Tax Exempt Investment: When Problems Can Arise

There are not many problems that arise from tax exempt investment. A tax exempt investment, such as that in municipal bonds made by a resident of the issuer, provides a way to reduce the taxable interest in an investor’s portfolio. This is generally a good thing for an investor. It should be noted however that when problems arise, they arise from an investor not paying attention to the type of tax exempt investment that is being purchased. This can result in the tax exemption being wiped out and subject the investor to a tax liability.

Receiving a Tax Exemption for the Investment

Tax exempt investing occurs when an investor purchases municipal bonds in the state or taxing jurisdiction that they are a residence of. A Michigan resident that purchases a Michigan Water Authority Municipal Bond will receive the tax advantage of not being charged local, state or federal taxes on the interest paid on the bond. This is an incentive to promote local investment in public improvements and other projects that positively impact the lives of local residents.

If a purchaser lives outside of the jurisdiction where the bonds are issued, they do not receive the local tax exempt benefit but will receive federal tax exemption. From this standpoint it could be viewed as a problem from the perspective that the local tax exemption would be lost. Otherwise problems do not tend to rise when investing in tax exempt investments such as municipal bonds.

Locate a Tax Exempt Investment

The process of investing in tax exempt investments involves locating investments such as municipal bonds that are in the area where the investor lives. These offer full tax exempt status to the investor and help the investor take advantage of having a tax exempt investment. A broker or brokerage firm can assist an investor in locating an appropriate tax exempt investment that is right for their investment goals and objectives.

Match the Investment to Objective

An investor looking for long term growth and is not concerned with current income is probably not concerned with investing in tax exempt investments. An investor looking for growth seeks what is known as capital appreciation and will invest their money in those investments with the greatest potential to appreciate in value. A tax exempt investment does not appreciate in value at the rate that other types of investments do such as growth stocks. The amount of return that is received for a tax exempt investment is lower than that of an appreciating investment. This is because an appreciation investment has a greater chance of losing money than a tax exempt investment.

 

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