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Geographic Arbitrage

Updated: Aug 1, 2022

Real estate as an investment vehicle has been discussed extensively in the FIRE community. Let’s look at it from a different angle.

Geographic arbitrage, the concept of living somewhere inexpensive so the value of one’s money goes further, is a common consideration in the digital nomad community. Among digital nomads, many of whom live on a shoestring budget piecing together income from remote web-based employment, cost minimization is the name of the game. Though FIREees are usually starting with a bigger pot, the concept of budgeting is not lost on them. Accordingly, there are a number of meaningful ways geographic arbitrage can positively impact the lives of those on FIRE.

Let’s consider state taxes. These range from 13.3% in California to zero in several states. Some states use a flat tax, taxing all income, while other states use a progressive tax and only begin taxing after a certain income threshold is crossed. While many FIREees will plan for frugality and only be withdrawing to a rate avoiding the lower tax threshold, many will live in flat tax states or will be living Fat FIRE, thus inevitably being subject to state taxes. When assuming a fixed income based solely on withdrawal from investments, the impact on one’s life from state taxes adds up very quickly. If you hadn’t noticed, states like Florida and Nevada attract a lot of retiree-age retirees living on a fixed income (it was never just about the warm weather).

So, you’ve decided to move to a zero/lower tax state. Your primary residence is subject to a ‘section 121’ exclusion, which state that you are not subject to taxes on gains up to $250,000 (or $500,000 if married and filing jointly). There have been serious gains recently so a few folks might see gains beyond the above limits. In that case, a primary residence can be converted to a rental and therefore conferring the tax benefits associated with a ‘1031 exchange’. Of course, you should discuss all tax implications with your accountant.

There may be taxes you didn’t anticipate in a state that otherwise does not have income tax, though you still may find other state-specific tax benefits. This is especially true as it relates to side businesses and other forms of passive income. For example, if you enjoy gardening and/or making wine (a lot, in a scalable way) and plan to have income from it, you may want to consider adding conservation easements to your real estate holdings to shield yourself from the associated taxes. While conservation easements are state specific, the benefits associated with them may be massive. There are a number of other state specific business oriented benefits and it would be worth discussing them with your accountant.

Another massive benefit to geographic arbitrage is a cheaper cost of living. Put simply, goods and services are expensive in expensive places. I think this is something everyone understands. However, it may be worth considering your specific hobbies and the impact of geography on them. If, for example, you really enjoy skiing, you might consider living nearby to Lake Tahoe in Reno, NV rather than nearby Tahoma, CA. You’ll avoid premium costs associated with living in a resort town as well as state taxes. Also, it’s often much warmer in Reno because it’s not on top of a mountain. Even better, you may consider switching coasts to Attitash in New Hampshire to take advantage of the state tax benefit and the lower cost of living overall.

An important consideration for those thinking even bigger about geographic arbitrage the tax associated with being an American. This tax is something most Americans have never thought about. Put simply, the United States will continue to tax your income as long as you are an American citizen, even if you’re living abroad. Renouncing citizenship, something most of you won’t want to do, will absolve you of this tax (and make you subject to others, of course). More information can be found at The Nomad Capitalist about this. While permanent voluntary exile is not for everyone, it might be a good fit for some FIREees.

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