ProPublica published an article highlighting how 25 of the wealthiest Americans paid a tiny fraction of their wealth in taxes. This makes sense because the type of tax that is often discussed is levied on income, not wealth. If you pay yourself a low income and never sell assets, then your tax bill won't be high relative to your wealth.
According to Forbes, 25 of the wealthiest Americans saw their net worth rise a collective $401 billion from 2014 to 2018. They paid a total of $13.6 billion in federal income taxes in those five years based on IRS data. However, $13.6 billion only amounts to a “true tax rate” of only 3.4%.
The article goes on to say Warren Buffet is a hypocrite for encouraging the rich to pay more taxes. Yet he only paid a true tax rate of 0.1% of the wealth he garnered over the 4-year period. We all know that actions speak louder than words. Given Warren is an ultra-capitalist, his actions shouldn't come as a surprise.
Let's Follow Billionaires In Order To Pay Less In Taxes
Instead of getting upset at billionaires for paying a small percentage of their wealth gains in taxes, let's join them. It's the same idea as investing with an institutional real estate investor if you're worried they'll make the homes you want to buy less affordable.
Complaining why something isn't fair when you can follow a similar path doesn't get you anywhere. Neither does waiting for the government to pass legislation to try and equalize things. At the end of the day, we must act rationally and immediately if we want to build more wealth.
Below is a chart that shows how there's a tight correlation between how much a typical American household makes and the amount of tax it pays. The chart should encourage you to be more like an owner of assets and less like a typical laboring American.
How billionaires pay less in taxes:
1) Pay yourself a token salary. For example, some CEOs pay themselves a token $1 salary. The rest of their compensation is in the form of stock grants or an existing ownership stake if they started the company. Jeff Bezos supposedly pays himself an $80,000 annual salary, which puts his income at a reasonable 22% marginal federal income tax rate.
2) Never sell any assets that would trigger a tax event. Let's say Bezos owns 10% of Amazon. So long as the stock doesn't pay a dividend and he never sells stock, he won't have to pay any taxes. Even if the stock goes up another 1,000%, he won't owe any capital gains tax.
3) Borrow money against your assets. Let's say you own $10 billion in Google stock. You could easily sell $1 billion of Google stock to buy a $500 million mega yacht and pay about $500 million in total capital gains tax. However, it would be more tax-efficient to borrow $500 million at a low interest rate to buy the yacht.
Plenty of banks will take a bet on you and use your stock as collateral. Even paying a 5% interest rate on $500 million is much cheaper than paying hundreds of millions in tax. Further, if you're bullish on the stock, you get to participate in any potential upside.
4) Borrow from another bank to pay off your other loan. Let's say your $10 billion in Google stock has grown to $12 billion a year later. At the same time, interest rates have declined. This is what has happened for many investors during the pandemic.
You can simply go to another bank to borrow $500+ million to pay off your previous loan. If you can get an interest rate of 2%, you'll have cut your interest payments in half. Further, you might find a way to deduct the interest. For example, say the mega yacht is for your mega yacht business.
Operate Like A Mini-Billionaire
Unfortunately, most Americans earn most of their income through a day job. Further, most Americans are not CEOs with massive equity stakes that can be used as collateral. However, all of us can certainly try to operate like a mini-billionaire to pay less in taxes.
Let's use various examples where we commoners can earn income more tax-efficiently. You want to lower your long-term capital gains tax rate.
1) Become A Rental Property Owner
The rental property owner gets to collect rental income and deduct all operating expenses associated with managing the rental. These expenses include mortgage interest, property taxes, insurance, advertising, maintenance, and transportation. In addition, a rental property owner gets to deduct a non-cash depreciation expense.
In the example above, we have a rental property building valued at $633,308 taking a $23,000 annual depreciation expense for the next 27.5 years. If you own 10 properties each with $23,000 in annual depreciation expense, that's similar to earning $230,000 a year tax-free.
When it comes to owning rental property, a good goal is to own it until your depreciation allowance runs out. But then you'd have to pay a depreciation recapture when you sell. Therefore, you might as well follow the billionaire's mantra of never sell assets.
Build A Rental Property Portfolio
Building a rental property portfolio is one of the best ways to build passive income for financial independence. You have a relatively stable asset that generates stable cash flow. Your rental properties can provide you and your family shelter if needed. Finally, your rental property portfolio can be managed by your children one day, if you have any.
Ever since 2003, I've been focused on growing a rental property portfolio to fund my retirement. It was my main way to diversify away from equities, given that was my profession.
Unfortunately, I couldn't hold onto a key property in 2017 due to constantly rowdy tenants and my desire to focus on my newborn son. However, I did end up reinvesting 100% of the proceeds, which have all risen in value.
Check out CrowdStreet, a private real estate investment platform which focuses on individual real estate opportunities in 18-hour cities. 18-hour cities have lower prices and higher yields usually. Before making each investment, you must thoroughly review the sponsor.
My favorite private real estate platform is Fundrise, which is vertically integrated and offers private funds for all investors. For most people, investing in a diversified real estate fund is the way to go. Fundrise manages over $3.5 billion in assets for 400,000 investors. It's nice to invest in a Fundrise fund and have them do all the work for you for a small fee.
I've invested $810,000 in real estate crowdfunding in the Heartland to diversify my expensive SF real estate holdings. It feels great to diversify and earn more passive income.
2) Own A Small Business
Owning a small business provides for great tax flexibility. For example, you can start an S-Corp and pay yourself a low salary to minimize your FICA tax bill. However, be careful not to pay an unreasonably low salary.
If your business is having a great year, you can decide to boost capital expenditure to reduce taxable income. Alternatively, if your business is having a bad year, you can delay capital expenditure or try and bring revenue forward to smooth out revenue. Or, you could smartly apply for a government forgivable loan, like PPP 1 and PPP 2 to get free money.
To reduce taxable income, you can have awesome quarterly board meetings in Hawaii. There’s no requirement to have them in your windowless basement.
The to and from Hawaii air tickets, meals, and accommodations are all deductible if your sole purpose is business. If you want to do a team-building event on a luxury catamaran and then eat a buffet of the finest toro sashimi, that’s probably deductible as well.
As an employer and employee, you also get to contribute up to $22,500 to your Solo 401K + 20% of operating profits. If you have the operating profit, the maximum 401(k) contribution is $66,000 for 2023. The combined maximum should go up every couple of years.
In the below example, the business owner contributes $18,000 + $13,000 = $31,000 in a Solo 401(k) that doesn’t get taxed. In addition, the business owner contributes another $10,000 to two traditional IRAs. Instead of paying taxes on $90,000 in gross profits, the owners pay taxes on a much lower income.
My wife and I are technically small business owners. We own 100% of Financial Samurai and will likely never sell for liquidity reasons. Selling would trigger a vomit-inducing tax event that creates economic waste. We should have enough ongoing investment income to pay for our living expenses indefinitely.
If we need cash for some reason, we could put up the equity in our business as collateral just like Jeff Bezos. But unlike Jeff, we can't borrow hundreds of millions to buy a mega yacht. Maybe we could buy a remote control boat for our little one instead.
3) Retire Early Or Give Up Maximum Money
No longer making a W2 income is one great way of paying less in taxes. You'll only have to pay taxes on your dividend income and capital gains. If you decide to never sell assets, your “true tax rate” as ProPublica calls it will also be a tiny portion of your growing net worth in a bull market.
You could also give up making maximum money for a lower-paying job. Once you start making over ~$210,000 as an individual or ~$420,000 as a couple, you start paying an uncomfortably high federal income tax rate of 35%. If you also have to pay state income tax, your combined marginal income tax rate plus FICA tax will easily bring you over 40%.
The standard deduction limit this year is $13,850 per individual and $27,700 per couple in 2023. Therefore, you could earn as much as these limits and pay zero income tax. For all you students out there, it's time to make some tax-free money and fund your Roth IRAs!
Further, if you are fortunate or unfortunate enough to have a household income of well over $400,000, you will likely have to pay a top federal marginal income tax rate of 39.7% if President Biden gets his way. Once you get close to paying 50% of your marginal income over a certain amount to the government, it doesn't make sense to try and work so hard to make more.
I've argued that earning $300,000 – $350,000 a year is good enough for a family of four in the highest-cost areas of the country. Earning more is completely unnecessary if you are not happy at your job.
Find A Different Way To Make Money
Earning W2 income is the worst way to earn because it faces an ordinary income tax rate that is higher than the investment income tax rate. Therefore, focus on earning investment income to pay a lower tax rate. Just don't make too much either because the top capital gains tax rate might go up as well.
The main lesson we can learn from billionaires is to change the composition of our earnings. The next important lesson is to never sell our beloved investments. Try to hold onto them for as long as possible so they can compound over time.
If we need money, we should be able to draw from our passive income streams. And if we need even more money, it's better to take out a loan, especially with interest rates so low. For many, a HELOC is a common source of funds.
If I were you, I'd focus on making more rental income, business income, and dividend income to pay less in taxes. Try and completely replace your day job income. If you do, you'll find that you really only need 80% – 90% of your day job income in the form of investment income thanks to it getting taxed at a lower rate.
Taxes Will Eventually Be Paid By The Rich
Billionaires and other executives will eventually have to pay a boatload of taxes if they get stock grants. They will either pay ordinary income tax on the award when it's granted and pay long-term capital gains taxes on the gain when they sell. Or they can pay ordinary income tax on the whole amount when it vests.
Upon death, the ultra wealthy will have to pay massive estate taxes as well. So don't worry! Billionaires and other extremely wealthy people pay plenty of taxes too. They just do so in a more efficient manner while living. Before dying, hopefully they give most of their wealth away to a surviving charitable organization that will be more efficient than the government at spending their money.
Finally, if you are really jealous of billionaires paying a relatively small percentage of their wealth in taxes, buy their stock! Clearly, these smart people with unlimited resources know better than most. Therefore, why not join them in their wealth extravaganza bonanza?
Related posts:
How To Pay No Capital Gains Tax After Selling Your Home For Big Bucks
Billionaires: They're Just Like Us
How The Rich And Powerful Get More Rich And Powerful
How A Grantor Annuity Trust (GRAT) Can Save You In Estate Taxes
Selling Stocks To Buy A House With Cash Is A Mind Bender
Readers, what else can we learn from billionaires in order to pay less in taxes? Why are people comparing a person's tax bill with their net worth growth instead of income earned? Is a wealth tax the right move? What else can we learn from billionaires besides reducing our tax liability? Disclaimer: Always check with a tax professional before making any tax moves.
For more nuanced personal finance contact, join 60,000+ others and sign up for the free Financial Samurai newsletter. I've been helping people achieve financial freedom sooner, since 2009.
I think I might have found an exception to borrowing against assets. I recently applied for a liquidities access line (line-of-credit borrowing against my securities) so that I can make the down payment on a house. This was easily in access of 6-figures!
I basically had borrow the money or the bank won’t even talk to me if I cannot put down 20% for a down payment. As it stands now, even with the Feds raising interest rates, my mortgage interest is a full 1% lower than what most banks are offering. It’s at 4.15%. The benefits of having high net worth means you play with private bankers and get privy to services most people otherwise would not have access to!
Anyways, back to my story…two of my financial advisers suggested I either a) pay off the line of credit as soon as possible or b) put down as much as possible to reduce the balance owed so that I eat less interest against my line-of-credit, or c) just pay it off with the securities I put as as collateral.
The reason for this is even at 20% down, I’m paying close to $4000 in a mortgage + interest + property insurance. With the line-of-credit, I’m paying another $535 in interest alone. They also said that borrowing against securities makes sense in a low-interest environment when the portfolio allocation can be skewed towards equiities (80% alone would be equities) and earn 1% to 2% more than what I’m paying in interest for the line-of-credit.
Of course, given the high inflation rate and the recent downturn of the market, the private banker suggested instead that I just pay off the down payment with the securities that was going through a 30-day seasoning period. So, that’s what I did.
I still have the line of credit open. One day, when things settle down with this new house, inflation goes down, and interest rates go down, I may well borrow against this account and invest in more REITs and other investments. (I cannot borrow money to buy more stocks as this is against the rules.)
I have a dilemma I have been working through, but I feel stuck. I am hoping that this community could provide some perspective that might convince me one way or another.
I have a six month cash cushion for my business. This cushion increases over time as my business grows and it takes on more expenses. The point of this money is to stay alive in rough market conditions and avoid cost cutting that hurts the long term vision. It also gives me psychological security to stay aggressive in growing the business. The business is structured as an S-Corp so that I can benefit from a smaller FICA tax burden. I don’t draw much of my business income because I leave the money there for reinvestment to grow, as opposed to purchasing stocks in another business.
The problem is that I will lose a lot of my cash at tax time because that income will pass through if I don’t spend it. My business is not capital intensive. I have no business debt. I have no need to purchase expensive equipment, so there’s not much opportunity for depreciation. My vehicle works out better as a mileage deduction. I am bothered by eating the income taxes on the saved money, but I have no good reason to spend it in the business. I really just want the cash for my cash cushion, but the cash cushion is creating a big tax burden. The cushion will continue to grow as I hire employees. This will be a constant problem until I stop growing this business. I have no plan to do that.
I see some options at my disposal:
– Stuff the cash cushion into a tax-deferred retirement account. Hopefully, I could access it under hardship provisions if I ever needed it. Maybe I could even borrow against it, as this article suggests. This is misusing the account, but if I can legally do it, it could be a move.
– Reduce my cash cushion requirement and put excess earnings into a retirement account to invest in other businesses. I cashed out my 401k in 2020 to take advantage of my lowest earning year ever and the special exceptions allowed by the CARES act. I have no retirement savings at the moment. I have focused my money 100% on my business since starting it in February 2020. I am now getting to a point where I could diversify away. Plus, I do like the idea of having more capital available beyond an emergency fund just in case of prolonged economic hardship. I like to idea of a 99.9% probability of never having to work for someone else.
– Set up a corporate structure that will allow me to reduce taxable income through depreciation from rental properties. I have none currently, and have lost interest in recent years mostly due to soaring property values in comparison to rents in my area and an aversion to debt. I am not scared of debt, but I just have a personal preference to not owe anyone money.
– Just pay the tax and move on. I would not have to worry about taxes going up in the future, or navigating around the tax codes. My return on investment for this cash is already very high, so the tax implications are really a good problem to have. If I keep focused on scaling my business instead of penny pinching on taxes, I will keep creating equity in the value of my business asset, which will not be taxable unless I ever sell the business.
Interested to hear thoughts about this. I am sure I am overthinking it, but I don’t want to waste hard earned money using it inefficiently.
Your chart comparing Bezos to the average American household is spot on. The very rich know how pay little in taxes percentage wise and in absolute dollars.
I read your article several times. It seems to me;
The really wealthy got wealth because they received free stock shares in a company they started (like an IPO) and the public stock grew in value. Therefore, they own 100,000 share of a stock now selling for $50, $0 profit to $5 million unrealized profit overnight. Never sell!
Sure they can get a loan against that collateral. But a regular JOE, earns a W2 or 1099 or passive income and all this income is taxable and it is difficult to build a base or nestegg that then profits for a $80k/yr for a salary.
You state the really wealthy can pay themselves a low salary but they have living expenses. Of course if they get $80k income per year they can borrow $2.6 million from the owned assets with an interest rate of 2.5% as a loan but if forgiven this loan may, most likely, turn into compensation income or it need to be repaid.
I understand, never sell to build wealth but then how to live with daily expenses?
Not sure what else I can say besides what I’ve written in the article. If you don’t believe you can do it, then that is the reality and vice versa.
Thanks, I was not intending to suggest this was not possible. I understand and agree with many of your points. My comments were to just point out, the really wealthy seem to have a win-fall at some point in their history that catapulted the nest-egg size. They most likely did a lot of work and/or took a lot of risk but it resulted in a hockey stick shaped wealth result. And yes, they will pay lots of taxes, or their beneficiaries will, some day.
I’m a bit confused. I recently decided to purchase a rental property in Las Vegas (this would be our 2nd rental property). I asked my tax accountant how much we’d reduce our tax liability from buying the property, and here’s what he wrote:
“Your planned Las Vegas (LVN) rental will save you zero in taxes. Because of the passive loss rules the rental property loss will not be currently deductible because of your income. The non deductible loss is suspended and is deductible when you get passive income or dispose of
the activity. Your Burbank rental currently has $105,000 of suspended passive losses as the rental losses have not helped you to date. The LVN rental will likely show a loss after depreciation and will just increase your suspended passive loss. Tax considerations should not enter your evaluation here.”
So, all we’ll be doing is adding to the suspended passive loss vs. reducing our tax liability, right? That being the case, how is buying more property helping us to reduce our tax liability for 2021 and going forward?
The only way to access the passive losses is for us to make considerably less money – I believe we have to be below $100,000 MAGI to get the passive losses to work in our favor in reducing our tax liability.
What other options are there? Starting a business? How will I have time to do my day job, spend time with my wife and kids, and run another business? That’s my pickle of a situation.
I do have a side hustle that brings in about $3,000 a year. Would I simply report that income as profit from the business, pay myself a small salary, say $1,000 (which would then get taxed at about 32% – that’s another $320 down the drain), but write off all the expenses from running the business and have a large net loss that I could use to reduce my tax liability on my personal taxes? Of course, then I’d have to pay another several hundred dollars to have the business taxes filed.
It seems no matter what, for now, we’re at the 32% tax bracket and we can’t get out of that. I love the ideas and I’ve thought of these, too, but when it comes to those of us who are considered “high earners,” we’re gonna pay a lot in taxes. We not even really high earners, in my opinion. We live near the beach in So. Cal., so everything’s expensive. And $200K a year isn’t much where we’re located.
Thank you for this article. I’ll keep on learning and trying to find ways to legally reduce our tax liability, but it’s looking pretty grim for 2021. I liquidated some stocks for the down payment on the Las Vegas property. When I did this, I figure the tax from the gains would be reduced by the investment of the property, but that’s not gonna happen. UGH!
Any advice from anyone reading this would be appreciated. I’m open to any/all ideas to help with my 2021 taxes.
Thank you!
Your tax guy is talking about using your rental property losses to deduct from your overall income. Given your income is too high, it’s a carryover passive loss. Could be used to increase your cost basis if you ever sell. Check with him.
I’m talking about using non-cash expenses and expenses needed to run your property to a profit or just break even. Given your depreciation is a non-cash expense, it’s not actually an expense coming out of your pocket. It just reduces your taxable rental income.
Really struggling with No. 3 right now: “Further, if you are fortunate or unfortunate enough to have a household income of well over $400,000, you will likely have to pay a top federal marginal income tax rate of 39.7% if President Biden gets his way. Once you get close to paying 50% of your marginal income over a certain amount to the government, it doesn’t make sense to try and work so hard to make more.”
I’ve done the math – I can see that if Biden raises taxes, all of my income will be taxed at the highest marginal rate … it’s brutal to know that ~ 50% of everything you make goes to the government! But if I leave my job, I’d be walking away from a few really awesome clients and great colleagues, and having been in much, much worse situations in the past, it’s hard to leave a good thing! And marriages don’t always last, and then what? Early retirement isn’t an obvious solution, even in this case.
Also, I absolutely love real estate as a tax shelter, and agree with never selling. There are times when your tenants can be a total pain, but tenants change, and sure, pipes break and other disasters happen, but you fix them and move on. If you can self-manage your real estate, never sell it (or sell and 1031 into an even better property, which I’ve done a few times), and reinvest 100% of the profits into your real estate business, at least while you’re working another job, real estate can create a surprisingly sneaky amount of wealth over time! The annual tax benefits that you outlined can be really helpful for someone like myself who has an above-average W-2 income.
” all of my income will be taxed at the highest marginal rate”
Don’t think this is possible. The highest marginal tax rate hits on every dollar above $400,000. So unless you’re making mega millions or billions a year, you won’t come close to paying 90%+ of your income at the highest marginal rate.
But focusing on investment income is the way!
It is possible if you make less than your spouse. Example, Spouse makes over $400,000 and you make a less than $400,000. Your is taxed at almost 50% if it is considered “secondary” to your spouse, who earns more.
That is true if you look at yourself as an individual, instead of as a team, despite being married. Thanks!
I still have no clue why the government favors capital over labor in terms of their tax codes. I would have thought that that means that people would just buy capital and never product any physical goods for customers to consume but surprisingly it hasn’t happened and I don’t think it will happen.
I think the tax codes should favor labor over capital but eh, that’s why I don’t get paid the big bucks.
Capital can produce physical goods, consider a semi-automated factory. Lot of capital there, relatively little labor. Way back when, a medium-sized local plant might employ 400 people. Unless their output has improved by staggeringly large amounts, chances are the same plant would only be employing a tenth as many people.
Currently, income is considered to be earned or unearned. Most earned income comes from one of two sources, wages or capital (provided by investments). You can derive the proportion each contributes to earned income overall. When the proportion of one rises, the other must fall (this is true even if both are getting larger in dollar amounts).
The problem being, when the proportion that is capital based rises rapidly, as it is doing and will likely continue to do, it can produce extreme income inequality (dirty words for some people, but it is really just the opposite extreme from socialism, which also a terrible condition for most people). Part of the reason for it is that those providing the capital believe income derived from the capital (such as the savings for eliminating 360 jobs) should be theirs. The workers tend to feel it should at least be shared, but tend to lack the power to enforce that belief.
This is when people start wondering if capital gains taxes, which were lower than taxes on wages, to encourage saving and investing, should be raised.
There may be something to that. But, I’ve been working for a wage for 40 years and have finally accumulated a comfortable retirement fund, even with starting over at negatives after my first wife’s terminal medical problems.
It was anything but easy, especially as a single parent, and it meant a fair bit of sacrifice (it also meant a fair bit of planning), and not always being able to do everything I wanted to do for either myself or my children. I’m trying to make up for that with my grandchildren, at least.
It also meant buying books and teaching myself a lot of new skills, on my own time, when I couldn’t afford to go back to school and get certifications. Then working extra hard to persuade people that I could do those things I said I could do.
If they change the tax structure on me now, so that wages are taxed less, or the same, and returns on our investments are taxed at a much higher rate . . . you can imagine my ire.
Capital can produce physical goods, sure. But someone had to labor to make those machines, another set has to operate them, etc. I believe the creator of the machine is more valuable than the machine itself.
I think the current tax codes favor capital to the point where all of us should just want to sit around and do nothing and let our money do all the work. For some reason, that hasn’t happened, surprisingly.
I would be mad if return on investments were taxed at a much higher rate too. However, I do think that the actual person laboring over to produce goods and services is much more valuable than just letting money do all the work while the person just sits back and relaxes.
“…the point where all of us should just want to sit around and do nothing and let our money do all the work.”
Umm, you know what web site this is, right? That’s kinda the Financial Samurai way, retire early and live on investments and passive income.
I actually do agree that the capital gains should not be given a tax advantage. But I think it’s a durn dirty trick to suddenly do it to people that have planned their retirement finances for decades. Needs to be a grandfather (and grandmother) clause for older investors, and the change needs to be gradual, not just wham bam and here is your new tax bill for this year.
Come to that. I don’t think income tax is rational if we are trying to encourage people to be productive. Personally, I would go with eliminating income tax, replacing it with a consumption tax with exemptions that would apply to everyone, billionaires and paupers, such that, if they were paying only for basic subsistence items for a near the poverty line household, the exclusions would cover almost all of it. I would also favor eliminating estate tax and replacing it with an inheritance tax (with a very large exclusion followed by a steeply graduated rate) that would encourage overly large estates to be broken up, as I think too much wealth inequality is like too much socialism. Both are extremes and extremes are generally bad things for humans.
Finally, I would outlaw any further attempts to use taxes as some sort of tool for people’s social agendas. Doing so has only made them so complex that even people with doctorates dealing with taxation never can be completely sure they have properly paid their own taxes.
Hello Financial Samurai,
I read that article as well, which was skewed towards those who don’t apply the abovementioned principles when it comes to lessening their tax burden. It’s another case of condemning those who use their knowledge to their advantage versus those who either don’t use or haven’t yet obtained the knowledge to do so.
If I remember correctly one key factor that they chose not to focus on is the fact that all of the wealthy people mentioned are business owners and investors who not only have provided employment to millions of people over the course of their careers… but also provided investment advice which has proven invaluable as well as spawned other careers in some cases—not to mention the multiple felonies committed in releasing their tax information in the first place.
Thank you for writing a piece on this.
> I couldn’t hold onto a key property in 2017 due to constantly rowdy tenants and my desire to focus on my newborn son.
Did you consider handing over your rental property to a property management company instead of selling it?
I did, but I got a good offer equal to 30 times annual rent. And it was my last year for tax free profit gains given I had rented it out for three years prior. So I decided to let it go. It wasn’t easy though!
Here’s a post that details the entire ordeal. Reality is, each year that goes by makes the sale cheaper and cheaper. And that’s just the way it is.
https://www.financialsamurai.com/why-i-sold-my-rental-home/
Also easy to look back and think what you could have done. (I almost played the lottery winning numbers but didn’t…) I think you made the right call at the time. Besides that money rolled into other money which granted other properties that you likely wouldn’t have bought if you held the original. Never regret decisions just line up the next option and decide again.
Most brokerages offer securities backed lending. Depending on the size of your portfolio, the rates can be VERY attractive. I’m getting 1M L + 1.25% (1.34%). I’ve been borrowing against stocks/etfs that I’ve accumulated over the last 20 years to invest in real estate limited partnerships which return 5-8% with significant tax benefits. I’ve only borrowed ~15% of my securities backed credit line. My equity portfolio has significant unrealized gains which I plan to hold until I die. I’ve been doing this for 5 years and have build a diversified real estate portfolio with significant cash flow to cover interest + some principal every year. I learned this by reading about what billionaires do to mitigate their tax liability.
What did you read to get this information?
This was a great article that shows ways to be smarter with investments, and how to avoid taxes. I really appreciate your way of thinking Sam!
As far as borrowing against your assets to fund your lifestyle, how do you get enough non-taxed money to then pay off the loan each month?
If you borrowed $1M @ 5% to fund yourself for years to come, and have $50K to pay back each year, is the assumption your assets are generating at least $50K passively and that is what you will be taxed on and you will hold the principal of the loan until you can borrow again to pay it off in full and start the process over?
The idea is to keep borrowing money, preferably at a lower rate, to pay off old loans. It’s actually what most American homebuyers do to trade up to a new property. It is borrowed from the bank to pay off their old mortgage, and then get another mortgage to buy another property.
Yes, the assumption is that the assets the person holds ends up making a much higher return than the cost of debt.
In this pandemic, with interest rates plummeting and asset values skyrocketing, it’s the perfect environment to get richer, if you take the right steps.
Sam – Can you expand on the last part?
Not sure what else I can say. It’s a strong market now. Discipline is in order.
What are your thoughts about the market and investing currently?
I used to avoid any topics about taxes because I was intimidated by the complexity of laws and rules I didn’t understand.
Over time I’ve learned more about taxes because I realized that having more knowledge would help me save more money and it’s true.
Great example about buying the luxury yacht. There’s more than one way to do it and those with means and who are wealth savvy use the best ways to minimize their tax bills!
Thanks for all the great information. Quick question on the solo 401k. In order to contribute, don’t the proceeds have to come from wages that are subject to payroll tax and not just from profits.
You contribute with pre-tax wage dollars as an employee. As an employer, the contributions come from a maximum percent of your operating profits for a total $58K max.
See for more: https://www.financialsamurai.com/how-much-can-i-contribute-to-a-self-employed-401k-plan/
When it comes to SCorps keep in mind that the bottom line net profit of the business rolls over to your personal income tax. I own an SCorp that had a net profit of 400K last year. My wife and I had a combined W2 income of $296K. After standard deductions our taxable income was $570K @ 35%. So no matter how low your W2 salary is, you still have to find a way to expense the gains of the business. Either through equipment, investments etc.
There is certainly an income threshold or it’s tough to save on FICA taxes As a business owner. In 2021, the Social Security tax limit is $142,800, up from $137,700 in 2020.
Unpopular Opinion: When the average Joe does a cash-out refinance, reverse mortgage, or opens a HELOC, they are doing the same thing as the Billionaire. The Billionaire simply has a lot more assets to borrow against to fund their lifestyle.
My wife and I are retired and own a multi-family real estate portfolio free and clear. After expenses and taxes, the properties generate about $65k in annual net profit. We are still enjoying a decent depreciation rate.
Given all the above, would we benefit by creating a small business around our rentals? If so, what type of business should we form? LLC? S-Corp? etc
May help for liability purposes. But as a rental property owner, you can deduct expenses related to your property anyway.
The part I’m confused on, which you touched on at the end is don’t they have to pay taxes on the stock when it is given to them? And if it isn’t vested, then is it even counted in their wealth? If it stock options, then I can understand it is delayed.
Also when they die, do some of the taxes on the capital gains not have to be paid due to the step up basis?
Yes, if they get stock grants, they will either pay ordinary income tax on the award when it’s granted and pay long-term capital gains taxes on the gain when they sell. Or they can pay ordinary income tax on the whole amount when it vests.
But let’s say you are the founder of Financial Samurai, a private company. You own 100% equity. And, there’s no issuing of stock grants. You just don’t sell to trigger a tax event. It’s the hired executives that are not founders that get compensated with lots of stock.
But once your estate’s value is beyond the estate tax threshold, your estate must pay the death tax. Of course, you can donate your money, set up trusts, and GRATs. But the ultra wealthy do end up paying plenty of estate taxes.