Stores may have a weekend of tax free shopping but you could go tax free every day if you had a Self-Directed IRA!
If you invest in real estate or trade in the stock market, chances are you are paying capital gains taxes associated with these investments that could possibly be avoided. Short-term capital gains are taxed at the taxpayer’s ordinary income tax rate; long-term capital gains, however, are taxed at anywhere from 5% to 15%. With the likely increase in these tax rates in the coming years, now is the time to go Tax Free.
There many investment vehicles that take tax advantage of their tax free status including 1031 Exchanges, Retirement Accounts and Municipal Bonds. But why invest in a tax free investment versus a taxable asset?
Quite simply, investing in a tax free investment allows you to keep more of what you earn from an investment. For example, if you held $100,000 in a taxable investment yielding 4.75% for one year, you would have earned a $4,750 gain. However, depending on your income tax bracket you could have to pay up to $1,660 in Federal Taxes leaving you with $3,090 of your investment earnings. On the other hand, if you were to choose a tax free investment yielding a slightly lower 4.50% return, you would have earned $4,500 during that same one year period and have paid nothing in federal income tax. As we see from this example, tax free investing allows you to keep more money in your pocket and away from Uncle Sam.
Another important factor to think about when considering tax free investing is the Time Value of Money. This is the most basic law in finance and states that a dollar today is worth more than a dollar at some time in the future. By taking advantage of tax free investments, you are putting more money back into your pocket, making the time value of money work for you.
Common Tax Free Investment Vehicles:
- Individual Retirement Accounts (IRA’s) – IRA accounts are tax advantage accounts that allow investments inside the IRA to grow tax free. Depending on which type of IRA you elect to open, contributions and distributions have different tax implications, but any investment made with an IRA account will grow tax-free.
- 1031 Exchanges – A 1031 exchange allows an owner of an investment property to sell his or her property and purchase a replacement property without having to pay any taxes associated with the transaction. Essentially, this type of transaction would allow an investor to avoid paying any capital gains tax or income tax on the sale of the investment property.
- Municipal Bonds – Although these types of bonds typically have lower interest rates, they provide investors with the possibility of earning income that is free from taxes with an investment that is virtually risk free. Municipal bonds are more attractive to high tax bracket investors; however, they can provide tax and diversification benefits to any investor.
Now may be the time to consider investing in tax free assets. We strive to provide the best educational tools so investors can make the most informed investment choices for themselves. To learn more about the benefits of tax free investing or any other investment option, call us today.