By Jonathan Howard, CFP®

There is little that Americans agree on more than our dislike of taxes. This goes all the way back to our days as a British colony, when “No Taxation Without Representation” was a rallying cry of the Revolution. We managed to escape the taxes imposed by the British monarchy only to create one of the most maddeningly complex tax codes on earth. Out of the frying pan, into the fire.

While there’s no way to completely escape tax liability, the tax code weaves in benefits for some investments that can help reduce a tax bill, diversify a portfolio, and maintain a profitable business. Four such strategies are outlined below:

1. Delaware Statutory Trusts

If you are a real estate investor, a Delaware Statutory Trust (DST) offers a way to defer paying the capital gains tax on a property sale. That’s because a Delaware Statutory Trust can work with a §1031 like-kind property exchange.

Essentially, this means that if you sell a piece of real estate and immediately invest the proceeds into a DST, you can defer paying capital gains taxes, and potentially also defer depreciation recapture as well.

If you’re planning on selling a highly appreciated property, this strategy can eliminate the tax due on the transaction. It also preserves the step-up in basis at death for investors wanting to hold real estate as a legacy benefit for future generations. All of this while eliminating the need for the investor to actively manage the property. That’s the job of the DST’s specially licensed trustee.

If you like holding real estate in your portfolio but find real estate management an expensive headache, DSTs may be worth investigating.

2. Oil and Gas Investments As a Limited Partner

This strategy is designed to reduce the tax cost of a Roth conversion using an investment in oil and gas commodities. There is much more to it than described below, but the broad strokes work as follows:

Using funds in a self-directed IRA, you buy a limited partnership interest in an oil or gas drilling project.
In year one, intangible drilling losses reduce the investment’s paper value.
You receive documents showing the reduction in the value of your investment.
You execute a Roth conversion to a self-directed Roth IRA using this new lower value. Since the conversion is for an amount less than what you originally invested in the project, the tax bill is not as high as it otherwise would have been.
You receive income from the oil and gas project based on the original investment amount, not the reduced value you converted to Roth.
Assuming the price of oil stays above an underwritten level described in the investment’s offering documents, income continues for 10 years. It is important to note that income is not guaranteed and that income in the first 5 years will be substantially higher than the final 5 years due to oil and gas depletion.
Returns from the investment are entirely generated by income produced by the project. The income received within the Roth is potentially income tax-free. The big “gotcha” here is that the income may still be subjected to unrelated business income tax (UBIT for short).

As you might see from the points above, this investment carries complications and risks that you won’t find with stocks, bonds, ETFs, and mutual funds. Make sure you understand what you are getting into and what to expect regarding costs, liquidity, valuation of the investment, and the income the investment generates.

3. Captive Insurance for Business Owners

If you own a business, captive insurance can be a helpful (if complex) way to protect the business and save on your taxes. This strategy involves hiring a captive insurance manager to create your own insurance company. The insurance company you create insures your business against various types of risks, including:

Business interruption (think about everything from road closures to COVID-19)
Reputational damage
Loss of a key employee or client
Cybersecurity breaches

You pay the insurance policy premiums through your business’s annual operating profits. Under tax code §831(b), the cost of the premiums is deductible up to $2.6 million in 2023, and increases each year. This means the operating profits that would have been otherwise taxed at individual or corporate tax rates are now taxed at a rate of 0%.

Years down the line, when you, the business owner, exit the business, you shut down your captive. The captive’s cash reserves now become an asset and are distributed at capital gains tax rates, not ordinary income.

When used correctly, captive insurance is a highly effective business and tax-planning strategy for business owners. But it is highly scrutinized by the IRS and, if not used first and foremost for insurance coverage, may lose its tax advantages and result in penalties.

A good rule of thumb for captive insurance company owners is that it must pay out claims every year; otherwise, the IRS won’t view it as an insurance company.

4. Cost-Segregated Depreciation of Investment Real Estate

If you want to lower your tax liability by increasing your deductions, cost-segregated depreciation is an option for real estate investors who directly own property. With this strategy, an engineering firm studies your investment property and finds components that can be depreciated separately from the structure itself. For example, straight-line depreciation on a commercial property has a 39-year schedule. However, components within the property may have schedules of only 5 or 7 years.

By implementing this strategy, you can get more depreciation in the early years of your property ownership. That translates to more tax deductions during the period of time when it is less likely that the investor will want to sell the property.

You might be wondering, “Isn’t this a super complicated version of accelerated depreciation?” Remember the §1031 property exchange described in the section on Delaware Statutory Trusts? If you use accelerated depreciation, you will not be able to defer depreciation recapture taxes at the time of the exchange. By using cost-segregated depreciation, you get the benefit of front-loaded depreciation without sacrificing the ability to defer depreciation recapture later.

If you opt for cost-segregated depreciation, you’ll need to hire an engineering firm to study your property and develop a depreciation schedule. The report the firm generates helps your CPA implement depreciation deductions; it can also be useful to have on hand in the event of an audit. The cost of the report is an up-front expense and should be compared to the potential tax savings this strategy may generate.

Tax-Planning Strategies: There Is No Free Lunch

Used correctly, the tax-planning strategies above can save your family or your business a significant amount of money once tax season rolls around. However, bear in mind that each one requires some commitment of time, money, and tolerance for risk. Talking to a financial advisor is one way to determine whether a tax strategy may be of benefit to you. If an advisor recommends a strategy above, or one like it, make sure you ask them to connect you with people who are using these strategies themselves.

At SeaCure Advisors, we’re committed to helping you navigate our complex and ever-changing financial landscape to help you create and preserve the wealth you’ve dreamed of. If you’d like to learn more about tax-planning strategies, we invite you to get in touch.

Schedule an introductory call online, call us at 877-328-4037, or email info@seacureadvisors.com. We look forward to hearing from you!

About Jonathan

Jonathan Howard is a financial planner at SeaCure Advisors, a financial services firm committed to developing custom-tailored financial plans to help clients meet their specific goals and needs.

Prioritizing education, diligence, and communication with a high emphasis on tax planning, his goal with everyone he works with is to help them use their resources as tools to enhance their prosperity and well-being.

Prior to entering the financial services industry as a licensed life & health insurance agent, Jonathan spent 17 years in Los Angeles, working as an editor and visual effects artist. Jonathan holds a bachelor’s degree from Middlebury College as well as the Series 7, 63, 65, and CERTIFIED FINANCIAL PLANNER™ designations. He has contributed to financial articles published in Forbes, USA Today, Fox Business, U.S. News & World Report, Kiplinger, Yahoo! Finance, and more.

Jonathan lives in Lexington, KY, with his beautiful and patient wife, two vivacious daughters, and two spazzy dogs. When he’s not working, he enjoys playing guitar, spending time outdoors, and family time. To learn more about him, connect with him on LinkedIn.

Securities Offered through AAG Capital, Inc. Member FINRA/SIPC. Investment Advisory Services are offered through Accurate Wealth Management, LLC an SEC-registered investment adviser. Registration does not imply any level of skill or training. Insurance products and services are offered through Accurate Advisory Group and sold through individually licensed and appointed agents in all appropriate jurisdictions.