In the US, it is better to be an owner than an employee. Use these proprietary strategies to accumulate wealth through tax-free income.
PIMD welcomes white coat investors. WCI is a physician-specific personal finance and investment website. White coat investing can help you become financially literate and disciplined, allowing you to devote your time and effort to the well-being of your patients, your family, and yourself. WCI truly believes that a financially secure doctor is a better partner, parent and practitioner. White Coat Investors is an authorized partner of PIMD.
There are many ways for owners to grow their assets that avoid generating any taxable income, that qualify the income generated for a lower tax rate, or at least defer that taxable income to later years. This allows owners to dramatically reduce the biggest barrier to wealth accumulation—tax—and thus build wealth at a much faster rate.
I have already written about how Ownership has its prerogatives And about how you actually want Become a capitalist as fast as possible. Although hardly risk-free, ownership is great in that when a business succeeds, the bulk of the profits accrue to the owners, not the employees. In a capitalist system, capital is king, so you want to do as much as possible to move from relying on your personal labor to being able to rely on your personal capital. Equity, like debt, works every hour of the day and night, 24/7/365. If you are famous J. Reuben swaps “capital” for “interest” in Clark’s quote and you’ll see what I mean:
“[Capital] Never sleeps, never gets sick or dies; It does not go to the hospital; It operates on Sundays and holidays; It never takes a vacation; It does not visit or travel; It takes no pleasure; It is never laid off or laid off; It never works at low hours; It never has low crops or drought; It never pays taxes; It buys no food; It wears no clothes; It is houseless and houseless and therefore has no repairs, no replacements, no shilling, plumbing, painting or whitewashing; has no wife, children, father, mother or relatives to look after; It has no cost of living; It has no marriage or birth or death; It has no love, no compassion; It is as hard and lifeless as a granite cliff. Once upon a time [invested], [capital] Your companion every minute of the day and night. . “
It’s a beautiful thing to come home from a vacation richer than when you left.
Not to judge the fairness of rules here
First, a warning. Many people think the “rich” don’t pay their fair share. Warren Buffett famously talked about how his secretary has a higher marginal tax rate than him. I’m not here to play judge, jury and executioner about the rules of our tax code. I’m here to tell you just what they are. You can decide what you want to do with them, both in your personal financial life and at the voting booth. But this is a blog aimed at high-income professionals and mostly discusses “first world problems”. I fully expect the vast majority of my readers to eventually become multi-millionaires. If you’re sick of learning the rules, playing by the rules, paying every dollar you owe in taxes but not a tip, and building wealth, then this blog is probably not a good place for you to hang out.
Key idea: Earn non-taxable income
The main idea I want you to take away from this post is that there are things that increase your net worth that are not taxable income. If it is not taxable income, you will not pay income tax on it. Only income is subject to income tax. Let’s talk about examples of non-taxable income.
Become a home owner
Perhaps the simplest is understanding home ownership. A home is often derided as a liability and not an asset. I completely understand this concept and I have written about it many times before. However, in some ways, your home is actually is An asset. yes your Home is an investment. It can appreciate in value and it pays “dividends” in the form of saved rents. However, today we are talking about taxes. So, what are the tax benefits of home ownership?
What are the tax benefits of owning a home?
Well, they’re not what most people think. Most people think that the big tax benefit is deducting your mortgage interest and property taxes on Schedule A. Well, the new higher standard deduction ($27,700 for those married filing jointly In 2023), most homeowners are no longer itemizing. Plus, even for those who do, only the amount above the standard deduction is really deductible. Also, the property tax deduction doesn’t really exist for high earners who already pay more than $10,000 in state taxes. Also, mortgage interest is deducted as you pay off the mortgage. No, my friends, Schedule A is not where you get the major tax benefits of home ownership
The main tax advantage of home ownership is that you don’t pay taxes if your home increases in value. Let’s say you bought your home 10 years ago for $400,000. Now, it’s probably worth $700,000. Your net worth is $300,000 more than ever. Yet you didn’t pay a dime in taxes on that $300,000, did you? No capital gains tax is due until you actually sell the asset. But wait, there’s more. Even when you sell, the first $250,000 ($500,000 if married) of the gain on a residence you’ve lived in for two of the last five years is not taxable at all. A married couple can swap homes whenever the home appreciates in value by $500,000 and never have to pay taxes on the wealth growth!
Guess what? Business ownership works similarly to reduce taxable income. The bulk of our personal wealth is in The White Coat Investor Value. Yes, we are trying to diversify as quickly as possible, but such is the life of many successful entrepreneurs. When I started blogging back in 2011, The White Coat Investor was worth $0. Now it is worth much more than that. None of the appreciation was subject to income tax, and if I left it to my heirs (thanks Proceed based on death) or leave it to charity, it will never happen.
Since most businesses are sold at multiples of profit, this increase in net worth can happen very quickly. Consider a business that makes $1 million a year and is worth 10X earnings or $10 million. Of course $1 million is taxed per year. However, if the business owners and managers find a way to earn $1.5 million a year, they will create another $5 million in wealth (plus $500,000 in additional earnings, for a total of $5.5 million). However, they would only pay taxes on $500,000 of that $5 million. This is better than the effects of quite significant leverage.
Purchase of stock
No, you probably don’t own a business like WCI, but the same concept applies to other businesses out there. And even if you don’t start or outright own a business, that doesn’t mean you can’t buy parts of other successful businesses. Many of the world’s largest and most successful businesses are publicly traded, and you can buy shares in them directly or through mutual funds on the stock market (especially Low-cost, broadly diversified index funds, my favorite way to own them). Many of these businesses will continue to appreciate in value as they develop new products and services, raise their prices, and reach new markets. Unless you sell your shares in these businesses, the increase in your net worth is not taxed. And if you inherit or leave them to charity, the tax will not be.
Tax benefits of real estate investment
Investment real estate $250,000/$500,000 of capital gain does not qualify for the exclusion for which owner-occupied real estate qualifies. But the rest of this applies and you get the added benefit of deducting or depreciating all your expenses on the property against the income from that property (and if you’re eligible Real estate professional status (REPS), against your ordinary income). Under the current bonus depreciation rules at the time of this writing, you can take more than 60% of the value of your investment as depreciation in the year of investment. Depreciation can “cover” a large portion of real estate income—income that would normally be subject to ordinary income tax rates—that income you may have tax-free. Yes, when you sell, that depreciation is recaptured at a rate of up to 25%, but there is probably an arbitrage between your marginal tax rate and 25%. In addition, you have three other options to avoid depreciation recapture:
- Die (and pass it on to your heirs on an income-tax-free thanks-to-death basis)
- Give it to charity (you get a deduction for the full value and neither you nor the charity recapture capital gains or depreciation)
- Exchange it for another property (1031 exchange), further delaying recovery until the second property is sold
Depreciate, exchange, depreciate, exchange, depreciate, die is the mantra of many successful real estate investors. If you don’t sell, you get the appreciation (including any depreciation recapture) tax-free.