The ground has radically shifted under the stock market, and though there will likely be some form of recovery, it will likely run into a massive wave of selling into strength by clients that are determined to lower their exposure in their equity portfolio following such a gut-wrenching correction. For many clients that are holding big positions in featured stocks that are down by as much as 50%, getting back half of those losses will feel like a win, so as to secure the lion’s share of the gains from the last 10-year rally.
Many clients that do follow this path in “lightening up” on stocks so as to de-risk from the market will most likely capture large capital gains that will have significant tax implications. Taxes may need to be paid later this year or in 2021. And if they are in their high-income years, they can pay as much as 20% on those gains come April 15, 2021. But it doesn’t have to be that way.
As laid out by federal law as of December 2017, clients have 180 days to roll their capital gains into Qualified Opportunity Funds, affording them plenty of time to consider the investment in an QOF once they’ve taken their focus off of raising cash from an oversold stock market rally that may be brief in nature. Thus deferring, reducing and even eliminating the capital gains if they hold their position for a predetermined period of time. Getting clients to study or jump right into a new and unfamiliar asset class when they are emotionally gripped by huge swings in their portfolio valuations is a non-starter in most cases.
But giving them six months to get educated on all the benefits and potential returns of investing in Qualified Opportunity Funds I feel is a smart and empathetic approach. Clients can gain a full level of knowledge of how QOFs work where one of the main features is being able to defer realized capital gains in 2020 out to December 31, 2026.
For many clients, especially those thinking of retiring, that can mean paying 23.8% tax if they earn over $441,450 (filing single), $496,600 (filing jointly) or paying 0% if they have adjusted annual income of $40,000 (filing single) or $80,000 (filing jointly). A lot can happen in six years, and this is a powerful option to make clients aware of.
And given how the current market correction has raised the premium on investments that are liquid, RIA’s should consider QOFs that are listed on an exchange.
Shares of my company’s publicly traded QOF, Belpointe REIT (BELP) were priced at $100 back on November 30, 2019 at $100 per share, and today, trade at $97.50 per share, down just 2.5% when the S&P 500 has been crushed by 34%. There is limited volatility in a publicly-traded growth and income tax shelter that consists of 100% newly constructed or fully renovated multi-family rental properties. But if they want to punch out, they can with the click of a mouse.
Here’s the situation as I see it. A highly attractive setup trade for RIAs to pencil out and be ready to act on. Once there are signs the Coronavirus caseload is going to plateau in the U.S., I believe that the stock market is going to experience a major snap back rally, maybe 6,000-7,000 points for the Dow in a very short period of time. That can take the blue-chip index up to its 200-day moving average that is now trending down.
Consider preparing clients with substantial short-term and long-term capital gains who want to lessen their equity exposure and have sold into that momentous market rebound and consider to roll those gains into a Qualified Opportunity Fund within 180 days that entitles the investor to defer the taxes on those gains out to 2026.
As those capital gains are invested in a QOF, they qualify for a stepped-up cost of their capital gains if they hold the QOF investment for 5 years. What a great way to diversify a portion of clients’ capital into tangible income-producing commercial real estate, that strives to generate a mid-to-high single-digit yield in annual dividend income with a 5-10-year investment horizon that can have a projected total return averaging 15% or more per year.
I believe that there is no time better than the present to bring to the table an intelligent plan to maneuver capital away from the stock market on rallies, capture gains, defer taxes and earn income and capital gains in U.S.-based real estate with the full blessing of federal and state government incentives.