Tax Loopholes You Should Know

tax loophole

Recently I came across an article discussing legal tax loophole in the states. It’s an article from MSN and for some reason, they love slideshow.

I’m going to summarize some of my favorite tax loopholes discussed in this article in one post to save you from all that clicking!

Tax Loopholes

The internal revenue services (IRS) allow for legal tax loopholes to promote certain goals such as saving for retirement,

When you think of tax loopholes, you will think that it’s only applicable to the rich. Well, my friends, there are tax loopholes for everyone, including you and me.

Yacht Deduction

But I thought you said tax loopholes is not for the rich? Well, it turns out you can deduct up to $750,000 in mortgage debt including a Yacht if you want to.

This “home” can be your brick and mortar subdivision house or it can be a mobile home, trailer or even a boat. As long as it has sleeping, cooking and toilet facilities.

So, if you’ve already paid the mortage, you can deduct mortgage interest on that Yacht instead!

15 Days of Free Rental Income

For all our homeowners out there, the IRS allows you to rent out your home for 15 days without any tax consequences.

This is especially lucrative if your home is located to a popular seasonal event like the recently canceled SXSW :(.

Health Savings Account (HSA)

I just recently learned of this tax loophole. In summary, HSA pays qualified medical expenses in the past, present, and future. You can think of an HSA as a better version of an IRA. You get triple tax benefits from HSA.

  • You don’t have to pay taxes on the money you save and invest to pay for your medical expenses.
  • Your HSA money will grow tax-free, just think of HSA as an additional investment vehicle in addition to your 401 (k), Roth IRA.
  • Contributions made are pre-tax, meaning you get the benefit of lowering your taxes owed.

In 2020, you can save up to $7,100 for a family or $3,550 for a single person. People ages 55 and older can add a catch-up contribution of $1,000.

Bad Loans

If you loaned someone money and you can’t get it back, you’re eligible to deduct it from your taxes. This deduction was originally intended for businesses, but this particular tax loophole allows anyone to deduct unpaid debts such as a loan to a friend, or family member.

The loan must be considered a total loss and it must be a debt, not a gift. This means that you need to have some sort of proof, such as in writing. And you’ve made reasonable attempts to get the money back such as phone calls, letters and in-person requests for repayment. Or if the person who borrowed your money declared bankruptcy.

Life Insurance Tax Loophole

If you have a whole life insurance policy with a a cash value, you can borrow against it. In other words, it’s the money in your policy that doesn’t cover insurance costs that’s growing tax-deferred.

Over time, this cash value will be built up above the death benefit. If you die, your beneficiaries get the death benefit, which is paid tax-free. However, if the estate is big enough, estate tax may be due.

The tax loophole here is that you can take out a loan on your policy while you’re still alive. This loan is free of income tax. However, you will have to pay back the loan with interests.

Home Office Deduction

Most of us probably are familiar with this tax loophole. If you set-up a part of your home as a home office, you can then deduct a percentage of your home improvement expenses equal to the percentage of the space your home office occupied.

For example, if your home office is 10% of your home, then you can deduct 10% of the cost of installing a security system. If you have clients coming to your home to conduct business, then you can deduct costs like landscaping.

529 Plan Tax Loophole

When you use a 529 plan to pay for college expenses, it’s on a tax-free basis. In some states, you also get a state income tax deduction from your contributions.

You may also qualify to take the American opportunity tax credit or the lifetime learning credit.

Backdoor Roth IRA Tax Loophole

Income limitations may prevent high-income earners from contributing to the Roth IRA. Roth IRA allows you to save after-tax money for retirement. Upon withdrawal, it is tax-free, money earned in the form of capital gains are also tax-free.

If you make more than $139,000 for a single or $206,000 for a married couple, then you’re disqualified from contributing to a Roth IRA.

In this tax loophole, you’re allowed to contribute to a traditional IRA first using after-tax earnings. You then convert the regular IRA to a Roth IRA. The whole process is called a back-door Roth IRA. You can get the benefit from tax-free withdrawals and escape the required minimum distribution as required by traditional IRA and 401 (k).

Pass-Through Business Deduction

If you own a business such as a sole proprietorship, partnership or S-corp where the business itself does not pay taxes, you can deduct 20% of the business income from your taxable income.

There are limitations, however. You’re eligible for this deduction if your earning is less than $157,500, or a married couple earning less than $315,000.

Final Thoughts on Tax Loophole

While there are practical tax loopholes for the laypeople, there are also ridiculous tax loops in existence like the Yacht and private plane tax deductions.

The main point of this post is to point out certain tax loopholes where you can take advantage of.

Make sure you’ve got the three most common tax advantage accounts: traditional or Roth 401 (k), Roth IRA, and HSA.

I have both traditional and Roth 401 (k), did my first backdoor Roth IRA conversion and will continue to do so in the future.

I’m still working with my wife to save enough to fund my daughter’s 529 plan sometime this year.

I started contributing to my HSA plan since January and I am halfway to my goal of $2,000 since this is the threshold where I can direct my account to buy mutual funds of my choice through Optumbank.

Once I reach that milestone, I’ll be sure to update you on it.

Have you taken advantage of some of the tax loopholes mentioned in this article?