Tax shelters have been described by the unsophisticated as gimmicks or "loopholes." The fact is, Congress created these loopholes, after careful deliberation (we hope), to serve some major economic or social goal.

A tax shelter is any investment designed to reduce or avoid income taxes. This is not bad. Former Internal Revenue Service Commissioner Donald Alexander once said, "As a citizen, you have an obligation to the country's tax system, but you also have an obligation to yourself to know your rights under the law and possible tax deductions -- and to claim every one of them."

Traditional tax shelters have included investments in real estate, oil and gas, equipment leasing, and cattle feeding and breeding programs.

Real estate is a great shelter

Real estate is the most popular shelter. Indeed, it's such a good tax shelter that, as Rep. Pete Stark, D-Calif., put it memorably: "It'd take a genius to invest in real estate and pay taxes." Real estate provides leverage, an inflation hedge, cash flow and equity buildup.

As your property appreciates in value (eventually, we hope), you are allowed a paper deduction for depreciation. If structured correctly, you buy the property with your down payment. Hopefully, your rents cover your mortgage interest, taxes and operating expenses.

But it's possible to come out ahead even if the property loses money. Remember, in the 28% tax bracket, a $5,000 paper deduction for depreciation creates a real cash tax savings of $1,400. This tax-generated cash can be used for any operating expense deficit.

Moreover, as you pay down the mortgage, you're building equity. It's a win-win situation. Once your mortgage is paid off, you have an annuity in perpetuity (rents), while owning something that historically has appreciated in value. The downside is that you must buy property that will appreciate in value, and, if you want to deduct your losses, you must be actively involved in its management. You can get killed if you super-leverage and the price of the real estate crashes. Remember the bubble and be careful!

On the other hand, if you have cash or credit, with historically low interest rates and depressed prices, now may be a great time to invest in real estate.

Oil and gas: No guarantees

Oil and gas investments are sold through limited partnerships marketed by major brokerage houses.

With oil and gas, you're allowed to deduct as a current expense your investments in capital expenditures known as intangible drilling and developing costs. Nearly all the costs of drilling and completing a well are deductible in the year incurred. Normally, you would not be allowed to deduct these expenditures until the year that either the product was actually extracted from the wells or the drilling was abandoned.

Moreover, with these investments, you can use either cost depletion or percentage depletion.

The downside is there are never any guarantees you will hit oil or gas. These deductions lose their shine when there is no income to offset them. You can minimize your risk by investing in development or combination programs rather than in wildcatting, as exploratory drilling is known.

Keep in mind, however, that as you reduce your risk, you also reduce your potential investment profit. Wildcatting produces the greatest returns, but it also has the lowest probability of success.

Equipment leasing: Structure correctly

Equipment leasing investments are also marketed through limited partnerships. They are used for financing computers, airplanes, railroad rolling stock, ships, etc. In many cases, a partnership provides the money to finance the purchase (hugely leveraged), which is leased to the company that uses it. The lease payments are used to amortize the debt.

With equipment leasing, your shelter comes from accelerated deductions and the use of the power of leverage in structuring the program.