How to Avoid Taxes on Investment Income
Good day and welcome to Season 2 of Bring Back the Bustle, a podcast about investing in rural America. I’m Shavon Jones, your host.
The Wall Street Journal recently ran a story about how investors lose a third of their earnings to taxes. Not because they have to, but because they don’t check. I’m talking about investments in your retirement account; private investments in major funds. Investors buy those investments without taking taxes into account.
The mistake that investors make is choosing investments solely based on promised returns and the fees a fund charges. Think about it for a second. Aren’t those the typical due diligence questions you normally ask: “What are the past returns or the projected returns?” and “How much are the fees?” In other words, “what’s my cut, and what’s your cut.”
The Journal points out, however, that investors who focus on those two questions don’t usually net the highest returns on their passive income. Why? Because the biggest cost that an investor faces is taxes.
Still, very few investors pick an investment based on its after-tax returns. As a result, over time, investors end up paying about 36% of their final wealth to the government, according to the Journal. We’re talking about sophisticated investors making unsophisticated moves with their money. Gasp.
I’m a tax expert. What makes me an expert, you might ask? It’s probably some combination of my accounting degree, my Master of Laws in Taxation degree, and my 20 years of experience in the field, including at a Big Four accounting firm and a Fortune 500 company.
As a tax expert, that article in the WSJ resonated with me. The title grabbed me, and the content held my attention. Here’s the title: “You won the battle on Investment Fees. You’re losing the war against taxes.” I have attached the first few paragraphs of the article so you can see if you want to read the rest on the WSJ website. Only click my link if you want to be persuaded to read the rest of the article. Because I don’t think you’ll be able to put it down, either.
PENNY WISE, DOLLAR DUMB
Without using the cliche, the article speaks to investors being penny wise and dollar dumb. (I don’t want to insult anybody, but if you’re winning the battle while losing the war—there’s a little bit of dollar dumbness going on. Is there not?) Investors get nervous about the fees the fund managers make (which usually aren’t any higher than 2%) but don’t even ask about the 20 to 36% Uncle Sam is going to take as soon as you cash out.
So, the author of the article wanted to make investors aware of the need to evaluate the tax aspects of investment offerings.
Knowing to include tax performance in your evaluation of investment options is a crucial first step. But what can be done about taxes? After all, it was 240 years ago when Benjamin Franklin famously said, “In this world, nothing can be certain except death and taxes.”
Well, all I can say is leave it to President Trump to devise a way to cheat taxes, if not death. Trump created opportunity zone funds as a virtually tax-free way to invest.
YOU CAN AVOID INVESTMENT TAXES
That’s great for us here at the Rural Fund, because we’re an opportunity zone fund. Opportunity Zone funds have the highest after-tax-return potential of any other investment type. Period. There’s nothing else you can buy that has lower taxes than an OZ investment. That’s because, with an OZ investment, you can pay no taxes at all. Zero percent. As long as you reinvest your dividends for 10 years before taking your earnings out, you can completely and legally avoid federal income taxes. Many states also do not tax OZ earnings.
Opportunity zones are low income areas where the government has decided to boost the returns of investors so that underserved areas have a shot at competing for investment dollars. OZ investments aren’t sexy investments. If you want sexy, invest in Manhattan or on Brickell Avenue in Miami. And see how far your dollar goes.
What OZ funds lack in sex appeal they make up for in long-term bang for your buck. The tax savings make rural OZ investments a better bet than the types of investments that investors flock to only to receive big tax bills on exit.
WHO SHOULD INVEST?
There are 3 groups of investors who should consider an OZ investment opportunity such as the Rural Fund:
- Investors who have sold a business or other capital asset in the past 6 months
- Investors who are facing a retirement deficit
- Investors seeking generational wealth for their grandchildren or great grandchildren
ROLLOVER CAPITAL GAINS
This first group is the group the Trump Administration designed OZs for: people who are already rich. If you have sold a business, a piece of real estate or any other capital asset in the past 6 months, you are flush with cash. You want to keep that cash, and you don’t want to pay taxes yet, if ever.
If that’s your situation, you’ve come to the right place. Investors in the Rural Fund get to defer paying taxes on their gains from the sale of their business or other asset for 5 years. After the 5 years end, Rural Fund investors get 30% tax forgiveness on your original investment. (The tax forgiveness is less if the OZ you invest in isn’t a rural OZ fund.) Now, you have to pay capital gains tax on the remaining 70% that you put in. But no taxes apply to the earnings you made during the 5 years. So, your money is allowed to grow tax-free. If you leave the money in for an additional 5 years, you never pay federal income tax on the appreciation. It’s tax-free passive income.
THE ULTIMATE RETIREMENT CATCH-UP CONTRIBUTION
The second group of investors who should seriously consider an OZ investment are those who are 10 to 12 years from retirement and worried that you might not have enough. Maybe the inflated cost of living has you on edge about the future. Or maybe you’ve spent your youth paying down student loans, buying your home, educating your kids in private school and college. Maybe you also needed to help your parents.
Now it’s time to fully fund a retirement that could last 30 years. Financial advisors estimate that you’ll need a minimum of $10M to avoid running out of money in retirement. Many professionals are trying to bridge the gap with catch-up contributions to their employer-sponsored retirement plans. However, those plans often invest in heavily-taxed investments. Plus, when you take money out of a traditional retirement plan, you must pay ordinary income taxes on the distributions. So, that’s double taxation of your money. It was taxed in the plan and then taxed again when you took it out.
Fortunately, there’s a better way! You don’t have to have sold a business to get capital gains. Any capital gains qualify for OZ benefits. There’s no tracing. You don’t have to use the exact dollars you made on the prior investment. So, if you sell your stamp collection, a vintage car, or any other capital asset, you can then use money from your job (or any other source that’s available to you) to invest in the Rural Fund. No matter the source—even borrowed money can grow in the Rural Fund, tax-free. It’s tax free while it’s in the fund, and it’s tax free when you take it out 10 years later. No taxation beats the heck out of double taxation.
GENERATIONAL WEALTH
Finally, group 3, grandparents should consider OZ investing. Grandparent investors may already be wealthy. They may be looking for an estate planning tool to avoid the tax man while they take care of future generations. So, just how far does this OZ tax break go?
If you get lucky and die. That’s tax humor. We tax pros crack ourselves up. Let’s look at another asset that you’re familiar with and compare it to OZs. Take life insurance. If you buy a term life insurance policy and outlive the term, you lost the bet. Money went out the door, and you’re not getting much of anything back. But if you get lucky and die during the term of the policy, you win the bet with the insurance company. Your chosen beneficiary gets a big payday in exchange for your relatively small outlay.
Now let’s talk about how OZ funds work if you get lucky and die. If you’re trying to give money to your grandchildren, The Rural Fund (all OZ Funds aren’t the same. OZ Fund creators have flexibility in how we structure our funds.) But the Rural Fund is organized to let you pass your shares outside of probate.
Moreover, your holding period gets passed on to your heir. So, if you’ve held the asset for 10 years, the heir gets the appreciation tax free. And OZ funds are great because you can hold a long term. You don’t have to get lucky and die within 10 years. The OZ rules give you up to 30 years to win the bet—to get lucky and die. You’re allowed to take the money out tax-free in 10 years OR you can leave it in for up to 30 years and still get tax-free treatment.
Thus, if you’re already at retirement age, chances are you’re going to win the bet. You’ll get lucky and die in the next 30 years. So, an OZ fund structured the way the Rural Fund has chosen to structure itself can be a great estate planning tool for grandparents.
THE KISS PRINCIPLE
This tax stuff can get confusing. It’s never a good idea to make decisions when you’re overwhelmed. In my first job at PricewaterhouseCoopers, my boss explained the Kiss Principle. Keep It Simple Stupid. Apply the KISS principle to your investing. Keep your analysis simple. Consider creating a table to make a side-by-side comparison of your options. The four factors I would include in your investment evaluation table are: taxes, investment returns, exit strategy, and fees/costs. Then make an informed decision based on your personal circumstances.
DOUBLE YOUR MONEY, GUARANTEED
Sometimes the best tax move isn’t the best decision for you. For example, some people will just want their money back fast, no matter what. They say “taxes, smackses.” Maybe they are like my mother—older and interested in spending her own cash rather than leaving it behind to someone who can take care of herself (me). Maybe they have a large expense coming down the pike, such as a child going to college, and they can’t wait years and years to get the best deal on taxes. These investors are short-term accredited investors.
The Rural Fund has an exit strategy for the short-term accredited investor that likely beats anything else available in the market. Place a minimum of $50,000 with us, and we’ll double your money in 24 months, guaranteed.
How can we deliver on such a bold promise? it really comes down to 2 things: (1) the way OZ funds work and (2) the way the Rural Fund works. First, OZ funds not allowed to horde cash. We have to invest it or pay it out to shareholders. Otherwise, we are hit with an IRS penalty. Second, the Rural Fund operates businesses like grocery stores, hotels, and entertainment venues that generate cash. That’s how we know we’ll have cash to pay you back.
Even if you take your money back in 24 months, the Rural Fund is a better investment than most others. Where else can you double your money, guaranteed, and only pay capital gains rates instead of ordinary income tax rates? No, seriously, if you know of someplace, tell me. I want some of that action.
I’m Shavon Jones, thanks for coming back for Season 2. If you’re an accredited investor and want to learn more about investing in the Rural Fund, use this link to schedule a consultation. We have two towns right now that we’re developing in. One town is in Richland Parish, Louisiana where Meta is developing its Hyperion data center. The second town is in Oklahoma near an energy plant and oil refinery. These are exciting opportunities in towns with anchor businesses that provide disposable income within the local market even if the national economy goes into recession. Reach out if you would like our pitch deck for these projects.
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