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Published On
August 23, 2022

How do you determine how much you need in retirement when you factor in taxes, and how does the 4% rule apply? Has one YMYW listener spitballed retirement well enough to convince his wife that they can afford a new luxury truck? Can another YMYW listener take advantage of what seems to be a big opportunity to sell company stock, pay no capital gains tax, and do Roth conversions? Can Big Al’s high school friend do a 1031 exchange to buy a rental property, make it his primary residence in 5 or 10 years, and pay no tax when selling? Is earned income from stock trading still taxable for Social Security if your LLC is in a trust? Finally, a compliment comes in, and Joe and Big Al assume it’s for them. 

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Show Notes

    • (01:36) 4% Rule: Spitballing How Much You Need in Retirement When Factoring in Taxes (Dale, Atlanta)
    • (10:36) Grade My DIY Retirement Spitball: Can I Buy a New Luxury Truck? (Wannabe Luxury Truck Driver)
    • (18:08) Is This a Big Opportunity to Sell Company Stock with No Capital Gains? (Danny Noonan)
    • (28:34) Rental Property 1031 Exchange Now, Primary Residence Later, Pay No Tax When We Sell? (Wesley)
    • (33:07) Is Earned Income Still Taxable for Social Security If LLC is in a Trust?
    • (36:56) Comment: I Love Your Haircut!
    • (41:00) The Derails

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Transcription

Just 8 days left to fill out the 5th annual YMYW Podcast Survey for your chance at a $100 Amazon e-gift card. Click the link in the description of today’s episode in your podcast app to go to the show notes and access the survey and the secret password. Answer 17 questions and help us make Your Money, Your Wealth your favorite, funniest, top, best personal finance podcast. US residents only, no purchase necessary, survey and giveaway close and winner chosen at 4pm Pacific time on August 31st, 2022. 

Today on Your Money, Your Wealth® podcast 392, how do you determine how much you need in retirement when you factor in taxes, and how does the 4% rule apply? Has one YMYW listener spitballed retirement well enough to convince his wife that they can afford a new luxury truck? Can another YMYW listener take advantage of what seems to be a big opportunity to sell company stock, pay no capital gains tax, and do Roth conversions? Can Big Al’s high school friend do a 1031 exchange to buy a rental property, make it his primary residence in 5 or 10 years, and pay no tax when selling? Is earned income from stock trading still taxable for Social Security if your LLC is in a trust? Finally, a compliment comes in, and Joe and Big Al assume it’s for them. Visit YourMoneyYourWealth.com and click Ask Joe & Al On Air to send in your money questions and comments. I’m producer Andi Last, and here are the hosts of Your Money, Your Wealth®, Joe Anderson, CFP® and Big Al Clopine, CPA.

4% Rule: Spitballing How Much You Need in Retirement When Factoring in Taxes (Dale, Atlanta)

Joe: We got Dale from Atlanta writes in, he goes, “Hello, I’ve been listening to your retirement spitball scenarios, and I’m learning a lot from them. I have a question about how to figure out what I need in retirement when I factor in taxes. I’m 55, single, will retire in 7 years. I have a pension of $30,000 per year. Will take Social Security at age 62, at another call at $30,000, and I’ll have around $1,200,000 in traditional IRAs at age 62 and $500,000 in a Roth. I have estimated that I will need $75,000 per year in retirement. I will have a paid off mortgage by then. However, I will need this amount, $6250 per month after taxes. If I assume I will likely be in the 22% or 24% tax bracket by then, how do I figure this out? I hear many people say they will likely need around $70,000 per year in retirement, then they subtract what they get with their Social Security and pensions, then they take that amount left-“ let me start this over- “If I assume I’ll likely to be in the 22% or 24% tax bracket by then, how do you figure this out? I hear many people say they will likely need around $70,000 per year in retirement.” So these are his buddies that need $70,000 per year?

Al: Yeah. Well, maybe that’s examples from the show.

Joe: Okay. “Then they subtract what they get with their Social Security and pension-“ Okay, so he wants to spend $70,000. He takes the Social Security-

Al: – to figure out the shortfall.

Joe: -he takes the pension -“then they take that amount left that is needed.

Andi: I think that means from the portfolio?

Joe: Yes. “And then you mentioned to divide into 4% to see how much you’ll need in retirement to arrive at this amount. But how do taxes factor into this? Do I really need $95,000 a year to reach my $75,000 amount after taxes? Thanks so much. You guys are the best podcast out there.” All right. Now I get Dale. Sorry.

Al: Yeah, you’re there.

Joe: He was talking about us guys.

Al: I think so.

Joe: So what he’s trying to figure out is how much money that he needs, but he needs to figure out the tax calculation because he’s going to get in the weeds here.

Al: He is, yep.

Joe: So the 4% rule is a high level rule.

Al: It’s not the gospel.

Joe: It’s nowhere close.

Al: It just tells you approximately how much you need to save.

Joe: Right. So it’s a really good guide for let’s say you want to retire- Dale wants to retire in 10 years, right? And he’s thinking, man, I want to spend this $75,000 but what is that adjusted for inflation? Maybe that’s $100,000 and he’s got $50,000 or $60,000 of Social Security and pension. So you take $100,000 minus $60,000, you’re left with $40,000, you multiply that by 25, or divide it by 4. You’re going to come up with a certain number. So you need $1,000,000. But that’s not including really anything. I mean, that’s just to see hey-

Al: Am I in the ballpark?

Joe: Am I in the ballpark? Will I have $1,000,000. If you have $200,000, you’re way off base. So you have to adjust your assumptions or your savings rate or your retirement date and so on.

Al: I think that’s a good way to say it. Anyway, to figure out your taxes. I mean, you can work backwards, come up with an amount, figure out the tax rate, get TurboTax, but that’s a lot of work. To me, here’s the quick and dirty way to do it, is you figure out approximately your tax rate, and this is just approximate if you don’t want to do it the most correct way, which is to do tax projections. But let’s just say you said you want to spend $75,000. You’re single. The top of the 10% bracket is- 12% brackets, is a little over $40,000, we’ll call it $40,000. And let’s say you want to spend $80,000. Super easy math, right? So you need $80,000 net. So your tax rate is going to probably be roughly half in the 12%, half in the 22%, right? It’s a little bit more, but you get the idea. So then if you split that, that’s 16%, we call it 15%. Super easy math, right? Okay, 15% tax. Now what do you do? Well, you take that $80,000 and you divide it by the reciprocal. Now I’m gonna
to lose people, I know.

Joe: You already have.

Andi: I thought you said quick and dirty.

Al: Well, it is quick and dirty, if you follow the math, if you paid attention in junior high. Anyway, you take 100% minus 15% and get 85%. You take that $80,000, divided by point .85. That’s going to tell you how much you have to have to be able to pay the taxes or you can just keep doing it backwards. Do a $90,000, take 15% taxes. Is that the right answer? No, do at $92,000, whatever. Right. But that’s the quick way for those that followed me. For all the rest of you, just trial and error. It’s roughly- in this particular case, let’s just call it 15%. It could be 20%. You got to add in state taxes. I’m way oversimplifying, this, right? So if you want to just do a back of the envelope, that will give you roughly how much you need to draw to come up with that net number.

Joe: So let me go two other ways here. So the 4% rule that came about by Bill Bangham from right here in San Diego.

Al: That was what, the 80s? 70s?

Joe: 70s. who knows? It’s probably the 3% rule today. But what the assumption is, is that, all right, if you get 6%, 4% is what you’re spending, 2% is for inflation and taxes. So it’s kind of already built in there on a very high level.

Al: That’s the idea.

Joe: That’s the idea, right. So you can look at it like that. Or you could say 4% plus tax ,plus the cost of living. That’s how we look at it. If we’re just really simplifying things is that here’s your shortfall, you’re short $40,000 plus tax on that, plus the cost of living, because you can control your taxes in retirement. Al, did you know that you can control your taxes more in retirement than any other time in your life?

Al: I think I’ve said that.

Joe: Yes, you have.

Al: I think I had a CPA once said that.

Joe: But I mean, it’s true. That’s why we harp on all of this stuff, because the tax rates could be zero even though you’re spending $70,0000, $80,000, $90,000 a year, right? Where’s the money coming from? Is it coming from a non-qualified account? Is it coming from a Roth account? Or is it all coming from a retirement account? How’s your Social Security going to be taxed? What’s your provisional income? How all of this kind of plays together is what’s going to determine your tax rate. So even though your income is $70,000 doesn’t necessarily mean that you’re in the 22% or 24% tax rate. That might be the last dollar that gets taxed at that rate because you got to take that minus the standard deduction, and some of it is going to be taxed at 12%. Some of it is going to be taxed at 22% and so on. So most people think, if here’s my income, and then they look at the tax rate, if $1 falls in that marginal tax rate, then everything is taxed at that rate. It’s not true. Like Al was just trying to give you the effective rate and then do so-

Al: – and then go backwards.

Joe: – and use the reciprocal to figure out the reciprocal of the tax.

Al: Yes. Which is for those engineers-

Joe: – for those people that went to elementary school, we should all know this.

Al: Anyway, but that’s a really good point, which is people assume if you’re in the 22% bracket, I’m going to need $20,000 to cover the tax. No. You got the 10% rate, you got the 12% rate, you got a little bit in the 22%. And it’s not as much as you think because of the standard deduction, which is over $12,000, right? So if you want to do this right, get TurboTax, figure it out. But if you want to back up the envelope, just realize that you’re in the 22% bracket, that’s your marginal-

Joe: – but your effective rate is a lot less.

Al: That’s your marginal rate. Which simply means if you make another dollar, you’ll pay tax at 22%. But your effective rate, which is the blended rates, is something much smaller.

With the consumer price index at forty-year highs, this is a good time to take a look at what types of investments might make sense in an inflationary environment. When inflation readings come in higher than expected, most major asset classes are likely to suffer. But, as your time horizon stretches out, you can take steps to position your portfolio for optimal performance in an era of rising prices. Learn how to invest when inflation is raging. Read the blog from Pure Financial Advisors’ Chief Investment Officer, Brian Perry, CFP®, CFA, in the podcast show notes at YourMoneyYourWealth.com. Click the link in the description of today’s episode in your favorite podcast app to go to the show notes, read the blog, read the episode transcript in its entirety, and to share the YMYW podcast and all the free financial resources.

 

Grade My DIY Retirement Spitball: Can I Buy a New Luxury Truck? (Wannabe Luxury Truck Driver)

Joe: All right, let’s go to Wannabe Luxury Truck Driver. “Hi, Joe, Al, Andi. Love the show, have been a weekly listener for almost two years and have been binge listening to many of the others. You guys are awesome. I have learned a lot, laughed as much as I’ve learned.” All right. Thank you.

Al: Cool.

Joe: “I’ve listened to Joe and Al do spitballs, and based on what I’ve learned from them, I decided to do my own. I’m hoping they will give me a grade on my work. I fear that snarky and flippant Joe will give me a C or C+ or even a failing grade. On the other hand, I hope that cool, calm, and collected Big Al might come through and give me a straight A.”

Al: Wow. You know us.

Joe: Yes, flippant and snarky. “My wife and I are 59, have no animals, consume no alcohol, and she drives her new cutie-“

Andi: Cute ute.

Joe: Cutie-

Andi: No, it’s a ute. A ute in Australia and English means truck.

Joe: Yeah, two utes.

Al: I read a cuuuute-

Joe: Cute ute- “- a Toyota Rav4 hybrid. I am made to drive the 13 year old Toyota Camry 4 banger with 175,000 miles. It looks like new almost, has been ultra-reliable and currently has absolutely zero problems that need fixed. That is part of the argument between me and her. Because it’s super reliable and looks great and fully paid for, she says I don’t need a new car. I hope that you approve of my spitball well enough to convince my wife that we can afford me to buy a luxury truck of my dreams with all the new gizmos, gadgets, and safety features.”

Al: Oh, that’s easy. Just go to your friend’s house and have his car parked next to you and slam the door into it a few times. Get a hammer on the back- make it look bad.

Joe: Here it goes. Let’s see. We got. “All of these steps are based on retirement at age 60.” And he’s got a few steps here. “First step, our current annual spending is $130,000 a year. This is based on my detailed spreadsheet tracking it for over several years. No, Joe, I’m not an engineer. We want to, and will need to, maintain this level of spending in retirement.” That’s why he needs to drink.

Al: And so far, no grade on that one. That’s just a comment.

Joe: “Step two, I inflated our annual expense up to $127,500 per year by an annual inflation rate projected at 4% per year for 8 years. This gets me to 2030. The first year, each of us will get paid our full Social Security benefits. Based on this inflation projection, our annual spend on 2030 is $175,000. In addition, I project that we will need enough to cover projected annual income tax of $12,000 per year. This means annual gross income of 2030 of $187,000.” All right, great.

Al: Okay, good.

Joe: “Step 3, I used the Social Security website to determine our projected PIA based on the current numbers and increase it by 2.5% per year. And assume inflation increase, we will receive a combined amount of $37,000 in 2030. Step 3, we own debt free, a small rental unit that produces annual income based on assumed 10 months rental rate at the current rate and a 2.5% inflation for 8 years which produces an annual income of $20,000 a year.”

Andi: And that was the second step 3.

Al: Yeah, there were two steps 3.

Joe: Two Step 3s.

Al: 3a and 3b.

Joe: He’s looking at his fixed income. So he’s got $37,000 in 2030 for Social Security and he’s going to get $20,000- right? Are we with?

Al: Yeah, we’re with.

Joe: $60,000. I then subtracted $37,000 from our projected Social Security income and $20,000 from our projected annual rental income from the $187,000 gross income goal. This leaves $130,000 of income needed from our investment retirement assets. Based on a 4% annual distribution rate, this means we need a total investment of $3,200,000 by 2030.” Boom. Right on. Look at that.

Al: So far-

Joe: You’re killing it.

Al: So ‘A’. ‘A’ so far.

Joe: So far, you’re a CERTIFIED FINANCIAL PLANNER™ here. “Step 5, Our total investment retirement assets as of June 30, 2022 after the losses of the first two quarters, are $2,400,000. These funds are held in a mix of tax-deferred after-tax Roth and small brokerage account. I then assume ongoing annual contributions of $42,000. These contributions will be maximum contributions to our Roth IRAs and 401(k) contributions to the company match. I also assume an annual growth rate on the investments of 4.5%. Again, I’m being conservative. With the continued contributions for 6 years and an annual growth rate of 4.5% on the investments, this should get us to $3,400,000. This is 144% more than our annual needed amount of $3,200,000.”

Al: $144,000.

Joe: “$144,000. I realize that there are a few alternative scenarios that would create the need for adjusting the plan into bringing our income- and bridging our income for several years. For example, we might decide to retire early at 65 rather than our full retirement age of 67. Or we might defer the larger Social Security payments age 70. I know this is generally a good idea and I know all my assumptions are speculative. So how did I do with my DIY spitball? Is my methodology sound and my assumptions appropriate? Are we on track? Can I buy my luxury truck? Will you allow me to tell my wife ‘I told you so’? Thanks again for the great show. The Wannabe Luxury Truck Driver.” The answer is yes, my friend. Go buy the truck.

Al: I think it’s a great plan. I got no complaints.

Joe: No complaints. I give you an ‘A’, except for you don’t have cocktails.

Al: The only thing we didn’t really get into is how much is Roth versus deferred? And should you be doing some Roth conversions on the way to take advantage of lower brackets? Maybe. Maybe not. I don’t know enough about your situation. That would be something you could add to this to make it an A+. But you’re right on track.

Joe: Yeah, I like it. I mean, he’s listening to the show. He gets it. You take your spending, you inflate it with inflation. He did that. He was conservative with his inflation rate. He was conservative with his growth rate. He figured, what’s the shortfall? He did the division of 4%. It says here’s what the need is. How do I get to the need? I think you’re right on. But now the problem is, is that that’s just a starting point. Now how are you going to create the income from the overall portfolio? What is your tax rates going to be? How are you going to pull from your tax-deferred? your taxable? your Roth accounts?
How is that going to bridge to the Social Security to age 70 and so on and so forth? So you could really maximize this to the fullest if you start now going to the next level.

Al: Yeah, that’s right. So how do you manage and monitor, right? Because if things change, you’re going to have to think about this a little bit differently.

Joe: Right. Unless the markets go down 20% and you’re pulling down $140,000 down now, now what is that going to do? This is spitball. So great job on the spitball, but now you got to wound that thing up a little bit more to kind of really hone this in. But yeah, go ahead, what the hell. Buy the truck.

Al: Anyway. I’m good with you buying the truck too.

Is This a Big Opportunity to Sell Company Stock with No Capital Gains? (Danny Noonan)

Joe: Alright. Dear YMYW team, this is Danny Noonan, writing in from St. Paul, Minnesota.” Alright, well, Minnesota. Danny Noonan. You know who Danny Noonan is, right?

Al: Yeah. Caddyshack, right?

Joe: You got it. “I discovered your podcast early this year, and now I can’t miss an episode. Listening to the new episode is one of my highlights each week.” Danny, get a life.

Al: Or we could say thank you for your compliment.

Joe: Go back to the golf course. “My wife, Lacy Underall-“ She’s a little something something. You know who she is? You remember her on the Caddyshack?

Al: Yeah. Caddyshack also? Is that the younger gal?

Joe: Yeah, it was Snail’s, Judge Snail’s niece.

Al: Yeah. Ooo, yeah, I do remember her. It’s taking me back. Let me think about that one. Okay, I’m back now.

Joe: “Lacy and I are both 51 and getting close to retirement. We began investing at a young age, and we’re looking forward to enjoying the fruits of our labor. Lacy has $1,200,000 in her current 401(k), as well as two others with a total of $300,000. We also have a Roth IRA totaling $280,000. I have $1,200,000 in my 457 plan, which I can start withdrawing at 55.” I like how they help us with the rules.

Al: That’s right. Yeah. In case we don’t know.

Joe: He’s probably listened to the show once or twice, right? “$312,000 in Roth Accounts, going to have a pension around $66,000 starting the year at age 66. We also have about $900,000 in various brokerage accounts, $300,000 in cash. We anticipate taking Social Security at 70 with the combined benefit of $70,000 per year. My target retirement is 55. We anticipate spending about $120,000 a year.” Did you add up all those assets, Al?

Al: I did. $4,500,000.

Joe: Okay. $4,500,000. And then it’s $120,000 to $4,500,000?

Al: Yeah, so at age 55, we would think of maybe a 3% distribution of, let’s see, 3% of $4,000,000 is $120,000, add another- $135,000- Yeah, no problem.

Joe: It’s close. “Although we are close to retirement, I still have a few years to be fully invested in the pension program. One option we are considering is to have Lacy retire at the end of the year. We have always filed our taxes jointly, but if Lacy is not working, do we have this big opportunity here?” I know where he’s going with this.

Al: Yeah, me too.

Joe: “Since I will be working next year, I anticipate earning $165,000, which would have us paying capital gains tax.” Why would he be paying capital gains tax?

Al: I think you have to read the next sentence.

Joe: “As part of our brokerage accounts, Lacy is heavily weighted in Company X stock. $272,000 from employer stock purchase plan, and $320,000 in restricted stock units which are fully invested and have had the taxes paid. The company stock has done wonderful over the last few years, and it’s at an all-time high, far different from the rest of the market. I know it is risky to have so much in one stock. If we file separately and Lacy has no income next year, would this allow her to sell all this company stock with no capital gains? Could she also convert about $53,000 to a Roth IRA? Does she need to be 59 and a half before she can start converting her IRAs to Roths?” Danny. Danny.

Al: A lot of questions here. Some- got derailed a little bit there.

Joe: Settle down here, Danny. All right, well, let’s just kind of burst this bubble real quick.

Al: Yeah, let’s start there. First of all, Lacy has restricted stock. I’m assuming that’s what it’s worth. You don’t pay tax on what it’s worth. You pay tax on the gain. So when it became- when it was not restricted stock, then you pay tax on that, whatever it was worth at that point is when you-

Joe: Whenever it was vested.

Al: -vested. That’s your tax basis. Okay, so in other words, $272,000 employee stock purchase plans. Let’s just say it was worth $172,000 at the time it vested. So that means you got $100,000 gain. Right. It’s not the whole amount. So you got to figure out what your gain is, not the value. And yes, you pay capital gains on that gain. If Lacy files separate, and that’s fine as long as Minnesota is not a community property state, which I don’t think it is. California is, I’m very familiar with that. If she could file separate, that means the top of the 12% bracket is about $42,000, right? $41,000, $42,000. You add the 12% standard deduction. So in other words, she could have about $53,000 of gains and pay no tax. Once she goes over that dollar amount, the gains are taxed at 15%. And if she goes over $200,000 some thousand, $215,000, that’s taxed at 20%. The capital gain rate is taxed at 20%. So anyway, I think if I’m understanding the question, a lot of people think that I’m in the 10% bracket, so I can have as many capital gains as I want. I pay no tax. No, you pay zero capital gains to get you to the top of that 12% bracket.

Joe: So you’re saying if he’s married, she’s got a lot of capital gains-

Al: Yeah. So she can file married, filing separately as long as it’s a non-community property state, this could work.

Joe: So it’s like, okay, well, here you’re going to have a lot of income, but my income is ordinary and your income is capital.

Al: Yeah. Or zero. Until you do something.

Joe: Until you make the transaction. File separately, she sells the stock, she could get a favorable tax rate because if they file jointly and he’s making $165,000, that could bump them up, depending on what the gain is.

Al: Right. And you and I don’t talk about that much because California, this doesn’t work at all. Because community property state means whatever I have, half of that’s mine and half of that’s yours and vice versa, whatever you have, half of mine, half yours. So it just doesn’t work. That’s why it doesn’t come up much for our clients.

Joe: So, in Minnesota, you would have to- maybe Andi does a little research here.

Andi: Sure.

Al: Yeah, I’m pretty sure it’s not a community property state because there’s only like 10 or 11-

Joe: Yes, I think you’re right. It isn’t.

Al: It’s mostly West Coast states, it seems. So then, to make matters worse, if you throw a Roth conversion on top of that, it just keeps adding to that taxable income. So now, all of a sudden, less of your capital gains are going to be taxed at zero because now you’ve got ordinary income to boot.

Andi: Confirming Minnesota is equitable distribution. It is not community property.

Al: Okay, that’s what I thought.

Joe: There you go. Danny. And then you do not have to be 59 and a half to do a Roth conversion.

Al: That’s true, too.

Joe: You can do a Roth conversion at any age unless you pay the tax from the IRA as you convert it. There would be a 10% penalty on whatever you take out of the IRA to pay the tax. To just pay the tax outside of the IRA and you’re fine. You can do the conversion there. So, to continue on here, we’re going to blow up the clock.

Al: That’s okay.

Joe: “It seems like anything beyond $53,000 level would put her in the 15% tax rate on all her capital gains going forward for the next couple of years. Would it make sense for us to file taxes separately until I retire as well given the anticipated tax rate starting 2026? I know we should start converting to the 24% tax bracket and possibly to the top of the 32% while we know the tax rates are certain. I believe our goal is to convert as much as we can by age 63, so our RMDs will never put us to $182,000 IRMAA limit in the future. Am I missing anything?” No. Danny, you’re dialed.

Al: Just realize that if you do a Roth conversion the same year you’re doing capital gains, it’s going to kind of mess up that strategy.

Joe: “If filing jointly, will the combination of the earned income and Roth conversions over the $250,000 trigger additional 3.8% NIT tax?” Yes. “Non-investment income tax?” Yes. Because the cap gain sit on top of ordinary income. In the Roth conversions., Ordinary income and your cap gain sit on top of that. And if that pushes you over the limit for net investment income tax, then anything over that limit will be subject to the other 3.8% tax.

Al: And married filing separately, once you’re over $125,000 of adjusted gross- modified adjusted gross income, you got to pay that net investment income tax.

Joe: Okay, so let’s see, “If Lacy retires next year, maybe all brokerage assets should be sold to avoid these additional taxes.” Yeah, I think we answered that. “I would appreciate your spitball in our situation and provide any optimization-“ Wow, we’re not doing some optimization here. We’re just throwing out ideas on the back of a napkin. “I always thought investing the money into various retirement accounts was the difficult part. Now I realize how important it is to have an exit plan to keep as much as possible. Thanks for all your contributions to financial literacy.” Well, thank you, Danny Noonan. Appreciate the Caddyshack-

Andi: We’re gonna have the entire cast on here pretty soon.

Al: That’s right.

It’s important to put market volatility into perspective to keep from making emotional decisions that can be difficult to recover from over the short or even long-term. Watch the latest episode of Your Money, Your Wealth TV show on Bear Market Money Mistakes and download the companion Bear Market Survival Guide from the podcast show notes at YourMoneyYourWealth.com. You’ll learn how a bear market versus a bull market can impact your portfolio. You’ll learn signs of the bear market, bear markets vs. recessions, market timing, staying invested to beat the bear, and some strategies that will help you put a long-term strategic plan in place to withstand the bear market and beyond. Click the description of today’s episode in your favorite podcast app to go to the show notes, watch Bear Market Money Mistakes, and download the Bear Market Survival Guide.

Rental Property 1031 Exchange Now, Primary Residence Later, Pay No Tax When We Sell? (Wesley)

Joe: “Hi, Alan. Hope all’s good with you.” All right.

Al: Well, this is from Wesley. It wasn’t your comment.

Joe: Here we go. I could just take the easy road here.

Al: You can.

Joe: It’s just like straight to you, Big Al.

Al: Just read it and I’ll answer the question.

Joe: Got it. “We are selling, in escrow now. Our one-bedroom rental condo in San Carlos.” Our old stomping grounds.

Al: Yeah, I do know Wesley. Name changed for privacy.

Joe: This is your buddy?

Al: Yeah, we went to high school together.

Joe: So he sent you an email and then what, we wanted to put it on the air? So every email you get, we’re reading it?

Al: Well, he sent me an email and he said if this would be good for your listeners. And I thought, sure. So I sent it to Andi and said, change the name.

Andi: And I actually edited out the part where he said, if you find this to be appropriate for your show, go ahead and use it. Because I didn’t think you would need to say that part.

Al: Every single time someone emails me a question, gets on the show.

Joe: Got it. All right. Our old stomping grounds.

Al: San Carlos. By the way, that is in San Diego, next to San Diego State. There is a San Carlos, I think, in the Bay Area. It’s not that one.

Joe: “We are thinking about doing a 1031 exchange and purchasing a home that we’ll eventually live in using the plus or minus $370,000 as a down payment. The plan would be to purchase the home within the required 100 day pay period and rent the property out for 5 to 10 years. After 5 to 10 years, we would make this exchange property purchase with a 1031 exchange, a primary residence. If we later sold the property, would we avoid the taxes on the $370,000?”

Al: All right, so I’ll maybe recap that. So Wesley’s got a rental property right now, and if you sell a rental property and do a 1031 exchange, all the gain defers into the next property, gets pushed into the next property as long as the property that you buy, the replacement property, is at least as expensive as the one you sold, and you do it within certain time frames. The main one is 180 days to close, from close of escrow, so it sounds like that’s going to be covered. Wesley wants to rent the property 5 or 10 years, sure, no problem. The thing about this is then can you turn the property into a residence? And the answer is yes, of course you can do it. And in fact, somewhat recently, Joe, the IRS came out with a new pronouncement with a safe harbor on this. In other words, what do you have to do to then change the character of the rental property to a residence where the IRS won’t bother you? Basically, it’s two years. And there’s a few other things at least two years, but 5 to 10 years, no problem. In other words, the rule is it has to be a rental, and the intent of it has to be a rental at the time of purchase, but after a certain time period, you can change your mind. So then you’ve got this residence that you still don’t have to pay the tax on until you sell it, right? You’re still breathing?

Joe: I’m good.

Al: So then it’s like, I got this residence, what if I sell the residence? Then do I still get the $500,000 exclusion and I won’t have to pay the tax on the $370,000? And the answer is not that simple. The answer is, first of all, any depreciation that you took, you’ve got to recapture that. You got to pay tax on that. And the second part of this is now there’s an allocation, number of rental property years versus the number of residence years, and you only get a partial exclusion. And then it depends when you originally bought the property that’s being exchanged into. It’s kind of tricky, but just understand that there’s an allocation. You will get an exclusion, but it’s not going to be the full $500,000.

Joe: I fell asleep 3 times. Well, I felt like I was hanging out with you and your buddy in your old stomping grounds.

Al: I was talking to Wesley, not you.

Joe: Just chatting. Oh, my God. When this going to end?

Al: I don’t say that to you when it’s just equally as boring.

Joe: I know, it’s terrible. Every time to ask you a question, you’re like, what? I wasn’t even listening.

Al: It’s like –

Joe: I totally zoned out of that one.

Al: You lost me at, ‘here’s your answer.’

Joe: You lost me at ‘Hi Alan-‘

Is Earned Income Still Taxable for Social Security If LLC is in a Trust?

“Hi, love your podcast and listen while doing household chores. You all 3 are funny and informative. I’m 60-year-old female and planning to retire at 62 years, two years to go. My husband is 60.5 years old and he plans to continue working till FRA.” Full retirement age for-

Al: Yes and we do know that one.

Joe: “He’s a stock trader-“ oh boy “- and is looking to put his LLC into a trust we are working on.”

Al: So that means I guess his stock trading activity is in the LLC.

Joe: Yeah, he’s a real big trader.

Al: Yeah, yeah. He needs a corporation for that.

Joe: Oh man, he probably read that in a book somewhere or a blog.

Al: Yeah right.

Joe: “So question, would his income be taxable under Social Security or other taxes If it’s in a trust? What other taxes would we incur under a trust?”

Al: Depends what kind of trust. I assume you’re talking about a living trust and then it’s a see-through trust. It’s as if it wasn’t there. So it’s like a non-entity. If you are putting it in an irrevocable trust where you’re not the trustee, then you don’t have access to the money. I don’t think you want to do that. So I’m going to say it’s living trust. It’s a flow through. There’s no tax impact.

Joe: Yeah there is, I mean it’s a flow through. Everything is going to be like the trust wasn’t there. All the trust does-

Al: What I’m saying is whether you put it in the trust or not it’s the same taxes.

Joe: Yes.

Al: That’s what I’m saying.

Joe: There’s no tax avoidance by putting in the LLC in the trust.

Al: Correct. So whatever income he is generating from his trading and I would imagine it’s a ton-

Al: And it would only be earned income if he’s a dealer under the IRS rules and that’s too complicated to get into.

Joe: “We both plan to take our Social Security pension at 62, his is $1000 with mine it’s $2300. We plan to invest the large check inside instead of waiting the 70 my calculation would be $1,000,000 compounded. I also have a pension. I have a Roth, traditional IRA. The brokerage account, too, our living expenses is estimated at $56,000 a year. We have a vacation rental and our main house is fully paid for. Does this plan make sense to you? Thanks so much.” Yeah, I think she’s doing a great job. Just hopefully she can keep her husband from trading all of that hard earned savings away.

Al: Yeah, be careful of options because you can lose a lot of money.

Joe: They want to spend $56,000 a year. She’s got a pension. The Social Security’s strong. That’s all good. There’s no debt and a ton of assets.

Al: House is paid off.

Joe: You’re not going to avoid any taxes, though by- oh, I got an LLC, and then now let’s put the LLC in the trust.

Al: Both of those are flow through.

Joe: Right. And so all the trust will do is avoid probate. So the ownership of the LLC will go through the trust and whoever you name is the beneficiaries of the trust. So a trust does not avoid tax. It avoids probate, period.

Al: And neither does an LLC.

Joe: Yeah, an LLC is just to help with liability.

Al: If someone trips at your office, not too much else.

Joe: You sprain your thumb trading, right? Clicking that mouse, getting in and out of the overall markets. And then they sue.

Al: You sue your company, which is you. You’re not going to get too much.

Comment: I Love Your Haircut!

Joe: Go to YourMoneyYourWealth.com, click on Ask Joe and Al and we’ll answer any question that you have. Got a comment here.

Al: Do we?

Joe: Yes.

Al: Okay, let’s see.

Joe: It says, “I love your haircut. That’s all.”

Andi: And this was emailed directly to me.

Joe: Are you sure?

Andi: Yes. Positive.

Al: I’m gonna guess she was talking about Andi, because Andi-

Joe: Andi, you do look great. I like this-

Al: Because Andi did get a new haircut. It’s really cool.

Joe: -kind of like retro-

Al: Yeah.

Joe: What are you going for- ?

Andi: Summer. I was going for shorter. That’s what I was going for.

Joe: Shorter for Summer.

Al: For the heat? Right?

Andi: Yep. So Tricia, thank you very much for that. I appreciate that. And that was in response to- the reason she actually sent that was because of the fact that we’re putting some shorts on YouTube. I did a short about the fact that the YMYW podcast survey is available right now. So if you go fill out the survey, you enter for your chance to win a $100 Amazon eGift card. So you can do that just by going to the podcast show notes for any of the podcasts that we release in the month of August. And it tells you on the page what the secret password is to access the survey, which, by the way, is all lower case ymyw.

Joe: Why do we have a secret passcode?

Andi: Because if we don’t, then we get all sorts of spam entries from people who really want to get that $100 gift card. So we got, like, 200 spam entries until I put a password on the account.

Joe: Well, we know if it’s spam, right?

Al: Yeah, but it’s a lot more work for her.

Andi: Yeah. But do you want to mine through them? Yeah, exactly.

Al: So we get this comment, “I love your haircut. That’s all.” So I know Joe and I are both thinking it’s us. You’re thinking you just got a haircut. I’m thinking I haven’t had one lately and she likes the longer hair. Andi, I’m going to say it’s you.

Joe: Yeah. Andi, you look great. I like the haircut.

Andi: Thank you.

Joe: I really do. Tricia, you killed it. Yeah. So we got the YouTube channel. We’re trying to do some really cool stuff there. I don’t think a lot of people know that we have the YouTube, but it’s been there for decades.

Andi: Well, we do have, like, 25,000, almost 26,000 subscribers. And so yes we do have-

Joe: Is that good? Or is that bad?

Andi: Considering how long we’ve been around, we could probably use some more. But the podcast is up there, and Joe and Al answering your questions is posted to our YouTube channel every single day. So you can go and see a brand new video of Joe and Al and I making fools of ourselves on camera every single day on our YouTube channel.

Joe: There you go.

Andi: And then fill out the podcast survey while you’re there.

Joe: Yes. We got to put Aaron. He cuts all this stuff up and makes me look like I’m 700.

Andi: Oh, he does that, really?

Joe: Yeah, I’m 6’4”, I weigh 220 pounds. And then the camera angles make me look like I’m like 7000 pounds.

Al: Well, when the camera is low and looking up, we all look older than we really are.

Joe: All right, that’s it for us today. Appreciate you guys hanging out. Go to YourMoneyYourWealth.com, click on Ask Joe and Al, go to our YouTube channel, you can give us a one-star review, give us any review you want, that’d be nice. And we’ll take it from there. See you next week. The show’s called Your Money, Your Wealth®.

The Derails

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And don’t forget to stick around for the Derails at the end of the episode if that’s your kinda thing.

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