Trends – Roth&Co

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Investing has been tough this year. We have seesawed up and down, with the downs swinging much more heavily. Long-lasting inflation pressures have caught the Federal Reserve flat-footed and are now forcing them to take drastic measures to try to dampen inflation. These measures have caused a lot of turmoil in the economy and have created a lot of volatility in the investing sphere. Equity markets, bonds and REITs have all been struggling.

One core question our clients challenge us with is why we don’t try to sell out before, or at the beginning of, market corrections, and then reinvest once calmer times have returned. This is much easier said than done. In the long run, investing on a constant basis and riding the ups and downs is the winning method. However, when you try to trade around market conditions, you need to be right twice: on the way out and on the way back in. What happens if you exit and the market creeps up another 10%? Will you get back in at the higher levels or wait on the side lines for safety for weeks, months or even years?

Having said that, there may be certain changes around the edges that can be appropriate based on economic conditions. But the slicing and dicing of trading in and out of the market can be a huge drag on long-term performance.

In Morgan Housel’s book, The Psychology of Money, Housel provides a great analogy for bearing the psychological pain to achieve higher returns:

Say you want a new car that costs $30,000. You have a few options:

Pay $30,000 for a new car.
Opt for a cheaper, used car instead.
Steal one.

Generally, 99% of people would avoid the third option because the consequence of stealing a car outweighs the upside. This is obvious, but say you want to earn a 10% annual return on your investments. Just like the shiny new car, there’s going to be a price to pay. In this case, the usual price is volatility and uncertainty. And just like in the car scenario, here too you have a few options:

You can pay it, and accept the volatility while you hold on tight to your investments.
You can find a more predictable asset and accept a lower return, such as government treasuries or CDs (the equivalent of the used car option).
You can ‘steal’ it – a.k.a. trying to simultaneously earn the return while avoiding the price that comes with it (volatility). People try anything to attempt this: trading, rotations, hedges, arbitrages, leverage – you name it.

Unlike the vehicle, with investments, many people attempt the third option. And while a few may get away with it, like car thieves – most get caught.

Running off with investment returns without paying for them – like driving off with someone else’s car – looks enticing (especially if you know that one guy who claims to have done it successfully). But don’t be fooled. The risk is great.

This warning may not be one you want to hear (especially with all the other warnings about economic storms coming our way) but your future self will be thankful. Investments made during bear markets yield amazing benefits down the line. Just make sure you have a sound financial plan in place, and abide by that plan through thick and thin.

(And if you aren’t sure if your financial plan is sound, you know where to find us.)

info@equinum.com

This material has been prepared for informational purposes only, and is not intended to provide, nor should it be relied upon for, legal or tax advice. If you have any specific legal or tax questions regarding this content or related issues, please consult with your professional legal or tax advisor.

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Warren Buffett once said that “trust is like the air we breathe — when it’s present, nobody really notices. When it’s absent, everyone notices.” As anyone in the business world will tell you, trustworthiness is one of the most important assets for a business and one of the most essential forms of capital a leader has. No matter what kind of work your business does, it is critical that your customers trust you with their money and personal information, and that your employees trust you with their reputation and their careers.

Trust is the natural result of thousands of tiny actions, words, thoughts and intentions. It does not happen all at once – gaining trust takes time and work. It can take years for a manager or leader to develop the trust of their employees or customers, but it can only take a moment to lose that trust. Without trust, transactions cannot occur, leaders can lose teams, salespeople can lose sales…the list goes on. Trust and relationship, much more than money, are the currency of business.

Jack Zenger and Joseph Folkman, executives at a leadership development consultancy, analyzed over 80,000 employee assessments and found three elements that predict whether a leader would be trusted by his direct reports, peers and other colleagues:

Good Judgement/Expertise. One factor that influences whether people trust a leader is the extent to which a leader is well-informed and knowledgeable. A leader must understand the technical aspects of the work and be competent in their area of expertise. They must use good judgement when making decisions and exhibit a high degree of confidence in their ideas and opinions.

Consistency. Another major element of trust is the extent to which leaders do what they say they will do. This may seem obvious, but people rate a leader high in trust if they honor their commitments and keep their promises. Even something as simple as quickly returning emails and phones calls can go a long way in building trust.

Positive Relationships. According to Zenger and Folkman’s research, the most important element of trust is based on the extent in which a leader is able to create positive relationships with other people and groups. To instill trust, a leader must balance results with concern for others. Last month, we spoke about how to communicate with empathy – a critical element in building positive relationships. Leaders must also be able to generate cooperation between others and resolve conflicts in a helpful way.

Trust is a measure of the quality of any relationship — something worth investing a whole lot in.

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Fall is here, and many not-for-profits are starting to think about their 2023 budgets. If your budget process is on autopilot, think about changing things up this year — particularly if you’ve experienced recent shortfalls or found your budget to be less resilient than you’d like. Here are some ways for you to rethink your budgeting:

A holistic approach

Your nonprofit may not always approach its budget efficiently and productively. For example, budgeting may be done in silos, with little or no consultation among departments. Goals are set by executives, individual departments come up with their own budgets, and accounting or finance is charged with crunching the numbers.

You’d be better off approaching the process holistically. This requires collaboration and communication. Rather than forecasting on their own, accounting and finance should gather information from all departments.

Under-budgeting tendencies

Another habit to break? Underbudgeting. You can improve accuracy with techniques such as forecasting. This process projects financial performance based on:

Historical data (for example, giving patterns),
Economic and other trends, and
Assumptions about circumstances expected to affect you during the budget period (for example, a major capital campaign).

Forecasting generally takes a longer-term view than budgeting — say, five years versus the typical one-year budget. It also provides valuable information to guide budget allocations and strategic planning.

You also might want to do some budget modeling where you game out different scenarios. Consider your options if, for example, you lost a major grant or were (again) unable to hold big, in-person fundraising events.

If the COVID-19 pandemic has proven anything for nonprofits, it’s the necessity of rainy-day funds. If you don’t already have a reserve fund, establish one. If you do have a reserve fund, avoid the temptation to skip a budget period or two of funding for it.

More ideas

Another idea is to switch from your annual budget to a more flexible, rolling budget. You would still budget for four quarters but set certain intervals during which you’d adjust the numbers as circumstances dictate. Typically favored by organizations that experience volatile financial and service environments, rolling budgets can empower nonprofits to respond better to both crises and opportunities in a timely manner. Reach out for more ideas on crafting an accurate and effective budget.

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Does your business need real estate to conduct operations? Or does it otherwise hold property and put the title in the name of the business? You may want to rethink this approach. Any short-term benefits may be outweighed by the tax, liability and estate planning advantages of separating real estate ownership from the business.

Tax implications

Businesses that are formed as C corporations treat real estate assets as they do equipment, inventory and other business assets. Any expenses related to owning the assets appear as ordinary expenses on their income statements and are generally tax deductible in the year they’re incurred.

However, when the business sells the real estate, the profits are taxed twice — at the corporate level and at the owner’s individual level when a distribution is made. Double taxation is avoidable, though. If ownership of the real estate were transferred to a pass-through entity instead, the profit upon sale would be taxed only at the individual level.

Protecting assets

Separating your business ownership from its real estate also provides an effective way to protect it from creditors and other claimants. For example, if your business is sued and found liable, a plaintiff may go after all of its assets, including real estate held in its name. But plaintiffs can’t touch property owned by another entity.

The strategy also can pay off if your business is forced to file for bankruptcy. Creditors generally can’t recover real estate owned separately unless it’s been pledged as collateral for credit taken out by the business.

Estate planning options

Separating real estate from a business may give you some estate planning options, too. For example, if the company is a family business but some members of the next generation aren’t interested in actively participating, separating property gives you an extra asset to distribute. You could bequest the business to one heir and the real estate to another family member who doesn’t work in the business.

Handling the transaction

The business simply transfers ownership of the real estate and the transferee leases it back to the company. Who should own the real estate? One option: The business owner could purchase the real estate from the business and hold title in his or her name. One concern is that it’s not only the property that’ll transfer to the owner, but also any liabilities related to it.

Moreover, any liability related to the property itself could inadvertently put the business at risk. If, for example, a client suffers an injury on the property and a lawsuit ensues, the property owner’s other assets (including the interest in the business) could be in jeopardy.

An alternative is to transfer the property to a separate legal entity formed to hold the title, typically a limited liability company (LLC) or limited liability partnership (LLP). With a pass-through structure, any expenses related to the real estate will flow through to your individual tax return and offset the rental income.

An LLC is more commonly used to transfer real estate. It’s simple to set up and requires only one member. LLPs require at least two partners and aren’t permitted in every state. Some states restrict them to certain types of businesses and impose other restrictions.

Proceed cautiously

Separating the ownership of a business’s real estate isn’t always advisable. If it’s worthwhile, the right approach will depend on your individual circumstances. Contact us to help determine the best approach to minimize your transfer costs and capital gains taxes while maximizing other potential benefits.

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Here are some of the key tax-related deadlines affecting businesses and other employers during the fourth quarter of 2022. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.

Note: Certain tax-filing and tax-payment deadlines may be postponed for taxpayers who reside in or have businesses in federally declared disaster areas.

Monday, October 3

The last day you can initially set up a SIMPLE IRA plan, provided you (or any predecessor employer) didn’t previously maintain a SIMPLE IRA plan. If you’re a new employer that comes into existence after October 1 of the year, you can establish a SIMPLE IRA plan as soon as administratively feasible after your business comes into existence.

Monday, October 17

If a calendar-year C corporation that filed an automatic six-month extension:
- File a 2021 income tax return (Form 1120) and pay any tax, interest and penalties due.
- Make contributions for 2021 to certain employer-sponsored retirement plans.

Monday, October 31

Report income tax withholding and FICA taxes for third quarter 2022 (Form 941) and pay any tax due. (See exception below under “November 10.”)

Thursday, November 10

Report income tax withholding and FICA taxes for third quarter 2022 (Form 941), if you deposited on time (and in full) all of the associated taxes due.

Thursday, December 15

If a calendar-year C corporation, pay the fourth installment of 2022 estimated income taxes.

Contact us if you’d like more information about the filing requirements and to ensure you’re meeting all applicable deadlines.

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Real Estate Right Now is a video series covering the latest real estate trends and opportunities and how you can make the most of them. Part one of our mini-series on real estate investment through syndication focused on the use of a clause called a ‘waterfall provision.’ We’ll continue with part 2 of our series, which discusses syndication and carried interest.

Watch the video:

A real estate syndicate is an organization, or combination of investors, who pool together capital to invest in real estate. The syndicate shares in the investment’s profits, even though it does not invest any of its own capital. When it realizes a profit, that profit is called a ‘carried interest’ or a ‘promote.’ The carried interest serves as compensation to the syndicator for the risk it assumes during the development of the project and the efforts made prior to its sale.

If a property has been held for more than a year before it’s sold, the carried interest has traditionally been treated as a long term capital gain. This is important because Uncle Sam recognizes a carried interest as a return on investment. So, it’s taxed at a lower capital gains rate than is ordinary income.

However, the IRS later extended that holding period from more than one year to more than three years. Does this paralyze a syndicator for three years, disallowing favorable tax benefits on an earlier sale? Apparently not. On January 13, 2021, the IRS posted final Treasury Regulations for Section 1061 of the Internal Revenue Code. Section 1061 extended the 1-year holding period required for long-term capital gains treatment to a 3-year period for entities termed, “applicable partnership interests” (APIs).

Section 1061(c)(1) defines the term “applicable partnership interest” as “any interest in a partnership which, directly or indirectly, is transferred to (or is held by) the taxpayer in connection with the performance of substantial services by the taxpayer, or any other related person, in any applicable trade or business.”

There’s an interesting – and potentially profitable – caveat built into the IRS’ definition. Section 1061 rules inadvertently include a favorable exception for real estate investors. After careful review of the updated code, practitioners realized that this new restriction omitted interests resulting from certain services. These services include investing and disposing of real estate held for rental or investment. In our scenario, the syndicate provides these real estate investment services for the investors. This means that a syndicator’s profits at the time a property is sold are the result of an allowable service that, if held for one year, can be treated as a long term capital gain. It is free of the three year holding period requirement and subject to advantageous capital gains tax rates.

Here’s the bottom line: A syndicators’ profits at the time a property is sold will be treated as long term capital gain, free of the three year holding period requirement, and subject to advantageous capital gains tax rates.

Speak to your professional advisor about investing through syndication to build wealth.

Why Stealing is Stupid

Trustworthiness in the Workplace

How Your Nonprofit Can Break Bad Budget Habits

Separating Your Business From Its Real Estate

2022 Q4 Tax Calendar: Key Deadlines for Businesses and Other Employers

Video: Real Estate Right Now | Syndication (Part 2)