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5 hidden tax deductions
Legal Disclosure: Tony Robbins is the Chief of Investor Psychology at Creative Planning, Inc., an SEC Registered Investment Advisor (RIA) with wealth managers serving all 50 states. Mr. Robbins receives compensation for serving in this capacity based on increased business derived by Creative Planning from his services. Accordingly, Mr. Robbins has a financial incentive to refer investors to Creative Planning.
What if you realized that a small amount of tax knowledge could save you from unnecessarily paying hundreds, if not thousands of dollars to the tax man? How much faster could you reach your financial goals?
One of the most common mistakes among investors is their focus on performance and return. It doesn’t matter if your investments get a 20% return if the fund you invested in takes a 50% tax bite! Remember, you only get to spend what you keep. But if you conscientiously manage your investments for tax efficiency, it can ultimately mean the difference between arriving at your financial goals a decade early or never getting there at all!
So how do you lower your tax bill and keep more of what you earn?
One of the best ways is by taking advantage of tax deductions. By structuring your investments around tax-efficient products, you can effectively reduce your taxes and accelerate your path to financial freedom.
To help you reduce your tax hit and enhance your after-tax returns, take a close look at some of the most-overlooked deductions and make sure you are missing any of them.
One of the smartest moves you can make as an investor is investing in a way that allows you to defer your taxes. And one of the best ways to do that is through retirement funds.
With tax-efficient retirement accounts like IRAs and 401(k)s, all contributions are tax-deductible (though are subject to income limits). This reduces your taxable annual income, putting more money in your pocket now. And more money now means more value later. Investing in these accounts also allows you to grow your money tax-free, providing you with maximum compounded growth for the expansion of your Freedom Fund!
Sure, you will eventually still have to pay taxes on your investments. The tax man will be right there waiting for you when you take your money out. But the whole idea behind retirement funds is that by the time you are ready to make your withdrawals, you will be in a much lower tax bracket than you are now. Besides, the money you save in income tax, and the money you create through tax-free compounding is almost guaranteed to offset the taxes you’ll pay at that point. And, don’t forget the power of sleeping soundly, knowing that you are taking care of your future self by saving and planning wisely.
Miscellaneous itemized deductions
From hiring a financial advisor to collecting investment income, there are countless costs and fees associated with making investments. But did you know that you may be able to write off those expenses?
The IRS refers to these deductions as “miscellaneous itemized deductions for investors.” When most people hear the phrase “itemized deductions,” they tend to think about the big ones: home mortgage interest, state and local income and property taxes, and charitable contributions. But itemized deductions extend well into the particulars of making investments.
Basically, any expenses that you incur while pursuing investment activities for the purpose of gaining profit can be deducted. And that can add up to a lot of extra savings!
These are some of the most common deductible investment expenses:
- Legal and professional fees. If you paid for any legal fees or advisory fees for counsel or advice regarding your investments, the expenses are deductible.
- Tax advice. If you paid fees to an accountant for advice to make your investments more tax-efficient, the expenses are deductible.
- Investment advice. Any fees paid to a broker or financial advisor who provides counsel or advice about investments that produce taxable income will be deductible. So a 1% advisory fee really could be closer to 0.5% when you take into account the deduction.
- Travel costs. If you spend money to seek investment advice from a professional, you can claim a deduction for travel or transportation costs. This does not, however, apply to travel costs associated with attending conferences, seminars or any other meetings for investment-related purposes.
- Service charges. Any fees you pay to participate in an automatic investment service are deductible.
- Safe deposit box. If you store documents on taxable income-producing investments in a safe deposit box, go ahead and deduct that rental cost.
- Office expenses. Clerical help and office rent can be deducted as long as those were applied to making investments.
- Collecting income. When you collect investment income, such as interest or dividends, you typically have to pay fees to a bank, broker, trustee or agent. Fortunately, you can deduct these expenses.
Just remember, these deductions are subject to certain limitations. Your miscellaneous itemized expenses will only be deductible if they exceed 2% of your adjusted gross income. For example, if your AGI is $100k, the starting point will be $2,000. So if you have $2,500 worth of deductions, you only get to write off $500 of that.
Back in 1986, the IRS stopped allowing Americans to deduct personal interest, like credit cards and car financing. But one of the key deductions it still allows has to do with investment interest.
What exactly is investment interest?
In general, it’s any interest paid on money you borrow to make an investment.
Say you have an account with a financial advisor. You then decide to borrow money to purchase more stocks. Your financial advisor will charge you margin interest. This interest is considered investment interest and is tax-deductible.
Another example is when you borrow money to purchase property for investment purposes. Any interest you pay on that loan is considered investment interest, and again, is tax-deductible.
Just remember that the deduction can only apply to interest on money borrowed to make an investment that you expect to provide you a return. You cannot deduct interest if you are making an investment in a product or piece of property that only produces non-taxable income, like a tax-exempt bond.
How much can you deduct?
In any given year, you can deduct up to the amount you earned in investment income. But as a bonus, any leftover interest expenses can be carried over for future use, without expiration.
Believe it or not, there is an upside of capital losses.
If your capital losses exceed your capital gains, you can actually use your losses to offset your gains, or even a portion of your everyday income, reducing your taxes and increasing your overall savings.
How does this work?
There are short-term sales and long-term sales, and each are netted separately to determine whether or not you have short-term gains or losses and long-term gains or losses. These net gains or losses can then be netted together to produce the final result. If you have an overall net loss, the IRS allow you to deduct $3000 of that (or $1,500 if you are married and filing separately) on your tax returns. Any remainder can then be applied to offset future capital gains.
Confused? Let’s look at an example.
Consider Larry. Larry has a short-term gain of $2,500 and a short-term loss of $1,000. This makes for a net short-term gain of $1,500.
Larry also has a long-term gain of $3,000 and a long-term loss of $8,000. This makes for a net long-term loss of $5,000.
Now, when we net Larry’s net short-term gain of $1,500 against his net long-term loss of $5,000, we see that he ends up with an overall net loss of $3,500.
The IRS allows Larry to deduct $3,000 (or $1,500 were he married and filing separately) of his overall loss against any kind of income, including his salary and interest income. Any amount of capital loss exceeding that threshold, which in Larry’s case is $500, can then be carried over to subsequent years and deducted against future capital gains.
We think that if we do our research, hire the right people and invest strategically, then we are guaranteed strong returns. But the only thing the market guarantees are ups and downs. At some point, we all lose money. It happens; it’s a part of life. The trick is to recover gracefully. How much money you save yourself is nothing more than a direct reflection of your ingenuity, your focus, and your understanding of the game. If you can find ways to create value even during a loss, you will have the chance to create economic value in ways you never thought possible.