Author Topic: additional tax shelters?  (Read 8775 times)

sol

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additional tax shelters?
« on: June 22, 2012, 03:17:01 PM »
Some people here are fortunate enough to be able to save relatively large sums of money each year.  After you've maxed out your 401k plan and your Roth IRA, what other investment vehicles can you use to shelter additional savings?

The only ones I can think of are...

an HSA, which is only available for people with a high deductible health plan

and municipal bonds, which typically grow tax free but compensate with pretty crappy rates.

mechanic baird

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Re: additional tax shelters?
« Reply #1 on: June 22, 2012, 03:27:54 PM »
You got kids right Sol?

I have been doing these and trying to bring the tax down a bit:
1) 529 plan
2) Participate at work's flexible spending account for both medical and child care. Child care alone is $5K.
3)Purposely not paying additional principle on my 30 year mortgage at 4%
4) create passive loss on a rental unit.

 

$_gone_amok

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Re: additional tax shelters?
« Reply #2 on: June 22, 2012, 03:59:26 PM »
You got kids right Sol?

I have been doing these and trying to bring the tax down a bit:
1) 529 plan
2) Participate at work's flexible spending account for both medical and child care. Child care alone is $5K.
3)Purposely not paying additional principle on my 30 year mortgage at 4%
4) create passive loss on a rental unit.

+1 on the 529 plan and flex spending account.

What's the benefit on creating a passive loss on the rental unit? Can you explain? Doesn't that cost you when you decide to sell the rental unit later?

sol

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Re: additional tax shelters?
« Reply #3 on: June 22, 2012, 04:40:37 PM »
Washington state has a prepaid 529 plan that we already participate in.  Like other 529s, it doesn't shield any income that you contribute (since WA doesn't have a state income tax), but at least you don't pay taxes on any earnings taken for qualified expenses.  So it basically works a lot like a Roth IRA, for a kid's educations instead of for retirement.

Our prepaid plan rates have been jacked up to ridiculousity the past few years, as tuition costs soar and the market tanks, so we may end up switching to a 529 savings plan from another state instead of our local 529 prepaid plan.

We also contribute to an FSA, but we keep the amounts a little below anticipated annual medical costs so we don't end up forfeiting any surplus at the end of the year.  It's not a large amount of money, so not terribly helpful.

We do have a rental, from our pre-marriage lives, but it just about breaks even unless you count the equity we gain by having someone else pay into our principal.  How do you utilize a rental property for tax purposes?  Landlording is still pretty new to us.

arebelspy

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Re: additional tax shelters?
« Reply #4 on: June 22, 2012, 04:47:38 PM »
We do have a rental, from our pre-marriage lives, but it just about breaks even unless you count the equity we gain by having someone else pay into our principal.  How do you utilize a rental property for tax purposes?  Landlording is still pretty new to us.

Business deductions, Mortgage interest writeoffs, and the big one: Depreciation.

As amok points out, you will be subject to depreciation recapture when/if it's sold (1031s, charitable trusts, etc. aside).
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sol

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Re: additional tax shelters?
« Reply #5 on: June 22, 2012, 04:48:29 PM »
Business deductions, Mortgage interest writeoffs, and the big one: Depreciation.

As amok points out, you will be subject to depreciation recapture when/if it's sold (1031s, charitable trusts, etc. aside).

This is a lot of words that I don't understand.  Please elaborate.

TLV

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Re: additional tax shelters?
« Reply #6 on: June 22, 2012, 05:01:29 PM »
If you intend on doing a lot of charitable giving in the future, jlcollins described how to create your own charitable foundation.

This can decrease your tax burden if your tax rates when you put the money in are higher than they would be when you actually give the money away. The downside, obviously, is that you can't ever use the money for anything else, so you have to be certain that's what you intend to do with it.

arebelspy

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Re: additional tax shelters?
« Reply #7 on: June 22, 2012, 05:02:16 PM »
Business deductions: writing off anything related to the rental (gas, car use, legal fees, etc.)
Mortgage interest write off: writing off the interest you pay on that mortgage from your taxes
Depreciation: Depreciating the house (usually over a period of 27.5 yrs) is a large write off.  It is due back when you sell the house.  It can be avoided through various means such as a 1031 exchange into a different property, donating the house to a charitable trust for your own use until you die, at which point it's donated, etc.

LMK which of those is not clear so I can try to elaborate.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

sol

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Re: additional tax shelters?
« Reply #8 on: June 22, 2012, 05:27:03 PM »
Business deductions: writing off anything related to the rental (gas, car use, legal fees, etc.)
Mortgage interest write off: writing off the interest you pay on that mortgage from your taxes
Depreciation: Depreciating the house (usually over a period of 27.5 yrs) is a large write off. 

Okay, I think we're on top of these.  It just feels like there is so much to learn that I'm afraid of missing something.

We already deduct mileage for trips over there, and any maintenance expenses.  This doesn't actually help us that much, since none of this is stuff that we would otherwise be doing if we didn't have the rental.  We take the mort int off our taxes.

I think we have the depreciation right, though it was complicated by a divorce that precipitated buying out the ex-spouse.  We weren't sure how to handle the basis on that one.  Is it the original purchase price plus any improvements, or the price at which the title switched from shared to single-ownership?  How does the subsequent refi figure in?

I hear of people doing all kinds of crazy stuff, like buying themselves new dining room sets "for the rental" and then putting them in their own house and moving their old one over to the rental.  Or buying a second home and renting it to their own home business for tax deductions all around.  Or using the rental to keep an attorney on retainer, who then provides additional services not rental-related.  There seems to be a pretty fuzzy line around what's actually legal when it comes to rental property tax deductions.

Uncephalized

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Re: additional tax shelters?
« Reply #9 on: June 22, 2012, 05:34:07 PM »
At some point doesn't all this rigmarole to save a couple percent in taxes just become way more trouble than it's worth? Why not just get over it and pay your taxes?

sol

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Re: additional tax shelters?
« Reply #10 on: June 22, 2012, 05:39:08 PM »
At some point doesn't all this rigmarole to save a couple percent in taxes just become way more trouble than it's worth? Why not just get over it and pay your taxes?

For people in upper income brackets with expensive tastes, I can see it making a difference.  If you're in the 28% bracket and want to buy one of these for your chateau, you save yourself about $1500 by declaring it a rental expense.  That basically pays for the upgrade over the $4k JCPenny version that is soooo gauche.

Uncephalized

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Re: additional tax shelters?
« Reply #11 on: June 23, 2012, 11:10:52 AM »
At some point doesn't all this rigmarole to save a couple percent in taxes just become way more trouble than it's worth? Why not just get over it and pay your taxes?

For people in upper income brackets with expensive tastes, I can see it making a difference.  If you're in the 28% bracket and want to buy one of these for your chateau, you save yourself about $1500 by declaring it a rental expense.  That basically pays for the upgrade over the $4k JCPenny version that is soooo gauche.
Eww. What a waste. But sure, I can see why you might be concerned about tax loopholes when you're regularly buying that kind of crap. My preference, however, is to simplify my lifestyle and increase my income to the point where spending many hours "optimizing" my taxes is not worth the effort because I simply don't need the extra money.

MooreBonds

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Re: additional tax shelters?
« Reply #12 on: June 23, 2012, 02:01:02 PM »
I hear of people doing all kinds of crazy stuff, like buying themselves new dining room sets "for the rental" and then putting them in their own house and moving their old one over to the rental.  Or buying a second home and renting it to their own home business for tax deductions all around.  Or using the rental to keep an attorney on retainer, who then provides additional services not rental-related.  There seems to be a pretty fuzzy line around what's actually legal when it comes to rental property tax deductions.

There are also people that illegally claim refunds for taxpayers that they are not entitled to, or flat out don't file their taxes. If you want to commit illegal acts of income tax evasion, you are only limited by how long you want to share a cell with Bubba your brazenness.

There are actually not too many 'fuzzy' lines around much of the tax code for most of the taxpayers (obviously, when you get to some of the very complex legal structures, legitimate questions will surface). The Tax Court and IRS have issued judgments or clarifications on some of the issues -  but some of the examples you describe above as 'fuzzy' are just a way of sugarcoating your conscience into accepting something that's illegal.

Generally, if you incur an expense in order to produce (or attempt to produce revenue), then it's usually a bonafide business expense (and the IRS has fairly decent examples on common allowable and non-allowable writeoffs in their various publications for small businesses and Schedules C and E).

iwannaretire

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Re: additional tax shelters?
« Reply #13 on: June 23, 2012, 02:43:35 PM »
Another possibility is investing in master limited partnerships (MLPs), which trade like ordinary stocks.  You can't shelter your taxes, but you can defer them because part or all of the interest paid on them is considered a return of basis, rather than income.  These are typically pipeline companies and they pay a pretty decent interest rate. 

Your income taxes, however, will be a little more complicated.  And, there's always the chance Congress can change the rules on you.

Lars

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Re: additional tax shelters?
« Reply #14 on: June 23, 2012, 11:47:22 PM »
Looks like all the good answers are taken. Just a couple tax reductions to add:

If you have a side business, you can still contribute some to a SEP IRA or Solo 401k even if you max out a work 401k.
Savings bonds - taxes are deferred until redemption
 

sol

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Re: additional tax shelters?
« Reply #15 on: June 24, 2012, 08:35:47 AM »
some of the examples you describe above as 'fuzzy' are just a way of sugarcoating your conscience into accepting something that's illegal.

Generally, if you incur an expense in order to produce (or attempt to produce revenue), then it's usually a bonafide business expense

Yes, but I still think that many of those valid attempts also have ancillary benefits.  If I have to drive over the the rental to fix something, and I have to drive right by Costco on the way home, is it tax fraud to stop and shop even though I'm not adding any additional mileage to my trip?  This is a tangible benefit I have derived from the rental, by writing off the mileage for a Costco trip that I would have otherwise taken for personal reasons.

If you have a side business, you can still contribute some to a SEP IRA or Solo 401k even if you max out a work 401k.
Savings bonds - taxes are deferred until redemption

What are the requirements and restrictions on these?  Can you contribute 100% of the revenue for the business?  Of the profits?  More?

Lars

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Re: additional tax shelters?
« Reply #16 on: June 24, 2012, 03:28:35 PM »
If you have a side business, you can still contribute some to a SEP IRA or Solo 401k even if you max out a work 401k.
Savings bonds - taxes are deferred until redemption

What are the requirements and restrictions on these?  Can you contribute 100% of the revenue for the business?  Of the profits?  More?

My understanding is you are allowed to contribute a percentage of the profit, essentially like profit sharing, that is around 25%. I looked into this with my side business but didn't find a well written answer that I saved a link for but remember a blog or two with a decent spreadsheet. Honestly, I didn't look that hard since I have a SIMPLE IRA at work and, as a result, have 6k left in my allowable contribution pool due to the different contribution limit on SIMPLE IRA's vs 401k's. 

MooreBonds

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Re: additional tax shelters?
« Reply #17 on: June 25, 2012, 08:13:53 PM »
Yes, but I still think that many of those valid attempts also have ancillary benefits.  If I have to drive over the the rental to fix something, and I have to drive right by Costco on the way home, is it tax fraud to stop and shop even though I'm not adding any additional mileage to my trip?  This is a tangible benefit I have derived from the rental, by writing off the mileage for a Costco trip that I would have otherwise taken for personal reasons.
The IRS has some definitions on travel expenses (for example, if you go to a convention in another city, but decided to add on a day or two for pleasure before/after the trip) that one can use as a guideline and comparable basis. Also, the IRS permits you to use a mileage rate for business-related travel from your principal location of work to a 'jobsite' (which your rental could probably count as).

If you have a side business, you can still contribute some to a SEP IRA or Solo 401k even if you max out a work 401k.
What are the requirements and restrictions on these?  Can you contribute 100% of the revenue for the business?  Of the profits?  More?

The IRS publications do a fairly decent job on explaining the options and requirements. Set aside an hour or two and look at the IRS publications/forms on Small Businesses and also on Retirement Plans.

A quick and dirty summary:

Solo 401ks offer the best bang-for-the-buck if you will only have self-employed income of up to $20k-$30k, since you can divert a much higher % of your income (I believe up to 100%, max of $17k, but verify). However, they require some fees/paperwork to give to your broker to setup and maintain it (maybe $150 in fees/year, plus some forms). Also, your max limit for a solo 401k is limited, and I don't recall the max limits if you simultaneously participate in a 401k with your full-time employer.

A SEP IRA is the easiest to set up, and typically doesn't carry any additional account maintenance costs w/ your broker (over and above standard account minimums and standard low balance fees). Also, you are allowed to put up to 20% of your NET self employed income (or 25% of your gross income, before self-employment tax, I believe - basically the same net contribution number, just a different percentage of a different number). The max annual SEP IRA contribution is roughly $46,000 of contributions (based on self-employed income of around $220,000). Exact numbers are probably dated by a few years, but you get the point.

Bottom line: If you will have relatively lower self-employed income for several years, it could be worth it to max out your Solo 401k for several years, build up the stash, and pay the $100 or so annual maintenance fees (for a decently-sized account). However, don't forget that if you aren't going to have anymore self employed income contributions to a solo 401k or SEP IRA, you can roll those over into a traditional IRA or rollover401k....so if/when you aren't going to have any more self employed income retirement contributions, you should be able to roll over that solo 401k with those pesky fees into a normal rollover IRA account w/o those extra fees.

However, remember that if you are truly taking all legitimate deductions for your rental properties (including depreciation), you probably aren't showing a huge taxable income from it. If you are, then you must really know how to maximize those rents!

If you are posting for free advice on a web forum for retirement plans advice, I'm assuming you're not pulling in net income from your rentals of $150k/year...if you ever do get that high, though, and you're self-employed (with no non-immediately family employees), you can really kick things up a notch with your own Defined Benefit Plan (pension plan). The benefit isn't as great for a 30-year old, but if you're 45 or older, you can set yourself up a DBP to pay out a certain $ amount at a certain age, and then put in the necessary funds every year to accumulate the cash to be able to fund that pension payout. We're talking contributions of $100k/year up to well over $200k/year to the account for someone in their late 40s/50s/60s, depending on income.

The 2 "personal pension plan" drawbacks:
1) You will most certainly almost need a pension consultant to set up the plan and administer the plan each year. Maybe $4k to set it up, $2,500/year to maintain.
2) You have to file forms with the Pension Benefit Guarantee Corp. Oh, and once you set up the plan, you have to fund it each year, regardless of what your net income is. Which would suck if 5 of your tenants stopped paying rent, and you have a hefty loss for the year. You can delay pension plan contributions (just like some business do), but if your unfunded balance drops too much, you'll pay fines. It is possible to change the equation and variables after they're set up, but I imagine it's a royal pain in the ass with paperwork, and not something you can do on a whim every year.
« Last Edit: June 25, 2012, 08:15:26 PM by MooreBonds »