A tax shelter is a financial technique used by taxpayers to reduce taxable income. Tax shelters include both investments and investment accounts that provide favorable tax treatment, as well as deductions as laid out by the Internal Revenue Service (IRS).
Typical investment accounts that shelter returns from taxes are 401(k) accounts and traditional IRAs. Other items that lead to tax efficiency are interest expenses and depreciation, which are deductible from taxable income. In some cases, a taxpayer may be able to realize a loss after these deductions are factored in, resulting in tax loss carryforwards that may be able to offset future profits.
Certain real estate investments may provide income tax shelters through mortgage interest deductions and depreciation allowance and, depending on the legal structure, may provide the ability to defer capital gains via a 1031 exchange.