Use These 3 Tax-Reduction Strategies of the Rich
By Brittany Lyte
Even more than a house or a top-notch college education, income taxes are probably the single largest expense you'll ever encounter in life. And you already know there are all sorts of little tax tricks that can be used every year to shave off a little of your overall debt to the IRS. What you probably didn't know is that there are a few more advanced strategies, mainly utilized by the millionaire's club, that can greatly reduce — and sometimes completely eliminate — your taxes. And they work just as well for the everyman (that means you!) as they do for members of the upper crust. (See also: 16 Great Tax Deductions You May Have Missed)
Intrigued? Read on for our guide to making the tax-reduction strategies of the wealthy work for you.
1. For People Who Own Stock
Warren Buffett's tax rate is effectively lower than the rate paid by the people who clean his office, and the strategy he uses to pull it off can also work for you. Most of Buffett's income is from dividends, which are taxed at a lower rate than ordinary income. But if he were to simply sell his shares for cash, he'd still get hit with a pretty hefty amount of capital-gains taxes.
For example's sake, let's say he has $200 million worth of stock that he wants to redeem for cash. If he sells, he'll be required to turn over a hefty $30 million, or so, in taxes. But if he borrows $200 million from an investment bank and uses the shares as collateral, he'll get the cash while avoiding having to fork over a small fortune to the IRS. Buffett's strategy of cashing in on stock without losing any gains is a smart one that you can use, too. In fact, Robert Willens, who runs an independent firm that advises investors on tax issues, told Bloomberg Business it's a tax-reduction ploy that's "alive and well."
Sound too complicated for you? Here's an easier trick: When you sell stock for profit, consider also selling any losers in your portfolio. This technique, known as "tax loss harvesting," can help you potentially shave thousands off your tax bill, since the IRS will subtract your losses from our gains for tax purposes.
2. For Commercial Property Owners
Here's a tip from the tax-avoidance pros, as explained by Bloomberg Business. The idea is to relinquish your property ownership in exchange for cash without getting hit by big capital-gains taxes. First, establish a 50-50 partnership with a partner for any properties you own. Then, allow one partner to cash out. If we're talking about a $100 million office building, a 50% cash-out would trigger about $7.5 million in capital-gains taxes.
Now, the partner who's cashing out needs to turn his ownership of the property into a loan. So the partnership borrows $50 million and puts it into a new subsidiary partnership, which contributes the cash to yet another new partnership. This newest partnership lends the $50 million to a finance company for three years in exchange for a three-year note. The partner cashing out now owns a loan note valued at $50 million, effectively liquidating his 50% interest. Three years later, the note is repaid and the partner gains ownership of 100% of a partnership sitting on a $50 million pile of cash — without triggering any capital-gains tax.
3. For Residential Real Estate Owners
Bill and Hillary Clinton use trusts to eliminate estate tax, and so can you. Here's the secret: create residence trusts and shift ownership of your home(s) into them. That's it! The advantage here is that any appreciation in the value of your property will fall outside the umbrella of your taxable estate. While your tax savings might not be huge at first, they could become quite significant a few years down the road. "The goal is really be thoughtful and try to build up the nontaxable estate, and that's really what this is," David Scott Sloan, a partner at Holland & Knight LLP in Boston, told a reporter for Bloomberg Business. "You're creating things that are going to be on the nontaxable side of the balance sheet when they die."