Susan's Scoop

The ‘Worth Less’ Strategy That Leaves You Worth More

Today I’m going to let you in on a financial secret of the Ultra Wealthy: Discounting. A few weeks back I wrote about the 3 different types of Roth IRA conversions, but there actually is a 4^th much less common type – the Discounted Roth IRA Conversion.

But before we get into the details of it, I thought it would be fun to dive into the concept of discounting in general, because according to recent surveys, almost all of us consider ourselves to be “pre-rich” (I like to fantasize about the private jet I will have someday 🤣) and our future selves will need to know how to preserve all of that money.

The concept of discounting is simple: do something to an asset to make it worth less (at least on paper). Taylor Swift is the Queen of Discounting – when her music catalog was sold out from under her, she started re-recording her music to de-value her previous collection, which eventually was discounted enough for her to buy it back earlier this year. Smart move!!

Where you will most often see the Ultra Wealthy using discounting is to avoid estate taxes. Let’s say you own 3 luxury properties, each valued around $6 million. Those properties (plus whatever else you may own) put you way over the estate tax exemption, therefore leaving your heirs with a large tax bill.

But here’s where discounting can help! Let’s say you group those 3 properties into an LLC with yourself as 1% owner but 99% voting rights, and put your children as 99% owners, but 1% voting rights. Now the value (at least on paper) of that LLC has been greatly reduced – who would want to buy an LLC where they have ownership, but no control over the company??!

You then hire an appraiser to come in and do an official appraisal of the ‘discounted’ value – she decides this LLC (consisting of the 3 properties) is now only worth $8 million instead of $18 million, which puts you under the estate tax limit. You can now ride off into the sunset tax-free while your heirs continue building their generational wealth.

So what does this have to do with Roth IRA conversions? Well, get this – you can sometimes do the same thing with assets inside your retirement accounts! Probably the most common example we see involves private equity investments; an investor uses their self-directed IRA to invest in a private equity fund as a Limited Partner – they have zero control over decisions related to the investment, and the money is now illiquid.

At that point, they get an appraiser to come in and “re-value” their investment, usually discounting it as much as 60%. Now that the asset value is reduced, they roll and re-title that investment into their Roth IRA at the reduced value (paying taxes on the lower appraised amount), even though the original amount they invested has remained the same.

This is not investing advice, and I’m not even sure I would recommend doing a Discounted Roth IRA conversion, but so far the IRS has let them slide. In my tax classes I talk about how the Ultra Wealthy are surfing a completely different wave than we are from a tax perspective, but there are opportunities here and there for us to grab their wave for a little bit. And here’s yet another one, the rarely-discussed Discounted Roth IRA Conversion.

And now you also know a secret way to possibly avoid paying estate taxes on your future luxury vacation homes! 🤫

What I'm Reading

​📕 Everything is Tuberculosis by John Green

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