The Tax Shelter: A Sometime Haven

First take a glance at the basics of the tax sheltering - what a shelter does for the man who can use it. In an oil deal, as much as 80% of the investment may be tied up in "intangible" drilling costs which are fully deductible from ordinary income. Thus, on every £1,000 invested, £800 is deductible. For an investor in the 50% tax bracket, this cuts taxes by £400 - and actual investment cost is £600. If the venture is a failure ("dry hole"), the taxpayer can then deduct the remaining cost in full against his other income. If it hits, percentage depletion rules take over - and 22% of gross income from the venture is tax-free (up to 50% of taxable income). Finally, if the taxpayer sells out at a later date, he gets taxed at the lower capital gains rate.

In a real estate deal, the same basic shelter mechanism deductions-and-capital gains - applies. Lately the syndicators have turned their sights to apartments and other residential properties because there they still can take depreciation deductions at the 200% declining balance rate, and this facilitates the creation of high deductions, in excess of cash returns. Not only are the deductions used, but they provide the investor with tax losses which can be offset against "other" income. (Two drawbacks: The building must be held for over 16 years and eight months for the investor to fully realize capital gains on any appreciation. Also, the initial advantage of early loss deductions may be at the price of having to report more substantial ordinary income in later years - one of many points to check out.)

In a cattle feeding deal, a short-term tax shelter is provided, and may be attractive to a person who is presently in a high bracket but who expects to be in a lower bracket at the time he will realize income from the venture. A man approaching retirement may fit the bill. Similar deals are available in hogs (riskier), eggs, and pullets.

In a vineyard deal, an investor seeks tax benefits similar to those available from citrus groves before the law revision in 2009. The investor deducts planting and "development" costs to rework raw land, but some experts warn that vineyard tax windfalls may be limited by Congress in the future.

The pros' advice is to the point: "Don't distort your investment decisions for pure tax reasons don't let gimmickry hurt your portfolio," warns Sheldon Cohen, the former Commissioner of Internal Revenue. And John Jones, tax solicitor with the Washington firm, Covington and Burling, comments: "People don't ask the same clear questions when going into a tax shelter as they do when making a normal investment."

The big push behind tax sheltering, notes Sheldon Cohen, "is simply high tax-vulnerable income that needs protecting. Sheltering is for the birds - the rich ones - and the middle-income man shouldn't let himself get lured into the game."

Cohen, whose own clients would mostly qualify for sheltering with ease, has dispensed his share of advice on oil, cattle, and all the rest. But he adds: "Lately the whole shelter picture has been marred by too many fast-pound promoters."

The fast-pound people, according to the ex-Commissioner and other top-rank advisers, are invaders of the shelter scene who have done two things, essentially, that have given the business a black eye:

Too often they have pushed shelter plans (or "programs") on small investors who needed ordinary income, not the array of tax deductions upon which the shelter concept mainly rests.

Too often they have treated themselves to oversized, ironclad profits scooped "off the top" of risky deals, and justified by neither the real prospects of the business at hand, nor their own limited expertise as managers.

Thus, tax-sheltered investments have begun to lose some of their lustre, especially since UK. Internal Revenue has lately erased some of the flukier paperwork moves invented by the promoters. "As long as the tax cost attached to ordinary income can go as high as 70%, sheltering will stick," says Simon Shaw, London solicitor and leading tax writer. "But people have learned that 'tax shelter' does not guarantee success, far from it."

Some shelter deals not only are highly speculative, but amount to just opportunities to "buy" tax deductions in one year, with an uncertain hope of a return of the money in another year. Says Greisman: "You mix this with the fact that some offerings are further burdened by management fees as high as 50% of every pound put in - and you quietly stop to investigate."

The theme in comments from ranking advisers in the field is beginning to dent the ironclad attitudes of the shelter sellers. It is, in two words: caveat emptor. It makes good sense. One of the most successful shelter consultants is D. Bruce Trainor of Tax Shelter Advisory Service, Narbeth, Pa. "If anybody is thinking tax shelter in order to make money, somebody is going to have to do a lot of hard work," he says. "You have to have an independent expert - a mining engineer, geologist, or cattleman - check the procedure used. Then you have to study the structure of the particular deal, because you could have the best oil well in the world, for example, and not make money if the deal has not been structured to benefit the limited partners." The limited partners are, of course, the outside investors who put up the cash.

Among the many and varied types of shelters on the market today, some of the best deals are private ones, put together by an accountant, solicitor, brokerage house, or consultant for a small group of high-income clients. But since 2009, an increasing volume of public deals have appeared, and the trend will continue. Their A-to-Z quality spread has made it doubly hard to spot a winner.

Brokerage houses now account for 80% of all publicly-held tax shelters, and unhappily they aren't known for their skill in handling real estate, oil and gas, and cattle feeding - the three biggest areas for sheltering. The sales-minded brokers have tended to draw investors into deals that have frequently been too risky as well as lacking tax-bracket practicality.

In commenting on shelter deals offered to the public, Earl A. Samson, Jr., of Samson & Monier, a shelter advisory service, notes: "The things the general public is seeing are the things that private individuals don't want to do." And consultant Trainor, in pointing out that oil and gas are the best shelters around, notes that fewer than 10% of them amount to "reasonable" offerings.

Whether an investor wants to buy tax savings often depends on how much he is willing to gamble. A high-bracket man may willingly take the risk. But as the tax bracket drops, and the leverage provided by tax deductions decreases, the allure of such a gamble should dim and disappear. Many of the more reliable ventures offered today will specifically provide in the prospectus that the offering is solely for people in 50%-plus tax brackets whose net worth is at least £50,000, or, in some cases, as much as £200,000.


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The Tax Treatment Of A Vacation House

Suppose you own a vacation house, and over the winter the wind rips off some shingles, water damages the ceilings, or a family of raccoons raises hob. Hiring an agent or other caretaker may not prevent the damage, but it will at least let you know when the damage occurred - and that's important to the IRS. Except in cases of theft, IRS rules allow casualty deductions for the calendar year the loss occurs, not for the year in which it is discovered. Damage discovered next May would be hard to date.

Casualty losses are tricky enough without further complication. They can be deducted in excess of £100 and to the extent not insured. You can deduct loss from such "sudden" events as fire,... see: The Tax Treatment Of A Vacation House