Using Tax Shelters to Reduce Taxes

Before considering an investment in a "tax shelter", it is important to look at the recent history of these products and understand the evolution and change that has taken place. Because of changing tax laws, regulations and IRS rulings, many significant changes have occurred over the last 30-40 years. The Federal Income Tax began in 1913 with the passage of the 16th amendment. Rates in the first two years ranged from 1% to a top of 7%. The top bracket has varied markedly since those early years ranging from 15% in 1916, 67% in 1917, 81% in 1940 and a high of 94% in 1944-45. As you may notice the high brackets occurred during war years. The top tax bracket hit another high of 92% in 1952-53.

Another important concept in this topic is the difference between tax shelters, tax avoidance and tax evasion. Many tax shelters were passed into law by Congress to encourage certain activities. Tax avoidance is simply the legal use of tax shelters to reduce income taxes, whereas tax evasion is the legal term used for individuals or other entities who illegally avoid paying taxes.

During the years of 1970 through the 1990s, the use of tax shelters proliferated due to legislation enacted to spur the economy. Some creative minds however stretched the law and many abusive shelters appeared. Many tax shelters offered investors write-offs of as much as 10:1 on invested money. In other words an investment of $10,000 would generate a tax deduction of $100,000 against ordinary income. It was very common to see write-offs of 3:1 or 4:1 during the 70's and 80's. Many investors looked to the tax write-off for their "economic" return. The tax savings would depend on each individual's tax bracket; the higher the bracket, the greater the savings. The underlying investment in many cases was overlooked.

The tax savings frenzy was exacerbated by the ability to use offshore accounts to hide assets and income. Such areas as off the coast of New Zealand, the Cayman Islands, Gibraltar, the Bahamas and the little island of Nevis were among the prominent offshore tax havens.

The Tax Reform Act of 1986 changed "life with tax shelters" as it was known and may have contributed to the end of the real estate boom of the early to mid '80s as well as to the Savings and Loan crisis. Real Estate passive losses were severely curtailed by limiting these losses to $25,000. The losses were also prorated on incomes between $100,000 and $150,000 and eliminated over that level. Although this was a shock to investors and the economy, the long term effect may be positive for the economy by redirecting money to programs that are economic in nature rather than driven primarily by tax laws.

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Property photos shown here are being provided for educational purposes only, to illustrate the different property types available in the real estate market. These photos are not intended to represent any particular type of TIC offering nor are they intended to represent any current or future TIC offerings.