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Why Does Our Government Allow Tax Deferral?

By TaxWealth -

It is not uncommon when I present a tax deferral or tax elimination plan to a client, that they stop me and with a puzzled look ask, “how is this possible?” Or, “this sounds too good to be true.” These are typical reactions because many taxpayers are not aware that there is much in tax law that can be used to eliminate, reduce or defer taxes.  Instead, they only assume that the government is desperate for cash, and looks for every reason to extract from us as many dollars in tax as they can get away with. People can’t believe that tax law gives as often as it takes!

This disbelief usually surfaces when I explain the tax code benefits they can implement when planning their sale of a property, business or some other capital asset. Going into our conversation about taxes, their assumption is that it is always nothing but bad news. They fixate in their minds that some or maybe all of their net profit will be confiscated by the government and there is absolutely nothing to be done about it.

Nothing could be further from the truth, of course. Yes, government does need to collect money to fund its operations. But government is also in the business of sustaining a vibrant economy, and most elected officials understand that an over-burdened tax structure works against that.

Why Would Governments Offer Tax Deferral Options?

A thriving economy demands the free and frequent circulation of money. (This is that famous money multiplier you may remember from your college Economics 101 class.) So, politicians create benefits to reduce or defer tax obligations so that more money can be circulated in our economy.

  • Tax credits for dependent children give families more money to spend.
  • Mortgage interest deductions allow people to “buy more house” because the government is funding part of their interest payments.
  • Interest paid on investment and business loans is deductible against interest earned.
  • Inherited wealth is only taxed currently on amounts above $5.45 million, or $10.9 million for a couple’s estate, and the assets inherited have their tax bases reset, by a step-up in basis of each asset at death.

These and other tax breaks keep money circulating in the economy.

People who sell commercial property, for example, can defer the tax bill in at least two ways, resulting in the owner being able to unlock tax-advantaged money that can be reinvested in new investment and business opportunities.

  • Using a 1031 exchange, they sell one property, and within six months buy another of equal or greater value; or,
  • They sell the property using a planning method by which the Seller of most any capital asset can walk away from escrow closing with no immediate capital gains taxes due and receive a tax-free lump sum of money that is nearly equivalent to the sale proceeds. (In my experience, this is a better choice than a 1031 exchange for a variety of reasons.)

Either way, though, the taxes for capital gains, net investment income, depreciation recapture and debt-over-basis are all deferred, allowing these dollars to be reinvested in the economy until they are paid many years in the future. Without these favorable tax laws, money would otherwise likely remain locked up in illiquid assets because the asset owners would have no incentive to sell.

So, in fact, some tax deferral planning approaches that may sound too good to be true, are very true. And they can be very effective.  Further, it is important to note that many laws have purposely been designed to actually help you solve tax issues and still remain economically active. And the benefits they offer allow tax credits, deductions and deferrals to keep money flowing through the economy.


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