Did you know that over 90 percent of the world’s millionaires became rich from investing in real estate? Tax deductible investments like real estate can help you generate serious wealth but you can only get in the game if you actually invest.
The IRS offers excellent incentives for investment by making many of them tax deductible.
But what are the best tax deductible investments to consider? Let us take a closer look at some of your leading options.
1. Tax Deductible Investments: Municipal Bonds
Municipal bonds are bonds local government issues which are used to fund various projects, like building schools or improving roads. By investing in a municipal bond, you are essentially lending money to the government.
For you, this means that you will earn a guaranteed rate of return as interest payments from the bond. Since these interest payments are exempt from taxes, some people use them for tax planning purposes. Municipal bonds usually offer a lower rate return than other investments, but they are also safer.
If you are part of a high tax bracket, municipal bonds can be an interesting option, especially if the state or city where you live is the one issuing them.
2. Real Estate
If you have ever asked yourself “Should I invest in property?” the answer is yes. Real estate can offer many benefits, from long term price appreciation, to cash flow, debt paydown by tenants, and tax advantages. Once you start making an income on your property, you are considered a business owner, opening you up to tax incentives.
The government does tax the income you make from rents and similar revenue, but it offers tax deductions on the operating costs of your business. You can lower your taxable income with these deductions and end up saving money that you would otherwise owe in taxes.
There are a number of different tax deductions you can claim. These include property taxes, mortgage interest, maintenance and repair costs for the property, the hiring of property management companies, marketing costs for advertising the property, and more.
You can also depreciate your property and other large expenditures, including renovation projects and large new appliances.
3. Traditional IRA and Roth IRA
An Individual Retirement Account, or IRA, offers tax-free growth. Traditional IRAs allow annual investments of $6,000 for people under 50 and $7,000 for people over 50. You can then deduct that investment from your taxable income.
With a Traditional IRA, you will not get taxed on this income until you withdraw it after retirement. In the meantime, your gains can accumulate tax-free, even if you buy and sell assets (like stocks and mutual funds) within your account.
A Roth IRA allows you to contribute after-tax dollars up to the annual limit. In 2021, the limit was $6,000 plus an additional $1,000 if you are over 50.
Because you are contributing after-tax dollars to a Roth IRA, you cannot deduct your contributions as you would with a Traditional IRA. Instead, the benefits arrive when you hit age 59 1/2, when you can start withdrawing money from your Roth IRA tax-free. Since you can get even the returns your investment has made over the years, you will enjoy tax-free returns.
If you are self-employed, you can turn to a solo Roth 401(k), in which you invest with after-tax dollars and your withdrawals are tax-free when you retire.
4. Health Savings Accounts (HSAs)
With a health savings account, you can save up for future medical costs while reducing your taxable income. Anyone who has a high deductible health insurance plan can get an HSA. You make annual contributions each year up to the limit ($3,500 for individuals and $7,000 for families).
An HSA can offer triple tax benefits. The contributions to the savings account are made from your paycheck before taxes are calculated, so you can expect a lower tax bill. Once the money is in the account, it will grow on a tax-deferred basis. When you choose to withdraw the money from your HSA for medical expenses, you can do so tax-free.
If you choose to use the money in the HSA for anything other than medical expenses, you will pay tax on them and have a 20 percent penalty if you are younger than 65.
5. Tax-Exempt Mutual Funds
A mutual fund is a collection of securities like bonds or stocks. It can be made entirely of one or the other or it can have a combination of them. If you are looking for hands-off investing, this could be an acceptable option since mutual funds are professionally managed. Just beware that you will pay (often hefty) fees to fund managers for this service.
A number of mutual funds are tax-exempt, which means you will not pay taxes on the returns. Most tax-exempt mutual funds hold municipal bonds and other government securities. You get the benefit of simplified diversification with this type of fund, as well as tax benefits.
Keep in mind that these mutual funds tend to offer a smaller return, but they are easy to manage.
6. Charitable Donations
This is another method of tax-free investing. When you gift stocks to a charity, you can pass on capital gains and get tax deductions. You can also gift money to a dependent. The Uniform Gift to Minors Act (UGMA), provides tax-free options and lower bracket options for a number of investments.
Do remember that UGMA can affect the child’s chances for later applications to financial aid.
Grow Your Wealth with Tax Deductible Investments
When you invest wisely, you give your bottom line a chance to grow. With the right tax deductible investments, you can create an abundant future. Which of these options appeals the most to you? Let me know in comments below.
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