What Types of Investments Are Tax Deductible?

If you start grumbling when tax season rolls around each year, you aren’t alone. Paying taxes is hardly an enjoyable process but tax-efficient investing can make it a little less painful. If done right, you can significantly reduce your tax bill, at least over time. 

Here are a few tax-deductible investments you might want to consider:

401(k)s and Traditional IRAs

Even if you aren’t planning to retire any time soon, it’s a good idea to invest in your future. That’s doubly true when you consider how it can positively affect your tax payments right now.

With a 401(k) account, you can invest up to a specific amount (set by the IRS each year), and your employer will often match your contributions. Since most people make contributions to their 401(k) before taxes, your taxable income for the year will be reduced by the amount of your contributions. Be sure to remember that you’ll need to pay taxes on 100% of the funds you withdraw from your 401(k) much later on. 

Traditional IRAs are also worth a look–these accounts work much like 401(k) plans, albeit without the fund-matching component. Traditional IRAs come with income caps on the deductibility of contributions. Be sure to look up the phaseouts and limits for the current tax year. 

Real Estate

If you own a home, the interest you pay on your mortgage loan and (part of) your property taxes are tax-deductible.

However, there’s a catch: the Tax Cuts and Jobs Act of 2017 capped state and local property tax deductions at $5,000 for married taxpayers filing separately and $10,000 for all other taxpayers. At the same time, standard deductions were increased. For 2021, these deductions were listed as:

• $12,550 (for taxpayers who are single or married and filing separately)

• $18,800 (for taxpayers who are the head of a household)

• $25,100 (for taxpayers who are married and filing jointly)

Charitable Giving

When you’re smart about what and how you donate, your gifts can also help you out in a big way. Generally speaking, donations can only be used as deductions if you itemize deductions vs taking the standard deduction on your tax return. However, in 2021, taxpayers can deduct up to $300 in charitable donations made during that calendar year, even if they choose to take the standard deduction. If you’re married, you can deduct $600 in charitable donations in 2021. 

Donating things like a private business interest, real estate, and/or highly appreciated stock can help you save on taxes. If you sold these assets and gave cash, you would have to realize the capital gain and pay taxes, but giving the asset itself avoids the capital gains tax, yet you still get to take the full market value as a charitable donation. In addition, the charity doesn’t pay tax on the shares of stock they receive from you when they sell it to cash. It’s this very reason why giving highly appreciated securities can be a valuable donation option.

Qualified charitable deductions (QCDs) are another method of using donations to help both others and yourself. If you have a traditional IRA, you’ll need to take required minimum distributions (RMDs) starting at age 72 under current tax law, which are taxable and could even bump you into a higher tax bracket. Assuming you don’t need these distributions to cover your expenses, you can give up to $100,000 in RMDs to charity each year. 

Donor-Advised Funds

Along with these forms of charitable giving, you may find donor-advised funds (DAFs) to be a worthwhile tax deduction strategy. These are 501(c)3 organizations established for charitable giving that can handle large donations. 

A DAF can be funded by cash or other assets, including securities. These assets are put into an account bearing your name and held by a sponsor. At some point, your assets will be donated to a charitable organization of your choice. Notably, people donating to DAFs can take a tax donation in the year they donate - even if the assets they contribute won’t go to charity immediately.

DAFs have a few drawbacks, some of which are related to the involvement of a sponsor. Since you’re legally ceding control of your assets to your sponsor, they may use them in ways you aren’t comfortable with, making it crucial to find a sponsor you can trust. DAFs have also come under scrutiny since people managing them aren’t legally required to donate assets in a timely manner, and the funds themselves can profit from fees charged to donors. Despite these concerns, a well-managed DAF can be a highly efficient way to donate assets while lowering your taxes.

Health Savings Account

Do you have a high-deductible health insurance plan? If so, it’s a good idea to look into opening a Health Savings Account (HSA). These accounts are tax triple advantaged–they boast deductible contributions, tax-deferred growth, and tax-free withdrawals (when you use the money you withdraw for qualified medical costs).

If your account hits a particular dollar value (usually in the $2,000+ range), you’ll be able to set up an HSA Investment Account. With this, you can invest the money in your HSA in various mutual funds. That way, you can boost your savings for retirement while still covering your health insurance needs.

Smart Investing

Making tax-deductible investments is a complex process on its own, creating long-term tax efficiency and optionality is another puzzle that’s often unique to each individual. 

Tax law is constantly changing, too. For example, the Tax Cuts and Jobs Act of 2017 introduced a bevy of changes, increasing standard deductions while adjusting caps on mortgage interest deductions and state and local taxes. There are also strategies that are beyond the scope of this article, like asset location and tax-loss harvesting. 

Since many of these tax strategies have to be completed during a calendar year, it’s the cost of a missed opportunity that really can compound over time. We believe that it’s more important than ever to make sure you’re investing the right way.

When you’re building a strategy for tax-deductible investments, nothing beats advice from qualified financial experts. The team at Consilio Wealth Advisors focuses on guiding you with jargon-free, transparent advice. Our goal is to help you reach your goals, ideally with a little less drain from taxes over time.

DISCLOSURES: 

Consilio Wealth Advisors, LLC (“CWA”) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where CWA and its representatives are properly licensed or exempt from licensure.

The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status, or investment horizon. You should consult your attorney or tax advisor.

The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

The above targets are estimates based on certain assumptions and analyses made by the advisor. There is no guarantee that the estimates will be achieved.

Risk associated with equity investing includes stock values which may fluctuate in response to the activities of individual companies and general market and economic conditions.

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