Tax Shelters in 2024

The IRS defines tax shelters as an investment that usually requires substantial contributions, often associated with a commensurate degree of risk. To individuals, a tax shelter usually means an investment that involves losses in the near-term, with the hopes of significant gains over the long-term.

For example, if someone were to invest in property located in a low-income neighborhood, the depreciation benefits of that property would be viewed as a legitimate tax shelter.

The tax deductions, or losses, an individual can take on a potential tax shelter is limited to the total amount invested, or at risk. For example, the amount considered "at risk" might be limited to:

• The adjusted basis of the property

• The cash invested

• Loans taken that someone is personally responsible for paying back

It is important to understand that business activity credits or losses are very likely considered passive activity credits or losses, which can only be used to offset income from other passive activities. They cannot be used to offset other income sources such as wages, interest, or dividends. Excess passive losses generated from a tax shelter may be carried forward, or until the investor disposes of the asset.

Be wary of tax shelters that are marketed with promises of write-offs larger than the amount invested. The IRS considers these Abusive Tax Shelters, and this topic will be discussed later on. Most of this is common sense; people invest with the hope of making money. A legitimate shelter involves some risk, reduces taxes fairly, and does produce income. If the IRS catches an individual in an abusive scheme, they will be paying the tax owed plus interest and penalties.

Perhaps the single most common tax shelter in the United States today has to do with individual retirement plans. Both individual retirement accounts and employee sponsored plans such as the 401(k) and 403(b) plans offer individuals the ability to defer payment of income taxes until their retirement years.

With the Roth IRA, Roth 401(k), and Roth 403(b), money is contributed on an after-tax basis, and the funds are not taxed when withdrawn in retirement. This is arguably one of the most attractive tax shelters of all time.

There are certain heavy industries, such as mining or oil drilling operations, that spend significant capital money on exploration, and dedicate years of effort before generating any real income for investors.

To encourage investment in these types of industries, the U.S. tax code allows the cost of exploration to be distributed to shareholders in the form of a tax deduction. This mechanism allows investors an immediate income tax savings, as well as the ability to realize future gains from the exploration effort.

The IRS allows individuals to claim these exploration losses only as an offset to passive investment income, not all earned income.

This type of shelter involves a financing arrangement whereby one person pays an extremely high rate of interest on money invested. By doing so, the individual can reduce the income associated with the investment. When the investment is withdrawn, a large capital gain is realized. Tax sheltering occurs because capital gains are taxed at a lower rate than interest or dividend payments.

If an individual transfers funds to an offshore company, that transfer is considered a deductible expense, thereby lowering taxable income. Because of certain international agreements or treaties, income realized from these countries may not be taxable. In this example, the arrangement exists for the sole purpose of avoiding the payment of income taxes.