Tax Deferral refers to the postponement of tax liability to a future date, allowing an individual or entity to delay the payment of taxes on income or gains until a later time.
This strategy is often used in retirement accounts, such as 401(k)s or IRAs, where contributions are made pre-tax, and taxes are only paid upon withdrawal in retirement. For example, if a taxpayer contributes $5,000 to a traditional IRA, they can reduce their taxable income for that year by that amount, deferring taxes on the earnings in the account until they withdraw the funds in retirement.
Tax deferral can also apply to certain investments, such as real estate, where capital gains taxes on the appreciation of the property can be deferred until the property is sold. This can be advantageous for investors looking to grow their wealth without immediate tax implications.
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