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Deep-dive into my Seven Figure Alternative Investment (and Real Estate) Portfolio: 2023 Q2 Update

Updated: Sep 20, 2023

My defensive portfolio had another great year (returning about 14.37% including 6.71% in income). In comparison, the stock market dropped -6.8%, bonds fell -8.52%, and bitcoin plummeted -34.01%. Here's an in-depth look at my portfolio strategy, allocations, deal-by-deal performance, tax considerations and future strategy.

Deep-dive into my Seven Figure Alternative Investment (and Real Estate) Portfolio: 2023 Q2 Update

(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.

About me


I'm a retired serial tech-entrepreneur and my investments support myself and my family. And my risk tolerance for loss is low, compared to many other people. So, I'm much more concerned about preserving my capital (not losing money) and generally am un-interested in going for the highest projected returns. 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." These fall outside the traditional box of public equities, bonds, and cash investments, which the typical investor recognizes and usually gets 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.

Here's more info on it.

  • 1) Core-satellite design: 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. I'll talk about this more, in the detailed sections below.

  • 2) Asset-class selection: 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, search fund sponsors and music royalties). More details on this are also below.

  • 3) Vintage-year strategy: I don't try to time real estate markets, because I believe it's too difficult to do. And had I tried doing that, I would have missed out on this year's great returns. Instead, I use a "vintage year" strategy (which is similar to dollar cost averaging in the stock market). Instead of deploying my entire portfolio in a single year, I deploy a portion of it every year. And this way, no single bad vintage year can take out the whole thing. Also, in the past, once-in-a-cycle high returns have happened right after some of the worst vintage years. But it can be very psychologically difficult to pull the trigger and invest at those times. So a vintage year strategy keeps me in the game, so I can participate when this happens.

  • 4) "Money bucket" design: Every portfolio is essentially just a single bucket of savings. But, that one bucket actually needs to serve several different purposes. And ignoring this can accidentally destroy it or un-necessarily reduce returns. For example: Many people have been struck out-of-the-blue with the unexpected loss of some or all of their income (i.e. lost their job, investment income or both). Others have been hit with an unexpected financial emergency. And without planning, this can mean the end of a portfolio and the life they knew before). And as an investor, I also want to to maximize my profit. And one of the few ways in today's hyper-efficient market to make a "free" extra return is the "illiquidity premium". This is when an investor is paid an extra return by an investment because it requires them to lock up their money for a certain period of time (versus being able to cash-out the equivalent investment at any time...like in the stock market ). Not all illiquid investments have enough of an illiquidity premium to make me want to pull the trigger. But when they do, I love being able to take advantage (as long as I can do it in a way where I still have enough liquidity for unexpected emergencies). So I use a "money bucket" design to address this. And I split my fund into 4 buckets: cash reserves, short-term, medium-term and long-term. Reserves hold several years of living expenses in cash (or close-to-cash equivalents...see later section). This helps me weather unexpected events and prevents them from becoming catastrophic. And it also allows me to take on illiquidity in other portions of my portfolio ( and maximize my overall return). Note: some feel holding years of reserves is excessive and only do months. And every person comes from a different situation and place, so there's no one "right" or "wrong" answer. The short-term bucket is for public market investments (which can be liquidated close to immediately) and certain private investments with very short timeframes. And I see that many investors will treat this as a "cash reserve" bucket. But I feel there's an important distinction here. If I had an actual cash emergency caused by a severe recession, then I would have to take a severe hit for liquidating public investments. And I probably couldn't liquidate the private ones at all (because they withdrawals would probably be gated). And that could cause big problems. So that's why I feel these can't replace true reserves. But I still like having another level of protection that could work in other circumstances. And again this allows me to take on more illiquidity in other portions of my portfolio. The medium-term bucket is for investments around 5 years and long-term is for 7 to 10 years plus. Also I stagger the timing of my investments in each bucket. So even in the long-term illiquid ones, the investments are actually maturing and producing cash. And when that happens, I can then either use the money as cash for expenses, replenish reserves, or deploy it into the next investment bucket (which makes the most sense at that time).


Returns

As of February 2023, the portfolio returned about 14.37% (for the trailing 12 months). The income portion was about 6.71%.

So this was the second exceptional year in a row and went far beyond my expectations. And I certainly don't expect to do this well every time. And again this year, my portfolio trounced other benchmarks. This includes stocks, bonds, cybercurrency, commercial real-estate, and core real-estate. This can't happen every year and I don't expect it to do so. 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 are 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): -6.80% (with a lot of volatility)


  • Bond market: S&P 500 bond index for large corporate grade bonds: -8.52%


  • Cybercurrencies: Bitcoin took a beating at -34.01%


  • Commercial real-estate: the Greenstreet Real Estate "All Sector" CPPI index was down -14%. 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%).



So this was a great year for my alternatives.

...And here's a comparison with my last update (in Q2 of 2022)


How did my portfolio do this time, compared to my last update in the second quarter of 2022? Back then, total return was a blistering-hot 41.32% (including 7.37% in income). So this year's performance was a huge step down from the previous year. But 2022 was a blow-it-out-of-the-water kind of year, which doesn't come around often. And I don't expect that to happen again soon (let alone year-after-year).


Also, I was grateful that I use a vintage year strategy, which kept me "in the game" this year. Otherwise, I might have been tempted to pull out after such a gangbuster previous year, and would have missed out.

Portfolio Allocation

Here's the low-level breakdown of my portfolio allocation.


As I mentioned above, I follow the core-satellite approach to managing risk. And so, the conservative core is made up of boring no-debt residential properties, which make up 61.2% of the portfolio (versus 55.3% last time). (More on this below.)


The rest is the satellite portion. And 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, that can lower the percentage because it's a relative measure.)

  • Litigation finance (non-correlated asset): now 3.2% versus 3.6% last time

  • MG Properties (real-estate): now 19.1% versus 19.1% last time

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 alternatives portfolio at 81.3%. This is a little more than the 75.6% in Q2 of 2022. Non-real estate is 18.7% and down a little from 24.4% last time. How is that 81.3% of real estate allocation broken up? Here's what it looks like (with all of the types 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 (although this isn't the case for us). And 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's changed since last time:

  • No-debt residential properties increased to 75.2% now (versus 73.7% last time).

  • Multifamily decreased to about 23.4% (versus 26.9% last time).

And for those who 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? See below:




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 (for instance, search fund sponsors and life settlements).

  • Partial J-curve: A few are partially in the J-curve (parts of litigation finance and parts of MG Properties). 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."

  • 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.

  • % instead of IRR: For simplicity sake, the returns are calculated as percentages (which most people understand) vs. IRR (which is often deceptively tricky even for experienced investors). Additionally, a focus that's exclusively on IRR can incentivize an investor to engage in riskier behavior (i.e., IRR is maximized by investing in riskier shorter-term "flips" versus more conservative, long-term buy-and-hold). So I feel IRR's are a nice tool to have in my toolbox, but not "the one metric to rule them all" that some other people consider them.

  • MG calculates its returns in average % per year. So I used a similar method for calculating it's price appreciation (total price appreciation % / # of years).

  • Front Street was a mixed investment with another sponsor for me. And it would be alot of work to split it out perfectly for such a tiny part of my portfolio (which wouldn't make much of a difference either way). So I estimated instead.


Investment-by-Investment Deep-Dives

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 17.57%. That's obviously knocking things out of the park, and not what I usually expect from a conservative investment. 8.34% was returned in income. The price appreciated 9.23% due to a hot property market (although it was actually higher earlier in the year before coming down). 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 house 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'd 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 fourteen different properties with this sponsor across multiple funds. Since then, I've added additional money and will end up being in about nineteen or so.

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 5 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. At the end of the year, MG adjusted their price values down to reflect the softening market.

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) GP Stakes (vs #4 last 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 its 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 tends 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 tend to be 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, so I require a team that has a very long track record of experience and success.


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).


Both of these investments exited out of the J-curve this year, and income did well at 4.17%. And as they continue to deploy, and the GPs have a chance to get extra promotes, I expect the overall return to increase over time.


4) Non-Real Estate Loans (versus #6 last time)

This investment is a non-real estate 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 with inflation and other post-recession factors. 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.)


5) Litigation Finance: (versus #5 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. So it is really for medium-term money (funds that aren't needed for 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) Music Royalties: (versus #3 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 returns in the industry can be high single digits to low teens net IRR. 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).


7) Dislocated non-real estate loans (versus #9 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. And there's no guarantee the sponsor will be able to deploy all the funds (and will just depend on what they see available).


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 business connections to sponsors).


8) Front Street Capital. Return: (versus #10 before)

Front Street is a rare company that has over 30 years of experience, with $100 million in capital, and it has lost zero investor money across multiple cycles. They develop and acquire office, healthcare mixed-use, and industrial properties 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: Front Street is still in the J curve and not yet fully deployed. So the income % shown is less than what it's projected to ultimately be (but to keep things simpler, I included it anyway).


9) 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 in the past have been 7.2% to 10% net.


However, prices have gone up alot in the last couple of years, and it's much easier for an undisciplined sponsor to over-pay (and more difficult to deploy at conservative valuations).

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).


10) Search fund sponsors

Search funds are a little-known niche asset class that's performed very strongly in past recession vintage-year groups.

They focus on buying microcap market companies with strong growth, recurring revenue streams and stable free cash flow generation. So this put them somewhere between the typical venture capital (VC) and private equity (PE) funds. The companies are more established and stable than VC funds but too small for a typical PE fund.

Historical performance has been strong with 30%+ gross IRR and 5x+ gross ROI (over multiple decades and cycles from 1984). And they've had positive performance in multiple vintage year groups containing a recession.


Then, a search-fund sponsor is one who creates a fund that invests in multiple search funds (for added diversity).


I invested in 3 different search fund sponsors in this asset class. Returns aren't expected for 5 years plus. So the asset class is for patient, long term money.

The sponsors have requested that their identity be kept confidential in this article. Club members can get full info including their names, 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).

11) Startups

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 extra stress from my investments (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. Also, if I don't feel comfortable writing it completely off, then that tells me I shouldn't be investing (and I don't). 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). By the way, I see many other investors who don't do this, and it can cause them a lot 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. Since I wrote these off, I haven't included them above.


What's next? (My strategy for the future)

So what will I be doing next?

Last year, the Fed had just started to seriously fight inflation by raising interest rates. So there was a lot of uncertainty.


And here we are a year later, and interest rates are a lot higher. And we didn't get the huge recession many had expected, as labor markets have remained tight. And the rate of Fed increases are slowing (which usually comes at the end of a tightening cycle, and could mean we dodged a bullet). But the Fed says it will remain data-driven and there's still a lot of mixed data. And there's a lot of controversy because it's unclear if there's more bad news still to come. So no one really knows if the Fed's fight is almost won... or if it still has a long way to go.


And the answers to those questions could have a significant effect on many different types of investments (including alternatives).


So my strategy is mostly unchanged from last time.

  1. Invest in asset classes that are uncorrelated with the business cycle (GP stakes, litigation finance, etc.).

  2. 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).

  3. 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

Here's how I manage my cash. First I max out on what I feel is one of the best risk/reward in the market: U.S. Treasury I-bonds. They have an inflation adjusted component, currently yield 6.89% andreturns 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.


Then I try to maximize the rest of cash. I could put them into a savings account or money market. But these are low-yield investment and instead I using a "breakable CD" technique to juice the return a bit. What I do is put the money into five year CDs (or whatever is yielding the most) and with a low penalty for breaking them. And 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).

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.

My situation

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 (which is really nice). On top of that, new tax laws went into effect two years ago which gave me an additional 20% deduction (for Qualified Business Income or QBI). These may be phased out soon. But if they are, then I enjoyed them while it lasted.

  • 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.

  • 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).

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About Ian Ippolito
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Ian Ippolito is an investor and serial entrepreneur. He has been interviewed by the Wall Street Journal, Business Week, Forbes, TIME, Fast Company, TechCrunch, CBS News, FOX News, USA Today, Bloomberg News, Realtor.com, CoStar News, Curbed and more.

 

Ian was impressed by the potential of real estate crowdfunding, but frustrated by the lack of quality site reviews and investment analysis. He created The Real Estate Crowdfunding Review to fill that gap.

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