As tax season comes to a head. Over 70% of Americans will file the standard deduction on his or her tax form 1040 this year. This means the vast majority of Americans are not in the most opportune position to create generational wealth. There are tremendous lessons for each of us to use and apply over the course of our lifetime via our financial management strategy and goals. Below are the 3 major deductions wealthy Americans use to create and maintain generational wealth.
Mortgage Interest Deduction. The mortgage interest tax deduction is designed to encourage home ownership. It basically allows you to deduct the interest you pay on your mortgage note. I did a return this current tax year where the mortgage interest was over $17,000, that’s a $17k reduction in taxable income filed right on IRS form 1040 Schedule A. In addition the IRS also allows you to deduct the interest paid on a second home. The lesson we should learn here is if you are not taking advantage of this deduction you are not building generational wealth. Most people, middle class and below do not take advantage of this deduction. The wealthy take this deduction on both a primary home and a secondary home. This should be at the top of every person’s goal if you desire to build generational wealth. Own a home. If you already own a home, aim to own a second one. It is very difficult to build generation wealth if you don’t.
- Capital Gains. The capital gains tax rate is the 2nd tool most often used by the wealthy but it is the tool that saves them the most money. It is at the center of the “tax the rich debate”. It’s why Warren Buffet pays a lower tax rate than his secretary. My goal here is not to argue the morality of our tax code; I just want to give you the seeds of capital (aka the facts) you can use to build generational wealth for yourself. Money taxed as capital gains is taxed at a much lower rate than money taxed as earned wages. So if possible you want to have income that is classified as capital gains instead of earned wages. So what are capital gains? A capital gain is a profit that results from a disposition of a capital asset, such as stocks, bonds or real estate, where the amount realized on the disposition exceeds the purchase price.
The lesson learned here is diversify your investments. Max out your Roth IRA contribution. Max out your employee contribution limits in excess of your employee matching. Most of us will never hit the lottery or get a huge inheritance but with planning attaining this level of wealth is very doable. Real estate is a vehicle many middle class people are using to accelerate the accumulation of capital assets in a relatively short period of time. Because of low home prices and low-interest rates today buying real estate at below market prices and making money by selling them at above market prices is one strategy that is allowing more and more people to create a large portfolio of capital assets. Through the “step up basis” these capital assets can be passed along to heirs just like the wealthy have been doing for years. This is a major generational wealth building tool. The step up basis principle saves the wealthy billions of dollars every year. Creating multiple streams of capital gains is the best way to create and maintain generational wealth.
3. Charitable Contributions. Last but not least, charitable contributions are also a great way to do greater social good while saving money. The wealthy take this deduction and it constitutes a larger part of their income mainly because they have more money. But the lesson here is God has blessed you with much so it’s important to make the effort to bless others [pay-it-forward]. So do not forget to give to your favorite nonprofit or charitable organization. Tithing, donations, and contributions to your community go a long way in teaching the next generation principles that will serve them well in life.
Stay tuned for my next lessons as I do my part to help create generational wealth for your family.
-A.Donahue Baker, CPA