When you're wealthy, managing your taxes is an important part of your investment strategy. After all, when you're facing potential tax bills of 30 to 50 percent, settling for a lower return on your investments in exchange for paying little or no tax on them can leave you putting more money in your pocket at the end of the year. While some passive investments get no special tax treatment, others offer favorable tax treatment that lets you get more bang for your buck. They also offer the same benefit as any other passive investments -- the ability to let your money work for you without having to be actively involved on a day-to-day basis in managing the investment.
Tax-Free Municipal Bonds
Tax-free municipal bonds make can be an option for high net-worth investors. These are fixed-income investments issued by cities, states and government agencies to finance projects. Interest on these bonds is exempt from federal tax and may also be exempt from state tax, giving you a yield that is equal to or higher than taxable bonds of comparable quality, especially if you are subject to a high tax rate. You can buy these bonds individually or buy funds that own a basket of them, giving you diversification.
Buying and holding growth stocks is can work well for high-net-worth investors. Growth stocks typically produce returns through share price appreciation instead of paying dividends. This means that you don't have to pay any taxes on your growth while it is occurring. When you do sell the stock after owning it for at least one year, your returns are taxed as long-term capital gains, giving you a lower tax rate than you'd receive on investments that are taxed as regular income.
Real Estate TICs
While real estate investments usually require their owners to take a relatively active role, tenant-in-common ownership is more passive. In a TIC, you buy a small piece of a large real state asset along with other investors. TICs typically have professional management in place that makes it easier for you to own the asset without doing work. Since a TIC is real estate, you get the tax benefits of any real estate investment, including having depreciation shelter a portion of your cash flow and the ability to sell and reinvest in more real estate without paying taxes by doing a 1031 exchange. In a 1031 exchange, you follow a set of relatively complicated rules to sell your property, have the money held by a third party, and spend all of your money buy a replacement property, all within 180 or fewer days.
Anything in a Roth
If buying tax-advantaged asset types doesn't fit your investment plans, there is another option for money that you don't touch until you retire. Roth Individual Retirement Arrangements are taxable when you put money in, but pulling contributions out is tax-free at any time, and earnings is tax-free after you turn 59 1/2. The IRS doesn't let you open or contribute to a Roth or traditional tax-deferred IRA if your income is too high, though. If you make too much for a Roth, there's a creative way to fund one, anyway: open a non-tax-deductible IRA, contribute money to it, then roll it over into a Roth.
- Forbes: IRS Announces 2013 Tax Rates, Standard Deduction Amounts and More
- Fidelity: Tax-Exempt Investing
- USA Today: For Taxes, Your Paper Gains and Losses Don't Matter
- IRS.gov: Topic 409 - Capital Gains and Losses
- Fresno Income Properties: What Is Tenants-in-Common?
- Nerdwallet: Income Too High for a Roth IRA? Try Sneaking in the Backdoor
- The Street: Best Municipal Bond Funds for 2012 - New York
- Commercial Partners Exchange Company: 1031 Exchange - Defer the Tax Retain the Gain
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