When you eventually sell the new property, you'll recognize the originally deferred gain plus any additional accrued since you purchased the replacement property. But if you don't need the proceeds and just want to get rid of the property, says Greenberg, a 1031 exchange could help postpone an investment tax bill. In effect, you get an interest-free loan from Uncle Sam in the amount you would have paid in taxes.
While like-kind exchanges are often used by real estate investors, the technique is available for any investment or business property. If you're interested in a 1031 exchange, consult an expert in the area. It can get complicated and there are strict rules, such as the requirement that any swap be made by a qualified intermediary rather than by the property owner. If you make a misstep in the exchange process, it could invalidate any tax benefits.
Municipal bondsIf you prefer more traditional investments, there are some tax shelter opportunities there, too.
"If bonds fit into your financial plan, look at municipal bonds," says Luscombe. These instruments are issued primarily by state or local governments, or state-related organizations.
The tax benefit? Some states don't tax interest on bonds issued by their municipalities. As for the IRS, municipal bond income is not taxed at the federal level.
Business tax breaksBusiness owners, including those who set up a sideline to supplement full-time wage income, can use several IRS-approved tax shelters.
Section 179 of the tax code allows you to deduct substantial costs of business property purchases in the tax year they are made. Without this provision, the costs of items such as furniture and other equipment special to your business would have to be recovered through depreciation over several years, says Scharin.If you operate your business out of your home, you could be entitled to a home office deduction. With this tax break, you can convert some of the maintenance cost of your home to tax deductions.
"The insurance on your house or if you need a new roof, a percentage of these costs would be deductible," says Scharin. The amount is figured using the percentage of space that your home office represents.
A business owner also can hire the spouse and kids as long as they do real work for the company. "That gets additional income to them and provides deductions to the business," says Luscombe.
Workplace benefitsYou don't have to be an entrepreneur to shelter income from Uncle Sam.
Greenberg says employees should take advantage of workplace benefits. Flexible spending accounts, to help pay child care costs and out-of-pocket medical expenses, allow workers to contribute money to the accounts before payroll taxes are figured. "You never pay taxes on that money," says Greenberg.
That same pretax break is available for workplace 401(k) retirement plans.
Retirement plansOther outside-the-office retirement savings also can help you shelter income. Some traditional IRA owners might get an immediate tax deduction on their returns, along with a deferral of taxes on the IRA earnings.
A Roth IRA is great way for some folks to avoid tax. You don't get any deduction for Roth contributions, but when you eventually take money out of the account, it will be tax-free.
And entrepreneurs have a variety of retirement plans -- SEP and SIMPLE IRAs, Keoghs, Solo 401(k)s -- that can help reduce their taxable business income as well as help prepare for eventual life after work.
With each of these various tax shelters, from your home to investments to your job to retirement savings, the IRS offers ways to hang onto more of your money. And when the tax man says it's OK to keep money out of his hands, who's going to argue?
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