Deep-dive into my Seven Figure Alternative Investment (and Real Estate) Portfolio: 2022 Q2 Update
Updated: May 22
My defensive portfolio enjoyed an exceptional year (returning 41.32% including 7.37% in income). In comparison the stock market dropped -3.35%, bonds fell -10% and bitcoin plummeted -33.87%. Here's an in-depth look at my portfolio strategy, allocations, deal by deal performance, tax considerations and future strategy.
(Usual disclaimer: I'm just an investor expressing my personal opinion and am not an attorney, accountant nor your financial advisor. Consult your own financial professionals before making any financial decisions. Code of Ethics: To remove conflicts of interest that are rife on other sites, I/we do not accept ANY money from outside sponsors or platforms for ANYTHING. This includes but is not limited to: no money for postings, nor reviews, nor advertising, nor affiliate leads etc. Nor do I/we negotiate special terms for ourselves in the club above what we negotiate for the benefit of members. Info may contains errors so use at your own risk. See Code of Ethics for more info.) Many people ask me, "What's in your alternative investing portfolio, and how's it doing?" So I've been regularly sharing a deep-dive review of it since 2017. This includes what I'm invested in, how it's doing and my detailed thoughts on each one. So here's the latest update. This article covers:
1) About me (so you can put my portfolio choices into perspective)
2) Current portfolio overview and strategy (and changes from last time)
3) Benchmark comparison with other alternatives (stocks, bonds, real estate indices as well as the performance of my last update)
4) Portfolio allocation
5) Investment-by-investment deep-dives
6) My strategy for the future
Plus bonus features:
7) How I manage cash
8) Investment by investment deep-dives on taxes
So let's start off with a little bit about me and my personal situation, so you can understand my portfolio choices.
I'm a retired serial tech-entrepreneur and rely on my investments to support myself and my family. So my risk tolerance for loss is low (especially compared to someone who's working and not depending on their investments to live). And I'm much more concerned about preserving my capital (not losing money) and generally am un-interested in going for the highest projected returns. So this makes me a conservative investor. Alternatively, a person who comes from a different financial situation, has different financial goals, and/or has a different risk tolerance will probably disagree with some or all of my choices. And that's fine, because (in my opinion) everyone's different and there's no such thing as a single sponsor or investment that's good for everyone.
My Portfolio Overview
My wife and I share financial decisions and have a broad portfolio. And this includes seven figures invested in "alternative investments": investments that fall outside the traditional box (of public equities, bonds and cash investments) that most investors recognize and usually get through a retail broker. Many alternatives are only available to higher net-worth investors and/or institutions. And they're typically only found through word-of-mouth, crowdfunding, and/or through an investment club. My alternative investment portfolio follows the core-satellite approach to portfolio design to manage risk. This means that the majority of it is placed in a huge, conservative core. And that lets me feel comfortable taking more risk on smaller satellite portions. The portfolio is mostly invested in real estate with additional investments in a variety of hard-to-find asset classes that are not directly tied to the business cycle (like GP stakes, litigation finance, music royalties and life settlements). More details on this are in a later section, below.
As of May 2022, the portfolio returned about 41.32% (for the trailing 12 months). The income portion was 7.37%.
So this was an exceptional year that went far beyond my expectations. And I certainly don't expect to do this well every time. Also this year it happened to trounce most of the other benchmarks (stock, bonds, cybercurrency, commercial real-estate and core real-estate). I also don't expect this every year. And that's why I have a diversified portfolio in the first place (and alternatives are just one part of it). Here's how those other investments did over the past year...
Comparison with alternatives (stocks, bonds, bitcoin and real estate indices)...
Here were the total returns (both dividends/income and price appreciation) for the following benchmarks for the trailing 12 months:
Stock market: Standard & Poor's 500 index for large companies (S&P 500): -3.35% (with alot of volatility)
Bond market: S&P 500 bond index for large corporate grade bonds: -10%
Cybercurrencies: Bitcoin took a beating at -33.87%
Commercial real-estate: the Greenstreet Real Estate "All Sector" CPPI index was up 21%. This index is composed of number of sectors including retail (20%), office (17.5%), apartment (15%), health care (15%), industrial (10%), lodging (7.5%), net lease (5%), self-storage (5%), manufactured home park (2.5%) and student housing (2.5%).
Core real estate: The NCREIF ODCE core real-estate index was up 28.47% (the highest in the history of the index).
So this was a great year for my alternatives. I certainly don't expect them to beat so many benchmarks every year (which is why I have a diversified portfolio). But when it does happen, I'm not going to complain.
...and comparison with my last update (in Q2 of 2020)
How did my portfolio do this time, compared to my last update in the second quarter of 2020? Back then, total return was a very good 11.58% (including a decent 6.77% in income) This year was exceptional and I don't expect to blow it out of the water like this every year.
Here's the low-level breakdown of my portfolio allocation.
As I mentioned above, I follow the core-satellite approach to manage risk. And so, the conservative core is made up of boring no-debt residential properties, which make up 55.3% of the portfolio (versus 49% last time). (More on this below).
The rest is the satellite portion. I allocated additional money to the following investments. (Note: added money isn't always easy to see from just the raw percentages, since more money is being put into other areas as well, and that can lower the percentage because it's a relative measure.)
Litigation finance (non-correlated asset): now 3.6% versus 3.5% last time
MG Properties (real-estate): now 19.1% versus 14.8% last time
And I made brand new investments in:
GP Stakes (non-correlated asset): 4.8%
I'll go into a deep-dive on each one of these in a minute.
My Portfolio: Real-estate Portfolio Allocation
But first, for all the real-estate buffs: here's how the portfolio is split out between real estate and non-real estate investments.
Real estate remained the largest portion of my portfolio at 75.6%. This is a little less than the 83.2% in Q2 of 2020. Non-real estate was boosted to 24.4% from 16.8% last time. How is that 75.6% of real estate allocation broken up? Here's what it looks like (with all of them adding up to 100%):
Again, you can see my core-satellite approach, with the majority of it in very boring no-debt residential properties. (The "mixed" is from Front Street which is mostly office, healthcare, mixed-use and industrial development).
Note that I deliberately haven't included my primary personal residence in any of these graphs and calculations. Technically, it is a real estate investment. And for many people, it's the largest investment they'll ever make (which isn't the case for us). On the other hand, my home also provides shelter, an additional value that's difficult to calculate. And more importantly, my family treats our home like more than an investment. We love it and spend money on it way above and beyond what would be done with a pure investment. So that's why I'm not including it here.
So going back to the graph... here's what changed since last time:
Hard money loans and Equity NNN were reduced to 0% (versus 10% and 12% respectively, last time). Both of these IPOed and moved out of my alternative portfolio and into my public market holdings.
No-debt residential properties increased to 73.7% now (versus 58.9% last time).
Multifamily increased to about 26.9% (versus 19.1% last time).
And for those are are curious, here's how my real-estate portfolio currently breaks out, by real estate investment:
A deep-dive on each one of the above is coming up in the following sections.
Trailing 12 Month Returns
How did each individual investment do? Here are the trailing 12 month returns:
And here's how these were calculated:
J-curve: Many alternative investments have an initial investment period (typically a year or two) during which they are deploying funds and are not yet making full distributions. So I didn't include these yet in total return calculations (GP stakes and life settlements).
Partial j-curve: A few are partially in the J-curve (parts of litigation finance, parts of MG Properties, parts of music royalties). It would've been too much work to split these out, so for simplicity I just included them. So this lowered my reported return a bit (versus what it would be if it was fully split out). But I figured it was "close enough".
The no-debt properties actually returned more income than shown (probably a couple percentage points higher). However since that part hasn't yet been fully calculated by my accountant, it wasn't included.
Price appreciation of real estate can be tricky to determine without an expensive appraisal (which isn't practical). And the other way they are valued is when properties are sold. But typically, that sale doesn't happen for 5-7 years after initial investment (to maximize the return). So, as a proxy, I used Zillow's home pricer, the Zestimate, for residential property appreciation. Many feel this underestimates prices. If so, the actual return would be higher than shown.
Here's a deep dive look at what's happening on each investment (from the largest to the smallest holdings):
1) Residential rental properties: (same as last time at #1)
This is by far the biggest part of my alternatives portfolio. Again, I follow the core-satellite approach to risk. And this large conservative core lets me feel comfortable taking more risk on smaller satellite portions. Residential renters tend to be more stable and longer term than multifamily/apartment renters, which I like. I target working class neighborhoods with affordable rents (to maximize the renter pool, and align myself with the long-term trend of a growing lack of affordable housing). I also pick neighborhoods that are low in crime (avoiding class-C) and properties that meet my yield and other minimums. These were purchased with no debt, which I believe hardens them extremely-well against a severe downturn. The vast majority of real estate investors would probably consider this to be an outrageously conservative strategy that leaves too much money on the table. And they would would prefer higher projected returns by taking on leverage instead. On the other hand, the strategy works for my purposes. This returned 53.13%. That's obviously knocking things out of the park and not what I usually expect from a conservative investment. 5.33% was in income (and actually it's about a few percentage point higher than that, but I didn't include it because that part has not yet been fully calculated by my accountant). The price appreciated 32.86% due to a hot property market. I don't expect this kind of price appreciation to happen every year. But when it does it's like getting extra gravy at a meal: a nice bonus. I regularly cull this portfolio when a property falls out of my minimum criteria (if the neighborhood looks like it's going bad or if there's too much turnover etc.). This time there weren't any sales.
My goal is to deploy additional cash into this asset class. But it will depend on pricing, etc, so we'll see what happens. Also, I'm not willing to buy rentals in a remote city via a turnkey operator, because I feel there are too many financial incentives and ways for them to hide significant problems that I'll never even realize. So if I can't redeploy here, I'll keep it in cash or find some other place for it.
2) MG Properties Group (versus #2 last time)
Last time, I was in ten different properties with this sponsor across multiple funds. Since then I've added additional money and am now in fourteen.
MG Properties is one of those very rare sponsors that appears to have gone multiple cycles without losing any investor money. They do multi family value-added, using moderate leverage, and high skin in the game (10 to 33%). They also are one of the few to implement a full-featured TIC 2.0 1031 exchange pipeline, which allows taxpayers to defer all taxes indefinitely. See this article on: "How to Invest in Passive Real Estate Without Paying a Penny of Tax (Legally): Part 2: "Defer, Defer and Die". This is generally a long-term 7 to 10 year hold, and on exit, I intend to 1031 exchange into a follow-up investment with MG (to defer capital gains). Ideally, I would like to hold a position with them forever, and when my wife and I pass away, pass it on to our son (who would inherit it on a stepped-up basis, and also not pay any capital gains). This is all part of the "defer, defer and die" tax minimization strategy mentioned above. Since last time MG's rental collections have been strong and income is up a bit. (Last time, it had fallen a little to 5.29% due to covid-19 lock downs).
Note: My % income number also includes newer MG investments which are still in the J curve (meaning not fully deployed and/or not producing full distributions). So this temporarily makes the overall % look a little lower than what really happened (had I properly split it out). But, it was too much work to do that, so for these purposes, I just kept it the current way.
3) Music Royalties: (versus #10 last time)
Music royalties have historically been very recession-resistant and not correlated with traditional and/or real estate asset classes. So this non-correlation can provide protection diversification to a portfolio during a downturn. Target IRRs in the industry can be very healthy 14-15% net IRR. The sponsor has requested its identity to be kept confidential in this article. Club members can get full info including their name, as well as detailed due-diligence, etc. here. (Membership is free but requires verifying that the applicant is truly an investor and has no conflicts of interest).
4) GP Stakes (new this time)
GP stakes is a niche, asset class that's isn't widely known (beyond institutional investors who keep it closely held). The core of it's profitability tends to be uncorrelated to economic cycles, stock market, etc. (which can provide helpful diversification to a portfolio and cash flow).
Here's how it works. The GP stakes fund purchases an equity share (stake) in a private equity company (the GP). This entitles it to receive a share of GP management fees, promotes (profit splits), balance sheet income (co-investments) for all current funds (and any new ones that are created). And the cash flow and downside protection from the management fees tend to be extraordinarily stable and predictable (even without growth). Then the other income factors (promotes, balance sheet income) provide opportunity for extra upside return. Not all GPs are created equal and the top tier are much more reliable and less volatile than the rest. So I don't feel comfortable bottom-fishing in this asset class. And I'm also very picky about which funds I invest in and require a team that has a very long track record of experience and success.
So I was very happy to find not just one but actually two funds that met my criteria over the last year. These sponsors have requested their identity to be kept confidential in this article. Club members can get full info including their name, as well as detailed due-diligence, etc. here and here. (Membership is free but requires verifying that the applicant is truly an investor and has no conflicts of interest).
5) Litigation Finance: (versus #6 last time)
Litigation finance is providing financing to law firms that need money to pursue cases with a higher than normal probability of success. It's not directly correlated to the business cycle/recessions, which can be great protection and diversification to a portfolio during a downturn/recession.
The asset class is becoming a favorite for institutional endowments and large family offices, but very difficult for most investors to access. Projected returns can be 18 to 20% IRR net.
The sponsor in which I invested has the longest track record in the industry. It created the asset class back in 2007 and has won numerous industry awards. This asset class does have a "J curve" meaning that it's expected to take a couple of years to break even and eventually produce a profit. It's also not expected to produce distributions in the first year. So it is really for medium-term money (5 years +). The sponsor has requested its identity be kept confidential in this article. Club members can get full info including their name, as well as detailed due-diligence, etc. here. (Membership is free but requires verifying that the applicant is truly an investor and has no conflicts of interest).
6) Non-Real Estate Loans (versus #5 last time)
This is a non-real estate related debt fund that has one of the most exceptional recession track records I have seen. Employees and family have almost half a billion dollars of skin in the game, and it has won many industry awards. It's also the #1 investment for members of Tiger 21 (investment club that requires $10 million in investments, minimum, and a $30,000/ year membership fee). I can say that I was impressed with the sponsor's diligence and competence during the Covid-19 crisis. And I also like how they are remaining conservative and taking precautions in case the worst is not over. I feel glad I chose to put my money with a sponsor that has been through a deep recession before. The sponsor has requested its identity and additional info to be kept confidential in this article. Club members can get full info including the sponsor's name, as well as detailed due-diligence, etc. here. (Membership is free but requires verifying that the applicant is truly an investor and has no conflicts of interest.)
Most startups fail and the few successful ones are usually white-knuckle roller-coaster rides. And when I was a serial entrepreneur it used to be my job to ride that coaster. But now that I'm a passive investor I don't want that stress (and instead pay the sponsor to do all that worrying for me). So when I invest in a startup, I write off the entire investments to $0 in my portfolio and budgets and assume the money is gone. That way if they go to zero (which is statistically the most likely outcome) then I'm not going to lose even a second's worth of sleep over it. And if they end doing well then it's a great extra bonus to celebrate (but not something that I was counting on). And I feel no urge to get upset about it, if and when succcess doesn't happen. Also if I don't feel comfortable writing it completely off, then that tells me I shouldn't be investing (and I don't). By the way, I see many other investors who don't do this, and it can cause them alot of unnecessary stress (over something they can't control anyway). And in my opinion, this can also lead to overly positive and overly negative emotional states that can cause bad investment decisions. Now, for the purposes of this article, I have actually included the amounts here. But if I wasn't writing this article, I wouldn't be doing this.
7a) De novo (new) bank startup:
This was an investment in creating a de novo (new/startup) community bank. Community banks are local, smaller banks that fill a niche of lending to local businesses. Typically, the big banks don't do these loans, because they don't know the local businesses well enough to underwrite them, and the amounts involved are too small to appeal to the larger banks. So the small banks perform a crucial role in local economies. But so many of them have been bought out by the bigger banks over the last couple of decades, that there aren't a lot of them left. And only a handful have been created since the Great Recession.
I liked this investment because the principals had 28% skin in the game, and the CEO had an exceptional underwriting record through the Great Recession, when he was with another Community Bank (which eventually was bought out). The charge-off/default rate for that bank was 4x-9.6x lower than the average community bank (which itself was much lower than the average big bank).
Prior to Covid-19, this had been performing well (hitting or ahead of projections on expenses and asset growth). Then Covid-19 hit, which caused the Federal Reserve to drop rates to rock bottom. And generally, this puts a squeeze on the profitability of banks. So, when that happened, I got worried for this investment. However, what I didn't anticipate was that there would be a new opportunity for them in writing Paycheck Protection Program (PPP) loans. And still managed to hit many of their projections on net profit (which was a nice surprise). Going forward however the PPP program is winding down. And the economic environment could get more challenging for borrowers (see my concerns about the future, below). So we'll see how they do. I'm hopeful for them. And at the same time, I've written it off to $0 (so it won't be the end of my world if they don't hit it big).
7b) Startups-PPE (Covid-19 "insurance"):
Initially the Covid-19 crisis had caused a significant shortage of critically needed PPE (personal protective equipment, such as n95 masks) for healthcare professionals in the United States. Part of the problem is that supply chains were based on manufacturing in China, and during the pandemic, China had diverted these to its own needs and away from the U.S. And the Chinese manufacturers who do ship to the U.S. are often inadequate due to fake certifications and quality control problems.
So I invested in a PPE manufacturing firm. I looked at this as a form of Covid-19 insurance. If the pandemic ran longer rather than shorter, and many other investments suffer, this one would actually do better. And if the pandemic is gone quicker, I would be happy to take a complete loss on this (because it would mean all my other investments would be skyrocketing). Ultimately the federal approval process for N95 masks became exceptionally bogged-down and dysfunctional (overloaded by massive amounts of fraud) and the N95 market has changed and there's now a surplus of certain types of masks and other challenges. I'm not authorized to reveal anything specific about this investment and will just say that in such an environment, any startup would have challenges. I'll just say that, like all my startup investments, I hope they can overcome all challenges that come their way. And if they can't, I've already written it off to $0 (so I'm not losing any sleep over it, either way.)
8) Life Settlements: (versus #8 last time)
Life settlement funds purchase life insurance policies from people who decide they don't want to pay for them (price gets too high, don't feel they need it, prefer immediate money, etc.). The fund continues making payments until the person passes away, and then the fund collects the life settlement.
The asset class is uncorrelated to public market/the business cycle and can be great diversification to a portfolio in a recession/downturn. Returns can be 7.2% to 10% net.
The sponsor has requested its identity to be kept confidential in this article. Club members can get full info including their name, as well as detailed due-diligence, etc. here. (Membership is free but requires verifying that the applicant is truly an investor and has no conflicts of interest).
9) Dislocated non-real estate loans (versus #12 last time)
As I mentioned in my previous update, I have set aside a considerable amount of cash. The idea is to be able to take advantage of dislocated and distressed opportunities caused by the next recession (and when cash becomes king). There's no guarantee there will be an opportunity to do this, or that it will be profitable. But this is how many small fortunes were built after the Great Recession.
This particular fund was designed to take advantage of dislocated, non-real estate debt caused by the Covid-19 crisis (and after-shocks). It's not a distressed fund, so they're not looking for deals that are in trouble. Instead, they're looking for healthy, cash flowing loans that can be purchased at a significant discount due to market dislocations and distressed sellers. So this takes on less risk than a distressed fund strategy.
The sponsor has an exceptional recession track record and has run multiple funds similar to this one successfully in the past.
The sponsor has requested its identity to be kept confidential in this article. Club members can get full info including their name, as well as detailed due-diligence, etc. here. (Membership is free but requires verifying that the applicant is truly an investor and has no business connections to sponsors).
10) Front Street Capital. Return: (versus #13 before)
Front Street is a rare company that has over 30 years of experience, with $100 million in capital and has lost zero investor money across multiple cycles. They develop and acquire office, healthcare mixed-use and industrial with conservative 65% LTV target leverage. Normally, I avoid ground-up construction at this stage of the cycle. However, Front Street eliminates the normally substantial refinance and interest rate risks by lining up the permanent loan in advance. And they also eliminate most or all of the tenant lease-up risk by placing the tenant in advance. So I felt comfortable making an exception for them on this (especially with their track record). This one was expected to return a quarterly distribution right away and did indeed deliver. And like most real estate syndications, it also will realize significantly higher returns if it can sell properties at a profit at the end. Note: I happened to invest in this via a vehicle that also invested in MG as well. And Front Street is still in the J curve and not yet fully deployed. So the income % shown is less than what it would have been (if I had split things ou).
What's next? (My strategy for the future)
So what will I be doing next?
My strategy has changed alot since my last update was back in the Q2 of 2020 (which feels like a lifetime ago). Back then:
The coronavirus pandemic had just hit and we were in lockdown. Never in a million years would I have imagined that entire portions of the economy would be shut down, millions would lose jobs and we would get the most severe GDP contraction on record.
But I was fortunate that I was already in a defensive stance because I had been concerned about cracks showing up in the business cycle. So I didn't invest in some of the riskier asset classes that ended up getting hammered (like hotels, business-cycle sensitive retail, certain types of office, etc).
Since then there's been alot of good news and alot of not-so-good news. The good news is that:
Successful vaccines and less deadly variants: Many parts of the economy came back to life after unusually good success with mRNA vaccines and the reduction in severe disease of newer variants (like Omicron and now BA2).
Rapid economic recovery: We rapidly recovered from a very short and unusual recession.
Strong job market: The job market is the healthiest it's been in a long time (with unemployment falling to just 3.6% and the best since back in February 2020).
On the other hand, there's also quite a bit of not-so-good news and uncertainty right now:
Inflation: Inflation is at highs unseen for decades due to supply chain problems, a shortage of semiconductors, a shortage of workers, the war in Ukraine (oil and gas price hikes caused by Russian sanctions and the elimination of food/grain supply from Ukraine that typically feeds much of the world, etc.) and China's covid-zero policy (causing shut downs of manufacturing plants relied on by many U.S. companies). This is causing alot of pain for consumer and companies. And so far it's defied predictions of disappearing quickly:
Rising interest rates: The Federal Reserve is in the uncomfortable role of having to play catch-up and try to contain the inflation genie by raising rates quick enough to stop it but without cause a recession (which most feel will be a tricky task at best). Meanwhile, decades of ultracheap money has caused some companies to run up record levels of debt, and this may not be sustainable if rates continue to rise.
Reversal of economic gains from globalization: The war in Ukraine is accelerating the split of the world into two competing spheres and calling into question the post World-War II global world order that has enabled unprecedented economic prosperity during those many decades. And intensifying confrontation with China is also speeding up the split and will likely reverse many of the economic gains from globalization.
More covid to come? And finally there's still the threat that the next mutation of Covid 19 may be more severe and cause renewed economic damage. With the global rollout of vaccines and treatments going at a relative snail-like pace, the virus will have many years to try to change things up.
So perhaps it's no surprise that recently the two and ten year treasuries inverted (which historically has been associated with an upcoming recession):
No recession predictor is perfect (and no one factor can accurately predict every recession). At the same time I personally believe this warning sign does accurately reflect that there's a high amount of uncertainty (and potential danger) at this point.
And then the economy just surprised many economists and pundits last quarter (Q1) by contracting 1.4%.
So rates have only barely started up, inflation is still unacceptably high and we are already just one quarter away from a technical recession.
This isn't a great start for those who believe the Fed will successfully thread the needle and engineer a "soft landing" (raise rates and conquer inflation without causing a downturn).
I hope things will all end up turning out great and we avoid a recession. But if rough waters are ahead, then it may be painful for many individuals and some investors. And some business-cycle correlated investment (including certain real estate classes) could come under heavy stress (or even default and lose everything). If that happens, then I'd rather not be invested in them. Also, some past recessions have provided once-in-a-decade or once-in-a-lifetime opportunities for patient, discerning investors who have cash to purchase dislocated/distressed assets at rock-bottom pricing. So I'm also keeping this in mind. So personally, my strategy is:
Invest in real estate and business cycle sensitive investments only when they're exceptional and they have high downside protection. Real estate deals must have full cycle experience, high co-investment, no floating rate debt and no unorthodox risks (i.e. no junk-rated securities and everything needs to be high quality).
Hold cash to be positioned to potentially take advantage of distressed sellers.
And my opinions and strategy will change if we get some better or worse news.
Bonus: How I Manage Cash
I don't actually hold my cash in a savings account or money market, because the returns are usually ridiculously low (much less than 1%). Instead, I invest it in five year CDs with a low penalty for breaking them, and which currently are around 2%-2.75%. To minimize the penalty fees, I break up the money into a bunch of little CDs and only liquidate what I need (so I only get penalized for that amount). For example, if I wanted to do this with $100,000 of cash, I would break it up into five CDs of $20,000 each. Then if I need $20,000 in cash I would break just one of them, pay a modest couple months interest penalty on that alone, and continue to draw full interest on the others. (Update April 22, 2022: Here's a site that highlights the penalties on different CDs). Also I max out on what I feel is the best risk/reward in the market: U.S. Treasury I-bonds. They have an inflation adjusted component, currently yield 9.62% are returns are backed by the full faith and credit of the US government. The biggest hitch is that there's a strict limit of $10,000 per investor. But there are techniques to save more than the $10,000 limit with spousal accounts, children, trusts, etc.
Bonus: Investment by Investment Deep Dive on Taxes
Another thing people ask me a lot about is the tax treatment of the different items in my portfolio. This can sometimes get complicated, so many people skip thinking about it. However, doing that can lead to expensive mistakes. So I think a smart investor should always think about the after-tax return of an investment when looking at it. At the same time, minimizing taxes isn't my first goal. Yes, I put a lot of time and thought into making sure that I minimize my tax burden as much as possible. But if forced to choose between minimizing taxes and preservation of capital/reduction of risk, I'll choose the latter every time. Someone coming from a different risk tolerance and financial situation might feel very differently. Or to put it another way: I'm usually fine with losing a few percentage points of projected after-tax return if gives me extra safety and protection of principal. So you won't see me loading up 100% my portfolio in the most tax efficient investments possible.
I live in Tampa, Florida and am lucky in that I have no state income tax. (We do have a sales tax but it applies to purchases and not to income). I also have a relatively small percent of my portfolio in a tax-sheltered self-directed IRA. So, I've saved it for other investments that have much worse tax treatment than real estate. But if you're in a different situation, your self-directed IRA or solo 401(k) can be a good way to save on taxes. (See "How to Liberate Your IRA / 401k to Invest in Real Estate.")
My portfolio tax breakdown:
Residential rental properties: This is taxed at passive income rates. Due to depreciation, distributions were 35% shielded from taxes last year. On top of that, new tax laws went into effect last year which gave me an additional 20% deduction (for Qualified Business Income or QBI).
MG properties group: Distributions are 100% shielded from taxes. Additionally they have traditionally given their investors the option at the end of the holding period to do a 1031 exchange into a new property. This defers paying back depreciation and paying capital gains. An investor can repeat this over and over and effectively delay paying taxes forever. Even when the investor dies, their heirs inherit it on a stepped-up basis and don't have to pay the taxes either. (See "How to Invest in Passive Real Estate Without Paying a Penny of Tax (Legally): Part 2: "Defer, Defer and Die".
Front Street: Distributions are 50% shielded from taxes. Again, the new tax law should also give me an additional 20% in QBI tax shielding this year.
Litigation finance: I've seen different funds structured and categorized differently. A common setup is income that is considered capital gains (which can be very tax beneficial when it is long-term) and ordinary gains (which is taxed at ordinary income rates, and thus not any tax benefit).
Life settlements: I've also seen these structured and categorized differently. I like it best when it's setup with preferential tax treatment (such as all gains projected to be qualified dividends and taxed at just 20%).
Non-real estate business loans: Like most of the funds in this asset class, this one has no special tax benefits and is simply tax-deductible ordinary income rates.
GP Stakes: I've also seen these structured and categorized differently. One setup is capital gains on carry (which is tax beneficial) and ordinary income on management fees(which is taxed at ordinary income rates, and thus not any tax benefit).