Tags: Taxes Investments

Have you ever stopped to consider the true impact of tax on your investment returns?

Not the impact in dollars, or even in percentages. I find that investors often have a hard time visualizing or internalizing metrics like that. 

Instead let’s consider HOW LONG it would take an investor to earn back what was lost to tax. How many years at a given rate of return would it take to get back to even?

Let’s assume we’re talking about capital gains and examine a 20% tax liability on the sale of an investment asset. That could be real estate or stocks or anything that has appreciated in value and might trigger a tax liability.

Let’s also assume reinvestment of the after-tax remainder at an annual compounding rate of 5%. Let’s ignore income or other taxes on the annual return. At that tax rate and with that rate of return on investment, it takes 4.5 years of TAX-FREE return just to break even! 

Let's do the math to demonstrate....

$1,000,000 – 20% tax = $800,000

After-tax $800,000 reinvested at 5% annual compounding return

 

Year 1: ($800,000) × 5% = $40,000

End of Year 1 Total: $800,000 + $40,000 = $840,000

 

Year 2: ($840,000) × 5% = $42,000

End of Year 2 Total: $800,000 + $40,000 + $42,000 = $882,000

 

Year 3: ($882,000) × 5% = $44,100

End of Year 3 Total: $800,000 + $40,000+ $42,000+ $44,100 = $926,100

 

Year 4: ($926,100) × 5% = $46,300

End of Year 4 Total: $800,000 + $40,000+ $42,000+ $44,100+ $46,300 = $972,400

 

Year 5: ($972,400) × 5% = $48,600

End of Year 5 Total: $800,000 + $40,000+ $42,000+ $44,100+ $46,300+ $48,600 = $1,020,100

It is only in Year 5 that the above investor has earned enough to make up for the original 20% tax liability and finally break even. And that doesn’t take into account the income taxes that would be owed each year, which would be likely to further erode the true return on investment.

To understand how this calculation changes based on a given rate of return and a given tax liability, refer to the helpful chart below.

Years to Breakeven

 

Another way to understand the impact of tax on investment returns is to evaluate the OVERALL return necessary to break even. This too can be calculated for varying levels of tax.

Let’s do the math to demonstrate, using the same numbers as before. We have a $1,000,000 asset sale with a 20% tax liability, leaving us with $800,000 to invest.

To invest that $800,000 and get back to breakeven at $1,000,000, it would require a return of $200,000. A $200,000 return on an $800,000 investment is equivalent to a 25% return. That means that even though the tax liability was just 20%, a 25% return on the remaining money is needed to make up for the tax loss! 

Again, refer to the helpful chart below to see the difference based on tax liability:

Screen Shot 2024-07-16 at 11.30.09 AM

Using the right strategies to defer, reduce, and/or eliminate tax liability can potentially have an outsized impact on your returns and the growth of your wealth over time. It is important to work with the right tax, legal, and financial advisors to make sure you are not missing out on key tax strategies!

Whether you are selling real estate, stock, businesses, or are simply a high-income earner worried about income tax, let our team at Fortitude Investment Group demonstrate the power of proper tax planning.

Contact us today to learn more. In the meantime, feel free to check out our valuable resources here

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Pursuant to requirements imposed by the Internal Revenue Service, any tax advice contained in this communication (including any attachments) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any tax-related matter.  Please contact us if you wish to have formal written advice on this matter.

Justin Kiehne

Justin R. Kiehne is a Financial Advisor with Fortitude Investment Group, located in Juno Beach, Florida, where Mr. Kiehne resides. Justin’s professional career began in the Aerospace Engineering industry, working in gas turbine engine design and analysis, managing technical teams and customer relationships. With his nontraditional background, Justin brings a unique, analytical perspective and a passion for customer service to bear in which he seeks to meet and exceed customer expectations. At Fortitude, Justin focuses on real estate and tax advantaged investments, retirement, and estate planning. He prides himself on delivering high quality, institutional grade real estate solutions, alternative investment options, and comprehensive, individually tailored portfolios to the retail investor that seeks to diversify investments, help remove market volatility, and maximize income potential. Mr. Kiehne was raised in Annapolis, Maryland and is an avid Navy Football fan. He holds a Master of Science Degree in Mechanical Engineering from the University of Florida and a Bachelor of Science degree with a Dual Major in Physics and Biology from Dickinson College. A former award-winning lacrosse and track athlete, Justin maintains an interest in weightlifting, golf, lacrosse, and fishing. Justin maintains his series 7 General Securities License.

This is for informational purposes only and is not an offer to buy/sell an investment. There are risks associated with investing in Delaware Statutory Trust (DST) and real estate investment properties including, but not limited to, loss of entire principal, declining market value, tenant vacancies and illiquidity. Diversification does not guarantee profits or guarantee protection against losses. Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated. Because investors situations and objectives vary this information is not intended to indicate suitability for any particular investor. This information is not meant to be interpreted as tax or legal advice. Please speak with your legal and tax advisors for guidance regarding your particular situation.

Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Advisory services offered through Concorde Asset Management, LLC (CAM), an SEC registered investment adviser. Insurance products offered through Concorde Insurance Agency, Inc. (CIA) Fortitude Investment Group is independent of CIS, CAM, and CIA.

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