Business: What Is Left in Tax Shelters

Some remain, though many have been blown away by a new law

Oh, a storm is

threatening

my life today,

If I don't get some

shelter, oh

yeah,

I'm gonna fade

away.

Those mournful lyrics from the Rolling Stones' rock classic Gimme Shelter touched a generation of troubled youngsters in the late 1960s. Today the lines might serve as a lament for affluent investors who are watching some of their tax shelters being blown away. The winds of change are coming from the Internal Revenue Service and Congress, which greatly restricted tax avoidance schemes in the Tax Reform Act of 1976, and continued the attack in the latest law, which becomes fully effective on Jan. 1.

Shelters enable people to generate paper losses to write off against their regular income, thus shielding their cash from the full bite of the IRS. Generally a group of investors forms a partnership, which enables members to claim personal deductions proportionate to the money they put into the group's investment. In a corporation, on the other hand, losses are charged against the company and provide no individual tax benefits.

The partnership buys into any property—movies, coal mines, lemon groves —on which fairly rapid depreciation is allowed. That enables the members to write off in four years or less most of the value of the property, even though it might continue to generate income for decades. When the depreciation benefits are fully realized and the investors have recaptured much of their original investment through write-offs, they can sell the property. The profits from the sale are taxed, but usually at favorable capital gains rates, which under the new law have been reduced even further, from an effective maximum of 49.1% to 28%.

What had made the shelters particularly fetching was that in most instances the investors had to put up only a small amount of their own cash. As a partnership they often borrowed the rest on a "nonrecourse" loan, paper for which the partners are not personally liable. If the notes were defaulted, the lender got the property, and the investors got their writeoffs from depreciation and had no worry about being sued for leftover debt.

For example, a promoter sold a lithograph stone plate. He figured that it was worth $40,000. But to make it attractive for tax purposes, he agreed to sell it to a partnership of investors for an inflated price of $100,000. They put up only $40,000 in cash and gave over the remaining $60,000 in nonrecourse notes made out to the promoter. Very often these notes were never paid off. Still, the partners got tax writeoffs of $100,000 because the stone depreciated with every print produced.