Sometimes it’s difficult to quantify the work I do for clients; Measuring the results of financial planning can be difficult. Sure, I can track income tax savings or investment portfolio growth, but it can be challenging to measure the change in my clients’ overall quality of life through my financial planning services. To best illustrate the true impact of my services on the lives of my clients, I decided to share the story of one of my clients as they transitioned to retirement, and how we adjusted their original plans to best position them for retirement.
I have changed a few details to protect my customers’ privacy, which are referenced below. To simplify the discussion, we’ll call them the Smiths.
Setting the stage
Married for many years, the Smiths have worked together to build a successful small business and through smart investments have developed an extensive portfolio of rental properties.
As they approached 65 and turned their focus to retirement, we continued to work on analyzing and updating their financial plan. As business owners, they had managed their tax burden effectively, but had also not built up large social security benefits or pensions. Their vision was always that their rental property portfolio would provide retirement security, but the problem was that they had lost the motivation to continue managing the rental properties as landlords.
They really wanted to retire, instead of dealing with tenants and maintenance issues. The Smiths had amassed approximately $1.8 million in real estate assets (16 units), along with $750,000 in investments in brokerage accounts and another $400,000 in IRA accounts. The Smiths needed about $9,000 a month to live on their pension, and Social Security would provide about $3,500 in monthly income (which would be deferred until age 70 for one spouse). The Smiths netted about $65,000 from their property after all their expenses for rent were paid. After taking the time to thoroughly understand the Smiths’ unique circumstances and weighing their options, I was able to recommend an effective course of action that would achieve all of their retirement goals. EntryPoint’s solution – the 1031 Exchange Strategy – was designed to help the Smiths effectively retire without landlord responsibilities, achieve an annual income of at least $65,000, and avoid creating a tax situation from the sale of their property.
The 1031 Exchange Strategy
Using the 1031 Real Estate Exchange strategy, EntryPoint helped the Smiths execute every aspect of their planning situation. A 1031 Exchange allows investors to transfer their investment properties into new investments without tax liability. Investors must meet specific IRS guidelines to complete the transaction without incurring income taxes. In this case, the Smiths had a very low residual cost basis (about $200,000). The rest was depreciated, meaning that if the Smiths had not properly completed the exchange, they would have been subject to taxes on $1.6 million, either from recapture of the depreciation or from capital gains.
A closer look at taxes
If the Smiths had sold their real estate holdings without completing an exchange, their $1.6 million gain could have generated nearly $400,000 in personal taxes. And the Smiths would have mainly reinvested in the stock market, where cash returns are around 3%, not nearly high enough to achieve their goals. Moreover, considerations would also show that the income would be earned with a much lower principal amount than the value of their real estate portfolio. The choice to complete the exchange became easier when you consider that the new real estate investments would pay approximately 6% in distributions based on the full principal amount, and that the Smiths would keep the assets invested without paying taxes.
Reinvestment of stock exchange proceeds
Through a 1031 Exchange, investors have two main choices: reinvest in personally managed real estate or opt for passive real estate investments. Professional operators manage these passive real estate investments in high-quality real estate positions in some of the best real estate markets in the United States. These passive investments are often institutional-quality properties in high-demand markets, which provide diversification and higher quality tenants and remove headaches for landlords. Often, investors who choose these passive real estate investments will leave the local real estate environment to upgrade their investment strategy through better opportunities. In this case, the Smiths took a passive approach. And as a result of their new portfolio, they say, “We’re getting more revenue while doing nothing. We wish we’d done it sooner.”
Through the reinvestment of their real estate portfolio, the Smiths have moved from single-family real estate to an infrastructure development fund and medical center in South Carolina, a land bank and shopping center in Texas, and a property with natural gas mineral rights in Texas. They have achieved greater diversification through better investment positions, along with greater cash flow, and can now be trusted with the management of their properties, allowing them to live their best retirement lifestyle. Of course, none of this would have happened if they hadn’t contacted me first to discuss their options.
Would you like to learn more about my Retirement Planning process and how I help high net worth individuals solve complex problems to achieve their best retirement situation? Contact me today for a personalized strategy session to discover your next steps. I have helped corporate executives, business owners, and real estate investors, like the Smiths, transition to retirement. Contact us and I will help you navigate the complexities of your unique circumstances to find an effective solution that achieves your goals.
This article was originalj published here and is republished on Wealthtender with permission.
About the author
Chris Ward, CFP® We help individuals achieve greater success in their life and financial affairs.
Chris Ward, CFP® | EntryPoint Asset Management
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