What is the Best Way to Reduce Your Federal Income Tax?

As a CERTIFIED FINANCIAL PLANNER™ , this is a subject that I get asked frequently. There is no one best answer to this question, however there are a number of places you can look to take advantage of tax breaks the government makes available. My first suggestion is “don’t let the tax dog wag the lifestyle tail”.

Before You Start:

• Review your “life plan”

Starting a business is one of the best ways to avoid (not evade) taxes if there is something that you have a genuine passion for. Starting a business is a major undertaking, however if you have interests in certain areas, think along the lines of how you could make a career of it . If you like photography, start a photography business. Fishing, how about a charter? Following your own interests will be your best guide as to the type of business you create.

As an individual, you might say that you earn money, pay taxes, and live on what’s left. A business earns money, takes deductions, then pays taxes on what’s left. Big distinction! The type of business (S corp, C corp, etc.) will dictate the specifics on business tax deductions.

In addition to deductions for running the business, you might be entitled to establish a retirement plan or pension plan for your business. Retirement plans are deducted from your income and are a deduction for the business. Depending on what type of plan you establish, contribution limits for retirement plans range from $44k to almost $200k per year! Deductions for retirement plan contributions could provide a major source of tax savings and be a good step toward securing a better retirement nest egg for yourself.

If starting a business isn’t your cup of tea,  home mortgage interest allows for a hefty deduction. Currently the government allows homeowners to deduct “qualified residence interest” of up to $1,000,000 of “acquisition debt” and up to $100,000 of home equity debt.

The Alternativee Minimum Tax (AMT) has been affecting average taxpayers more and more over the years.  The AMT can severely limit your ability to take certain kinds of deductions and it is important to work with a qualified tax professional or financial planner who can advise you on your individual situation before you implement a new strategy.

Opportunity abounds for people to save money on taxes. The right strategy will depend on your goals, opportunities, and stage of life.

When Will Realtors Start Using Google Earth?

I’m a big fan of Google Earth software. The program allows anyone to add information into the program to show any kind of data and display it within a geographic representation. In the case of Realtors, I think that it would be wonderful to have all of the homes on the Multiple Listing System (MLS)imported into Google Earth. Currently, when I look at homes on the MLS, it only tells me the town and school district that the property is located. As a buyer not familliar with a local area,  this information isn’t meaningful to me. If the property address were loaded into Google Earth, I would be able to see an aerial view of the neighborhood, proximity to highways, parks, or any other geographic feature that would be of interest as a buyer. In addition, a Realtor has the ability to link the placemark in Google Earth to their website, providing more information for a prospective buyer if they wanted it. I know it’s just a matter of time before this concept catches on, however in my opinion, the Realtors or developers who are the “early birds” on this opportunity could have a real technological and marketing lead on the competition.

What is your take on the current real estate market? Is it a good time to buy REIT, builders, personal housing, etc?

I think it’s important to preface by saying that there are a number of ways to buy into these kinds of investments. In recent years, more and more investment firms have developed investment products to allow investors to invest in specific sectors of the economy (including the ones mentioned). Some of these include mutual funds, index funds, and exchange traded funds (ETF’s). My answer to you would depend on how you are intending to invest in these areas.

The sectors mentioned have been very hot for some time now. While the Federal Reserve has stopped raising rates (and there is now a strong indication that they may cut rates in the spring), a significant inventory of unsold homes that were purchased by Real Estate speculators could cause the price of homes to continue to decline. On the flip-side, while the Fed has raised rates, prices of home mortgages have been trending down for several months now. While it is difficult to say whether this will continue, I see this trend as a factor that will help to stabilize the housing market. When money becomes cheaper to borrow, this makes homes more affordable. You will find many people who agree that the fevered housing market of the last several years was fueled by falling mortgage rates. In my own opinion, I would not be surprised to see home prices stabilize in 2007 or early 2008. If the scenario were to unfold in this way, one could argue that we were approaching a bottom. It’s also interesting to see that home-builders like Toll Brothers and (symbol TOL) and D.R. Horton (DHI) have seen their stock prices rise as the rates on the 10 year treasury bond have fallen (this is what many mortgages are tied to). This could be another indication that much of the housing bubble has been priced into securities of home-builders.

As mentioned, there a many ways to invest in this area. You could go out and buy a single stock (like a Toll Brothers) or a publicly traded REIT. When investing in in individual stocks, your results are tied not only to the success of the underlying trend, but also to the results of that company. This obviously introduces more risk into the picture. An alternative to buying individual stocks would be to buy a basket of these kinds of companies through a mutual fund, index fund or ETF’s. ETF’s are becoming the rage on wall street due to their tax efficiency, low cost, and liquidity (not all ETF’s are liquid).

Ishares , Powershares, and Wisdomtree  are some of the companies that offer ETF’s in various sectors.