Let's face it, nobody likes paying taxes. You've got expenses, you've got retirement to plan for. With federal tax brackets ranging from 10 to 39.6 percent and state income taxes rates as high as 12.3 percent as of the date of publication, tax-free investing can be a wise choice for anyone. Even if you only pay 25 percent federal income tax and 5 percent to your state, tax-free investments can still save you a great deal of money.
When a city, county or other local government agency borrows money for a project, it frequently does so by issuing bonds. These bonds work like any other bond -- you lend them your money and receive interest and, at some point the future, a return of your principal, but they have an important difference. The interest you earn isn't subject to federal income tax and is usually also not subject to state income tax in the state that issues the bond. While muni bond yields are usually lower than comparable taxable bonds, you can come out ahead when you factor in your tax savings.
Oil and Gas Partnerships
Partnership shares in oil and gas pipelines and other energy-producing assets are also frequently tax-free. While the income from these master limited partnerships would be taxable, energy assets are usually eligible for generous depreciation deductions. The depreciation deduction cancels out most or all of the income, potentially leaving you with a tax-free investment. The depletion and drilling cost amortizations can sometimes offer a similar scenario for investments in oil and gas wells.
Investment Real Estate
Investment real estate properties also let you claim depreciation. Depending on how much cash flow you earn or how much you pay down your loan, the depreciation could end up cancelling out all of your profits and giving you a tax-free investment. At the same time, the IRS doesn't tax you when the property's value goes up as long as you don't sell it. When you do sell it, you can use the proceeds to buy more investment property and defer paying your capital gains taxes.
Harvest Tax Losses
You can turn any taxable investment into a tax-free investment if you have a loss that can offset your gain. For example, if you own shares in your taxable stock portfolio that went up in value and shares that went down in value, you could sell both. The loss would cancel out the gain. You could then use the proceeds from selling the losing stock to buy more shares of a similar investment. While you wouldn't have the exact same thing, you'd have something very close that you'd be buying at a similarly depressed price.
There's also an easy way to invest tax-free in straightforward assets like stocks, bonds and certificates of deposit -- the Roth Individual Retirement Account. As with many other tax-free investments, you can't write off the money that you put into a Roth, but if you let your money sit in the Roth account for at least five years and you wait until you're at least 59 1/2 years old to withdraw it, you will be able to take your original contributions and your profits out on a completely tax-free basis.
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