We all have a silent partner when it comes to our taxable investments—Uncle Sam. He insists on his cut of our investment income and capital gains, even though he doesn’t share in the risks. At least our good uncle is kind enough to allow us a few tax breaks.
For example, we have tax-advantaged vehicles such as 401(k)s, IRAs, annuities, 529 college savings plans, Coverdell Education Savings Accounts and so on. And, if it makes sense for your marginal income tax bracket, you can also get a break on tax-exempt municipal bonds held in taxable accounts. And don’t forget the lower rate for long-term capital gains and qualified stock dividends.
But the tax breaks don’t end there. The Internal Revenue Service also lets you deduct certain investment expenses incurred on your taxable investments. Check with your tax professional to make sure you’re taking full advantage of investment-related miscellaneous itemized deductions, investment interest expense and capital losses.
Let’s look at each of these in turn.
Miscellaneous investment-related itemized deductions
Miscellaneous itemized deductions are generally limited to the amount of expenses over and above 2% of your adjusted gross income (AGI). In other words, there’s a floor below which you lose the ability to deduct.
For example: Say your AGI is $75,000 and you have $3,000 in miscellaneous itemized deductions. Your 2% AGI floor is therefore $1,500 (2% of $75,000). You lose the first $1,500 of the $3,000 you claim but get to deduct the remaining $1,500.
Here’s a list of investment-related expenses that you may be able to deduct:
• Fees for investment counsel and advice, including subscriptions to financial publications
• IRA or Keogh custodial fees, if paid by cash outside the account
• Software or online services used to manage your investments
• Safe deposit box rent, if used to store certificates or investment-related documents
• Transportation to your broker’s or investment advisor’s office
• Attorney, accounting or clerical costs necessary to produce or collect taxable income
• Charges for automatic investment services and dividend reinvestment plans
• Costs to replace lost security certificates
Investment-related expenses that can’t be deducted include:
• Trading commissions—these are “capitalized” to increase your cost basis and/or reduce your taxable sales proceeds
• Costs of traveling to attend a shareholder’s meeting
• Investment advisory fees related to tax-exempt income—you generally need to prorate these fees based on the portion of tax-exempt investment income versus total taxable investment income
• Borrowing costs associated with life insurance
Investment interest expense
Investment interest expense is the interest on money you borrow to purchase taxable investments. For example, you can deduct the interest on a margin loan you use to purchase stock, but not if you use the margin loan to buy a car or tax-exempt municipal bonds.