While taking flights, I usually will listen to podcasts. Among several, one podcast stimulates the brain consistently is Planet Money (by NPR). A recent episode that was new to me: My Favorite Tax Loopholes. Let’s talk about this fascinating topic as it is a real interest for me as a blue collar worker. Here are a few from this episode.
1031 Exchange
This is a tax loophole that originally was intended for farmers but has evolved into home, land or building purchase and exchanges exclusively. Investopedia sums it up like this:
- A 1031 exchange is a tax break. You can sell a property held for business or investment purposes and swap it for a new one that you purchase for the same purpose, allowing you to defer capital gains tax on the sale.
- Proceeds from the sale must be held in escrow by a third party, then used to buy the new property; you cannot receive them, even temporarily.
- The properties being exchanged must be considered like-kind in the eyes of the IRS for capital gains taxes to be deferred.
- If used correctly, there is no limit on how frequently you can do 1031 exchanges.
- The rules can apply to a former principal residence under very specific conditions.
Buy Barrow Die
Here is a tax loophole that is used by the wealthy: “Buy, borrow, die” is a popular personal finance strategy that suggests individuals should buy appreciating assets, borrow strategically to leverage their investments, and ultimately preserve their wealth to pass it on to beneficiaries after death. This approach aims to build wealth and leave a lasting financial legacy.
- Buy: The first step involves purchasing appreciating assets, such as real estate, stocks, or other investments. These assets are chosen with the intention of increasing in value over time.
- Borrow: After acquiring the assets, the individual takes out a loan or borrows against the value of these assets, often using a low-interest loan, like a mortgage or a home equity line of credit (HELOC). The borrowed funds are then used for various purposes, such as funding expenses, investments, or gifts to heirs.
- Die: Upon the individual’s death, the assets, including any remaining debt, become part of their estate. At this point, the heirs may inherit the assets, and the estate’s assets are typically used to pay off any outstanding debts, including the borrowed amount.
The key idea behind this strategy is that, in many jurisdictions, assets passed down through inheritance receive a “step-up in basis” for tax purposes. This means that the heirs’ tax basis is adjusted to the value of the assets at the time of the original owner’s death. As a result, any potential capital gains on the assets that occurred during the original owner’s lifetime are effectively wiped out, and the heirs may sell the assets without paying capital gains tax on the appreciation that happened before their inheritance.However, it’s important to note that tax laws can be complex and can vary significantly depending on the jurisdiction. The “buy, borrow, die” strategy may not be suitable for everyone, and it is crucial to consult with financial advisors and estate planning professionals to ensure it aligns with an individual’s specific financial situation and goals. Additionally, borrowing against assets carries inherent risks, including the possibility of interest rate changes and the need to repay the debt during one’s lifetime if the asset’s value declines significantly.
FEIE Form 2555
Loophole: if you are a US resident living abroad, then you don’t have to pay Federal Taxes.
FEIE stands for Foreign Earned Income Exclusion, and Form 2555 is the tax form used by U.S. citizens or resident aliens to claim this exclusion. In summary: FEIE Form 2555 allows eligible taxpayers who live and work abroad to exclude a certain amount of their foreign earned income from their U.S. taxable income. To qualify for the exclusion, the taxpayer must meet either the “Physical Presence Test” or the “Bona Fide Residence Test,” which determine their residency status abroad. By filing Form 2555, qualifying taxpayers can exclude a specific amount (adjusted annually for inflation) of their foreign earned income from U.S. taxation, potentially reducing their overall tax liability. However, it’s essential to understand the eligibility requirements, keep accurate records, and comply with all IRS regulations related to the Foreign Earned Income Exclusion. Please note that tax laws can be complex and subject to change, so it’s always advisable to consult with a tax professional or the IRS for the most up-to-date and accurate information related to Form 2555 and the Foreign Earned Income Exclusion.
FSA: Flexible Health Account
This loophole is designed for the blue collar worker. This allows people to put money in an FSA account. One stipulation is that money in this account may have a use or loose time limitation. Money that is put into this account isn’t taxed. Spend your FSA money.
A Flexible Spending Account (FSA) is a tax-advantaged financial account offered by some employers in the United States. It allows employees to set aside a portion of their pre-tax salary to pay for eligible healthcare and dependent care expenses. There are two main types of FSAs: the Healthcare FSA and the Dependent Care FSA.
- Healthcare FSA: Employees can contribute a portion of their salary on a pre-tax basis to a Healthcare FSA to cover qualified medical expenses not covered by insurance. Eligible expenses may include co-pays, deductibles, prescription drugs, and some medical devices.
- Dependent Care FSA: This FSA allows employees to set aside pre-tax money to pay for eligible dependent care expenses, such as daycare or preschool for dependent children or care for elderly or disabled dependents. It helps employees save money on childcare expenses.
It’s essential for FSA participants to estimate their yearly expenses carefully, as FSAs are “use-it-or-lose-it” accounts. This means any funds not used by the end of the plan year or the grace period are forfeited. Some plans may offer a carryover option or a grace period to give employees extra time to use their FSA funds.FSAs can be a valuable benefit for employees, as contributions reduce taxable income, resulting in potential tax savings. However, they are subject to IRS regulations, and eligible expenses must follow specific guidelines to be reimbursed. It’s advisable to review the FSA plan documents and seek guidance from the employer’s HR department to understand the rules and benefits of the FSA offered by the employer.
415 Renting Residential and Vacation Property
Renting your home for fewer than 15 days in a year, you don’t have to report the rental income. That is tax free income.
Section 415 covers the tax rules for Renting Residential and Vacation Property. In summary: When renting out residential or vacation properties, the income received is generally considered taxable. Owners must report rental income on their tax returns, and they may also be eligible to deduct certain expenses related to the property, such as mortgage interest, property taxes, repairs, and maintenance. For properties rented for fewer than 15 days in a year, the rental income may be exempt from taxation under certain conditions, making it a tax-free income source. However, expenses related to the property cannot be deducted in this case. It’s essential for property owners to keep accurate records of rental income and expenses and understand the specific tax rules and deductions related to renting residential and vacation properties. Tax laws can be complex and may vary based on factors such as the property’s usage and the number of days it is rented out, so consulting with a tax professional can be beneficial to maximize tax benefits and ensure compliance with IRS regulations.