Book Review: Tax Free Wealth

Tax Free Wealth: How to Build Massive Wealth by Permanently Lowering Your Taxes is a financial self-help book written by Tom Wheelwright, an entrepreneur, best-selling author, Rich Dad Advisor, certified public accountant, and recognized authority on tax law across the globe. Tax Free Wealth teaches business owners, entrepreneurs, and other professionals — including physicians — how they can permanently reduce their tax burden while collecting vast amounts of money.

None of Wheelwright’s advice is illegal or unethical. As Wheelwright says in his personal mission statement, “My life’s mission is to make taxes fun, easy, and understandable!”

Amazon customers gave Tax Free Wealth 4.3 stars out of 5 in an average of more than 200 reviews. First published in 2012, Tax Free Wealth is one of several books Wheelwright has written or contributed to, including several in Robert Kiyosaki’s Rich Dad series: Rich Dad Success Stories, The Real Book of Real Estate, Who Took My Money, Unfair Advantage, and Why the Rich Are Getting Richer.

Table of Contents

Important Lessons From Tax Free Wealth

When you require legal help or need to have your car maintained, you likely leave such tasks to trained experts. But before committing to a costly legal case or auto repair, you should have some awareness of the factors at play in the legal system or the mechanics of your automobile.

It follows, therefore, that even if they prefer to have their taxes handled by a CPA or accountant, successful physicians should always have a firm grasp of the variables that influence their financial destiny. If you have a fundamental understanding of concepts like income, business expenses, and taxes, it stands to reason that you should be better able to assess the quality of assistance you’re getting from an accountant or tax professional and make more informed decisions.

The Foundations of Investing and Taxes

When focusing specifically on today’s investor-friendly tax structure, it’s necessary to have a solid understanding of taxes and the motivation behind tax legislation.

Key principles taught by Tax Free Wealth include:

Local, state, and federal governments employ tax laws as incentives for a wide range of economic and social programs.
Encouraging economic growth, rather than raising tax revenue, is the fundamental goal of every new tax policy.
Net profit — what’s left after deducting all expenses — is what really counts, not gross profit.
Everything you do, both personally and professionally, will have an impact on your eventual tax bill.
Taxes have such a pervasive impact that they need to be a part of daily, rather than yearly, planning.
Among the four types of wage earners — employees, self-employed persons, business owners, and investors — investors and business owners benefit the most from tax code provisions.
Passive income is taxed at lower rates than active income and includes things like monthly real estate rental income and gains from the sale of real estate.
Careful estate planning may be one of the most efficient ways of permanently lowering your tax liabilities.
One of the most attractive aspects of investing in U.S. real estate is the tax benefits associated with deducting mortgage interest and property taxes on real estate.
Many real estate owners produce sizable positive cash flow while reporting little or even zero taxable income by using efficient tax techniques.
Owning real estate under a formal corporate organization, such as an LLC, provides critical tax advantages and asset protection.

Foreward by Robert Kiyosaki

For this review of Tax Free Wealth, we’ll look closely at a select few chapters of the book. We’ll start by looking at the book’s foreword by legendary wealth advisor Robert Kiyosaki.

According to Kiyosaki’s bestselling book Rich Dad, Poor Dad, the only two things that can be counted on in life are death and taxes. But if you’re wise, you should put off both as long as you possibly can.

When it comes to living a long time, regular exercise, nutritious eating, and other healthy behaviors have been shown to increase life expectancy. When it comes to taxes there are almost always ways to reduce that liability. Although it’s highly unlikely that a physician would have no tax payment whatsoever.

Tax Liability

According to Kiyosaki, to minimize your tax liability, you first need to determine which of four “Cashflow Quadrants” you belong in:

E = Employee

S = Self-Employed

B = Big Business Owner

I = Investor

Although it sounds counterintuitive, employees and self-employed people (physicians usually fall into one of these two categories) generally have a higher tax rate than business owners and investors. This is true even though they typically take home a lower salary. That’s because they’re basing their tax strategy on an incorrect set of assumptions.

Kiyosaki explains that taxes are a major cause of financial hardship for many individuals. The Pew Research Center classifies the middle class as having an annual income of $40,500 to $122,000. This class is currently feeling the pinch as governments legally take an ever-increasing share of their money.

Tax Laws

Both the federal and state governments utilize tax laws as a tool to encourage or discourage certain behaviors. For example, to encourage real estate investors to support affordable housing and urban redevelopment efforts, a city government may establish laws providing tax advantages to those who do so. A city that’s serious about limiting sprawl will make development close to its borders more difficult, more expensive, and more time-consuming.

Physicians who are financially successful don’t strive to evade taxes; rather, they find ways to benefit from the incentives that exist within the tax code that federal and state governments have already set up. One of the primary ways to do this is with investment in real estate. Wheelwright’s book teaches how to lawfully minimize taxable income via business and real estate rental property write-offs without ever having to talk to an Internal Revenue Service (IRS) official.

Two Primary Principles

Bear in mind that if you want to reduce your tax liability, you don’t have to choose the option that best benefits the government. There’s no patriotic duty to increase the amount of taxes you pay.

At the beginning of Tax Free Wealth’s third chapter, Wheelwright quotes Judge Learned Hand of the Second Circuit of the United States Court of Appeals. The judge’s comments may shock some readers, but we’ve been programmed to believe that we owe money to the state.

As Hand once wrote, “Any one may so arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury. There is not even a patriotic duty to increase one’s taxes.”

In fact, the tax code is written in a way that makes legal tax avoidance by investors and business owners easy. Whether you work in the healthcare profession or in another field, if you don’t take advantage of tax breaks, you’re shortchanging yourself, your loved ones, and your future.

According to Wheelwright, the tax code consists of just two basic principles:

What’s Yours Is Yours

First and foremost, the government is not entitled to any of your wealth. The government has pressing expenses, such as for schools, roads, and defense, and may demand a financial contribution from you. But you should keep in mind that, in the end, your money is yours and not “theirs.”

Tax Code Structure

The second guiding principle is that the tax code is structured to help you pay less tax. Wheelwright maintains that almost all tax laws are designed to help you pay less, not more, in taxes. Unfortunately, the tax code’s complexity masks its underlying goal: reducing your overall tax liability.

Surprisingly, many tax experts don’t grasp these two fundamental concepts, and as a consequence, they may strive to help the government out rather than you by not reducing your tax burden.

There are two reasons for this. First, a lot of financial advisors are intimidated by the tax code’s complexity and aren’t prepared to put in enough of the work that’s necessary to learn how to use it to their clients’ advantage. Second, some advisors are very risk-averse, and rather than helping you reduce your tax bill, they focus on staying on the tax authorities’ “good side” and safeguarding their own interests.

Related Reading: 5 Ways for Doctors to Save on Taxes

Entrepreneurs and Investors Reap All the Rewards

There’s lots of public resentment against “unfair” tax breaks for corporations. Some wealthy property owners have gained notoriety for accumulating vast fortunes despite evading taxes.

Yet critics are missing the point when they ignore this reality: almost anybody in the United States can form a corporation and realize benefits from the system’s numerous beneficial aspects. As explained in the third chapter of Tax Free Wealth, real estate investment is a tried-and-true method for generating income, building wealth, and permanently reducing tax liability.

Let’s look again at Robert Kiyosaki’s aforementioned Cashflow Quadrant:

E = Employee

S = Self-employed

B = Big business owner

I = Investor

Owners of businesses and investors pay far lower tax rates than employees and the self-employed. Wheelwright believes that the “B” and “I” tax classes were intentionally set at a lower rate by Congress.

Remember, the purpose of tax law is to reward certain economic behaviors. Business owners and entrepreneurs are thus encouraged by the government to be some of the primary creators of new jobs and housing.

The tax breaks for real estate investors, for instance, are incentives to have more buildings constructed and occupied. This attracts companies, high-paying jobs, and new residents to an area. This all contributes to that area’s economic growth.

Every person has the right to form a business in America. However, in order to qualify for tax benefits, a business needs to be real with the intention of making a profit. Becoming educated in a skill or trade is essential for establishing a business, simply because it’s less expensive to pay taxes than to run a failing business.

Thus, many of the people who start and invest in businesses do well because they’re skilled and their businesses are profitable; tax breaks are simply incidental to their success.

Maximize Your Earnings

Will Rogers famously said that death, unlike taxes, doesn’t become worse every time Congress meets. But in the U.S., the opposite can turn out to be true when it comes to taxes.

Tax rates, costs, and benefits for different types of income vary widely from one country to the next. If you’re looking to save money on taxes in the long run, it makes good business and financial sense to generate income in the most tax-efficient way possible.

Employees and the Self-Employed

Both wage earners and self-employed individuals must actively work to bring in income. Because the U.S. levies its highest tax rate on earned income (compensation), these two groups from the Kiyosaki Cashflow Quadrant end up footing a disproportionate share of the tax bill. Earned income is subject to additional taxes, including payroll, unemployment, and social security taxes.

Big Business Owners and Investors

Now think about the other two groups represented in the Cashflow Quadrant: big business owners and investors. They produce some earnings via salary and other forms of earned income. However, the vast majority of their financial resources originates from their businesses and other assets. After deducting as many legal expenses as possible, they’re left with the “net income” from their businesses and/or investments.

Meanwhile, homeowners or condo owners who are simply employed or self-employed in unrelated businesses can typically only deduct mortgage interest, property taxes, and charitable donations as expenses from their taxes. For renters, it’s even worse; only those who make donations to charity are eligible for a tax deduction.

Compare and contrast this with the tax breaks you can claim as a real estate business owner or investor:

Property Taxes
Mortgage Interest
Charitable Contributions
Business Supplies
Business Equipment
Marketing Expenses for Your Firm
Expenses Associated With Working From Home
Vehicles for Business Use
Meals and Entertainment for Business Purposes
Travel

Investors and business owners in real estate can reduce their net income by spending some of the money they receive as rent before deducting the items above. The following are examples of common additional real estate-specific tax deductions:

Closing Costs
Property Management Expenses
Leasing Costs
Maintenance and Repair Costs
Property Supplies
Depreciation

As you can see, real estate investors and business owners stand to be able to keep more of the income they earn from real estate.

Money Buckets

Tax Free Wealth makes the case that different sources of income can be thought of as “buckets” of money. The author goes into detail about the following five types of income buckets and their relative tax rates:

Earned income from employment — high income and employment taxes
Income from a retirement or pension plan — high income taxes
Investment income such as capital gains and/or dividends — lower income taxes, and in certain cases (such as with a 1031 tax-deferred exchange), no income taxes
Income from an inheritance or gifts — no income taxes for the recipient in most cases
Passive income, such as that earned by a business or investment real estate — this is taxed at normal income tax rates after the passive income has been lowered via deductions

Thus, he asks, if you could only put money into one of these five buckets, which one would it be?

For physicians, the two options that may seem obvious are to build a business (such as a clinic or chain of clinics) or invest in real estate (which could be residential or potentially house their existing medical practice — or both). In certain cases, these two efforts could overlap.

If you’re considering opening your own practice, read our guide on How to Start a Medical Practice

What Is It About Property That’s So Great?

“It’s tangible; it’s solid; it’s beautiful. It’s artistic, from my standpoint, and I just love real estate.” – Donald Trump

As detailed in the nineteenth chapter of Tax Free Wealth, a serious real estate investor should never have to pay tax on the cash flow from, or the gain from, the sale of their real estate.

Besides reducing their taxable net income via deducting expenses, real estate owners can postpone or even avoid paying taxes altogether by using two additional strategies – depreciation and like-lind 1031 exchanges.

Depreciation

Real estate investors can benefit from a non-cash deduction called depreciation. This will lower their taxable net income while still having the same amount of cash available for investments or expenses.

According to the IRS’s guidelines for rental properties, buildings and improvements (but not land) can be depreciated at a rate of 3.636% each year for 27.5 years.

The tax benefit of depreciation could reduce your yearly taxable net income by $4,363 ($120,000 x 3.636%) if the value of a single-family home you own and rent out is $120,000.

Your taxable net income would therefore be just $637 if your rental property generated $5,000 after all costs were deducted but before depreciation was accounted for. While just $637 of your income would be subject to taxation, you’d still have $5,000 in the bank.

Like-Kind 1031 Exchanges

When the government offers a tax break, it often wants something in exchange. When selling a rental property, you may be obligated to pay capital gains tax when the sale closes.

Continuing with the above example, let’s say you decide to sell the aforementioned single-family home after renting it out for five years. If the home’s value has increased from $120,000 to $140,000, you could owe capital gains tax of $41,815 (the $140,000 sale price minus the $98,185 tax basis, which is the home’s previous value of $120,000 minus the product of five years times the depreciation value of $4,363 per year [$21,815]).

Both the “depreciation recapture” and the increase in value of the property are taxable, since you’re effectively making up to the government for the depreciation deductions you took while you were the owner.

Fortunately, however, the IRS allows you to avoid paying taxes on the $41,185 capital gain you generated if you buy an investment that’s of “like-kind” to the one you sold, i.e., a real estate property. This tax benefit is known as a “1031 tax-deferred exchange.”

Many real estate investors perform like-kind, tax-deferred exchanges to rebalance their portfolios, such as if they transition from selling commercial office or retail properties to buying single-family rental residences. In this case, the IRS considers any new commercial or investment real estate property purchase to be of “like-kind,” meaning that owners can deduct the purchase price of the new property from their taxable income.

Note that depreciation and like-kind exchanges are just two ways business owners and investors can save taxes using real estate.

Is Tax Free Wealth Something You Ought to Read?

There’s been a mixed response to Tom Wheelwright’s Tax Free Wealth. Some reviewers found it “too generic and fluffy,” while others were grateful for the new perspectives it provided.

Positive Points About the Book

For business owners, investors, and anybody else who wants to stop living paycheck to paycheck, Tax Free Wealth is likely a must-read. Tax Free Wealth explains how to legally reduce your tax burden while making use of many of the available deductions and credits. By distilling thousands of pages of tax law into one easily digestible book, the author demonstrates he has a passion for taxes that’s shared by only a select few.

Negative Points About the Book

Overall, Tax Free Wealth is content that claims to be “mind-blowing” yet falls short of being a panacea. The book is motivating, but without enough detail. Unfortunately, it proposes far too many generalized, oversimplified recommendations to reduce tax burdens for everyone.

The suggested tax strategies could backfire without the guidance of a professional. Additionally, they hold the greatest promise for investors in the top 5 percent of U.S. income distribution.

The key is not the amount of income they earn but how they invest their money. This is true for physicians, many of whom fall into this bracket. As the book stresses, it’s important to invest in the right vehicles (such as real estate) and be classified as a business owner rather than a self-employed individual to realize the greatest gains from the tax code.

Keep Reading: The Beginner’s Guide to Physician Tax Planning

Conclusion

Tax Free Wealth: How to Build Massive Wealth by Permanently Lowering Your Taxes, by Tom Wheelwright, covers important concepts dealing with tax law, taxes, and real estate investing, including:

Why entrepreneurs, businesspeople, and investors get most of the tax breaks
How the tax code is written to encourage types of economic activity and not to bring in tax revenue
Why your tax planning should be integrated into your daily activities instead of a last-minute, end-of-year rush to locate receipts and create reports
Five kinds of income buckets and which one of them leaves investors with more cash in their pockets
Four kinds of income earners and why governments want wealthier individuals to pay less tax
What real estate investors do to not pay tax on their capital gains or cash flow

If these topics are of interest to you, you would likely profit from reading this book.

Physicians Thrive helps physicians and professionals of all kinds with financial planning, tax planning, investments, estate planning and insurance. If you would like assistance of any kind, please reach out. Our advisors are well-versed in the unique needs of physicians and can help you make wise financial choices.