In this episode of FIN-LYT by EWA, Matt Blocki and Jamison Smith discuss strategies for unwinding a sizeable real estate portfolio. They explore the financial, tax, and lifestyle considerations involved in transitioning from active real estate ownership to a more traditional investment approach.
Matt and Jamison break down key factors, including the tax implications of selling properties, the benefits of 1031 exchanges, and the impact of capital gains taxes. They also compare the long-term returns of real estate versus the stock market, helping investors assess whether holding or selling is the best move.
The conversation also touches on strategies for gradually liquidating properties to optimize tax efficiency, the pros and cons of selling in bulk versus individually, and the role of real estate in generational wealth planning. Whether you’re considering an exit or just want to make smarter decisions with your portfolio, this episode provides valuable insights to help you navigate the process.
Speaker 1 – 00:00
Welcome to EWA’s FinLit podcast. EWA is a fee only RIA based out of Pittsburgh, Pennsylvania. We hope all listeners
of this podcast will beneft as we deep dive into complex fnancial topics that we will make simplifed for you. And
we hope that this really serves as a catalyst so that you can make the best fnancial planning decisions for your
family and also save time.
Speaker 2 – 00:28
Welcome everybody. Today’s episode, James and I are going to talk about a situation we’ve actually helped many
clients with that had a substantial amount of wealth in real estate that they built up over the last couple of decades
and they decided they wanted to go to a more traditional way of investing basically for peace of mind and getting
time back on their plates every week. Because real estate can be surprisingly can suck a lot of time with issues that
come up. So we’re going to talk about how to do this, some of the lessons learned in working with these clients and
actually evaluating the returns that they made. You know, was it all worth it, would they go back and do it again, etc.
So Jameson, let’s kick it off.
Speaker 3 – 01:13
Yeah, I think the, just to preface, like there’s a lot of differing opinions on real estate. People think it’s like passive
income, easy way to get rich. And I think the reality just from helping many clients with this, it can be a really good
wealth generation tool. However, I would say the caveat is like it’s no different than any type of other business. Takes
a lot of time, energy. There’s no real get rich quick. So a lot of these situations, what we’re, what we’ve helped clients
with, you know, like you said, they’ve done this last 20, 30 years. They’ve put the time in. Was it worth it, was it not?
We’ll talk about. And now it’s like we have this big nest egg of a real estate portfolio. You know, maybe they’re in their
50s, 60s and they’re getting ready to stop working.
Speaker 3 – 01:57
People normally that we help, that’s not their full time job. They have a profession doing something else. It’s like, you
know, maybe what’s retirement look like? How do we unwind this? So why don’t we frst, I mean Matt, let’s assume
we have like, we’ll just use the same example the whole time. So you have like a $10 million real estate portfolio.
You’re collecting rent. We’ll say there’s no mortgage. What’s the frst thing you should start looking at?
Speaker 2 – 02:18
Yeah, I think the. And so you’re Saying, let’s just break this down in detail. 10 million. Should we just say that’s a
breakdown of between like 25 properties?
Speaker 3 – 02:29
Yeah, I say 20 $500,000 properties, $2,500,000 properties.
Speaker 2 – 02:33
Okay.
Speaker 1 – 02:34
Yeah.
Speaker 2 – 02:34
So I think, you know, the frst thing is looking at, from a tax perspective, there’s a couple ways to look at this. I think
every decision we need to look at the fnances. So specifcally in the fnances, we need to look at what are the, if we
sell this, what’s going to happen? Are we selling this at a good valuation? Is this sector of the market good or bad?
What are the tax ramifcations of this? And then we have to look at the peace of mind aspect. So is this property, has
this historically been a pain? You know, tenants, this is like we’ve had, this is a section in town, maybe we’ve had
young, you know, graduates out of college, they throw a lot of parties.
Speaker 2 – 03:11
There’s been a lot of issues and you know, we have to go and fx a lot of stuff. So there’s a peace of mind aspect as
well. And then, you know, purely from like a return perspective, what is the return we’re getting if we don’t sell it?
What’s the return we’re getting if we do sell it? So let’s just talk about the taxes frst. So from a tax perspective,
generally speaking, if you bought a property, let’s say 20 years ago and it was 100 grand and it’s now worth 500
grand, the frst thing from a tax perspective we have to consider is if you just let this thing ride under today’s tax law,
if you have children, you want to pass wealth on to children, you could let this pass on to your children.
Speaker 2 – 03:57
Let’s just say in Pennsylvania specifcally, there’s going to be real estate transfer fees. On top of that, Pennsylvania’s
going to impose a four and a half percent inherit state inheritance tax. And that 4.5% is going to hit on the current
valuation on the 500,000. However, the advantage of waiting would be they would get a step up in basis. So your
kids would get that half a million dollar property. They could then sell it after paying transfer taxes, after paying those
fees, after paying the inheritance tax, they could then sell it at $500,000 and not incur a capital gain tax. Now if you
decide the other option is you could do a 1031, you could take this property that you purchased for 100, you’ve
probably depreciated the thing, you’ve written off a Lot of stuff. So you probably have a basis close to zero.
Speaker 2 – 04:44
But if we wanted to defer that half a million dollar gain, we could sell it and within six months get it to a like kind
property. If you do that correctly, then you’re basically kicking the can down the road. You pay taxes if you sell, we’re
living. You can give it to your kids tax free when you die from it. Just from a capital gain perspective. So a lot of
people just sit on the real estate because of that step up in basis that occurs. But that step up in basis currently is,
has been under attack. I mean it’s how many years of how many election cycles they’ve been talking about getting
rid of that. It’s been at least two, right?
Speaker 3 – 05:15
Yeah, yeah, defnitely the last two.
Speaker 2 – 05:18
So if the frst thing we have to realize, if we’re going to just sell this and go to the more traditional route, which is
typically what we help people with, is if that basis written down to zero, you’re gonna pay a capital gain tax of a half a
million dollars. So some of our clients, they’ll sell these properties in different tax years because that half a million
dollars will get treated as capital gains, but it’ll still show up as income on your total taxable income bracket. So this
may affect a Roth conversion you did. This may affect you jumping into a higher tax bracket and other. This may
introduce Amtrak. So we have to look at from a very detailed tax perspective, generally speaking, capital gains, you’re
going to pay 0, 15%, 18.8% or 23.8% depending on how high your income.
Speaker 2 – 06:05
So if you just were to sell all of these properties all at once in Pennsylvania, you’re most likely the majority of the
gains are going to pay 23.8% federal tax, plus an additional 3.07% state tax. So the question is, if we do this slowly,
could we get that 23.8 down to 15? And what’s your experience been? Because usually it’s more afuent people that
would have a $10 million. How much tax savings is really on the table by spreading it out?
Speaker 3 – 06:34
Yeah, it depends one thing I want to note. Kind of a nuanced detail, doesn’t really matter that much. But the
depreciation recapture, so there’s a capital gain and then anything that you’ve depreciated down, I believe it’s 25%.
So if you’re in that highest capital gains rate, it’s going to be roughly the same similar tax, but it’s taxed slightly
differently, but yeah. How much tax, it really depends on income. So if you’re still working full time and you’re making,
do you have the capital gains? Just pull the capital gains rates.
Speaker 2 – 07:06
Let’s, let’s use Mary fling jointly just for simplicity.
Speaker 3 – 07:09
Yeah, yeah. So basically the frst, the 15% capital gains rate is between 94,000. I’m rounding in 583,000. And if you’re
above 583,000 of income tax at 20% plus the 3.8% net investment income I believe is about 250 of income. So the
very big variable is are you still working? What’s income look like? But if with the capital gains and earned income
you’re below that 583 number, there could be a 5% tax savings from spreading it out. Now if you’re making a million
bucks a year doing other things, it’s not really going to matter. You’re probably always going to be in the highest tax
bracket. And the other thing, when we did this a couple years ago with so.
Speaker 2 – 07:55
5%, that’s like 5% of 10 million. It’s 5 just to monetize, it’s half a million bucks.
Speaker 3 – 07:59
Yeah, that’s signifcant.
Speaker 2 – 08:00
It’s signifcant, absolutely. But I’m also going to say on a $10 million portfolio, the real estate portfolio could fuctuate
by 5% on a year to year basis as well. So if you think you’re at a high, you should consider, you know, eat the higher
taxes because we’re exiting it out versus if the market drops 10%, maybe you’re saving 5% in taxes. But now we’re
still in a negative 5 because the market shifted. You’re not selling at an all time high.
Speaker 3 – 08:24
Then another thing to think about which we helped, I’m just thinking of a client we helped do this. I believe it was like
2021. So in 2020 after the election there is a big tax overhaul that got proposed then got passed in the House, didn’t
get passed in the Senate. But one of the things that they were proposing and has been on the table could happen,
could be another thing that depending on who gets elected could be on the table would be increasing capital gains
rates. I believe that proposal was any income earners over 400,000 would get, get merged with your federal income
tax rate. So it could go up to like 37 or 39.6%. So when we had this discussion, you know, three or four years ago, it
was, yeah, you’re going to be in the highest tax bracket.
Speaker 3 – 09:08
We could potentially wait fve years when you’re not working and maybe we could save some in capital gains or we
could sell now and lock in this 23.8% plus you know, the state tax. And then in the future if your capital gains rate
goes up to 40%, it doesn’t matter. And that was enough that they decided just to sell everything immediately. Yeah,
yeah.
Speaker 2 – 09:28
And it turned out great because that though they did exit at a high point.
Speaker 3 – 09:34
Yeah, yeah. And that’s what I say. The frst thing you should probably do is just get a gauge. And if you’re in, if your
day to day is in real estate a lot, you probably already know this, but get a gauge on property valuations, the area that
the properties are in. You know how it. Because you could look at it and say, hey, these are, you know, the real estate
market in the city that these houses are entered at like an all time low and I’m going to wait a couple years to try to
sell that. So that’d probably be the frst thing. And just get a gauge on the market.
Speaker 2 – 09:59
Yeah. So let’s talk as well, again, just again, high level $10 million portfolio, 2020 properties, single family units, 500,
000 is probably what, 2500?
Speaker 3 – 10:10
3000, I would say.
Speaker 2 – 10:11
3000Amonth.
Speaker 3 – 10:12
Perfect.
Speaker 2 – 10:12
Yeah. So we’re cash fowing 60amonth or 720 a year. So that’s basically a 7.2% rate. On 10 million you’re getting
7.2% of income plus maybe some appreciation. You know, historically the last decade, real estate’s gone up
tremendously. But if you look back the last hundred years, real estate only appreciates at about 2 to 3% a year. So
720 a year, that’s a 7.2%, you know, return from a cash fow perspective. Plus there’s going to be some appreciation.
However, if you back out the turnover, you know, maybe it takes you a month or two to fnd a new tenant. If there’s
high turnover, there’s going to be expenses. Typically we estimate expenses like repairs and maintenance to be
about a third of your cash fows. So if we take a third off the table now, we’re looking at a 4.8% on the 10,000,480
plus appreciation.
Speaker 2 – 11:08
So we’re probably looking at about as back, if you’re honest about it, a 6 to 7% return. A 6 or 7% return you could
historically get in the market. S P 500 has done about 10 over the last Hundred years. But if you diversify, risk versus
reward 6 to 7% has not ever been an issue. Getting long term in the market. And the difference there would be
managing 20 properties and the logistics of contractors and tenants and repairs and maintenance versus, you know,
having a meeting or two a year with a fnancial advisor that takes two hours a year.
Speaker 3 – 11:42
Yeah. And one thing, one of the rebuttals that I’ve heard a lot is there’s a lot of tax benefts with the depreciation and
there are. But let’s just use this example of 10 million. Assuming you’re still able to, you’re on the, you know, 27 and a
half years of depreciation, that’s about 363,000 a year, that could offset the real estate income. So yes, there could
be some tax benefts. But if we compare it to, you know what you said investing in the market, if you took 10 million,
let’s just compare that to if you invested it, what you could safely live off without ever touching the principal. So
there’d be some taxes. Yeah.
Speaker 2 – 12:19
If you could direct index it to erase a lot of the taxes.
Speaker 3 – 12:22
Is it 10 million after taxes? If you just sold everything, let’s say you get seven and a half, say eight. Because let’s say
there’s some bases you get back. Let’s say you get 8 million.
Speaker 2 – 12:29
Yeah. A guardrails approach, you could pull 5% a year easily. So 400 a year.
Speaker 3 – 12:36
400 a year for not doing anything.
Speaker 2 – 12:37
Versus after taxes, probably 360 because that’s all basis.
Speaker 3 – 12:41
Yep.
Speaker 2 – 12:42
And then 30amonth.
Speaker 3 – 12:43
And so with the real estate income, let’s see if 620. And you said what, a third of that or 727, 20. A third of that’s
expenses for 80. So you’re close to the same. You may be within $100,000.
Speaker 2 – 12:57
But yeah, I’m going to say you’re 40amonth working full time.
Speaker 3 – 13:00
Yeah.
Speaker 2 – 13:01
Because if you’re not, then the property management fees are bringing you right back. Or you’re 30amonth with no
concerns and no stress.
Speaker 3 – 13:07
I think that’s the biggest consideration with real estate. It’s. Do you enjoy. I’ve met people that love doing it. That’s
their, that’s their job. They love managing the properties, they love fxing it. And it’s like, hey, if you want to spend your
time doing that, go ahead. But we fnd is a lot of people get into it and realize how much work it is and they’re trying
to do something else. And so when you compare it to, well, you could just put it in the stock market and not do
anything and still collect, you know, close to the same amount of income, I would say that’s probably the biggest
decision.
Speaker 2 – 13:32
Absolutely. And back to the tax perspective, if someone’s doing an active election to manage these properties, that,
and the huge beneft there can be that appreciation, repairs and maintenance that can actually work off if you’re
married, fling jointly, let’s say to like a physician, that’s seven fgure that can all work off that active income if you’re
taking an active role in the real estate. So that’s where the benefts can be basically put on steroids during your
working years. But once that active income goes away, then that really, the beneft of that goes down dramatically
during retirement.
Speaker 3 – 14:05
Yeah, yeah. So let’s talk through. Let’s say someone does choose to sell, they get that 8 million bucks, what are they
doing with it? Because this could be a total, you know, they’re used to, they may not have liquid assets. They might
literally their whole portfolio could be real estate and this could be a whole new world to them.
Speaker 2 – 14:21
Yeah. So if they have existing assets, then we’re looking at the makeup of those. You know, what do they have in a
401k Roth conversion? So those make sense. If the market goes down having some, you know, available cash, we
want to make sure we have a war chest of at least seven years worth of safe money. So let’s say they’re, they get 8
million. Say, you know what guys, we want to live off of 20amonth. Just saying that hypothetically, and Social
Security is giving us fve, we need 15. So 15 times 12, that’s 180 a year. Times seven, what is that? 1.56 mil? 1.26,
1.26 miles.
Speaker 3 – 14:57
Say 1.3 math.
Speaker 2 – 14:58
Yeah, 1.3 million of the eight. We’re keeping, you know, in a laddered strategy of tax efcient bonds, some
governmental securities, treasuries, etc. That way, you know, we’re never worried about market fuctuations. The rest
of it is going in equities and we’re being extremely tax efcient. But to get that money position, then we’re probably
dollar cost averaging that over a three to six month period, if the market drops more than 10%, we’re fulflling that
position of the allocation immediately. Otherwise on a weekly basis, we’re dollar cost averaging it and making sure
there’s a high educational process if someone’s used to real estate. And how come the stock market.
Speaker 3 – 15:37
And one strategy, this would be very situational but let’s say you’re going to spread this out every couple years and
you’re active so you’re a qualifed real estate professional. Let’s say you have retirement plan set up. Let’s say you
have a Real Estate LLC, you have a 401k, maybe we’ve helped them set up a 401k cash balance plan because it’s
active income these years that you start selling, you may have extra. If you don’t need the income to live on and you
have extra infux of cash that could be a good opportunity to maximize The Retirement Accounts 401 cash balance
plan while they’re still earned income and take money from the sale and essentially put it into a tax deferred account
that then you can pull later at a lower tax bracket.
Speaker 3 – 16:18
So would be a lot of variables there depending on the situation, but could be one way to get some signifcant tax
savings as well.
Speaker 2 – 16:24
Absolutely. One other thing I think a good question is like would it be easier to sell all of these in bulk? And I
remember the scenario you had referenced early on they got some quotes in bulk and they were I think 60%.
Speaker 3 – 16:43
Yeah.
Speaker 2 – 16:44
Of what they would have gotten if they sold them individually. So generally speaking there may be, there’s a good
deal out to be had. But from our experience in the feld out there is typically if you have single family homes, it’s, you
know, work with yourself or a professional to unwind them one by one. That’s how you’re going to maximize the
value.
Speaker 3 – 17:01
Yeah, I would say there’s some very like, I’d say generally that’s true. When I think yeah, when they looked at it there
was going to be an investor to just buy them all and it was a signifcant discount. So if you have a 10 million dollar, if
each one adds up 10 million bucks, they may offer you six or seven for it all which could be really easy way to just
ofoad it and be done with it. I would say that depends on your fnancial situation. So if you have a 50 million dollar
net worth outside of this, you may not care and you might want to just get it done with. If this is the bulk of your
portfolio, could be worth taking the extra time to get your extra couple million.
Speaker 2 – 17:33
Out of it for generational wealth and passing on values. Do you ever see scenarios where maybe you hang on to real
estate, pass the real estate to the kids while you’re living?
Speaker 3 – 17:44
Yeah, I think we’ve talked about this on other episodes. It’s a big issue and problem that a lot of high net worth
parents have is how to ensure that your kids have the same drive, work ethic and you know, when they inherit the
money that they don’t just blow it. And one strategy that I’ve talked to clients about which could benefcial is taking
some of the properties and giving it to the kids while you’re living. Because if they, let’s say you sold and you gave
them a million bucks, they can do whatever they want with that. If they have, if they don’t have the values, work ethic,
they might just blow right through that.
Speaker 3 – 18:22
Or you could say, I’m going to take a million dollars of two properties, I’m going to give this to you in a tax efcient
way and now I’m going to teach you how to manage what I did for 20, 30 years, how to manage this property, how to
work with the tenants, how to, you know, collect the rent. And that’s a really healthy way to get the kids to
understand, you know, working for the money, learning the business side of it. And they could always sell it in the
future if they choose to. But that could be a good alternative to just giving them a lump sum of money. They can just
do whatever they want to because they have to, you know, work to maintain the properties.
Speaker 2 – 18:52
Absolutely. That’s a good point. Lots of aspects, not just fnancially, psychological values, peace of mind, time, lots
of aspects should be taken into consideration when making these decisions.
Speaker 3 – 19:05
Yeah.
Speaker 1 – 19:05
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