a Qualified Opportunity Fund for 5 years receives a 10% basis adjustment and a 15% basis adjustment for capital gains deferred into a Qualified Opportunity Fund for 7 years. Example: The wording of this tax benefit can be confusing. If you have an income property held for decades with the entire basis (except land) depreciated, the basis is rather low or even zero. However, for this adjustment we use the basis of the deferred capital gain. If $1 million of capital gain is deferred, $100,000 is added to basis after 5 years and $150,000 after 7 years, thereby reducing the deferred capital gain by 10 or 15 percent.
  • There is a 10 year rule when investing in a Qualified Opportunity Fund to receive tax-free treatment of the capital gains from the Fund. Do not confuse this with the original deferred capital gains. Example: Using the above example, assume an $800,000 capital gain while invested in the Qualified Opportunity Fund over a 10 year period. The original capital gain is reduced by the 15% basis adjustment and reported (if held 7 or more years) when divested or on the 2026 tax return for calendar year taxpayers. The additional $800,000 capital gain from the 10 years invested in the Fund become tax-free.
  • While the beauty of investing in Qualified Opportunity Funds involves the deferral of capital gains, there is nothing precluding someone from investing non-capital gains funds for 10 years to receive tax-free capital gains from the Fund. (Jake Drum, a reader, suggested the following edit: You will be able to contribute non-capital gain dollars to the Fund, but only the capital gains contributed will receive tax benefits. See his comment below with my response.)

 

Observations and Examples

The concept is simple in theory, but nothing in the Tax Cuts and Jobs Act is as simple as it seems. (A true statement of the entire tax code.) The details are important when such a long-term investment is required to receive tax benefits. Details of your personal situation can color the benefits of the program.

  • Only one election can be made per sale or exchange. However, a temporary election can be made and a permanent election made later. The temporary election is the one made from gains invested in a Qualified Opportunity Fund where gains are temporarily deferred and the permanent election is made when you the sell an investment in a Qualified Opportunity Fund.
  • Revenue will need to clarify the temporary and permanent election issues. It seems the one election limit prevents reinvestment of gains from the sale of a Qualified Opportunity Fund into another Fund.
  • It is possible the gains from an installment sale would be limited to one temporary election only. This would limit the value of an installment agreement if deferral is desired.
  • Section 1400Z-2(a)(1)(A) of the Code appears to be in error as it references the wrong section of the Code. There is a similar error in §1400Z-2(b)(1)
  • If your investment in the Qualified Opportunity Fund declines the FMV is used to compute the gain after the deferral period ends, allowing for a reduction in the reporting of the deferred gain on your tax return. This effectively reduces your original capital gain.

Example: You defer $100,000 of gain by investing the gain in a Qualified Opportunity Fund. The investment declines by $10,000 at the time of sale. The reported original gain is now $90,000 ($100,000 deferred gain minus the $10,000 loss in the Fund).

  • While nothing precludes an investment in a Qualified Opportunity Fund from non-gain sources, the basis of your investment in the Fund is zero with some exceptions. If the Fund is sold prior to the 10 year period all the sale price is considered gain. If you are considering an investment of non-gain funds you must be certain you will remain invested the entire 10 year period or your original investment will be taxed as well as the Fund investment profit.
  • The only adjustments to basis is a 10% addition to basis after holding the Fund investment for 5 years and 15% after 7 years.

Example: A deferred gain (or non-deferred gain if you choose to do so) is given basis at the 5 and 7 year mark. If you invest $100,000 in a Qualified Opportunity Fund the basis is zero during the first 5 years, less a day. At 5 years the basis would be adjusted to $10,000, and $15,000 at 7 years. It also appears this only applies to deferred gains when the temporary deferral period ends December 31, 2026 and recognition of gain is required. An actual sale of your Fund investment would cause a circular computation negating the basis gains.

  • If you invest gains and non-gains into a Qualified Opportunity Fund it is treated as two separate investments: deferred gains as one and other than gains invested as the other.

Example: You sell an asset with a $100,000 gain. You elect to defer $80,000 immediately by investing in a Qualified Opportunity Fund. Later you decide to invest the remaining $20,000 of the gain. Unfortunately, the one-election limit doesn’t allow deferral of the $20,000 portion on the Fund investment. The $20,000 does not qualify for deferral and must be included in income the year the gain was realized.

Example: Let’s go the other direction. You once again have a $100,000 gain. You instead invest $125,000 into a Fund. Only the $100,000 gain is deferred and considered one investment (the temporary election) and the additional $25,000 as another investment. This is true even if the investment was made in one combined sum.

  • Once again, the temporary deferral period will be different from the permanent exclusion period. Deferred gains (if held to December 31, 2026) are reported on your 2026 tax return while the exclusion period of the Fund gain will continue for 10 years which means most deferred gain will be reported as income prior to the exclusion gains becoming effective due to the 10 year investment requirement.

 

Risks

Qualified Opportunity Funds are new and must invest at least 90% of Fund assets in Qualified Zone property. Qualified Zone property is located in low-income areas of the U.S. These untested investments could suffer significant losses in an economic downturn. There is also the risk new Funds are operated by unseasoned professionals.

Serious levels of due diligence is required before and investment is made in any Qualified Opportunity Fund.




Investment Choices

Several Qualified Opportunity Funds have opened to date. Still, the choices available are lower than in many other asset classes. You can use a search engine to find Funds to invest in. The Fundrise Opportunity Fund is one such example of a Qualified Opportunity Fund.

Fundrise is not an affiliate nor affiliated with this blog, nor have I reviewed their portfolio. I make no claims as to the suitability of investing in Fundrise. It is advised you begin your search for a suitable Qualified Opportunity Fund as soon as possible. The 180 day investment window provides adequate time for in-depth review of Fund choices if you start early.

 

Starting Your Own Qualified Opportunity Fund

You can also start your own Fund to manage your deferred gains.

An Opportunity Fund could be a better choice over a like-kind exchange when it comes to how much money you keep after taxes. Learn the details here to keep more of your money. #wealthyaccountant #taxes #capitalgains #investments #oppoertunityfunds

An Opportunity Fund could be a better choice over a like-kind exchange when it comes to how much money you keep after taxes.

A Qualified Opportunity Fund must be a corporation or a partnership. (An LLC electing to be treated as such for tax purposes should pose no problem as it isn’t specified or excluded in the Code. An S corporation is not an option; only a regular corporation or partnership can be a Fund.)

 

Observation: A Fund can’t be organized for the purpose of investing in other Qualified Opportunity Funds. The IRS may provide future regs modifying this situation. As of this writing a Fund should not invest in another Fund.

 

Here is the best part of starting your own Qualified Opportunity Fund: you self-certify. Do you like that? The IRS will have a form by late summer (not yet available as of this writing) which you fill out and attach to your corporate or partnership return. It’s as simple as that.

 

Observation: Here is a map of the U.S. with all the Qualified Opportunity Zones listed. Starting your own Fund gives you some control over how your money is invested. However, you can only make investments in Qualified Opportunity Zones.  You will need to zoom in to see the actual Zones.

 

What can your Fund invest in? Investments must be tangible property used in trade or business of the taxpayer and meet these three requirements:

  1. The property was acquired after December 31, 2017 in a Qualified Opportunity Zone.
  2. Use begins with the Fund or the Fund substantially improves the property. Substantial improvements are defined as additions to basis for the property after acquisition during a 30-month period where the basis is increased by an amount greater than basis at the beginning of the 30-month period. Example: Property has a $100,000 basis at the beginning of the 30-month period. Substantial improvements would require additions to basis of greater than $100,000 by the end of the 30-month period.
  3. Substantially all the use of the property must be within a Qualified Opportunity Zone.

Intangible property is not a qualified investment for a Qualified Opportunity Fund; only tangible property counts.

If you are running your own Fund you cannot make an acquisition for your Fund from a related party. There also appears to be errors in the Code in regards to related party purchases by a Fund. These errors will not negate the related party prohibition.

Some investments within a Zone are also prohibited: golf courses, massage parlors, hot tub facilities, country clubs, suntan facilities, racetracks and other gambling business and liquor stores.

One final consideration if you plan on starting your own Qualified Opportunity Fund. There are penalties if the Fund has less than 90% of assets  invested in Qualified Opportunity Zones.

 

Final Comments

The IRS has answered some questions on the topic at hand. Keep in mind the IRS is not the final arbiter in these matters: the Tax Court is. You cannot use advise from the IRS as substantial authority. That is only gained from an enrolled agent, CPA, attorney, the Tax Code, Tax Court rulings and other qualified sources.

Turn capital gains taxes into a powerful tax-free income generating income machine. The ultimate in passive income: the Opportunity Fund! Stop paying taxes on gains today. Read more here. #wealthyaccountant #passiveincome #taxes #taxfree #tax #taxes #investments

Turn capital gains taxes into a powerful tax-free income generating income machine.

Deferring capital gains is easier than ever. While the like-kind exchange has been limited to real estate now, investing in a Qualified Opportunity Fund might be the best remaining option.

There is an argument where the like-kind exchange even for real estate might not always be the best choice. Investing gains in a Fund has more flexibility and liquidity in many cases. Coupled with the increases in basis and potential (if held for 10 years) of excluding all the gains from the Fund investment, a like-kind exchange is no longer an automatic choice for deferring gains.

This is a difficult topic with an easy to understand framework (invest capital gains in a Qualified Opportunity Fund for 10 years and defer 85-90% of the temporary gains until 2026 and the the remainder of the gains are excluded from income permanently.)

The details is where the tire meets the pavement. It would be a good idea to either print out this page or bookmark it for future reference. Unless your gains are a simple transaction the details will motivate your decision process.

 

I know this got technical. Regular readers normally expect a bit lighter reading. However, this has to be published. Too many people need the information as the traditional press is glossing over the subject and many tax professionals are still struggling with the implications of all the nuances of the Tax Cuts and Jobs Act. I have one more in-depth tax issue to address before we lighten the reading material for a family audience. Until then, take car, kind readers. May this lighten your tax burden at least a bit.

 

More Wealth Building Resources

Credit Cards can be a powerful money management tool when used correctly. Use this link to find a listing of the best credit card offers. You can expand your search to maximize cash and travel rewards.

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Side Hustle Selling tradelines yields a high return compared to time invested, as much as $1,000 per hour. The tradeline company I use is Tradeline Supply Company. Let Darren know you are from The Wealthy Accountant. Call 888-844-8910, email Darren@TradelineSupply.com or read my review.

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

PeerSteet is an alternative way to invest in the real estate market without the hassle of management. Investing in mortgages has never been easier. 7-12% historical APRs. Here is my review of PeerStreet.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

A cost segregation study can save $100,000 for income property owners. Here is my review of how cost segregations studies work and how to get one yourself.

Amazon is a good way to control costs by comparison shopping. The cost of a product includes travel to the store. When you start a shopping trip to Amazon here it also supports this blog. Thank you very much!