The Internal Revenue Service, the Courts and the U.S. Congress have instated significant safeguards against aggressive tax planning that in some cases borders on, or is, criminal conduct. But have the above institutions done away with tax planning in its entirety? The answer is no, there are a number of creative actions that an individual can take to reduce their current income tax liability.

 

 

Most U.S. citizens use the funds in their IRA to invest in individual stocks and mutual funds. However, the tax law, within limits, allows an IRA to invest into just about anything. As most people are aware, an IRA does not pay current income tax on its investment income, and income accumulates on a tax free basis until a distribution is made.

 

So what can you do with this fund that is legal? As an example, I have a friend who is saving for retirement by buying small apartment houses with 4 to 8 apartments per building. The current rent is being used to pay the mortgage, real estate taxes and other expenses, and to pay income taxes on what is a considerable net income. After paying Federal and State income tax, net income is about 55 cents on the dollar. The net income is then accumulated to buy another building.

 

Upon retirement, my friend plans to live off the net rental income and to sell off the substantially appreciated buildings if additional income is needed.

 

What my friend did not realize is that these building could have been bought by his Self Directed IRA. If the IRA owned these buildings, there would be no Federal or State income tax to pay each year, and instead of only 55% of the net income being used to buy another building, that the IRA could have used 100% of the net income to make another investment.

 

And if the Self Directed IRA was a Roth IRA, my friend would never have paid any income tax on his investment.

 

What else can you invest in? A recent article in the New York Times indicated “investment in such diverse properties as private jets that can be leased out, race horse that generate prize money, and bulls that are in demand among cattle breeders.”

 

What can’t you invest in? IRS Publication 590 lists collectibles such as artwork, rugs, antiques, metals, gems, stamps, coins, and fine wine as being prohibited. You also cannot sell property to the IRA; receive unreasonable compensation for managing the IRA, or buy property in which you will live through the IRA.

 

Given the breadth of potential investments, many questions as to permissible investments end up being resolved in Tax Court. For example, suppose your IRA bought a condo in Orlando that was used as a rental property all year, except for one week that your family uses it. Under the rental property rules this is a permissible use but may not be if it is owned by the IRA.

 

 

It is not unusual to hear about a corporation selling it’s headquarters building to raise immediate cash, and then to rent it back on a long term lease from the buyer.

 

If your parents are retired and living in a significantly appreciated residence, they have probably paid off the mortgage and real estate taxes may be there only itemized deduction. Given that they have a standard deduction of $10,700; it is likely that the real estate tax deduction is of little tax benefit to them.

 

Consider doing a sale and leaseback with your parents. The sale should be at or near fair market value. Assuming that your parents have owned and lived in the residence for two of the five years prior to sale, they can exclude $500,000 of gain from the profit on the sale. And the remaining gain, if any, would be taxed at 15%. The sale has two advantages as it provides your parents with cash to invest, possibly into tax free municipal bonds, and it also removes future appreciation of the residence from their estate.

 

The lease back of the home to your parents should be at fair rental value, but the Courts have allowed a 20% discount from fair rental value when you rent to your parents. While you have to declare the rent as income, your offset will be the real estate taxes that you pay, possibly mortgage interest, maintenance costs of the property, utilities, insurance and depreciation. In some situations, you may in fact be subsidizing your parent’s retirement, without any gift tax consequences, and with the ability to take a complete write off of all the expenses incurred.

 

 

A lot of individuals lost a ton on money when Enron collapsed. Losses on stock transactions are considered capital losses and only $3,000 of the loss can offset ordinary income each year, with the remainder of the loss carrying forward until it is used.

 

Several individuals attempted to report this loss on amended tax returns as a “theft loss” using the loss in full and carrying back excess losses for 5 years. The IRS has privately ruled that this is a capital loss and not a “theft loss” and disallowed the claim for refund on the amended tax returns.