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Tax tips for investors
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December 10, 2001: 6:34 a.m. ET
Here's what you need to know to save money this tax season.
By Paul R. La Monica
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NEW YORK (CNN/Money) - As tax season rolls around, investors should keep in mind that there are several investment-related expenses that they can probably write off. The operative word is probably. This wouldn't be a tax story if there weren't some confusing caveats.
First things first: You need to figure out whether or not you are an investor or a trader. This is a key distinction. You are able to deduct a larger percentage of investment-related expenses if you are a trader since your investing can be classified as a business.
There is no hard and fast rule, but here's what the Internal Revenue Service's Web site says: "If your day-trading goal is to profit from short-term swings in the market rather than from long-term capital appreciation of investments and is expected to be your primary income for meeting your personal living expenses, i.e., you do not have another regular job, your trading activity might be a business."
In layman's terms, if you like to check your portfolio often and make some adjustments now and then but you have a day job, you're an investor. If you put food on the table by sitting in your home office buying and selling stocks all day, then you're a trader.
What are deductible investment expenses?
So let's assume you're an investor, as most of us are. What can you deduct?
Once again, there's another stipulation. Investment-related costs are considered to be miscellaneous expenses by the IRS. That means you must itemize them on Schedule A of your 1040. Other miscellaneous expenses include job-related education expenses, unreimbursed business expenses such as travel and meals, and gambling debts. But in order to deduct these costs on an itemized return, your total miscellaneous expenses must exceed 2 percent of your adjusted gross income. If this is not the case, then you should probably claim the standard deduction rather than itemizing.
If you've met all these requirements, you can worry about what exactly you can deduct. Investment advisory advice, for example, can be written off, as can any accounting and legal fees you pay to manage your portfolio. The cost of any newsletters, books or magazines that you purchase for investing purposes also should be included in your list of deductions. Where it gets a little dicey, however, is with newspapers.
Mark Luscombe, principal analyst for the federal and state tax group of CCH, a provider of tax information and software, says the IRS probably won't let you include a local newspaper in your deductions, even if you claim you only read it for the stock quotes. So stick to purely investment-focused publications.
Correspondence between you and your broker also can be written off, be that the cost of stamps or a telephone call. And if you keep your stock and bond certificates in a safety deposit box, you can deduct the rental cost.
But be careful. Some investment-related expenses, mainly those involving travel, are not deductible. While you can deduct the cost of transportation to visit your broker, expenses incurred by going to a shareholder meeting are not deductible. Keep that in mind in case you were planning to take a trip to Omaha to go hear Warren Buffett speak. The cost of enrolling in investment seminars is also not deductible.
Strategic investing tips
Of course, there's more than just deductions for individual investors to worry about come tax season. Experts have some strategic tips that could prove useful.
One strategy that usually makes sense for investors might not be as beneficial this year. It is usually considered a wise move to buy some short-term Treasury bills or certificates of deposit (CDs) towards the end of the year that allow you to defer taxes on earned interest until next year. But because interest rates have fallen drastically, that might not apply this year.
"If a security is going to mature in 2002, the only interest you're deferring is from now to year end. With interest rates at extraordinary low levels relative to the last number of years, obviously the amount of interest on a short-term obligation that will accrue for the first few weeks in December is not very large," says Richard Shapiro, a tax partner at Ernst & Young. Bottom line: It probably would be more worthwhile to invest in something else, even if it isn't as advantageous from a tax standpoint. "If there aren't other economic benefits as well it may make the taxes deferred significantly less valuable," Shapiro says.
There's also a quirk that could help you lower your capital gains taxes in the years to come that you can only take advantage of this year.
As part of the new tax laws instituted in 1997, long-term capital gains taxes will be reduced to 18 percent from 20 percent for investments made in 2001 and held for five years. But there's a loophole for investments made prior to 2001. It's a little odd since it is in essence a mock sale. You deem a sale of a security, saying that you sold it on Jan. 2, 2001 and then bought it back that day at fair market value, i.e., the same price. By doing so, you can qualify for the 18 percent capital gains rate five years from now.
Tom Ochsenschlager, a partner in the federal tax solutions group at Grant Thornton in Washington, D.C., says if you have a stock that you are firmly convinced will appreciate in the next five years, you should consider deeming a sale on it. The trick, however, is to find an investment that has had only a small gain since you purchased it because you will have to pay taxes on that gain this year. It makes no sense to pay an exorbitant amount of taxes now just to reduce your capital gains by two percentage points in 2006.
Investors thinking of selling a security to claim a loss and then buy it back shortly thereafter should also remember the wash sale rule. Under that rule, you cannot claim a loss on an investment if you buy back that same investment 30 days before or after the sale date.
Ochsenschlager says one way around this would be to buy another security that would give you similar exposure. For example, you could bond-swap. If you own a bond with a 5 percent coupon that matures in 10 years, you could sell it for a loss and purchase a bond that matures at the same time with another coupon. "Bond-swapping is a good idea. You can invest in almost the exact same thing and not be subject to the wash sale rule," Ochsenschlager says.
Another good idea is to make sure you have $3,000 worth of capital losses in addition to losses that offset capital gains, since this loss can be applied against ordinary income. However, be aware of the differences between short-term and long-term gains and losses. A short-term gain or loss applies to a security held for less than a year while a long-term gain or loss applies to securities held longer than a year. It's usually better to avoid long-term losses since they will be taxed against your long-term gains, which have a lower tax rate.
"Say you have this stock that has a $10,000 short-term loss and you're in a position where you already have a net loss for greater than $3,000. If the short-term loss will turn into a long-term loss in February because that's when it has been held for longer than a year, you may still want to take the loss as a short-term loss to carry forward because if you wait until next year, it will be a long-term loss," says John Battaglia, tax director in the private client advisors group of Deloitte & Touche.
Finally, investors also should try to avoid purchasing mutual funds that have their distribution date at the end of the year.
"Don't buy funds before the record date for distributions. If the fund has large capital gains for the year, you might find you're paying more to acquire the fund," says Luscombe. Funds reporting a capital gain typically pay out a distribution towards the end of the year to avoid being taxed on these gains. But shareholders have to pay taxes on the distribution. So if a fund makes a distribution on Dec. 21 and you bought the fund on Dec. 20, you will have to pay taxes on the distribution even though you owned it for one day. 
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