Real estate

Conventionally tax shelters included investments in real estate, oil and gas, equipment leasing, and cattle feeding and breeding programs.

Real estate is a great tax shelter. It provides leverage, an inflation hedge, cash flow and equity buildup.

As the real estate property appreciates, you would be allowed a paper deduction for depreciation. If properly structured, you could buy the property with your down payment. Your rent covers the mortgage.

interest, taxes and operating expenses.

In the 31% tax bracket, a $ 5000 paper deduction for depreciation creates a real cash tax savings of $1,550. This tax-generated cash could be used for any operating expense deficit.

Moreover as you pay the mortgage, you build equity with the principal pay-down. Once the mortgage is paid off, you would have an annuity (rents) while your investment would appreciate in value. On the other side you must by a property that would appreciate in value. To reduce losses you must be actively involved in management of the property.

Investments in oil and gas

Oil and gas investments are other popular tax shelters. An investment in oil and gas allows you to deduct it as a current expense in capital expenditures and is known as intangible drilling and developing costs. Mostly all the costs of drilling and developing a well are deductible in the year incurred. Usually these expenditures are not allowed to be deducted until the year of actual product extraction from the wells or till the drilling is abandoned.

On the other side there is no guaranteed that you would hit oil or gas. You could minimize the risk by investing in development or combination programs rather than exploratory drilling commonly known as wildcatting. Wildcatting could yield the best returns, but the probability of success in it is very small.

Equipment leasing

With equipment leasing, tax shelter comes from accelerated deductions and the use of leverage in structuring the investment.

In the first few years, you could deduct more than the cash you put into the deal. However in the later years you may have what is known as Phantom income. This is the stage where your taxable income would be more than your cash inflow. By taking more deductions in the first few years, there would be fewer deductions in the later years. While the amount of interest paid on the investment loan is reduced, the payment itself is not. You would be now paying principal that is not deductible. However, if structured correctly, an equipment leasing tax shelter gives an opportunity to get an interest free loan from the IRS by paying less taxes today and making up for it tomorrow.

Your investments should be driven more by economic reality and a profit objective rather than just the availability of tax deductions.

Cattle shelters

Cattle feeding and breeding shelters also offer tax savings by accelerating the deductions and the potential exchange of ordinary deductions for capital gains. Nevertheless, the economics of such programs could be affected by the cyclical market price of the cattle.

Tax shelters that are to be avoided

Certain tax shelters should be avoided completely. Such shelters include art reproduction and non-cash gifts. Both of them are frauds that would result in a bad audit.
 
Single premium life insurance and tax straddles have legislatively lost their tax shelter elements and no longer provide the tax saving opportunities. They may make sense on an economic basis, but using them as tax shelter wont work.