InSight

Tax Mitigation Playbook: What are the Requirements and Rules for a 1031 Exchange?

Financial Planning Dentist

1031 Rules require all 1031 exchanges regardless of the type have a 45-day identification period and a 180-day exchange period.

For a 1031 exchange to be in accordance with IRC § 1031 Rules, within 45-days of the close of the sale of the Relinquished Property the taxpayer must identify their potential replacement property(ies) in writing to the qualified intermediary. The replacement property(ies) description must be unambiguous and specific using a physical address or legal description. 

In relation to the 45-day identification period, there are rules that a taxpayer must follow when identifying their potential replacement property(ies). There are three distinct identification rules that the taxpayer can use, and they can choose the appropriate rule for their specific exchange situation. The three rules are as follows: 

  1. 3-property Rule: A taxpayer can identify up to three properties without regard to the fair market value of the properties and they must close on at least one of the identified properties for the exchange to be valid. 
  2. 200% Rule: A taxpayer can identify more than three properties, but the fair market value of all properties combined cannot exceed 200% of the fair market value of the Relinquished property(ies). 
  3. 95% Rule: A taxpayer can identify infinite properties, the combined value of which exceeds 200% of the value of what they sold, but they must acquire at least 95% of the fair market value of the properties they identify. 

All 1031 exchanges have a 180-day time limit starting from the day of the close on the sale of the Relinquished Property. If the taxpayer has not completed the purchase of the Replacement Property before or on day 180, then the exchange is closed, and the taxpayer must recognize and pay taxes on the proceeds from their Relinquished Property sale. There are no extensions or exceptions available.

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Kevin Taylor

Is a U.S. Housing Market Crash Inevitable?

It is almost inevitable that housing correction is coming. Most of the upswing nationally in housing prices is caused by low borrowing rates. A mortgage payment is mostly made up of three different columns 1) Principle 2) Interest 3) Other required costs of homeownership like insurance and taxes. The bulk of the payment comes from the first two.  Banks start the process by determining your “ability-to-repay” the debt. This comes to a given amount that they assume borrowers can repay, let’s say this number is $100 a month. This means you are approved if Principle, Interest, and Other Costs can come to less than $100 a month. So all of the “costs” combined need to stay below that mark, a zero-sum figure. Now as interest rates were low, the amount of the interest portion of the loan was low. Meaning more money could be freed up for the principal portion. And that principal portion is the rate at which the loan is being repaid. So if over a 360 payment loan $75 on average is getting paid in principle, the loan can retire $25,200 in debt. So the borrower can offer $25,200 for a home with faith from the bank that they will be able to repay. Thus, the buyer in the real estate auction can spend $25,200 max (and they will spend all of it).  Now if that same borrower, who can afford $100 a month in mortgage payments has to borrow in an interest rate environment that is 10% more costly than before, a rate change of borrowing from 2% to 2.2% the borrower will need to borrow from the principal repayment part of the pie. That means that the average payment they can afford to make comes down, and they will only be able to offer $21,600 when making an offer on the house. This is 14% less, after a 10% move up in borrowing costs.  This is where it will get interesting.  The “rates” that you may have heard are rising, are the percentages at which banks borrow. That money has cost banks 0.25%, since 2020. It’s made spending during the pandemic easier and lowered the cost of capital risk for banks in order to keep the money flowing. So, a bank borrowing at .25% or close to it can lend a 30-year mortgage at really low rates. Hence the sub 3% and 2% mortgage rates we saw in the last 2 years and on the heels of the 2009-2016 recovery cycle.   The by-product of this low-interest rate, high spending environment is inflation (the rising costs of goods and services). So if the cost to the bank to repay these loans increases, the cost for borrowers increases at a faster rate. So the rate of change is more than the 10% increase we discussed above. A borrower seeing their interest rate go from 2.2% to 4.4% (while still historically low) will see their capacity for repayment severely impacted. By just returning to normal lending rates the portion a borrower can repay is reduced. The borrower who could afford a $100 a month payment, now sees his buying power reduced to $9,000 over the course of the 360 mortgage payments in a 30-year mortgage. The borrower now has 41% of the buying capacity by doubling the borrowing rate, this change in the amount of borrowed capital buyers brought into the house buying equation, means that the bid sizes will invariably contract. Bringing the prices that a home clears the market down. Knock-on-effects: Inflation In the above scenario, the ignored part of the pie is the “Other.” This is mostly tax and insurance, but also includes power, water, HOA’s, and other required expenses for the ownership of a home. These costs are also climbing, and they too will erode the buying power of borrowers. This has been a largely understood space for some time, but as inflation continues to outpace wages, this will have a growing negative effect on the buyer’s ability to borrow. This is simply shifting payments from principle into insurance. What is missing from the “crash” in ‘08?: Leverage So just understanding that buyers are going to lose buying capacity in a given market doesn’t result in a crash, it just means that home prices will contract. What is still missing in this equation is selling pressures.  The housing crisis wasn’t just the rising cost of home prices, it was also the deterioration of credit quality borrowers, and excess leverage. As the housing market of the early 2000s looks eerily similar in growth, an important distinction is made between the two when we look at the leverage ratio of borrowers. This is a result of the bad actors in the housing crisis leveraging one house with another, and another, and another. This allowed the rampant contagion of home selling. One default in the leverage on leverage structure meant that a single default meant 2 or more defaults as a result. The low credit quality and poor borrowing strategies (adjustable rate mortgages, and subprime lending) meant that all borrowing became interconnected. Now while the current system has become somewhat lax on the underwriting standards again, the use of adjustable mortgages and equity requirements for vacation and second homes remains largely intact. Limiting the contagion of contraction to single borrowers. What is missing from the “crash” in ‘08?: Employment Employment is well below 4% and that is encouraging. That means that there is plenty of demand for workers and that if a borrower is qualified when they are employed, the risk of losing that employment is at its lowest point ever. Broadly speaking this means that it’s worth keeping an eye on, but will limit the amount of forced selling that could trigger a true “crash”. 

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Boulder Financial Advisors, Planning and Zending
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Kevin Taylor

Mindfulness and Positive Reinforcement: The Path to Healthy Financial Habits or “Zending”

In today’s fast-paced society, it’s all too easy to fall prey to the temptations of instant gratification. This attitude often trickles down to our financial habits, where we seek immediate pleasure rather than considering long-term consequences. Enter mindfulness: a mental state achieved by focusing on the present moment, while calmly acknowledging and accepting feelings, thoughts, and sensations. By pairing mindfulness with positive reinforcement, we can cultivate a resilient financial mindset and pave the way for healthier savings habits something we are going to call “Zending” (Zen + Spending). You are Zending when you can save, and spend with mindful clarity, you are not spending in a way that inflicts anxiety later about the bill, and you are living in a way that is on your own terms and harmonious.  What is Mindfulness? Mindfulness originated from Buddhist meditation but has become a secular practice in recent decades. It’s about being present and fully engaging with the here and now. In the realm of finance, this means making decisions with awareness, rather than on autopilot or driven by impulsive desires. Why is Mindfulness Relevant to Financial Health? When we’re not mindful, we tend to make financial decisions based on emotions, societal pressures, or even habits formed in our youth. This often leads to spending beyond our means, not saving adequately, or not investing wisely. By being mindful, we can: Recognize our financial triggers: Understand what drives our spending habits, be it stress, societal pressures, or emotional needs. Pause before spending: Taking a moment to reflect before making a purchase can prevent impulsive decisions. Make intentional choices: Mindfulness allows us to align our financial decisions with our core values and long-term goals. Positive Reinforcement for Financial Mindfulness Set yourself up for success, and have a “positive reinforcement” plan in place. It will help when things get hard, and the road feels long.  Positive reinforcement involves adding a favorable stimulus to encourage the behavior that led to it. By rewarding ourselves for positive financial behaviors, we can reinforce and strengthen our newly-formed habits. Here’s how you can apply positive reinforcement to encourage a mindful approach to finances: Set Clear Goals: Start with clear, achievable financial goals, whether it’s saving for a vacation, paying off debt, or building an emergency fund. Breaking these down into smaller, actionable steps can help make the process less daunting. Reward Milestones: Every time you achieve a financial milestone, no matter how small, celebrate it. This could mean treating yourself to a small luxury, spending time in nature, or even just acknowledging your achievement with a moment of gratitude. Visual Representation: Create a visual tracker for your savings goals, like a chart or jar where you can see your progress. Watching your savings grow can be its own reward. Enlist Support: Share your financial goals with friends or family, and celebrate your achievements together. They can serve as accountability partners and cheerleaders, amplifying the sense of accomplishment. Mindful Spending Rituals: Before making a purchase, take a few deep breaths. Ask yourself if this purchase aligns with your financial goals and values. If it does, go ahead, and if it doesn’t, walk away. Consider this act of restraint as a victory and reward yourself in a non-financial way, like taking a moment to enjoy nature or spending time on a favorite hobby. Conclusion Combining mindfulness with positive reinforcement is a potent strategy for fostering healthier financial habits. By being present in our financial decisions and rewarding ourselves for positive changes, we can pave the way for a future of financial stability and well-being. It’s not just about saving money—it’s about cultivating a mindset that values long-term well-being over short-term pleasures.

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Inflation
Articles
Kevin Taylor

Four Things That Actually Matter With Inflation

Inflation is simply the rising costs of goods and services over time. It’s an important part of the planning process to make assumptions about buying power over time. It allows you to know how to budget your money using a placeholder that should represent to some academic degree the effectiveness of your dollar as you get closer to the time you need it. However, I have had several discussions with clients who assume the incline of inflation is something like 2% annually. And while that is a reasonable, and likely adequate initial placeholder, if your financial advisor is simply using that number because the talking heads on TV or the software they use have that number already baked in, then you need to have a serious discussion about the gaps that arise from such short cutting. A miss on the inflation discussion has two permanent repercussions on your financial plan: Inflation assesses its toll further and further into plans. It’s insidious and you won’t know the impact until the end of retirement, when you have fewer resources to make course corrections. It will affect what your expectation should be for your internal rate of return, particularly in your fixed income investments. If you are assuming a 2% inflation rate a 2% treasury may be appropriate, but if your personal inflation rate is actually 4% (likely from the reasons below) you will have an unaccounted for gap between the rising costs of goods and services and the yield from your chosen investments. This article is a good checklist to make sure that your financial advisor can discuss and will make adjustments for this gaps in inflation math: Your lifestyle No two retirees live the same lifestyle in retirement. If heard other advisors say that, and be able to adjust the product suite they use for risk, or which goals they bake into a plan, or even change the expected costs they use from goal to goal. But then each of them will extrapolate the costs of that lifestyle inflating at 2%. This is a mistake. This shows a lack of understanding as to what causes inflation and the effect it will have on your plan.  Inflation does not affect all products equally, in fact the most impacted items are usually isolated to the items that are purchased by everyone. Groceries, gasoline, and basic services are more impacted by steadily rising costs than that of large ticket consumer goods and electronics.  You may think that this isn’t a big deal right? We all buy groceries and that is a part of my financial plan. This type of thinking is ill-advised and offers a major gap in the calculations and the expectations you should have for your income.  Example: A client of mine said:  “I have a simple life, I don’t buy that many new things, and I’m not all that interested owning new cars, clothes and gadgets in retirement, my calculation for inflation should be pretty low.”  So he wanted me to lower his expected rate of inflation. I said wait a minute, you’re not thinking about that correctly, while yes, he is right that the things he buys may be simple and he’s not going to buy much, he’s wrong about the effect of inflation. Because he’s using the “2% average” he’s heard about he’s missed where the number comes from. The CPI is the change in a basket of goods and services, so it takes into account everything a regular american can reasonably buy (and it doesn’t include gasoline). So in aggregate the number may be 2%, but by not buying those items he’s taking on more, not less, inflation risk for the normal person. See in the chart below where we have eliminated the baskets he didn’t see himself buying (recall that the higher ticket consumer goods generally are disinflationary – the cost of a flat screen TV comes down with time and not up).  Item Annual change in inflation as a Percentage(%) Example clients inflation estimate Groceries +4% +4% Utilities +5% +5% Gasoline +5% +5% Movie Passes +4% +4% Healthcare +6% +6% Automobiles -3% NA Consumer Electronics -3% NA Clothing -2% NA Average 2% 4.8%   So while he is thinking that his appetite for spending is low, his exposure to inflation is more than twice the normal of people in retirement. So when we plan we are trying to extrapolate the costs of a certain lifestyle in retirement, in this scenario the inflation expectation should rise for this client, not fall. More severely, using a standard 2% inflation rate, will cause him to have a shortfall that becomes more complicated as he gets deeper and deeper into retirement.  Declining quality is inflation Several of the items that comprise your quality of life today, deteriorate in quality over time. This is not a hard and fast rule, and in some cases the opposite is true. But if you think about the nature of appliances, automobiles, and other big ticket consumer goods they can become suspect. The refresh cycle for large appliances in the 1990’s was 20% longer than it is for today. This is the result of a few elements, the “smart” revolution and added technology creating more demand for new items, and the decline in their quality. Both of these are measured as disinflationary, the costs of these items have come down year over year, and the “features-scape” is expanding. This all seems disinflationary and in the CPI it’s measured as costs coming down on these items. And while that might be a true statement for someone, the Bureau of Labor Statistics “buys” these items year over year to test the market changes, and for most people this is actually hidden inflation. Here is the math. If the price of an item comes down year over year by say 4%, but the refresh cycle is impacted by anything greater than 4% in a year, the result for regular people is actually inflation, not deflation. Because the

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