Tax-Efficient Investing

Taxes are unavoidable – but with smart planning, certain investments become even more attractive.

Learn how to retain the most from your investments and grow your wealth exponentially by managing your tax liability in our guide to tax-efficient investing.

One of the top reasons high-income earners invest is to minimize their tax burden. If you are among those in the higher tax brackets, or if you simply want to owe less money to Uncle Sam, it’s important to understand how to recoup your earnings through tax-efficient investing.

What is tax efficiency?

Tax efficiency is a phrase used in the finance and investing world that means “reducing your tax liability.” A particular investment is considered tax-efficient if the tax outcome is lower than what you would get with a different type of investment or financial decision. In short, tax efficiency is how much of an investment’s profit you get to keep after your taxes are paid.

How do I know if my investments
are tax-efficient?

Figuring out the tax nature of your investments is the first step in determining tax efficiency.

Investments typically fall into three categories:

  • Taxable
  • Tax-Deferred
  • Tax-Advantaged

Investment Tax Buckets

IN after-tax pre-tax after-tax
GROWS taxable tax-deferred tax-deferred
OUT taxable taxable tax-free
EXAMPLES Banking (CDs, MM) Brokerage
– stocks
– bonds
– mutual funds
– ETFs
– 401k
– 403(b)
– 457
– deferred compensation
– annuities
– ROTH (IRA, 401k, etc.)
– municipal bonds
– 529/ESA
– cash value life insurance

A taxable
is one in which you invest your income after-tax, and you pay taxes on the profits from the investment each year you hold the investment. Examples of taxable investments are bank accounts, money market accounts, and mutual funds.

A tax-deferred investment is one in which your money goes in pre-tax, and the income grows tax-deferred as long as it remains within the investment vehicle. You pay taxes on the investment once you withdraw the earnings from the account. Examples include 401(k)s, IRAs, and annuities. This offers an instant tax reduction. There are often tax and other penalties associated with accessing capital in these investments.

A tax-advantaged
is one in which your money goes in after-tax, but it grows tax-free and the disbursement is also tax-free. Examples of tax-advantaged investments are ROTH IRAs, municipal bonds, and educational savings accounts.

Example of how investment tax buckets have different tax liabilities:

Someone needs $100,000. Assumed at 22% federal income tax and 15% capital gains tax, here’s how the different tax buckets would break down – showing just how major of a difference proper planning has on your tax liability.

How tax-efficient are REITs?

REITs offer incredible tax advantages. Since REITs are required to distribute 90% of their annual taxable income to investors, REITs are allowed to avoid taxation at the fund level. Because of this, investors avoid double taxation and the maximum amount of capital is returned as investment income.

Under the 2017 Tax and Jobs Cuts Act adds further benefit, allowing up to a 20% pass-through deductions for REIT investors.

REITs offer an incredible opportunity for a low barrier to entry tax-efficient investment, giving exposure to investors who may not be able to access the required capital for their own private real estate deals.

Depending on how you invest in a REIT, it can land in any of the investment tax buckets discussed above. Compared to other
fund structures, REITs have two major advantages:

  • REITs distribute the most income to investors.
  • REITs lose the least in taxes.

At Upside Avenue, we are always seeking to maximize the return for our investors. Our team of professionals constantly
assesses tax efficiency as we operate our portfolio. With access to a tax-efficient professionally managed diversified portfolio of income-producing real estate, you can feel confident investing in our REIT.

To see how you can use your investment retirement account to invest in Upside Avenue, visit our SDIRA Funding Allocation page.

You should always seek out your own legal and financial advisors – this information is solely provided as informational and should not be taken as a recommendation. Consult on your specific situation with a tax professional.