The Beatles song Gimme Shelter was not referring to a tax shelter, but nonetheless a “shelter” is a “safe haven”. A tax shelter is an investment strategy that allows you to legally decrease or avoid taxation. It is a way of off-setting losses to other taxable income.
The beauty of investment Real Estate is that it is a natural tax shelter. There are no gimmicks and no loopholes to create. Uncle Sam created it this way, and “fools we mortals be” for not taking advantage of it. (Note that there is a special break allowing a “passive loss” from rental real estate to be deducted from “non-passive” income such as wages. The passive loss deduction is limited to $25K but is reduced by 50% of the amount of the taxpayer’s adjusted gross income that exceeds 100K.).
You may be thinking “Oh I’m just a small time investor”. What does a tax shelter mean to
the small investor in the San Diego income property market? A great deal! Up to $25K in mortgage interest and property taxes is money paid by you for your investment. Some of this “passive income” is deductible against your “active income” or “wages”. In 2011 the following income tax rates apply to a single person:
10% on 0-$8500
15% on $8500-34,500
25% on $34,500-$83,600
28% on $83,600-$174,400
33% on $174,400-$379,150
35% on $379,150+
That means with no tax shelter, if you are making $60K annually $.25 of every dollar is paid by you in taxes to Uncle Sam or $15,000 . If you are making $100K annually, $.28 of every dollar is paid by you in taxes to Uncle Sam or $28,000. I don’t know about you, but if I had an extra $28K annually I would be blogging right now from a sailboat in the British Virgin Islands (using a waterproof laptop) or a Yurt in Mongolia (do they have wireless there?) Do you see where I am going with this?
Depreciation is also used to shelter your income, since it is treated as an expense for tax purposes. It is an “accounting” loss, which shows up on paper only. However, you can deduct some of the cost on your tax return each year via depreciation.
Of course you must decide where the funds for down payment on any investment would best serve you. Using funds for one investment eliminate the use of those funds for another investment (i.e. stocks). Consult with your CPA or Tax Attorney for your own personal “wealth-building” strategy.
Disclaimer: I am not a CPA and encourage everyone to consult with their CPA or Tax Attorney for personal tax advice regarding their specific tax situation. The tax laws change frequently and this Blog is by no means attempting to give tax advice.