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Reasons Not To Do A 1031 Exchange To Save On Taxes

Reasons not to do a 1031 exchangeIf you read about the 1031 exchange, you’ll immediately think it’s the greatest thing on earth for real estate investors. What’s not to like about paying zero capital gains tax after the sale of a property? The government already taxes real estate investors through an annual property tax and a transfer tax upon sale. Having to pay capital gains tax on the way out can be very painful, especially since prices have surged to all-time  highs in many areas of the country.

But I don’t mind paying taxes. After all, taxes help keep our country running. I just mind paying an amount much greater than 30% on gains or income earned. In other words, after you start making over $300,000 as a single person or $500,000 as a couple, based on our current tax rules, it doesn’t make sense to kill yourself at work to make much more.

Making more than $300,000/$500,000 won’t increase happiness because you can buy pretty much anything you want at this level. And since you’re no longer gaining more happiness, you’ll start losing happiness once the government starts siphoning a larger percentage each minute you spend away from your family chasing the all mighty dollar. Trust me, there are plenty of miserable couples making $500,000 a year.

For those on the fence about conducting a 1031 exchange, here are some reasons for not proceeding.

What Is A 1031 Exchange

A 1031 Exchange allows an investor to “defer” paying capital gains taxes on an investment property when it is sold, as long as another “like-kind property” is purchased with the profit gained by the sale of the first property.

To do a 1031 exchange effectively, you must exchange one property for another property of similar value. Further, the purchase price and the new loan amount has to be the same or higher on the replacement property.

In my case, I had to find a single family or multi-unit property worth at least $2,740,000. I could find a property worth less than $2,740,000, but then I’d have to pay the capital gains tax on the difference in sale price and purchase price of the new property known as “boot.”

The property owner has 45 calendar days, post-closing of the first property, to identify up to three potential properties of like-kind. After the properties are identified, the investor has 180 days to make the purchase and initiate the exchange OR by the due date of the income tax return with extension, whichever is earlier.

Finally, you’ve got to pay a Qualified Intermediary anywhere from $1,000 – $3,000 to hold your proceeds (you never get to see or touch the proceeds from your home sale) to conduct the exchange. If you are unable to identify and buy a new property, you lose that money and all that time.

How does a 1031 exchange work

Main Reasons Not To Do A 1031 Exchange

* You don’t mind paying taxes

* You haven’t found the right property

* You want to reduce exposure to real estate

* You want to simplify your life

Different Investment Strategies For Different Life Stages

Different investment strategies at different life stages

the man from young to old

A number of people have asked me to share some different investment strategies for different life stages. What I’ll do is highlight the various investment strategies I think make sense for most people, discuss a couple more alternative investment strategies, and round up what strategy I think is most appropriate by life stage.

We all know that step one to building financial wealth starts with saving. What really widens the wealth gap over the years is HOW one invests. Before investing in anything, I encourage everyone to tell themselves five things out loud.

1) I will lose money.

2) I will feel like a complete idiot when I lose money.

3) Nothing goes up forever.

4) There are plenty of exogenous variables outside of my control.

5) No risk, no reward.

Now that you’re mentally set to invest your hard-earned savings in the stock market where one change in government law, a corrupt CEO, a terrorist attack, a natural disaster, or a declaration of war could instantly wipe out half your gains, let’s begin!

Various Investment Strategies To Consider

1) Indexing. A simple, low-cost strategy where you pick a particular stock index to purchase through an ETF or mutual fund. The most common US index to follow is the S&P 500 index. You can buy the ETF, SPY or buy a Vanguard S&P 500 Index fund, VFINX. Given its been shown that active fund management can’t outperform their index benchmarks over the long-term, saving on fees through an ETF or index fund is a prudent way to go for everyone. Wealthfront, the leading digital wealth manager is the best at investing idle cash at a low cost. The first $10,000 is free to manage, and it’s only 0.25% for every dollar afterward.

2) Smart Indexing. The S&P 500 is a market-cap weighted index. In other words, if we go through a three year bull market in technology, technology stocks will account for a greater weighting of the index than other sectors. This can be good for momentum investors, or bad as the tech sector tumbled by 80% in 2000, and the financial sector corrected by a similar amount in 2008-2009. Smart Indexing aims to keep all sector weightings equal, through constant rebalancing so that no one sector can dominate. Personal Capital is the leading hybrid digital wealth advisor who uses human advisors as well as technology to help manage your money. They are proponents of Smart Indexing. You can sign up to use all their financial tools for free if you don’t want to pay ~0.89% for them to manage your money.

3) Target Date Funds. Target date funds are a smart invention by the money management industry that allows retail customers to allocate all their money into one specific target-date fund and forget about things until they reach that target date for retirement. For example, you could be 40 years old and have a target date to retire in 20 years. You’d therefore choose the XYZ 2034 Target Date Fund. The fund will already be diversified for you in terms of stocks and bonds. It’s up to you to read the fund prospectus and understand the allocations, holdings, and decision making process. You should also examine the fund for fees, as they will be much higher than index funds.

4) Actively Managed Funds. As a whole, actively managed funds underperform index funds. That said, there will certainly be long term winners who do outperform. Otherwise, there wouldn’t be titans in the money management industry like Capital, Fidelity, Wellington, Dodge & Cox, Oakmark, Artisan, and so forth. I used to cover many of these fund managers in my previous life-time, and am friends with many of them now. What you need to watch out for is Portfolio Manager turnover. You’re really betting on the money management skills of the portfolio manager and his/her analysts. Many of these large money management firms will lose their PMs and analysts to competitors, and try to utilize their existing brand to prevent defection. To see how actively managed funds are rated, pick up your latest Money Magazine issue and look to the back, or check out MorningStar, whose business is to rate all different types of funds for performance.

5) Combination Index + Actively Managed. In general, you shouldn’t really be thinking about how to beat the markets, because it’ll cause you a lot of stress and you’ll probably lose in the long run. What you should be thinking about is market exposure, since we can get a good idea of future equity performance based off historical performance (6%-8%). Let’s say you are comfortable with a 100% equity exposed portfolio. You can consider allocating 70% of your portfolio in an Index fund, and allocate the rest of your money in your favorite actively managed funds. Many people will like this approach because people want to feel that they are making a positive difference with their investment choices.

How To Win Under The Proposed Republican Tax Plan

How to win under the new GOP tax planHere are the latest key points from the Trump administration’s tax plan for 2018 and beyond. The administration’s goal is to get the plan enacted before 2018. Surely there will be some compromises before the final plan gets passed, if at all.

After reviewing the key points, I share my thoughts on how to win under this possibly new tax environment. The audio version is at the end of the post.

Republican Tax Plan Highlights

* No change to existing rules on 401k retirement accounts and the ability to contribute the current $18,000 into the accounts tax-free, and $18,500 for 2018 and beyond

* Lowers the deduction for mortgage interest for new home loans of $500,000 or less from the current $1,000,000 cap.

* Limits the deductibility of local property taxes to $10,000

* Eliminates the deduction for state income taxes

* Reduces the number of tax brackets from seven to four, with respective tax rates of 12 percent, 25 percent, 35 percent, and 39.6 percent.

* The plan sets a 25 percent tax rate starting at $90,000 for married couples, with a 35 percent rate kicking in at $260,000.

* The long-term capital gains and qualified dividend thresholds will remain as they are under the current system e.g. those in the bottom two tax brackets are eligible for 0% capital gains and dividend tax rates, those in the middle get a 15% tax rate, and those in the top pay a 20% tax rate.

Recommended Net Worth Allocation By Age And Work Experience

Squaw Valley USA, Lake Tahoe With the average savings rate below 5%, a median 401(k) of only $110,000, and an average 401(k) balance at retirement age 60 of around $230,000, many Americans are financially screwed as of 2017. Just do the math yourself. Add the average Social Security payment per person of $18,000 a year to a 4% withdrawal rate on $230,000 and you get $27,200 a year to live happily until you die at 85. That’s clearly not enough!

Let’s think about this some more. You spend almost 40 years of your life working just to live off minimum wage in retirement. Hopefully you were able to live it up during your working years, otherwise, how else can we explain a national sub 5% savings rate? Blowing lots of money for fun is fine if you expect to live like a pauper when you’re old. The better way to do things is to smooth out your spending across your expected life expectancy to reduce stress and live a much steadier lifestyle.

We’ve talked in detail about the proper asset allocation of stocks and bonds by age. Just know that stocks should be a minority portion of your net worth by the time you are middle age. If you so happen to have 100% of your investment allocation in stocks before retirement and 2009 happens, well then you are poop out of luck. Calculate how much you lost, equate your loss to how many years it took you to save the value of the loss, and expect to work that many more years of your life. Now that’s depressing.

We also found out that the median net worth for 2010 plunged to $77,300 from a high of $126,400 in 2007. Surely the median net worth has recovered since 2010, but such data from the government only rolls around every three years. The main nugget of information is that from 2007 to 2010, the median home equity dropped from $110,000 to $75,000. In other words, the median American’s net worth almost ENTIRELY consists of home equity! What another bad idea.

Finally, despite a ~200%+ rebound in stocks since the bottom of the crisis and savings interest rates of only 0.1% due to a dovish Fed, a lot of people missed out on the recovery as evidenced by a tremendous amount of cash still sitting on the sidelines due to fear. Anybody who has lived through the 1997 Russian Ruble crisis, the 2000 internet bubble, and 2006 – 2010 housing correction probably has a good portion of their net worth in CDs, bonds, and money markets because they’ve been burned so many times before.

Focus On Trends: Why I’m Investing In The Heartland Of America

Investing In The Heartland Of AmericaMaking a small fortune is really fun. You can do so more easily if you can correctly predict a trend. Not only will you earn a much higher return on your investment, you’ll also suffer less anxiety and grief.

In 1997, I studied abroad in China for six months and realized its economy was on the verge of explosive growth. So I minored in Mandarin and joined the Asian Equities department at a major investment bank to ride the opening up of the region. I was probably the dumbest donkey in the industry, but being Asian, knowing how to speak Mandarin, and having the good sense to hustle for 13 years was good enough for me to retire at the age of 34.

By 2001, after the dotcom bubble burst, it was clear the public’s love affair with the stock market was over. So I shifted the majority of my wealth from stocks to real estate and witnessed SF property prices soar while stocks languished for a decade. Of course, I screwed myself in 2007 by buying a vacation property in Lake Tahoe right before the housing collapse, but the exposure wasn’t large enough to cause me mortal damage.

During the financial crisis, I realized it was now or never to start a website to at least try and take advantage of web 2.0. I had no plan. All I knew was my happy days were numbered due to a structural decline in the banking industry. Increased regulation and narrowing spreads made work less fun. Eight years later, Financial Samurai is now an established brand in the personal finance space that’s generating a healthy income.

So what’s the next trend already? In my opinion, the next money making trend is investing in the heartland of America through real estate crowdfunding. To escape high prices in the coastal cities, people — often younger and with lower- or middle-class incomes — are looking toward the Inland Empire and nearby states for additional square footage and a lower mortgage payment. With technology enabling geo-arbitrage, the opportunity is ripe for investment!

Reduce Emotional Stress By Seeing Life Through A Different Perspective Reduce Emotional Stress By Seeing Life Through A Different Perspective

Beautiful Sunset In MexicoThere’s nothing better than being free to do whatever you want. However, unless you’re born with a multi-million dollar trust fund, you’ll unfortunately have to work for your freedom.

You can follow my savings guide to increase your chances of a wonderful retirement by 50-65. But, what if you want to retire earlier? Say at the age of 40 or 45? You’re in luck, because I have a very simple, yet effective plan for you. This is something I’ve been following for the past 13 years to allow myself the option to retire as early as 35-4-. I think you’ll like the option as well!

What’s important is recognizing your inner frugality, your Herculean discipline, the government’s generosity, and your enormous hustle. There’s nothing better than taking action with your finances and seeing results!

EXAMPLES OF PEOPLE WHO’VE RETIRED EARLY

Realize that it’s an absolute fallacy you must work until 60-65 to be able to retire. It’s up to you whether you want to have the freedom to do whatever you want. You just have to make some sacrifices.

I will assume that you enter the work force at age 22 after college. All you have to do is work for 18 consecutive years and save 55% of your after tax profits without fail. At age 40, mathematically you have now saved enough to last you 20 more years until age 60. At age 59.5, you are then allowed to withdraw any money from your tax-deferred retirement savings penalty free.

The money you saved in this time period can be spent in full, if so desired, every year until you hit age 60. By the time you are 62-65, you are then eligible for Social Security benefits to complement your other tax deferred retirement savings.

Reduce Emotional Stress By Seeing Life Through A Different Perspective

Reducing emotional stress by seeing life through a different perspectivePerfect happiness is an illusion.

You would think life is a piece of cake being a stay at home and work from home dad with a stay at home spouse. But I recently went through two weeks of intense lower back pain due to emotional stress. The last time I went through this type of pain was during the dotcom collapse between 2000 – 2003 because I was constantly fearful of losing my job.

After reading Dr. Sarno’s book, Healing Back Pain, I became back pain free for 14 years until recently. If you are suffering from chronic pain, you must read this book.

So what’s the issue today? It’s simply adapting to the loss of 100% freedom, being a new parent, receiving judgmental comments, getting bombarded with endless requests over e-mail, keeping up a regular posting schedule, and being the sole provider for my family.

Something had to give. And that something was my back. Chronic pain is the mind’s way of distracting us from emotional stress.

My back pain is a reminder that health is more important than wealth. It doesn’t matter how much money you have if you can’t take care of your physical AND mental well-being. Do not be embarrassed to seek help, especially for mental health issues.

Now that I’ve recovered, I’d like to share some thoughts on reducing emotional stress in order to appreciate life more. Might as well turn a bad situation into something useful for those who currently suffer.

Scraping By On $500,000 A Year: Why It’s So Hard For High Income Earners To Escape The Rat Race

Living Paycheck To Paycheck On $500,000 A Year

Help! I’m drowning from all my money!

I’ve highlighted in a previous article how living off $200,000 a year in an expensive city is really just an average lifestyle. In this article, I’ll discuss how one couple is living paycheck to paycheck while making a combined $500,000 a year. They are a real couple who shared with me their financial details to anonymously share with you. Judging others, after all, is an American pastime!

$500,000 a year or higher is a level which I think is considered rich. Anybody who thinks otherwise has no concept of financial reality. Even the government almost agrees after compromising by raising the income level for when the highest marginal tax bracket kicks in to ~$400,000 from $200,000 back in 2013. But things are going to get more painful for the upper middle class in 2018 with the proposed elimination of state income taxes, capping mortgage interest deduction, and limiting property tax deduction to $10,000.

Although making $500,000 a year may sound like a Herculean task, you’ll be surprised to know there are plenty of regular folks who hit the half million mark every year. I literally get e-mails and comments from similar income-earning couples every week asking for financial help. This article will discuss why many folks who earn a large income won’t be retiring any time soon. 

Various Combinations Of $500,000 Households

1) A couple 30 year old lawyers in their fourth year at a big law firm

2) A couple 32 year old second year associates at an investment bank after business school

3) A single 31 year old VP at a private equity shop two years out of business school

4) A 35 year old senior project leader at a management consulting firm and her schoolteacher husband

5) A couple 35 year old doctors (cardiologist and anesthesiologist) three years after their fellowships

It Feels A Lot Like 2007 Again: Reflecting On The Previous Peak

It feels a lot like 2007 againReflection helps us appreciate how far we’ve come. Reflection also helps us learn from our mistakes. In this post, I’d like everybody to reflect on several key items: Career, Finances, Health, Family, and Happiness. See if you can tie the five together and weave a story about who you are today.

The one thing I know for sure is that 2017 feels a lot like it did 10 years ago. But this time, every asset class is expensive. I’ve got folks asking me about investing in cryptocurrencies when they haven’t even invested in stocks. Other folks are asking whether they should use their HELOC to buy another property with an 80% loan-to-value ratio. Traffic is insane. Restaurants are always booked way in advance. Everybody has maximum investing FOMO right now!

It’s an exhilarating time, but it’s also a perilous time for those who don’t have perspective.

Ranking The Best Passive Income Investments

Passive Income Streams Allows You To Be Free

In order to relax, you must first work very, very hard!

After about the 30th day in a row of working 12+ hour days and eating rubber chicken dinners at the free cafeteria down at 85 Broad Street, I decided I had enough. There was no way I could last for more than five years working in a pressure cooker environment like Wall Street. I became obsessed with generating passive income starting in 1999.

We’ve discussed how to get started building passive income for financial freedom in a previous post. Now I’d like to rank the various passive income streams based on risk, return, and feasibility. The rankings are somewhat subjective, but they are born from my own real life experiences attempting to generate multiple types of passive income sources over the past 16 years.

The passive income journey is a long one. But thanks to innovation and technology, the ability to generate meaningful passive income is accelerating!