The 10 Best Sources of Tax-Free Income

October 5, 2022
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Tax-free income? It almost sounds too good to be true. However, there are numerous sources of tax-free income if you really study the Internal Revenue Code. Here are some of the best ways of generating income that is essentially tax-free if you know how to do things right:

1. Roth IRAs

A Roth IRA is not truly “tax-free” because you will be paying taxes when you put money into your retirement account. The primary advantage comes when you are ready to withdraw money from your Roth IRA. Those withdrawals and any gains you earned over the lifetime of the account are tax-free and penalty-free once you are over the age of 59½.

2. Social Security

Social Security benefits can offer tax-free payments up to certain taxable limits. If you keep your payments below a certain amount, you can avoid paying taxes. You will want to talk with your tax advisor or financial planner to understand your personal limits and restrictions.

3. Home Sale Gains

If you sell your home, you can collect gains of up to $250,000 without paying income taxes. This limit is up to $500,000 if you are married and filing jointly. 

4. Tax-Free Capital Gains and Dividends

There is a “sweet spot” when it comes to capital gains and dividends for certain investments and business ventures. Again, this is where a seasoned tax expert or investment advisor can help you with the right financial plan. Good planning can minimize your tax liabilities while maximizing your tax benefits.

5. Capital Losses

One way to shelter some or all of your capital gains is by deducting capital losses. It’s important to know which losses you can and can’t deduct—as well as how much you can claim.

6. Stepped-Up Inherited Assets

If you inherited property or other valuable assets, you can use the stepped-up basis (or step-up in basis) strategy. It allows you to raise the cost basis of the asset at the current higher price than it was originally worth, which helps minimize capital gains taxes if you later sell the property.

7. Section 1031 Real Estate Exchanges

A Section 1031 exchange is a useful real estate investing strategy. It allows investors to exchange an investment property for another similar property, while deferring capital gains/losses or capital gains taxes that would otherwise have to be paid when the first property was sold.

8. Qualified Small Business Tax Gains

There are some small business gains that can be claimed free of taxes. Work with your business tax advisor to understand your options and optimize your business tax plan.

9. Section 529 College Savings Plans

Section 529 plans are tax-advantaged savings plans that enable you and your family to save for future education costs. Your contributions will be taxed, but any saved funds and gains can be withdrawn tax-free when used for qualified education expenses.

10. Coverdell Education Savings Accounts

Coverdell accounts are similar to Section 529 plans, but can cover more education costs. It is important to understand the difference and determine which tax-advantaged college savings plan is right for you.

To learn more about these tax-free income sources and other ways to maximize your tax benefits as an individual or business owner, contact Illumination Wealth today and schedule a confidential financial consultation with one of our top advisors.