wearmanyhats

Hypothetical situation:  David goes to a stamp convention and finds one he likes featuring Miss Piggy.  Delighted, he buys the stamp for $10 and puts it into a special display jacket.  It looks great.  Months later, a Miss Piggy revival hits the media.  People are suddenly crazy about the pig, and when reading the Stamp Collecting magazine, he notices that the Miss Piggy stamp is now fetching $10,000 on the trading circuit.  He finds a buyer, sells and pockets the money.  Easy as pie, right?

No, no, no.   $10,000 will trigger bells and whistles from the banks to report his deposit, and soon the IRS will come knocking.  David waves goodbye to a good chunk of his money and thinks his love affair with Miss Piggy has made him brilliant.

 Rewind and plan. Let’s let him be truly brilliant. Before he sells, he needs to plan.  Suppose he contacted a 1031 agent first, arranged the sale next, and sat calmly for some 45 days after the sale to figure out what he could buy next.  He plops down an additional $100 and picks up a rare Ben Franklin stamp that just happens to be on the low side of its usual up and downs in the market.  Suddenly, Pennsylvania plans a big birthday party for old Ben and Ben memorabilia shoots up at an astonishing rate.  David sees that his Ben stamp has raced up to $20,000 a year later.  Does he sell it out?  If he does, he pays the tax from the transition before.  Instead, he shops around for a stamp on the low end that can be had for $20,000 and does another 1031 exchange.

Does poor David ever get to enjoy the fruits of his labor?  Technically, yes he can.  Remember, he’ll have to pay taxes on all of these earnings, but all he ever put down was $110.  And he can exchange that stamp as long as he wants to make even more and more money for the rest of his life. He can sell it out for full profits and pay the taxes after he retires when his regular income has become considerably less.  He can even transfer the wealth to his family when he dies.  It all takes planning.

Consider Farmer Friend who raises goats.  Let’s say that one day he sees a young male cow he likes and gets it for $100.  Thinking that this animal might some day be useful, he feeds it, plays with it and gives a great home until one day the baby turns into a bull.  Delighted, he sends it to play with some neighboring women cows, for a fee of course.  He likes the money that generates, and after a few years, realizes that all good bulls eventually go to the Great Pasture in the Sky.  He decides to sell.  Now he can get $2000 for his bull.  Does he take the money and run?  

Well, maybe if he isn’t afraid of the IRS.  But why not do it legitimately?  1031 exchange the beast for a younger bull of a special breed for maybe a hundred dollars more, and go on earning stud fees.  This type of exchange does not generate the terrific returns that other collectibles will, but it still saves you by letting you retain your assets.  But stud fees can generate immediate income and the sale of this animal doesn’t need to be eaten up by taxes.  

 Many people think that the 1031 exchange is just for real estate. This is where it works the best.  But the truth of the matter is that any asset can be exchanged for the same type of asset, which works well with the Modern Portfolio Theory .  Exchanging the right type of asset, art for art, stamp for stamp, movie poster for movie poster,  can make you wealthy by just deferring taxes. Of course you should always consult your C.P.A when considering such a move to make sure it will help at tax time.  But  it’s worth keeping in mind when figuring out your money strategy. 

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