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  • Kimberly Stone

7 Tax Pointers for Investors

Your investment choices can definitely have an impact on your income tax situation either in a positive or negative way. While taxes should not drive your investing strategy, understanding how taxes affect your investment earnings will help you minimize taxes and maximize your return. Some things to consider as you plan your investment activity:

1. Capital gains. The tax rates on long-term capital gains carry a special favored tax status and are lower than the rates on ordinary income such as wages and business income. Consider putting more of your investment dollars into investments that produce capital gain income, such as stocks and real estate that will appreciate in value. Hold investments at least long enough to qualify as long-term.

2. Balance stock winners and losers. You can deduct up to $3,000 of capital losses in excess of gains each year. Consider selling enough losers each year to arrive at an overall $3,000 loss for the year to help shelter your gains. You can also carry over any unused capital losses exceeding this amount to subsequent tax years.

Use caution if you buy the same security within 30 days before or after the sale, because your loss will not be allowed. If earlier sales generated losses over $3,000, consider selling enough winners before year-end to get back to that level. Taking these gains will not increase your current taxes.

3. Tax-free investments. Many investments can be found that escape taxes at the federal, state, or local levels. For example, municipal bonds issued by your state of residence are generally exempt from all taxes. Conversely, U.S. Treasury securities are only exempt from state and local taxes.

When considering tax-advantaged investments, make sure you compare the after-tax yield of a comparable taxable investment with the yield of the tax-advantaged investment.

4. Savings bonds. Guaranteed U.S. savings bonds can be a sound long-term investment if you don't mind a few caveats. The rate of return is determined by the government and subject to market conditions. Keep in mind that it can take up to twenty years for the bonds to fully mature, although you can cash them out early.

While you don't have to pay state or local tax on U.S. savings bonds, they may be subject to gift or inheritance taxes. Income tax on the bond earnings are due the year that you cash the savings bonds.

5. College funds. Investigate all the options for tax-advantaged investing to build college funds. Consider Series EE and I savings bonds for college savings as the bond interest may be exempt from income tax if the bond proceeds are used for certain higher education expenses.

To get tax-free status, the bonds must meet the following requirements:

  • They must have been purchased after 1989.

  • They must be purchased and owned by someone 24 or older.

  • The bonds must be used to pay educational expenses incurred by the bonds' owner, a spouse, or a dependent.

  • They must be used to pay higher education tuition and fees only.

This interest exclusion is phased out for higher-income families. The income test is based on the parents' income at the time the bonds are redeemed.

6. Real estate. Investing in real estate can offer significant tax breaks. Real estate investments provide tax deferral through growth in the value of the investment due to inflation and other economic forces. Also, investors can engage in tax-deferred exchanges of their property for property of a like kind.

Real estate investors who actively participate in managing their property can deduct up to $25,000 a year in losses against other income. However, this break disappears once your adjusted gross income exceeds $150,000.

Tax-credit investments can be found in certain real estate opportunities. Currently, tax credits are available for real estate investments in low-income housing, rehabilitation of commercial buildings originally placed in service before 1936, and rehabilitation of certified historic structures.

7. Mutual fund shares. Choose the method that best minimizes your taxes when you sell mutual fund shares. You can choose among three methods to determine capital gains and losses on mutual fund shares that you've purchased over a period of time: the first-in-first-out method, the specific identification method, or the average-cost method.

Contact us to ask for assistance in identifying investment strategies that will best benefit your tax situation.

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