How a 1031 Exchange Powered Their Move from Landlord to Retiree, Providing More Income and Less Stress
Sometimes it’s hard to quantify the work that I do for clients—measuring outcomes from financial planning can be a tricky thing. 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 have decided to share the story of one of my clients as they transitioned to retirement and how we adapted their original plans to position them optimally for retirement.
I have changed a few details to protect the privacy of my clients, who are referenced below. To simplify the discussion, let’s refer to them as the Smiths.
Setting the Stage
The Smiths have been married for many years, working together to build a successful small business and, through savvy investment, had developed an extensive rental property portfolio.
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 effectively managed their tax burden, but also had not accumulated large payouts from Social Security or pensions. Their vision was always that their rental property portfolio would provide retirement security, but the issue was that they had lost motivation to continue managing the rental properties as landlords.
They wanted to retire truly, rather than deal with tenants and maintenance issues. The Smiths had accumulated approximately $1.8MM in Real Estate Assets (16 units), along with $750,000 in Brokerage account investments and another $ 400,000 in IRA accounts. The Smiths needed approximately $9,000 per month to live on in retirement, and Social Security would provide about $3,500 in monthly income (which for one spouse would be delayed until 70). The Smiths were earning about $65K net from their Real Estate after all of their expenses on the rentals were paid. After taking the time to thoroughly understand the Smiths’ unique circumstances and weigh 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 truly transition to retirement without landlord responsibilities, obtain at least $65,000 in annual income, and avoid creating a tax situation through the sale of their real estate assets.
The 1031 Exchange Strategy
By utilizing the 1031 Real Estate Exchange strategy, EntryPoint helped the Smiths execute each aspect of their planning situation. A 1031 Exchange allows investors to transition their Real Estate Investments to new holdings without incurring a tax liability. Investors must meet specific guidelines dictated by the IRS to complete the transaction without triggering income tax. In this case, the Smiths had a very low remaining cost basis (about $200K). The rest had been depreciated, meaning that if the Smiths did not complete the exchange correctly, they would have been subject to taxation on $1.6MM either from depreciation recapture or capital gains.
A Closer Look at Taxes
If the Smiths had sold their Real Estate holdings without completing an exchange, their $1.6MM in gains could have triggered almost $400,000 in personal taxes. And the Smiths would have been mostly reinvesting in the Stock Market, where cash yields are around 3%, not nearly high enough to meet their goals. Additionally, considerations would also reveal that the income would be earned on a much lower principal amount than the value of their Real Estate Portfolio. The choice to complete the exchange became easier when considering that the new Real Estate Investments would pay roughly 6% in distributions based on the entire principal, and the Smiths would keep the assets invested without paying taxes.
Reinvestment of the Exchange Proceeds
Through a 1031 Exchange, investors have two main choices: reinvest in personally managed real estate or choose passive real estate investments. Professional operators manage these passive real estate investments in high-quality real estate holdings in some of the best real estate markets in the United States. These passive investments are often institutional-quality properties in high-demand markets, providing diversification, higher-quality tenants, and eliminating landlord headaches. Many times, investors choosing these passive real estate investments will be moving from local real estate environments to upgrade their investment strategy through better opportunities. In this case, the Smiths opted for a passive approach. And as a result of their new portfolio, they state that “We are receiving more income while doing nothing. We wish we had done it sooner.”
Through the reinvestment of their real estate portfolio, the Smiths transitioned from single-family real estate to an infrastructure development fund and medical center in South Carolina, a land bank and retail shopping center in Texas, and a natural gas mineral rights property in Texas. They have achieved greater diversification through better investment holdings, along with increased cash flow, and can now entrust the management of their properties, allowing them to live their best retirement lifestyle. Of course, none of this would have happened if they had not first reached out to me to discuss their options.
If you would like to know more about my Retirement Planning Process and how I help high-net-worth individuals solve complex problems to achieve their best retirement situation. Reach out today to set up a personalized strategy session with me to uncover your next steps. I have helped corporate executives, business owners, and real estate investors, such as the Smiths, transition to retirement. Please get in touch, and I will help you navigate the complexities of your unique circumstances to find an effective solution that achieves your goals.
This article was originally published here and is republished on Wealthtender with permission.
About the Author
Chris Ward, CFP® We help individuals achieve more success in their Life and Financial matters.
Chris Ward, CFP® | EntryPoint Wealth Management
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