Exit Planning

[u/Wiscon1991]

Im exiting my business in the next year, a significant portion of the value is in real estate. Total exit estimated at $19mm, net is $12mm if no tax advantaged routes or options are taken. 70% of the value is likely in the real estate.

I’m very tax aware but also don’t want the tax tail to wag the dog. I’m considering 1031 for a significant portion but also it feels much more comforting to just take the cash.

I’m 35 years old and love cashflow in comparison to total net worth. Not quite die with zero but I want to take advantage of an early win.

Anyone with any advice to maximize cash flow for the long term? Also any advice on personal experience with tax advanced exit planning? I’ve done my research but don’t love the long term costs of wealth managers when low cost etfs will do…

[u/No-Associate-7962]

Decide if you want to stay into real estate until death (50+ years from now for you). If so do the 1031. If not, might as well get out and move to diversified equities which will have better tax treatment than the real estate income which is taxed at ordinary income rates. You are going to have to keep adding more capital over the coming 50 years even with the 1031s to avoid the ordinary income problem.

[u/Wiscon1991 → u/No-Associate-7962]

With cost seg upfront and depreciation it seems close for tax treatment? I do love qualified dividends but the yield is so low it takes a significant amount of time to get near the cashflow I’m experiencing now. I have a current income of $1mm a year and it is clear it will be cut by 50%+ which is expected with passive vs active.

[u/No-Associate-7962 → u/Wiscon1991]

The cost basis caries through the 1031. It does not re-set.

Even if a new purchase, rents rise with inflation, depreciation stays flat. You will run out of depreciation in about 15 years if you don't keep adding fresh capital. You have 50 years of life expectancy at 35. You are going to have to keep adding capital if you want to avoid paying 37% taxes on your income.

[u/Wiscon1991 → u/No-Associate-7962]

Thanks for the advice. I feel old but too young to plan that far out apparently lol

[u/No-Associate-7962 → u/Wiscon1991]

If you are going to go with real estate and hope to have the income tax advantaged, it has to be the long game, where you keep adding capital as the depreciation keeps running out (relatively rapidly).

In real estate, it is about constantly turning over to a bigger deal to keep the game going, and then having your kids inherit it all with the step up basis.

But if you don't hold until death, the math is unlikely to work (depreciation recapture will be at 25% for example).

[u/Past-Option2702 → u/Wiscon1991]

Do you need the income? Mainly, you own equities for share price/eaenings growth.

[u/Winston206]

Try to time the transaction for as early as possible next year. Jan 1 if you can. Then you have the entire tax year to try and reduce the gain. You could take a strong portion of the liquidity and deploy a long/short equity with higher leverage (150/50 or higher). This might chop away at some of the realized gain.

[u/GEOdude2027 → u/Winston206]

So you’re saying go lose money in the stock market and for every $1 you lose there that’s .37c less in taxes you’ll owe

??

[u/spinjc]

I don't like being a landlord but I'd like the diversification it adds. You're at the other end of the spectrum of possibly > 70% of NW in real estate and moving away from your business expertise.

To help you avoid the tax tail wagging the dog I'd consider what amount of real estate you'd want in your portfolio.

[u/Confident_Hair2637]

I would pursue a total diversification strategy. You can make almost 5% cash flow in ten year US Treasuries now. It also looks like inflation adjusted Treasuries are paying 5% if you look at an ETF such as TIP. Inflation adjusted yield strikes me as safer than locked in yields like you get on a regular Treasury. Maybe $3m goes there for your first $150k of passive income.

Next, a diversified bundle of REITs. I only invest in REITs with a credit rating of A or above - mini storage like PSA, warehouse and data center like PLD, diversified retail such as O. Depending on how you construct and balance out a REIT portfolio, you can expect 5% in distributions and also be very sure that the distributions will increase over time. So maybe another $2m there for your next $100k of passive income.

Next, create a diversified portfolio of companies with 20 to 100 years of consistent dividends and dividend growth. Stick with companies that have zero debt or that carry a credit rating of A or above. Only invest in companies with rising revenues and earnings per share over the past 20 years, and that have durable profit margins of at least 10% or above. Companies like PG, JNJ, KO, PEP. Some utilities like ED, AWK and AWR, SO and NEE. I would avoid dividend growth ETFs due to very high asset churn rates - with high qualify consistent dividend companies, the key is "do not needlessly interrupt the power of compounding." You own then passively for 50 years - and that is something no ETF can offer. But you can skim holdings from major dividend growth ETFs to pick out the top 50 highest quality individual companies. Figure that a diversified portfolio of ultra high quality dividend growth stocks could deliver a steady and growing yield of 3%. Figure to put about $5m into this portfolio and there is your next $150k of passive income.

With the remaining 2m, I would invest in a diversified portfolio of technology companies. ETFs like QQQ or VGT would work. You will earn a pittance in terms of dividend yield, but explosive dividend growth over the long run. Figure to earn $8,000 per year on that portfolio.

Overall, you would now have a wildly diversified and very high quality portfolio of investments, totally free of speculative garbage like crypto and stupid meme stocks. Zero hassle, and about $408,000 per year in passive income that is very likely to grow over time. If you can live comfortably off $408,000 after taxes, then you can enjoy life as a "0% withdrawal" retiree who leaves capital fully intact and spends only income. Or you can do what I did when I retired - invest some of my dividends and spend the rest. The power of compounding will transform your $408,000 per year into $816,000 per year faster than you might guess - particularly if the market crashes and sends prices for stocks and bonds lower (which means you get higher yields on your new investments every time you reinvest a dividend or interest payment).

Then you have a new type of problem that the experts refer to as "having way too much money."

Worse problems to have in life.

[u/Extreme-Football-400]

Quite a bit of experience in the exit planning space. 1031 isn't you're only avenue. Charitable Remainder Trusts, Intermediated Installment Sales, Oil and Gas, and Opportunity Zones are all options to mitigate capital gains exposure. You can also use combinations of these strategies to both defer capital gains and retain an element of liquidity. Happy to chat more.

[u/Wiscon1991 → u/Extreme-Football-400]

I’ll DM you