If you haven’t heard, the fiscal cliff, by way of our newly re-elected government, has changed the tax landscape for you in 2013.  The recent changes are designed to take more money out of your pocket and turn it to over to the government.

Protect yourself from higher and additional taxes.  Self-directed IRAs and other self-directed accounts are one of the strategies you can use to protect your income and profits this tax year while creating wealth through real estate.

How might you be affected in 2013?

Start planning now.   Seventy-seven percent of taxpayers will pay more tax in 2013.  Tax brackets are going up across the board.  New taxes are being levied like never before.  Even people who make less than $10k this year will see taxes go up on average $68 this year.

In addition to the higher tax brackets, there is potentially added tax you will pay.  The 3.8% Medicare tax was previously only levied on earned income.  Earned income is classified by a W-2, net income from self-employment, and certain 1099s.   Medicare taxes were never due on unearned income, which is one of the features that made certain types of investments, like real estate, so attractive. The Medicare tax is now due on net investment income, which includes interest, dividends, royalties, annuities, rents, and gains from the sale of an investment property.  As a real estate investor, you will potentially owe tax on your investment and rental income.

Are you going to pay the additional 3.8% tax on your rental income?

Yes, if your Adjusted Gross Income (AGI) is $200,000 filing singly or $250,000 filing jointly your rental income will be taxed.

As if the increase in marginal tax rates and the additional Medicare tax wasn’t bad enough, there was another increase that may potentially affect you the Capital Gains Tax.  In 2013 the Capital Gains Tax increased from 15% to 20% for certain tax payers.  If your AGI is above $400,000 filing singly or $450,000 filing jointly you are subject to the higher 20% Capital Gains Tax Rate.

Don’t shoot the messenger

If this news comes as bad news to you, don’t shoot the messenger.  The reality is there are things you can do to insulate your income and profits if you start preparing now.  The tax benefits about to be shared with you are brought to you by the very same people that created the pain in the first place, so it is important to know how these strategies work and how you can use them now.

A potential bright spot

Looking at it from a historical perspective, even with recent rises in taxes, the 2013 U.S. tax rates are low relative to what we have seen in the last 50 to 60 years.  This is a double-sided coin.  On one side, we can do some tax planning today to take advantage of these historically lower rates.   On the other side of the coin, the government knows taxes are at a historical low, which beg the questions Is this now the sign of things to come? Will taxes continue to rise to historic highs?  We’ll keep you posted.

What are the tax savings strategies you can implement in 2013?

One of the most effective and simplest strategies you can implement this year is to take advantage of Self-Directed IRA’s and other Self-Directed Accounts.

Seven strategies that can help you immediately:

1.    Your taxable income is taxed and subject to the higher tax rates; however, qualified distributions from a Roth SDIRA are not taxable. If you are generating current income or preparing to create future income from a Roth SDIRA, you will be completely protected from this year’s and future years’ tax increases.  No income tax, no capital gains tax, and no Medicare tax will ever be due on qualified distributions from a Self-Directed Roth IRA.

2.    You can lower your 2013 Adjusted Gross Income (AGI) and pay fewer tax dollars by contributing to tax-deferred SDIRAs.  Contributions can allow you to lower AGI immediately. Your AGI in 2013 will include almost all sources of income less “certain above the line deductions” such as IRA contributions. So contributing to your self-directed retirement accounts can immediately lower the dollars you give to Uncle Sam this year.   Even better, contribution limits increased this year so you can protect more money.

3.    Net investment income generated inside the SDIRA is not exposed to the Medicare tax.  When you own real estate outside of a SDIRA, your income can potentially be subject to the 3.8% Medicare Tax.  However, when you own real estate inside the protective veil of a self-directed retirement account, the rental income returns to your SDIRA and is not subject to the 3.8% Medicare tax, regardless of how much money you make inside or outside your SDIRA.

4.    The capital gains tax is taxed on, well, your capital gains -no avoiding that one.  The only question is are you going to pay 15% or 20%?  Another tax protection feature that SDIRA’s offer you is that your profits (gains) are not taxed when generated in a SDIRA.  This gives you the benefit of keeping all of your income and profits and being able to reinvest it so you can exponentially compound your wealth.  Thats an additional 15% to 20% in your pocket by utilizing a SDIRA.

5.    In case you’ve been vacationing on a desert island and are unaware, the U.S. Government is a little short on money these days.  Specifically, they have a $12 billion shortfall they would like to shore up.  This became the impetus for a new rule that took effect in 2013.  The rule now allows “in plan” conversions from traditional a 401(k) to a Roth 401(k) at any age and at any income level.  There are currently $4.3 trillion held in 401k plans as of September 2012.  Being allowed to convert from a traditional 401(k) to a Roth 401(k) can afford you a never before seen opportunity and generate billions of dollars in current revenue to the federal government.

6.    The 2010 conversion rule change for Traditional, SEP, and SIMPLE IRA plans is still in effect.  That means regardless of your income, you can convert your IRAs to Roth IRAs.  This will be a taxable event in 2013; however, if you believe taxes will continue to rise, then you can convert at today’s still historically low tax rates.

7.    You can exponentially grow your wealth investing inside your SDIRA.  To illustrate how this translates to real dollars in your pocket, let’s look at a simple calculation factoring in the effect of taxes.  If you were to invest $5,000 per year for the next 30 years and let’s assume you were able to achieve a Cap Rate of 10% annually, what would your investment be worth 30 years from now?  If you paid taxes each year on your income and profits, and let’s assume a 30% tax bill per year, your investment would be worth $502,075.

However, let’s assume you did that same exact investment inside of a SDIRA where you did not pay income tax, capital gains tax, or Medicare tax. What would your SDIRA now be worth?  The figure comes in at $991,964.  Impressed?  It gets better. If you subtract the $150,000 you made in contributions from your $896,786 account balance and divide it by 30 years you come up with $28,000.  What does that mean to you?

In the above illustration, for every $5,000 you invest in your SDIRA, you are rewarded with an annual $28,000 return when averaged over 30 years. Thats a 5.6 multiple return on your investment every year for 30 years and that is amazing.

With the changes in taxes in 2013, unaware investors can see their incomes and net worth dissipated if they are ill prepared.  However, using the SDIRA strategies outlined above you can benefit by the current tax rules and continue on your path to create wealth through real estate.

Edwin Kelly is the CEO of Horizon Trust Company, a remarkably different Self Directed IRA Custodian that allows investors to invest in real estate, tax liens, trust deeds, mortgages, and virtually anything allowed by the IRS.  Edwin Kelly has been involved in the investing and retirement industry for over 22 years and is considered America’s leading authority on Self-Directed Retirement Investing.

Connected Investors talking about SDIRA