We all know that paying taxes is a necessary part of life. Yet the news is constantly filled with reports of people being caught with offshore, untaxed funds in an effort to (illegally) avoid paying their fair share. Often, these tax evaders end up paying hefty fines or, worse yet, doing some jail time.
Is tax-free living purely a fantasy? Or can you turn it into a reality—without ending up behind bars?
Lots of Americans already live relatively tax-free. In 2010, nearly 28 million households didn’t pay taxes. Here are a few ways you may be able to live tax-free:
1. Municipal bonds. Invest all your assets into your state’s tax-free municipal bonds or in bond funds that invest in your state. The rate of return on municipal bond funds ranges from less than 1 percent to more than 7 percent, according to US News.
When investing directly in your state’s bonds, none of the interest is taxable to the IRS or state. When investing in bond funds, there may be a small taxable amount when the bond fund manager sells the bonds. The money received from the sale is held in an account, earning interest until the manager purchases more funds. That interest is taxed.
2. Rentals. Invest in rental real estate and manage your properties full-time. If you make wise purchases, you will have enough cash flow on which to live. Keep in mind that the income will be reduced by the depreciation losses on the buildings.
As a full-time real estate professional, your losses are not limited to $25,000 (the limit for passive investors). As a result, you may be able to live tax-free.
3. 1031 Exchanges. If you’re selling a property you’ve been fixing up for the last few years, you may sell it at a substantial profit. You can avoid the taxes on the profit by doing a little planning in advance. Find one or more good replacement properties and do a tax-deferred exchange. It’s a bit complicated, but if you do everything precisely you can avoid most of the taxes.
If you draw some cash out of the sale, you will pay taxes on that cash, but if you have little or no other income, your taxes will be low. Work with an experienced tax professional on these exchanges.
4. House flipping. The easiest way to live tax-free may be to buy and sell a new home every two years. The IRS doesn’t tax the first $250,000 worth of the profits on the sale of your home, and that number jumps to $500,000 for couples.
Do careful research; you can often find a run-down house in a great location. Move in and fix it up nicely, doing as much of the work yourself as is possible. When it looks as good as the neighboring houses and you feel you can make a profit, sell the home—without paying taxes on the profit. Do this every two years and you’ll never pay a dime in income taxes on these profits.
All of these ideas are reasonable, legal options, but they may require some adjustments in how you live your life and manage your finances. It may take a year or three to change your lifestyle, but you can live tax-free without any IRS problems.
If you have other great ideas for living tax-free, please share.
Eva Rosenberg, EA is the publisher of TaxMama.com, where your tax questions are answered. She is the author of several books and ebooks, including Small Business Taxes Made Easy. Eva teaches a tax pro course at IRSExams.com and tax courses you might enjoy at http://www.cpelink.com/teamtaxmama.