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Discuss Latest WCI Blog Post: How the Wealthy Can Avoid Paying High Taxes

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  • #16
    A lot of these strategies have to be set in motion early in retirement. By our mid 40s we already had ~$50k per year in taxable account dividends. This has only grown over time. Add to this maturing I and EE bonds; receiving deferred compensation; RMDs; part time income; Roth conversions; SS and/or pension; maybe an inheritance; and it gets increasingly difficult in mid-late retirement to avoid income and the taxes that go with it without having to sell off a bunch of assets which would generate capital gains and its own tax headaches.

    I think these high income/low tax situations are unique cases and most of us are going to pay the piper.

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    • #17
      Originally posted by The White Coat Investor View Post

      I"m not sure why you need someone to point this out, but okay, here we go.

      You have a $100K Roth IRA. You use it to buy a $400K property. It's slightly cash flow positive. You continue to make BD Roth IRA contributions each year. Your property is in a rapidly appreciating area and within just 3 or 4 years has appreciated to $500K. So now you go buy another property with the IRA using $100K in equity and another $30K that you have contributed to the IRA. This time you buy a $600K property which is again just slightly cash flow positive. You now have $1.1 million in property in the IRA with mortgages of about $725K. 3 or 4 years later, your original property is worth $600K. The second property is now worth $750K. You refinance them both, freeing up another $250K in equity. You've made some more contributions and they've had a little cash flow, so you put $300K into a $1.2 million property. You now have $2.55M in property in the IRA with mortgages of $1.8 million. 3 or 4 more years ago by. Your properties have continued to appreciate. You have continued to pay down some debt and accumulate cash. Perhaps you now have $500K you can invest in another property. This time you buy a $2 million small apartment building. Rinse and repeat. Over 20 to 30 years, you've got an 8 figure IRA. Now if you're also periodically rolling over 401(k) money in there? It goes even faster.

      You're not losing the benefits of leverage just because you're paying a little more for it just because you have to get a non-recourse loan. Real estate investors don't get rich because of depreciation. They get rich because the properties appreciate and produce cash flow. Add leverage and it all happens relatively quickly.
      If you are using leverage, buying something that is slightly cash flow positive, and your property is vacant for slightly more than your assumptions, all of the sudden you are cash flow negative and you can't service your debt (and you can't make up the difference with money from outside of the IRA) - a bad situation to be in when using leverage. Some areas are rapidly appreciating during certain time periods, but if this was knowable in advance - everybody would exploit it until there was no remaining excess returns. I guess maybe this serves the purpose of illustrating that it is possible, the same way it is possible to beat the street for an unusually long period (like Warren Buffet or Peter Lynch), but these are not reasonable assumptions for a potential investor. Maybe someone pulled it off, but I would be skeptical. I'm even more skeptical that they followed all the rules.

      Muni bonds seldom pay so well vs taxable bonds that they entirely make up for the marginal tax rate of the people investing in them. If I was considering purchasing muni bonds in my IRA you would immediately stop me and say "the price of that asset already reflects the tax benefit, so why would you not purchase it in a way to enjoy that benefit." It just wouldn't make sense to hold it in an IRA. While most real estate markets are admittedly less efficient than other capital markets, the prices for most real estate generally reflects the available tax benefits. If you purchase something that could potentially provide value through leverage, depreciation, step-up in basis at death, etc. - but purchase it in a way that you receive none of those benefits, you are overpaying for the value it provides - not a good path to 8 figures.




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      • #18
        Originally posted by PHANTASOS View Post

        If you are using leverage, buying something that is slightly cash flow positive, and your property is vacant for slightly more than your assumptions, all of the sudden you are cash flow negative and you can't service your debt (and you can't make up the difference with money from outside of the IRA) - a bad situation to be in when using leverage. Some areas are rapidly appreciating during certain time periods, but if this was knowable in advance - everybody would exploit it until there was no remaining excess returns. I guess maybe this serves the purpose of illustrating that it is possible, the same way it is possible to beat the street for an unusually long period (like Warren Buffet or Peter Lynch), but these are not reasonable assumptions for a potential investor. Maybe someone pulled it off, but I would be skeptical. I'm even more skeptical that they followed all the rules.

        Muni bonds seldom pay so well vs taxable bonds that they entirely make up for the marginal tax rate of the people investing in them. If I was considering purchasing muni bonds in my IRA you would immediately stop me and say "the price of that asset already reflects the tax benefit, so why would you not purchase it in a way to enjoy that benefit." It just wouldn't make sense to hold it in an IRA. While most real estate markets are admittedly less efficient than other capital markets, the prices for most real estate generally reflects the available tax benefits. If you purchase something that could potentially provide value through leverage, depreciation, step-up in basis at death, etc. - but purchase it in a way that you receive none of those benefits, you are overpaying for the value it provides - not a good path to 8 figures.



        Yes, I know about vacancy. In my hypothetical example, it's still slightly cash flow positive after accounting for vacancies.

        Look, nobody is making you buy real estate, much less do it in your IRA. I don't own properties directly in my IRA. But that doesn't make me think that nobody does and that it never works out well for anyone. But I don't have any more data than you do on the subject, so you can have your opinion and I'll have mine.
        Helping those who wear the white coat get a fair shake on Wall Street since 2011

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        • #19
          If Warren Buffett were to liquidate his assets, pay his capital gains, and then buy munis as to avoid paying taxes going forward(just to avoid taxes I suppose), would that be reasonable?

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          • #20
            The non-recourse loan troubles me. I tend to think these will get pulled first by lenders when conditions tighten or the interest rate margin to non-recourse will balloon. There are fewer lenders, so I suspect you can get stuck with no good choices when conditions change for the worse.

            Case study 1 is interesting, but actually having 15M debt, there is not an insignificant risk of ruin.

            Case study 3, to get Roth to 15M, you need to have something that appreciates 10X.

            I am trying this in retirement space with a development property (vacant land).
            I would not have bought it in this structure unless I thought it was very unlikely to go down if I had to liquidate.
            There is always (hopefully small) chance you have significantly miscalculated the future cashflows and end up having to liquidate.

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            • #21
              Originally posted by burritos View Post
              If Warren Buffett were to liquidate his assets, pay his capital gains, and then buy munis as to avoid paying taxes going forward(just to avoid taxes I suppose), would that be reasonable?
              Considering the fact that his effective tax rate is 0.1%, probably not.

              Perhaps a few other reasons why that’s a losing strategy as well.

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              • #22
                Originally posted by burritos View Post
                If Warren Buffett were to liquidate his assets, pay his capital gains, and then buy munis as to avoid paying taxes going forward(just to avoid taxes I suppose), would that be reasonable?
                Well no - he would use a pledged asset line - like all wealthy people do.

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                • #23
                  Originally posted by xraygoggles View Post

                  Well no - he would use a pledged asset line - like all wealthy people do.
                  But the pledged asset line doesn't generate revenue. Munis do.

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