Investors: Avoid These 5 Common Tax Mistakes

For many investors, and even some tax professionals, sorting through the complex IRS rules on investment taxes can be a nightmare. Pitfalls abound, and the penalties for even simple mistakes can be severe. As April 15 rolls around, keep the following five common tax mistakes in mind – and help keep a little more money in your own pocket.

1. Failing To Offset Gains

Normally, when you sell an investment for a profit, you owe a tax on the gain. One way to lower that tax burden is to also sell some of your losing investments. You can then use those losses to offset your gains.

Say you own two stocks. You have a gain of $1,000 on the first stock, and a loss of $1,000 on the second. If you sell your winning stock, you will owe tax on the $1,000 gain. But if you sell both stocks, your $1,000 gain will be offset by your $1,000 loss. That's good news from a tax standpoint, since it means you don't have to pay any taxes on either position.

Sounds like a good plan, right? Well, it is, but be aware it can get a bit complicated. Under what is commonly called the "wash sale rule," if you repurchase the losing stock within 30 days of selling it, you can't deduct your loss. In fact, not only are you precluded from repurchasing the same stock, you are precluded from purchasing stock that is "substantially identical" to it – a vague phrase that is a constant source of confusion to investors and tax professionals alike. Finally, the IRS mandates that you must match long-term and short-term gains and losses against each other first.

2. Miscalculating The Basis Of Mutual Funds

Calculating gains or losses from the sale of an individual stock is fairly straightforward. Your basis is simply the price you paid for the shares (including commissions), and the gain or loss is the difference between your basis and the net proceeds from the sale. However, it gets much more complicated when dealing with mutual funds.

When calculating your basis after selling a mutual fund, it's easy to forget to factor in the dividends and capital gains distributions you reinvested in the fund. The IRS considers these distributions as taxable earnings in the year they are made. As a result, you have already paid taxes on them. By failing to add these distributions to your basis, you will end up reporting a larger gain than you received from the sale, and ultimately paying more in taxes than necessary.

There is no easy solution to this problem, other than keeping good records and being diligent in organizing your dividend and distribution information. The extra paperwork may be a headache, but it could mean extra cash in your wallet at tax time.

3. Failing To Use Tax-managed Funds

Most investors hold their mutual funds for the long term. That's why they're often surprised when they get hit with a tax bill for short term gains realized by their funds. These gains result from sales of stock held by a fund for less than a year, and are passed on to shareholders to report on their own returns -- even if they never sold their mutual fund shares.

Recently, more mutual funds have been focusing on effective tax-management. These funds try to not only buy shares in good companies, but also minimize the tax burden on shareholders by holding those shares for extended periods of time. By investing in funds geared towards "tax-managed" returns, you can increase your net gains and save yourself some tax-related headaches. To be worthwhile, though, a tax-efficient fund must have both ingredients: good investment performance and low taxable distributions to shareholders.

4. Missing Deadlines

Keogh plans, traditional IRAs, and Roth IRAs are great ways to stretch your investing dollars and provide for your future retirement. Sadly, millions of investors let these gems slip through their fingers by failing to make contributions before the applicable IRS deadlines. For Keogh plans, the deadline is December 31. For traditional and Roth IRA's, you have until April 15 to make contributions. Mark these dates in your calendar and make those deposits on time.

5. Putting Investments In The Wrong Accounts

Most investors have two types of investment accounts: tax-advantaged, such as an IRA or 401(k), and traditional. What many people don't realize is that holding the right type of assets in each account can save them thousands of dollars each year in unnecessary taxes.

Generally, investments that produce lots of taxable income or short-term capital gains should be held in tax advantaged accounts, while investments that pay dividends or produce long-term capital gains should be held in traditional accounts.

For example, let's say you own 200 shares of Duke Power, and intend to hold the shares for several years. This investment will generate a quarterly stream of dividend payments, which will be taxed at 15% or less, and a long-term capital gain or loss once it is finally sold, which will also be taxed at 15% or less. Consequently, since these shares already have a favorable tax treatment, there is no need to shelter them in a tax-advantaged account.

In contrast, most treasury and corporate bond funds produce a steady stream of interest income. Since, this income does not qualify for special tax treatment like dividends, you will have to pay taxes on it at your marginal rate. Unless you are in a very low tax bracket, holding these funds in a tax-advantaged account makes sense because it allows you to defer these tax payments far into the future, or possibly avoid them altogether.

David Twibell is President and Chief Investment Officer of Flagship Capital Management, LLC, an investment advisory firm in Colorado Springs, Colorado. Flagship provides portfolio management services to high-net-worth individuals, corporations, and non-profit entities. For more information, please visit www.flagship-capital.com.

How much of your home equity loan interest is tax deductible?

To find out how much of your home equity loan is tax deductible, you must look the amount of money that you borrowed and the purpose for borrowing it.

As with all other financial products, before you start counting the savings from using a home equity loan to finance any type of debt, you must take a complete look at your financial picture, IRS schedules and deductions rules, and consult your tax advisor to make sure that you are getting your legal deductions and not paying back more than is needed to the IRS.

Currently, you can deduct the interest on the first $100,000 that you borrow on a home equity loan. This money can be used to finance cars, education expenses, credit card debt, home improvements, home repairs and more.

All of these items if done separately would carry their own varied interest rate. In addition, the interest on some of the items would not be tax deductible. If you wrap them up all under the $100,000 home equity loan, you can usually get a low interest rate and get to deduct the interest payments on your annual tax returns.

However, if you start getting to a point where the amount of your first mortgage and your home equity loan are more than the current value of your property, you won’t be able to deduct all of your interest payments. This means that if you get a home equity loan using one of those 125 percent LTV programs, you can lose big time.

You will now owe more than your home is worth; have no ability to get another home equity loan or home equity line of credit until you pay down the excess amount and start building up new equity, and the interest payment on the excess amount is not eligible for any tax deductions.

If you are in this position, try to pay down the debt as quickly as possible. You don’t want to lose out on any tax deductions, but you also don’t want to lose the financial cushion against emergencies and high interest debt that can get form a home equity loan or home equity line of credit.

Syd Johnson is the Executive Editor of RapidLingo.com, Web Articles Guide. This article may be freely distributed as long as the author's bio is included with an active link to http://www.rapidlingo.com

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