How High Earners Beat the Tax Man

And so what we see with the most successful investors, the billionaires, this billionaire mindset, is focused instead of growing your income, which is again taxed at the highest rates of any of the income, is focused on buying assets that will improve in value over time so you can pay less in taxes. You can get this compounding curve working for you faster. And ultimately the goal is to make your money make money for you.

Welcome future billionaires to another episode of the Invest Like a Billionaire podcast. And we've got a big topic today, one that is actually asked a lot. And this is really for high earners. So if you're a doctor, an executive, maybe a business owner or a sales leader, you probably get a little frantic this time of year as you're trying to figure out how do you lower your tax liability. And really, I mean, regardless, somehow it feels like the harder you work, likely the more the government takes. But here's the thing, the ultra-wealthy don't play that game. They've learned how to shift from earning income to owning income, and in the process, how to legally keep far more of what they make. And so today I am joined as always with Ben and Bob Fraser, authors of Invest Like a Billionaire, managing partners of Aspen Funds, to break down how high earners can beat the tax man. Welcome guys to, uh, another episode.

Yeah, should be good.

So this is a core concept in the book that you guys wrote. And I really think it's so relevant for where we're at today, ending the year. And I know we get a lot of people calling in really looking for ways to not pay as much taxes. But I do want to ask this, the first question: how do the ultra-wealthy think differently about paying taxes?

Well, I think a lot of the big endowments, they're tax-free. So they have a pass, believe it or not, they don't even pay taxes. I think a lot of them take a really a long-term view of kind of minimizing their taxable income. And as we point out in the book, they don't have an income mindset, they shift to a balance sheet mindset. And because a growing balance sheet is not taxed, income is taxed. And so as long as you grow your balance sheet without taking any realized income, you can generally grow that tax-free. And when they need liquidity, when they want to buy something with their increased wealth, they borrow. To do it. So that's kind of the billionaire's playbook on that.

Ben, not to put you on the spot here, and maybe you don't have the numbers in front of you, but just how important are, or maybe how detrimental are taxes to compounding wealth? I mean, talk about just, you know, as a chief investment officer here, how you think about taxes in terms of building long-term wealth.

Yeah, I mean, I think it's one of the biggest hurdles and headwinds that high earners face as they try to build wealth. All right, because you potentially went to school for 8 to 12 years. If you're a doctor, you spent all this time, now you come out and you start making big income. It's exciting. But hey, now you got to go pay your student debt. And then that paycheck that you get looks like you're only getting about half of what you thought you're going to be getting, right? And one of the challenges we have in our tax code with high earners is we have a graduated income tax system. So the more you make, the more you pay as a percent of your income. And so it, it penalizes the high earners more than the low earners. And this is a big challenge, right? Because you have all these other things that are grasping and vying for the money you're making, right? Lifestyle creep is a big challenge that a lot of people face. And to your earlier comment, most high earners just think this is inevitable, right? This is just the way the game is, and I gotta play by the rules and try to make the best of it. There is a different way. And that's what we talk about in the book, is going from this income statement mindset to the balance sheet mindset. And we'll break that down more here in a minute, what that means. But there is a legal way to pay less taxes, but it's, you have to understand the game. You have to understand how it's played. And to your question on, you know, you think about the power of compounding, right, over time. And if you are not getting 30 to 50% of the income that you are earning, going to taxes every year, that is a massive drag on that, that snowball effect of compounding, and it just pushes out how quickly that compounding curve can grow substantially.

So you guys talk in the book about— you mentioned 3 types of income. There's earned income, there's portfolio income, and then there's passive income. Can you break these 3 down and why some are taxed so much more heavily than others? I think this is a core concept for everyone to understand.

Yeah, so there's 3 buckets and pretty much the US divides your income into these 3 buckets and then there's a lot of sub-buckets and nuances. So it's quite a bit more complicated than this, but you can think of it in terms of 3 buckets. And by the way, most international countries follow the same pattern and the earned income bucket is always the highest one. So this is your W-2 wages, your doctor's earnings. This is the stuff you get from your business, from your wages. And you're going to pay the most taxes on that. And because the governments want to encourage you to invest and to run businesses, they give tax breaks for these activities. But what's important to understand is these buckets, they separate the income and any losses in one bucket cannot be used to offset losses or gains somewhere else. So the idea is the more they compartmentalize your income, the more taxes you're going to pay because they lock up losses in little buckets that you can't take and use.

Well, I think it's such an important thing to understand, right? Because a lot of people get excited about investing in real estate because you hear about losses. Oh, I can use these losses against my income. But the big question is, which income can you use it against, right? You cannot use losses from real estate against earned income unless you're a real estate professional, which we can get to in a minute. But most high-income earners will not qualify for the real estate professional status that would allow you to do that. So you have all these losses that kind of stack up and build up in one area of your income, but they don't benefit you in maybe the bigger area of your earned income.

So the way to maximize this is you've got to figure out— you've got to look at your tax returns, sit down with your tax professional, and figure out where you have locked up losses, right? And figure out where you have these losses that are sitting there. And that means if you can earn any income in those buckets to offset those losses, that income is tax-free because it'll be first applied to those losses. So, so you need to dig into your tax returns and figure out where it's being lost. That's called balancing your income buckets. And then the other thing you want to do is be moving your income into the more advantageous tax areas like long-term capital gains, these kind of things, versus active income.

Yeah, so let's go there. I mean, this— you guys have mentioned this already, the shift from income statement to balance sheet thinking. And you often tell investors to stop focusing on income and start thinking in terms of assets. Let's talk about what that means. What does that look like?

Yeah, well, an income statement mindset is what I would say most people have, right? Especially high-income earners. The goal in that mindset is to earn more income, right? And then you're trying to hold back the tides of lifestyle creeps. You're trying to reduce your expenses. And inevitably, to increase your income, you're generally trying to work harder. You're trying to just acquire more skills to become more valuable, to increase your income. And there's nothing wrong with that, but the challenge is it's very inefficient and you never really tap into the power of compounding. And so what we see with the most successful investors, the billionaires, these— this billionaire mindset, has a very, very different mindset, which we call the balance sheet mindset. And it's focused instead of growing your income, which is again taxed at the highest rates of any of the income— earned income is— then you focus on balance sheet growth. You focus on buying assets that will appreciate, that will improve in value over time. Because Bob mentioned earlier on, this is such a key part. The increase in value is not taxed on an asset unless you realize it, unless you sell the asset. And another beautiful thing that you can do when you have increases in value and you have, say, real estate, for example, that is a very attractive asset to banks, you can get debt against the increase in value to realize and to take out some of the value there without having to pay taxes, 'cause it's not a taxable event. So you can increase the value of your assets over time. You pay less in taxes. You can get this compounding curve working for you faster. And ultimately, the goal is to make your money make money for you, right? Let your wealth and your assets start to generate income for you because there's, in that scenario, the passive income or the portfolio income, it's much more tax efficient and you can use a lot more losses against those types of income to reduce your effective tax rate.

Bob, what are some practical steps someone can take to, as Ben mentioned, start buying assets or buying their income instead of solely earning it?

Well, it's getting passive income and compounding it. So yeah, I mean, any of our investments, you know, in real estate or any of the assets, that's what they're designed to do. So yeah, find good sponsors and place some capital there and compound.

I mean, I think one of the obvious things you can do is you can go and buy an asset yourself, or you can go buy a building, a multifamily building or an office or a retail building. But the challenge for for high-income earners, you generally have a W-2 job. You're either building a business or you're working for a practice or a firm that is paying you a large income. You don't have the time, you don't have the resources to go and do this. And so it generally, for high-income earners, it makes more sense to do this all passively, working with sponsors like Aspen and others that can do all the work for you and you get to earn the income and the gains passively. But it's also, it's a slower curve, right? Because initially, you may be generating some losses from your real estate investments or your energy, you know, oil and gas investments, but you may not have the income yet to use against it. And so it's kind of this, you want to start this compounding curve of buying assets, building your balance sheet, building your net worth. And eventually, over time, it becomes, it can become very, very efficient as you put more emphasis on that.

But it's true that, right, you can stack losses to use in future years. I mean, this is kind of like playing a game.

Absolutely. I mean, losses are amazing because there are limits for different types of losses for different types of income, but they don't go away. You carry them forward. So if you have losses in one year, but you don't have the income to offset it, eventually you'll be able to use them. And again, this is, this is all subject to talking to your CPA, your tax preparer, because there's a lot of nuance here. But as a general statement, those losses, if you can't use them, they can be stored for the future. And so even if you don't have the income right now, because you're just starting small, you can really set yourself up for the future by doing that.

Understood.

So, so far, we really— step 1, I would say, maybe is kind of mindset, understanding what buckets you are sitting on, your CPA, understanding where you have maybe stack losses. Step 2 is, you know, really beginning investing in assets and creating income from other buckets just outside the active bucket, I wanna shift the conversation to strategic tax shelters. You talk about several of these in the book. What would you guys say are some of the most powerful legal tax shelters that everyday high earners potentially often overlook?

Oil and gas is probably the most incentivized investment you can make in the US tax code. You automatically get depletion allowance. You only pay taxes on 85% of your earnings. And you get immediate recognized losses against all intangible drilling costs. So for— there's any drilling. And so if you have a blended play like the funds we have and there's a little bit of drilling, it can just wipe out most, if not all, of your income and paper and your, your tax liability. And so it's very good. And there's also options for active earners that it can go against. Any losses generated through drilling can be applied to active income. So the downside of that is you are drilling to do that, which is a risky play, but there's definitely options. But that's a real good one. As I point out in the book, 1031s are great. A 1031 is where you exchange one piece of real estate for another and you roll forward your basis and you don't pay taxes on it. You get 100% tax deferral, which is great. They're, in practice, they're very difficult to execute and a lot of times come with You're not buying the best properties because they're marketed as DSTs and 1031s and they're not that great. Today with 100% bonus depreciation, the number one tax deferral strategy is a lazy 1031. And that's just using bonus depreciation. And I'll let Ben explain that, but that's a, it's kind of an all upside, no downside.

Yeah, it's a very powerful tool, but you have to exchange one asset to another that are considered like-kind. And you can't go from, I'm selling a multifamily building that I own and operate as the sole owner into a passive investment. That's not considered like-kind. So there are some challenges for investors if they don't own assets outright, because it's very difficult to make it work with the 1031 rules. But what Bob said, which is, you know, the lazy man's 1031, which is not a technical term, but, you know, more a simple process that you can use when we have In this case, in 2025, bonus depreciation came back. That means we can do a cost segregation study where you break out the different types of depreciation curves on a real asset. And this is all real estate, right? You can accelerate certain types of depreciation and basically compress it into the first year. And so you can get a big write-off that first year. Well, what, what can you do if you have an asset that you're selling in 2025? or even in a passive investment where now you have depreciation recapture, you have to now pay the tax man, you have to pay some taxes on the gains. Well, you can then offset those gains if you can invest in the same calendar year by investing in another property that is going to accelerate those tax losses and potentially offset a good chunk, if not all, of the tax liability. And the beautiful thing of this, my favorite part of this whole thing, is you actually reset your basis, right, where the basis is now stepped up to the value of the new investment and helps with the future gains. You don't have to pay a big recapture from a low basis. And so that's something right now I think a lot of people should be taking advantage of on assets that are selling this year for gains. And right now, that bonus depreciation is anticipated to be here for a few years, you know, at least through Trump's presidency. We'll see what happens after that. So it's a nice window of time for investors to be taking advantage of this specific strategy.

Yeah, going back to the buckets, you know, you talk about losses, just want to clarify for listeners, even myself really, is let's say you do that and you're, you know, you do the cost seg and most appreciation, you take on all these losses, what can you apply that to? Can you apply that to the capital gains of a previous real estate deal? And what about, let's say you sell stocks, capital gains and income.

So So the first investment you make, you're going to get these passive losses and they sit there and they don't do you any good. But now let's say 3 years later, that thing sells and you make some money, like our Iron Horse deal just sold and you're going to be booking some gains. Well, then what you do is you're going to pay taxes on that unless you go take that capital and in the same calendar year, you invest it with some bonus depreciation, which generates losses and wipes out those gains You know, you follow me? So the idea is that the first deal, it doesn't help you. And then after that, you just keep rolling it and you end up basically not having to pay taxes as long as the bonus depreciation is there and you can keep rolling forward.

But to your other point, Ellis, you can't take those losses from real estate and offset your W-2 income.

Right.

You know, on that counter, that doesn't move over that wall. They get stuck on the investment income.

Unless.

Yes, unless you become a real estate professional, which we've talked about a lot in other episodes, we won't spend a lot of time on what that means. But again, probably somewhat unlikely for the folks that are the high income earners, except we have some friends and we know people that do this that are high W-2 earners where their spouses actually decide to become real estate professionals. And so this is something I think absolutely every couple should look at to see if it's a possibility because What happens here, and this is the power of becoming a real estate professional, is all those losses that you get from your real estate, they get unlocked right now. All of a sudden, those losses don't just get stuck against other passive income. They can be used against earned income. They can be used against other types of income. And so it's a very, very powerful tool. We actually have a friend— said it many times on the podcast, so apologies if you heard the story, but Both spouses were working. They talked with their CPA about this and had already owned a little bit of real estate. They've been building on the side. They ran the math and found out that if one of the spouses quit working and became a real estate professional, they would actually, at the end of the day, keep more of the income that they earned on one income than they would if they were both working and paying taxes at the very high rates. And so they did that. And it was a great lifestyle change for them. They're keeping more income. And they can now go and do more real estate investing themselves. So it's a very, very powerful tool. There's actually another— I'm gonna call it a loophole, if you want, though it's legal— that I talked with CPA on a podcast a few years ago on the short-term rental loophole. So there is another qualification that you can effectively get the same ability to use passive real estate losses against earned income, but a much, much lower bar to meet. The real estate professional status is a pretty high bar to meet, but the short-term rental loophole is a pretty low bar relatively. And so it is something that you could very, very reasonably do as a W-2 income earner alongside it. So just a few little nuggets there. You know, you have interest of doing that, definitely do more research. And we have other podcasts we can link to in this episode. Where we talk more in depth about these strategies.

Yeah, we just did, released an episode. It was called, just scrolling down here for a second so people can know. Yeah, September 23rd, Advanced Tax Saving Strategies for Passive Investors. That would be a great episode if you're interested in any of those two strategies.

Yep.

That was just a couple episodes ago. So go check that out. Guys, as we wrap up here, I do want to just ask the question. These are incredible strategies, very helpful for I think the everyday high-income earner really starting to learn about the problem that they now face for bringing value to the marketplace. The question is though, when does it not make sense? I mean, not every tax-saving move is a smart financial move overall. And so how do you weigh whether a deal is worth doing just for the tax benefits? And I guess a better way to ask the question is, when does it make sense just to pay the tax man?

That's a great question. And yeah, when you say tax shelters, so to me, tax shelters mean investments designed to minimize taxes. And there's a lot of those that have been, you know, like conservation easements and other things in the past. That the IRS really goes very hard to, and literally they've thrown people in jail for these things that seem like they're good deals. And, you know, and so there's a lot of things like even deferred sales trusts that I think are questionable today. And I would avoid these things unless you are really ready to lose the tax battle entirely and have your claim of tax benefit be nullified. Beyond that, Here's what I've seen. So a lot of people, for example, try to play the 1031 game and by using DSTs, these kind of things. And the problem is they're buying such— so they're trading into new investments that are marketed as DSTs, but these DSTs are so loaded with fees and reserves and they're very low leverage and they're not necessarily great investments. That you're earning, maybe you're earning a 6% return and you're paying high sales fees in addition, so you're paying 10% sales fees. Well, if you're paying a 10% sales fees and you're earning 6% returns on the real estate, well, how does that make sense? Why don't you just pay 15% taxes for capital gains and earn 15% on your next value-add deal, you see? And so that's the problem that I see is people are trading into getting poor returns because of bad investments that avoid the tax man. And that's when I see a mistake. That's why I put together this really nifty little Excel spreadsheet that's your tax calculator that kind of helps you run the traps and figure out, should I just pay the taxes or not? And it lets you see the difference. And so a lot of times I think it's better just to pay the taxes. Long-term cap gains, they're not that high. Sometimes it just makes a lot of sense to pay the taxes. Run the numbers.

Yeah, the other area we see this a lot is in oil and gas, right? Because we have oil and gas investments, and a lot of what investors come looking for are pure drilling programs where you invest into an offering, they're going to go drill a couple wells. And because of what Bob Fraser said, they have these very powerful tax incentives where you can write off pretty much all the costs for your intangible drilling costs, you can get a pretty hefty tax loss year one right away. It's very attractive, right? If you're coming to the end of the year, you're about to have a big year in income. Man, I want to reduce my taxable income. I'm just going to go invest in something that gives me losses right now. Well, the problem is you're investing in something that's inherently very risky. And what you're essentially saying is, I'm willing to pay a little bit less taxes now, but the trade-off might be that you end up with a complete loss on your investment that does turn into a tax benefit, thankfully, but it's not a good financial building method. You don't build wealth by investing in zeros and losing money. So we say this all the time, but we should— you should never let the tax tail wag the dog. You should never let the primary motivator or reason that you're investing into something be the taxes, or at least the sole motivator. There should always be a sound investment thesis behind it. There should always be good reason for making an investment. And if there's tax efficiency in it, that's only a bonus.

I think that's a great piece of advice. I'm going to actually take that as your final piece of advice because I love that one. Don't let the tax tail wag the investment dog. Bob Fraser, as we wrap up, if you could give one piece of advice to high-earning professionals who feel stuck, what would that be?

Yeah, I'll give you a little sneak peek into our current thinking and where we're headed. So there's a couple things that are pretty much no-brainers, but they're difficult to do. And that is 1031 exchanges. And the problem is to do a 1031 exchange, you can't do it as a passive investor because the title of the property you sell needs to be the same as the title of the property you buy. The titling of the properties need to be the same. So passive investments, it generally doesn't work. So you can use bonus depreciation, but a lot of these things don't work. We didn't talk about this, but the other big strategy for paying no taxes is cash-out refinance and hold. So you own an apartment complex, rather than sell that, go pull cash out by refinancing, and that's tax-free. So our current thinking is, and we're working right now to design an investment fund a passive investment, a passive real estate investment fund that is a zero tax fund. It's designed to be a zero tax fund by using internally all of these levers and mechanisms. So using 1031s, bonus depreciation, cash out refinance and hold to generate appreciation that does not generate taxable income. So we're working really hard right now. I think it'll be the first of its kind to design a fund that is super tax friendly and puts all these very difficult to execute things to work as an individual, but put them at the fund level where we work hard to do them and we can deploy the resources necessary to pull these strategies off as kind of big institutional investors that we allow little investors to benefit from.

So everyone, if you're listening to this episode and you want to grab any of the resources we talked today, like the tax calculator, go to investlikeabillionaire.org. That is now live by the time you're listening to this episode, and all the book resources including the tax calculator is there in the community for free for you to download and use. And then of course, if you're interested in learning about the strategy that Bob was talking about, go to AspenFunds.us and join the investor club to be one of the first folks really to be able to hear when we're going to launch that and how to be a part of that. Guys, thanks so much for your time today. We look forward to chatting again next week.