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5 Creative Ways to beat Uncle Sam

We have heard the popular expression, “There are many ways to skin a cat.”  While this expression is about the many ways to skin a catfish, it can also be equally effective when applied to all the ways to beat Uncle Sam.

Tax season is around the corner, and Republican front runner Romney is facing critics who claim that his tax plan does only favor the rich.

Before you vehemently argue in favor or against Romney’s tax plan, I want to ask you, “Have you given any thought to being tagged as rich yet?”

Here’s the scoop — you don’t have to be rich to enjoy the many tax savings normally fall into richs’ hat.  Before you nod your head in disbelief, I’ll reveal the secret — you have to think like an entrepreneur to save big on your tax bill.

All it takes is to learn legal ways to find deductions by planning ahead to beat Uncle Sam. I have several tips to significantly reduce the drag of taxes on the growth of your assets. You don’t have to make any radical changes in your life to get these favors from Uncle Sam. You just have to learn how to beat Uncle Sam in his own game.

1. Own a rental property

Real estate that you own as an investment — and not the one that you live in — offers several tax shelters.  The twist is that you get to depreciate your rental property, even as — in fact — it may be appreciating. If you purchased a foreclosed duplex from a bank for $120,000, you get to depreciate the value of the building — which may be $100,000 — for 27.5 years. So, you can deduct $3,637 every year from your tax return even though — in real life — your property is generating positive cash flow, and it is also appreciating over the time. Not to mention, you get to deduct interest and taxes every year also. So, if you are paying 6% interest on $100,000 loan, you can deduct $6,000. If you are paying $2500 for the property taxes then you can deduct total $12137 for owning a single rental property.

2. Open an LLC or S-Corp

There are many tax benefits given to a business entity. Incorporation Canada is key to avoid any fines or expensive penalties for failure to operate within compliance of the law. You can open S Corporation or LLC for the rental property that you own. If you are managing this rental property yourself then you can deduct 55.5 cents for the mileage when you drive back and forth to your rental property. You have to keep track of your mileage but, if you are driving on average 2000 miles per year to manage your property then you can deduct $1,110 from your tax return. Not bad to get rewarded by Uncle Sam for owning and managing your own rental property.

3. Invest in 529 plan

If you have kids, a 529 plan provides a terrific alternative to the education savings account. Nearly all states allow 529 plans. You can invest in a 529 plan and let it grow tax-free until it reaches the limit of the maximum tuition charged by a private university in your state. Even though the plan itself is non deductible on your federal income tax return, your investment grows tax-free. Also, in most states, the limit to invest in 529 is $300,000 per child. So, if you are a high income earner, you can squirrel away big chunks of money every year in your children’s 529 plan. What makes this plan more attractive is that you are allowed to invest in 529 plan in Georiga and let your children attend college in California or New York.

4. Maximize contribution to your retirement plans

This is the simplest form of tax shelter you can use to beat Uncle Sam. Yet, surprisingly, only 54% Americans  hold stocks in their 401(K) or IRA account. Most employers provide matching contribution of up to 5% to employee’s 401(k) plan. That’s free money. And it is tax-free. To even make it more juicier, try to maximize your contribution — $16,500 for the current year — to deduct entire amount from your tax return. If you are 50 years and older, you are allowed to contribute additional $5,500 as catch-up contribution. You can’t rely on social security for your retirement. So, maximizing your retirement plan contribution is the sure way to not only get tax deduction, but also to secure your retirement.

5.  Your own home

If you own a home and if you are paying more than $11,500 in interest and taxes, you must avoid standard deduction when you file your tax return. You are allowed to deduct the entire amount paid in interest and taxes from your federal tax return.

You will soon have to file a tax return. Why not start planning for ways to beat Uncle Sam by focusing on ways to reduce your tax bill? Given that Romney has a team of tax advisers to help him pay less but, you can do the same on your own. Uncle Sam loves those who can scrupulously beat him on his own game.

The taxpayer – that’s someone who works for the federal government but doesn’t have to take the civil service examination.  ~Ronald Reagan

(Photo Courtesy: malice chris  T7XV2QHMECEE)

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Comments (25)

good stuff. here’s a couple more:

Interest and dividends are taxed at 15%, a sharply lower rate than the top earned income tax brackets.

Municipal Bonds are tax-free. This was the tool Ross Perot used to bring his tax rate effectively to zero.

I work as a volunteer tax preparer for VITA providing free help to low income folks to prepare their tax returns. They, too, have special benefits built into the system. So does the middle class.

In the training we are required to take to certify each year the IRS focus on accuracy in tax preparation. They also make the point that this means being sure our clients take advantage of every benefit legally available to them.

As should we all.

Good points. I didn’t think about the Municipal Bonds. Thanks for sharing your thoughts.

I was thinking about this last night and how after I graduate, I might slowly get another degree. I can reduce my taxes with the tuition amount, and plus, I’d be getting something out of it!

Daisy, it’s always prudent to think about tax consequences to grow your nest egg for the long haul. It’s awesome that you are thinking about it so early in your life. I wish I was that smart.

Some great tips here, I’m looking to buy a home around next year and I heard the refunds you get back can be pretty good

Yes — it depends on your income, and amount of property tax, interest you pay. Nonetheless, it’s one of the advantages of owning a home for sure.

Shilpan, I have been quite a regular reader of your blog. I just want to say that I like your commitment towards your site.

Thank you for the kind words!

Very informative Shilpan! Being a landlord does have its advantages!

MC, Indeed, being a landlord has plethora of advantages including tax savings!

Great tips. Really need to buy a house. Besides your advantages, need to jump in on the rock bottom interest rates!

Buck, Warren Buffett said that this is the best time to buy a home. So, there you go. :)

Thanks. It’s good to be reminded of how the tax code can favor you.

Those chomping at the bit to get Capital gains raised to one’s marginal tax rate may be shooting themselves in the foot. Especially if you are a landlord. For instance, say you buy $100,000 property and sell it 27.5 years later for $1,000,000. First, you’ll have to pay back all depreciation as ordinary income through depreciation recapture (sorry, no free lunch here). Then, you’ll have to pay taxes on the $900,000 as ordinary income as well. So, a landlord who made a living just getting along renting out property is going to get a huge tax bill! Under current law, you have to pay the depreciation back as ordinary income, but then the appreciation is taxed at 15% (for 2012). A huge difference, especially if one was banking on the appreciation as part of their nest egg.

Also, you may have accidentally typed $11.5k as the max 401k contribution in 2012

You’ve made excellent point about the tax consequences for the rental property. Not to mention, property taxes that you pay over the time. At one point, I was paying around 72K just on property taxes for the hotels that I owned. Thanks for the 401K catch — the limit is $16,500 for 2011. And, thank you for stopping by.

Great write-up! I really want to be a landlord one day, but I’m going to make sure I’m on the proper financial footing before I take the plunge.

There are some great tax advantages to being a business owner (regardless of it’s for real estate)!

I agree with you about making sound financial decision. No one should buy a property just for the tax benefits.

Good advice! Taxes are one area that I think a lot of us neglect when we’re designing our investment strategies. This is too bad because, as you point out, there can be a lot of benefits. I’ve been taking advantage of 3-5 for a while now and will probably make some attempt at 1-2 in the next few years. I love the fact that the government treats a house like a depreciating asset (like an old piece of factory equipment) when your county usually proclaims that it increases every year on your property tax statement. Go figure.

Depreciation can mean many things. Typically, with rental property it is better to view depreciation as allocating the cost of an asset over a period of time. Generally, and especially over the long term, real estate will rise in value. And when you go to sell your asset, the federal government will want their “tax break” back, up to the amount you depreciated. The amount depreciated is taxed as ordinary income, as you deduct it as ordinary income. This is known as depreciation recapture.

So, it’s not really depreciating in value, nor a true tax break. Rather, a deferment of taxes due (assuming you will sell at a profit).

Thanks for clearing that up. I hope to one day put all this to work if I ever get around to purchasing rental property.

Thank you for clarification on depreciation. You are absolutely right about the fact that it is more of a tax deferment than a true tax break.

So, true about county government’s attempt to appraise your property at the higher end of the range for the tax purpose. In fact, I sold one of my commercial properties due to the fact that while revenue was down, county claimed that value of the building was higher due to the replacement cost. Go figure!

Exactly! They want as much as they can get from you!

Very useful recos.
We are considering investing in real estate for rental purposes and this comes handy, especially the depreciation part and LLC one.
Thank you!

Alik, good luck on your new venture!

even better buy property abroad. I know alot of Aussies that have bought in the UK because the $ is so high to the £ and hen the $ drops they will make a massive profit!