Municipal bonds

Municipal bonds are bonds issued by municipalities, oftentimes for the purpose of funding infrastructure or other public works projects.  One of the major advantages of municipal bonds is that their interest is exempt from federal income tax, making them especially attractive to investors in high tax brackets.

Municipal bonds can be either general obligation bonds or revenue bonds.

Revenue bonds are backed by revenue generating municipal projects including stadiums, toll roads, and transit projects such as New York State’s Metropolitan Transit Authority.  Because they are not backed by the full faith and credit of the issuer, these bonds are typically riskier and subsequently pay a higher coupon than general obligation bonds.

General obligation bonds are backed by the full faith and credit of the municipality issuing the bonds and are serviced using general municipal government revenue including income taxes and property taxes.  General obligation bonds are typically less risky than revenue bonds and subsequently pay a lower coupon than revenue bonds.

Like all fixed income instruments, municipal bonds have both interest rate risk and credit risk.  From a credit risk standpoint, municipal bonds tend to be slightly riskier than sovereign bonds and slightly less risky than corporate bonds, although this is not always the case.  As with other fixed income instruments, the interest rate risk of a municipal bond increases as the duration of the bond increases.

Tax advantages of rental real estate

Rental real estate can be an excellent investment.  Real property offers a significant opportunity to obtain income and capital appreciation for an investor.  It also has many advantages to an investor from a tax perspective.  These advantages include the ability to exchange property on a tax deferred basis, as well as the ability to write off numerous expenses associated with the property, including depreciation and depletion of the underlying assets.

Tax deferral

Investment property can qualify for a “like kind exchange” which is known as a section 1031 exchange.  Under a section 1031 exchange, the investor can defer gains on the property as long as the proceeds from the real estate sale are re-invested in another property.  Certain requirements must be met, including the identification of a replacement property and subsequent closing on that property within certain time frames, as well as the use of a qualified intermediary to transfer the funds from one property to another.  It is important that such an exchange be done in consultation with the appropriate advisers as the rules are complex.

Deduction of investment expenses

In addition to expenses associated with operating the real property including contractor and employee expenses, real estate taxes, utilities, repair costs, and travel related to running and managing the property, real estate investors can also deduct depreciation of the property and of many of the fixtures inside the property.  There are certain IRS conventions which are used to depreciate property, including the accelerated cost recovery system (“ACRS”) as well as the modified cost recovery system (“MACRS”).  Under these systems the depreciation is calculated based upon the current basis in the property as well as the number of years remaining in the cost recovery period.  A unique feature of deducting depreciation expenses is that the cash flow of the property is not affected.  In certain situations an investor can operate a property which has positive cash flow but which shows a loss on the income statement, resulting in a tax advantage.



Tax deductions for small business owners

As a small business owner, you are able to take numerous tax deductions against your business income.  How these deductions are taken will vary depending on whether your business is structured as a sole proprietorship, corporation or partnership.  This article will restrict the discussion to the sole proprietorship situation, which includes single member LLC entities which have elected to be treated as sole proprietorships.

Mortgage interest, medical expenses, and other tax deductions

This article will cover deductions which are taken on Schedule A of the IRS form 1040.  Filers are entitled to either take the standard deduction (for 2016 these amounts are $6,300 for single and married filing separately, $12,600 for married filing jointly, and $9,300 for head of household) or itemize certain deductions.  These deductions include mortgage interest (including certain “points”), medical and dental expenses, charitable contributions, certain taxes, casualty, disaster and theft losses, and certain miscellaneous expenses.  Some of these deductions are subject to certain thresholds, for example medical and dental expenses are only deductible to the extent that they exceed 10% of adjusted gross income (“AGI”).

529 Plans

529 plans are savings vehicles for the purpose of funding higher education expenses.  They have numerous tax advantages, including tax deferral and tax free withdrawals.  The withdrawals are typically tax free as long as they are used to fund qualified higher education expenses such as tuition, board, fees, books and other expenses at an eligible school.  Under certain circumstances, 529 plan contributions are eligible for a tax deduction at the state and local level.

With a 529 plan, the owner sets up an account for the benefit of a child, grandchild, or other family member (the beneficiary).  Unlike with custodial accounts, the owner retains control of the 529 plan account, even after the beneficiary reaches the age of majority.  The owner also has the ability to change the beneficiary of the account after establishing it.  For example, if a parent creates an account for the benefit of one child and that child later decides not to attend college, the beneficiary of the account can be changed to another child.

Keep in mind that 529 plan contributions are considered gifts and are thus subject to the gift tax rules.  For 2016, the gift tax exclusion is $14K per beneficiary.  Keep in mind that all gifts, not just 529 plan contributions, are subject to this limit.  There are rules unique to 529 plans which allow the gift tax exclusion for the next five years to be taken in the current year by making an election on your gift tax return.  Using this election you could make a contribution of $70K ($140K for a married couple) to a 529 plan for a single beneficiary in the current year.