Tax Tips for the Individual Investor
A few simple tax tips of record-keeping, investing, and reporting can apply to most investors and can help you save money.
Reinvest Dividends
Investors can limit capital gains on the sale of mutual fund shares by automatically reinvesting dividends in the fund. Reinvested dividends increase your investment in a fund, effectively reducing your taxable gain (or increasing your capital loss).
While the reduction in taxable income in this example may not seem like a big difference, failing to take advantage of this rule could cost you in the long run. By missing out on tax savings today, you lose the potential compounded growth those extra dollars would have earned in the future, and if you forget to consider reinvested dividends year after year, your tax-adjusted returns will suffer.
Keep accurate records of your reinvested dividends, and review the tax rules applicable to your situation every tax season.
Bonds
When the stock market performs badly, investors look elsewhere for places to put their money. Many find a haven in bonds, which often perform counter to equities—and provide interest income to boot. The best part: You may not have to pay tax on all the interest you receive. If you bought the bond in-between interest payments (most bonds pay semiannually), you usually won’t pay tax on the accrued interest prior to your purchase. You must still report the entire amount of interest you received, but you’ll be able to subtract the accrued amount on a separate line.
Municipal bonds (aka munis) can also offer significant tax advantages. These bonds are often issued by state governments or local municipalities to finance a particular project, such as the construction of a school or a hospital or to meet specific operating expenses.
Most munis are issued with tax-exempt status, meaning the interest they generate does not need to be claimed when you file your tax return. Those that are highly rated, and thus low-risk, can be very attractive investments.
Reducing Taxes
Investors who invest in small business ventures or are self-employed can write off many operating expenses. For example, if you take business trips during the year that require you to obtain accommodations, the cost of your lodging and meals can be written off as a business expense within specified limits depending on where you travel. If you travel frequently, forgetting to include these types of seemingly personal expenses can forfeit a lot of tax savings.
For homeowners who moved and sold their home during the year, an important consideration when reporting the capital gain on the sale is the cost basis of the purchase. If your home underwent renovations or similar improvements with a useful life of more than one year, you can likely include the cost of the improvements into the adjusted cost basis of your home, reducing your capital gain incurred on the sale and the resulting taxes.
Match Profits/Losses
In many cases, it is a good idea to match the sale of a profitable investment with the sale of a losing one within the same year. Capital losses can be used against capital gains, and short-term losses can be deducted from short-term gains. Also, if you have a particularly bad year, you can carry $3,000 of your loss over to future years.