I don’t freak out about taxes too much. They will always be there and their implementation is largely out of my control. So I try not to sweat the fact that I will pay taxes. And that the absolute value of the taxes that I pay as a high-income earner will be large. But, this doesn’t mean that I don’t try to reduce my taxes. There’s a difference.
What’s the difference?
The difference is that you will never hear me railing against taxation as a principle. Heck, when we lived in NYC with 2 kids on just a resident salary, we used public service and tax funded programs. They helped a lot. Even the other day, I got a flat tire on the highway. While on hold with my insurance company trying to get roadside assistance, a worker for a New York State tax funded highway maintenance program came and replaced my tire for free.
So I’m not anti-tax.
But I still don’t try to pay more taxes than I need to. I’d rather save on taxes and give the same amount of money directly to a cause that I support.
How can you save on taxes?
The tax code is a big book of incentives. It’s the government telling you how they want you to live. Live according to their preferences and you get to pay them less taxes.
Have kids? Uncle Sam likes that. We need kids to build our future. You get a tax credit.
Own rental real estate? People need places to live. Tax deductions for you.
Contribute to your retirement account? That means you will need less public assistance in the future. Good for the government. More tax deductions.
Run a business? More jobs for the people. More tax benefits.
You get the picture.
The sooner that you start looking at the tax code as your friend instead of your enemy, your whole mindset will change. In my humble opinion, taxes are necessary to certain extent. You can’t fight that. But you can fight how much of them you pay. And the government is telling you exactly how to do that.
So pay attention.
What if tax laws change?
Tax law changes all the time! So does everything else in this world!
So, when they do change, adapt accordingly.
I don’t know how they will change in the future and I don’t have a crystal ball. So I don’t prematurely make any changes. That would be the definition of the tax tail wagging the dog.
And, as an aside, no one else has a tax or any other kind of crystal ball. So don’t believe them if they tell you that you need to invest in X, Y, or Z to reduce your taxes due to upcoming tax law changes…
My tax journey
Before filing my 2020 taxes, I didn’t really have any concept of tax reduction strategies. That’s not surprising because I didn’t have any concept of personal finance or financial well-being either.
So, I went to H&R Block (literally) and had some random person there input our information into a computer. And whatever came back, I just accepted. I unfortunately had done this for my 2019 taxes just a couple weeks before staring my financial education.
Luckily (or not) I was a low-income earner as a resident. Plus I had kids. So I usually got a small refund.
But this year, I started making a lot of money. When Selenid and I were developing our budget with a little help, we realized that we were due to pay 6 figures in taxes each year. So, we went about learning how to reduce this amount.
We learned as much as we could about taxes through books, blogs, podcasts, and anything else.
And then we implemented those plans.
3 things I did to reduce my taxes this year
1. Invest in real estate
This wasn’t the first thing we did to reduce our taxes. But it definitely is the now that has resulted and will continue to result in the biggest bang for our buck.
I will also say that tax benefits are not the main or even one of the top 3 reasons that we invest in real estate. It’s important to mention this because many people want to get into real estate for solely this reason. And that is missing the picture in my opinion.
But, there are huge tax benefits in real estate investing
All of our rental income filed for our 2020 taxes was sheltered by depreciation of our real estate properties. Moreover, we had a ton of expenses that we could deduct as business expenses. This doesn’t mean that the expenses were free. But we had to buy them anyway, so it’s nice that the government subsidized part of the purchase. And maybe we can even use some of the purchased items at home too, like lawn maintenance tools, etc.
For this year’s taxes, we plan to have Selenid qualify for Real Estate Professional Tax Status by materially participating in our real estate business more than 750 hours (and more than half of her overall work hours). We will also then person cost segregation studies of our properties and take advantage of accelerated depreciation. This will allow us to shelter our active W2 income from taxation using our real estate losses.
Let’s take an example
We currently own 3 properties (8 doors). Their total value is around $700,000. Let’s say $100,000 of that value is land, so the building value is $600,000.
After performing a cost segregation study, if 1/3 of thahttps://prudentplasticsurgeon.com/t value can be depreciated immediately using accelerated depreciation, this means we could tax shelter $200,000 of our W2 income. Therefore, we reduce our taxes by about $67,000!
Like I’ve said many times, real estate investing does take work and commitment. But you can automate your processes to make it quite passive like we have.
And, at least for us, the benefits are well worth the effort!
4 Reasons That Cash Flow Is King in Real Estate
Powerful Case Study of Passive Hustle in Real Estate Investing
The Complete Physicians’ Guide to Real Estate Syndications
Real Estate Investing: The Good, The Bad, and 50% Returns!
2. Maximizing tax advantaged accounts
This is the lowest hanging fruit for any W2 employee like myself and Selenid. Yet many people don’t take advantage of this.
Both Selenid and I contribute the maximum to our 403(b) retirement accounts through work. Not only does this ensure that we get a hefty employer match and grow our money via safe, smart investments. But these contributions also get deducted from our taxable income so we pay less taxes.
To be fair, I do have a 457 account which I don’t contribute to currently. Ditto a backdoor Roth IRA account. That’s because I use this money to invest in real estate to reduce my taxes as described above. If I wasn’t investing like this in real estate, my money would be in these accounts and my taxes would also be reduced (although by not quite as much as with real estate).
We also place money into our children’s 529 accounts which results in a state tax credit.
If you have a Health Savings Account available through work, this represents a very rare triple tax free investment vehicle when used appropriately. We don’t have one available so we don’t use one.
This is really step #1 for tax savings strategies for most people.
A Quick and Dirty Guide to All Types of Investment Accounts: Where Should You Put Your Money?
Stress Free Stock Market Investing Is Easier Than It Seems!
My Written Financial Plan Update: New Financial Goals and Priorities
3. I started a business
I also started The Prudent Plastic Surgeon in June 2020. Now I didn’t do this for the tax benefits. In fact, I didn’t plan on making any money. But I did. And thus I became educated in all of the tax advantages available to people who own their business in comparison to employees (of which I am one in my main job).
Through business expenses that resulted in deductions in addition to the various other credits and deductions, my side gig income was taxed at a much lower percentage compared to my W2 income. Beyond that, I was able to deduct many expenses that I would otherwise have purchased and used even if I did not start a business. So that is a big win.
And, I didn’t even talk advantage of things like the home office deduction when I filed this year. But don’t worry, I have already created a new home office and will be doing so when I file my 2021 taxes.
This is how I reduce my taxes…
…But it doesn’t have to be how you reduce your taxes.
You may hate the idea of real estate investing. Your circumstances may be different. Each situation is unique.
But the point is that you need to start thinking about strategies to reduce your tax burden if you are not already doing so.
The best 2 books for anyone interested in reducing their taxes is found in this list:
What do you think? Do you employ tax reduction strategies? What ones? What is your take on taxation? Let me know in the comments below!
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