REIT
These Unit Investment Trusts have a tax advantage that corporations do not. They are not taxed at the corporate level if they pass at least 90% of their net income to investors.
Compare this to buying shares of a stock in a company that pays corporate taxes, then maybe pays dividends or manages to grow in business potential (which is the main element of stock market price growth). Theoretically, a REIT will produce a greater net return because of less total taxation at the two levels. This return is mostly income for those investing in mortgages; mostly capital gain for those primarily investing in actual properties that are eventually sold off as it liquidates or reinvests.
Investors desiring income buy these; they always liquidate in a decade or less. When they sell off properties, like-kind exchanges can take place that defer capital gains unless the investor reinvests. This capital gains-related tax-deferral shelters some of the current income, causing investors to become addicted—so to speak—to reinvesting or else face recapture of some of the deferred gain. In the accumulation planning chapter, we examined the lack of transparency (cash thrown off can be new investor money, net rent, rent when maintenance should have been paid for, etc.). But publicly traded REITs have many eyes examining the properties and management decisions, so that version is far more transparent. If your portfolio is quite large and the management team as well as the brokerage are both committed to transparency, then these can be a partially tax-sheltered form of income and gain. Obviously, if they generate income, they would be cumbersome in an IRA or qualified plan, as reinvestment of the income would constantly build up non-invested cash, but it is possible to hold these in such plans Limited partnerships and general partnerships generally have extra tax benefits derived primarily from special oil and gas exploration or fleet accelerated depreciation or medical research, etc.
These ventures are more risky than REITs because they seek things that may not exist in full or may deplete faster than expected. Incentives in the tax code are specific to the activity that Congress deemed should be advantaged for the sake of the nation, and these credits, deductions, and accounting advantages pass through to the investor in addition to the entity escaping corporate taxation.
If you are addicted to 1031 exchanges, especially with realty that must be exchanged in-kind with certain time restrictions after sale in order to buy the new property and so avoid recognition of capital gain or certain types of tax benefit recapture, then consider these two reputable middlemen: Asset Preservation, Inc. and the website apiExchange.com. These can help you comply with timing issues through trustee handling of the sale and acquisition.
As always, involve the applicable experts in your planning and negotiations, perhaps assembled by your financial planner: tax attorney, real estate attorney, estate planning attorney, CPA, insurance specialist, and commercial or residential Realtor and an appraiser (business appraiser, commercial realty appraiser, etc.). Don’t trust anyone else’s estimate of value. Get your advisors onto your payroll and acting as fiduciaries to you.
Most municipalities allow discounted residence property tax rates for seniors. One must be a certain age, usually 65, and with low adjusted gross income. Some municipalities use gross income or add back deductions to AGI.
Nature/Historical Easements and Other Gifting
It is possible to obtain a current state and federal income tax deduction beyond normal limits for donating this sort of land or donating easements (rights-of-way and use) to the government or specially chartered conservancies and societies. Other types of gifts to charities can also reduce income taxation over several years. See the estate planning chapter’s gifting discussion.
Non-Qual Deferred Compensation Plans for Key Employees
These are “golden handcuffs” that you might negotiate with an employer. You will pay no income tax as long as the employer does not write you a check; in essence, it’s a way to tax-defer income outside the normal limits of qualified plan contributions (sweet!). The risk, though, is that the employer controls the cash or perhaps merely the liability to fund this in a timely fashion. In other words, you incur credit risk of the employer. The best way to deal with that risk is to negotiate into your contract that the employer will fully, or nearly fully, fund some investment every time you get paid. Many employees and employers prefer that this funding vehicle be life insurance because the policy will enable the employer to make good on all promises of funding and ongoing payments without having to recognize gain in the event that the employee dies before the total obligation is funded. If the employee had the right to take money from the funding vehicle (mutual fund, insurance policy, whatever), then the IRS will deem the plan to be currently taxable to the employee. The employer does have invasion rights unless you negotiate to limit this, so negotiate well!
The cost of asset management-related portion of your financial plan (and all of a business entity financial plan) is tax-deductible, by the way. Any part of the planning that reasonably relates to asset management (asset allocation, retirement planning that deals with asset type selection for assets under management) are also tax-deductible. The tax management portion of the plan is not because that is not tax preparation.
Working Abroad and Social Security Taxes
The US has Totalization Agreements with twenty-seven nations. These agreements accomplish two primary things. First, the US counts your work time and pay level in these other nation(s) even when they will not pay you their version of Social Security (you did not work there long enough). Second, it works to reduce (but not eliminate) double taxation for Social Security benefits. In other words, there is little to worry about in losing Social Security benefits here; you can earn them there if you stay there long enough. But do check with your employer’s HR department; it will have the specific arrangements. This assurance is not so regarding income taxation, however.
US citizens, like those of other nations, pay income tax on income derived from work in other countries and must annually file state, federal, and (if applicable) municipal income tax returns. The only way around this is to either earn nothing or to change citizenship. Here’s the good news, though: Most of our trading partners will not expect income tax from the US citizen whose employer certifies intent to return eventually to the US; you will file a tax return there, but usually pay no taxes if you can show that you did pay US taxes. In a case where you are required to pay income taxes, the US will allow you to deduct from your income most foreign income and even some special items like housing cost. To plan for this, you must have the specifics from your HR department or research the international relationship on your own. The best place to start, if your HR department lacks all information, is IRS Publication 593.
The Net Investment Income Tax is almost certain to be repealed. It was created as part of the Affordable Care Act. This 3.8% tax is to help pay for Medicare and is in addition to the usual Medicare tax on employment earnings. Losses from self-employment are disallowed in applying the 3.8% tax to income. But until repeal, keep in mind that you might want to wait and defer income from interest, dividends, capital gains (except on your primary residence up to the first $500,000 of gain harvested via sale or via reverse mortgage income), rental and royalty income, nonqualified annuities, and any other income vehicle until this surcharge is reduced or repealed. By the way, if you under-withheld tax payments, this tax will be accompanied by an under-withholding penalty. Of course, it is only assessed on investment income to the extent that such income contributed to your adjusted gross income exceeding these thresholds:
- Married filing jointly – $250,000
- Married filing separately – $125,000
- Single or head of household – $200,000
- Qualifying widow(er) with a child – $250,000
Enhanced Medicare benefits still could not be adequately funded, so there’s a nearly 1% surtax on most of your earned income too, effectively increasing the Medicare tax rate for high earners. You can’t do anything about this accompanying tax, other than choosing to not earn a living. (Now—see?—you’ve got me started again!)
As one examines the big picture of a revenue system that causes the People to report to their government, rather than merely the other way around, one can make two observations. First, this form of taxation causes what is referred to in the “dismal science” of economics as a market distortion. If the tax system favors annuities over mutual funds, for example, doesn’t your government manipulate your investment and timing decisions? Second—and more importantly—one must wonder what greater progress our economy might achieve if the million or so great minds employed in the nonproductive job of helping the People comply with, or navigate, the economic and other dicta of their government were, instead,
employed in productive pursuits from invention to marketing. “Hi. I’m here from the government. I’m here to help you.”
There are many more tax issues connected with your finances—many, many more. But these are the most powerful tips and strategies that remain after the last twenty years of tax reform that has limited or eliminated numerous major strategies. Looking out for this deduction or that, keeping careful records of sales tax or employment-related gas or other expenses, are items I leave for the accounting function and tips from TurboTax and the like. We have examined the major concepts remaining, the most powerful. Where do these tax strategies lead? The next phase of life, though you will continue to plan your finances in light of tax strategies, is your retirement. Modeling these tax strategies well before retirement can help you and your planner determine the most efficient retirement strategies. Ongoing awareness of tax issues can help you determine whether any strategies should change.
This excerpt is taken from “The Secrets of Successful Financial Planning: Inside Tips From an Expert,” by Dan Gallagher. To read other articles of this book, click here. To buy this book, click here.
