Learn why knowing how to choose your “Investments” in a wise manner is critical for your “Wealth Building” success…
In today’s economy there are a number of choices or investment options for you to choose from after you have determined your cash flow position, maximized your credit position and looked into the future of your finances in a comprehensive manner.
In this discussion TheWealthIncreaser.com will discuss several investment options—along with the tax angle that you can use to build wealth more efficiently in the economy that we are now in.
You can invest in stocks, mutual funds, bonds, MLP’s, real estate, futures, precious metals and many others—and it is important that you understand your potential tax position going in.
Although the creator of TheWealthIncreaser.com has been quite busy this tax season, the inspiration to create this page occurred as many of my clients over the past few weeks made investment choices and had capital gains and an increase in their net worth in the 2018 tax year.
STOCKS & MUTUAL FUNDS
First and foremost you must understand the difference between short-term and long-term gains and you must know the tax treatment of investments when they are “inside” or “outside” of your retirement account.
In addition you want to be aware of when and if you can carry losses forward and from what type of investment.
If your investments are outside of your retirement accounts your purchase price, sale price and how long you hold the investment is key!
If your investments are inside of your retirement accounts you may avoid or defer taxation until a future date–normally retirement or at the time of withdrawal!
If your investment is held for less than a year outside of your retirement account(s)–you will have a short-term gain and you will be taxed at your ordinary income tax rate (if you have your 2018 tax return get it out and look at line 10 of form 1040 page 2 to see where you fall as far as taxation) that could range from 0% (lower end of spectrum) to 40.8% (higher end of spectrum).
If you hold your investment for one year and one day you will get the more favorable rate that is determined by your taxable income (long term capital gains rate that could range from 0% to a maximum of 23.8%). If your brokerage or mutual fund company sell during the year and “they don’t specify a date” or if they state “various” on the 1099–your gain will be taxed as “ordinary income” unless you can prove that the stock or mutual fund was held for one year and one day.
If you have a combination of short and long-term capital gains and capital losses you can offset the gains against the losses.
However, you must offset short term losses against your short term gains and long-term losses against your long-term gains —you then aggregate your losses and if they exceed your gains you can use the losses to offset your taxes. If the losses exceed $3,000 you can carry them forward up to a maximum of $3,000 per tax year until it is used up.
Qualified stock dividends (stock held 60 days before or after the ex-dividend date) are also taxed at capital gain rates and if the stock dividend is unqualified it would be taxed at your “ordinary income” rate (which is usually a higher rate) and would be entered on your tax return as “ordinary dividends” on line 3b of your 2018 tax return.
If you invest in a mutual fund or your investments are handled by a brokerage they will normally spell out the differences on their 1099’s that you get around tax time.
They will also normally provide you your cost basis (the purchase price adjusted for tax purposes).
Always remember that it is important to adjust your cost basis for re-invested dividends.
You pay tax on re-invested dividends in the same manner as if you received cash. The good news is you won’t be taxed twice because your cost basis will be adjusted upward as a result of the dividend re-investment and again most brokerage companies will do this for you.
When you decide to sell your stocks or mutual funds you have four options to choose from:
- FIFO or first in-first out
- LIFO or last in-first out
- Use the average cost per share
- Specify certain shares
Be aware that there are caveats and regulations that apply when categorizing for tax purpose so be sure you use competent tax professionals.
If you own stocks or mutual funds you may have to pay tax on the capital gains even if you don’t physically utilize the gain!
If you have a desire to avoid capital gains consider an index fund that only pays dividends or a tax efficient fund that avoids both capital gains and dividends.
Also if your fund has foreign holdings they will withhold taxes paid on dividends and if box 7 on 1099-DIV has an entry that means foreign taxes were paid.
You can use the foreign tax credit (U.S. residents) to reduce some or all of those taxes or you can choose the deduction (reduces your taxable income—use form 1116).
BONDS, MLP’S & REAL ESTATE
There are a number of bonds and the taxation depends on what type you own:
- Corporate–taxed at ordinary income rates
- Treasury–income is subject to federal but not state
- Municipal–income is not subject to Federal and if issued and purchased in your home state may avoid state and local
- Series I and EE bonds—taxation depends on how you use the proceeds at maturity or cashing in of bond
In most cases Master Limited Partnership‘s and Real Estate Investment Trust‘s are taxed at ordinary income tax rates. Under the new tax law enacted in 2017 you may be able to deduct 20% of MLP or REIT income as qualified business income.
If you buy and sell real estate such as a personal residence and you meet the 2 out of 5 year rule—you have a tax free gain up to $250,000 if single and $500,000 if married filing joint.
If you sell rental property that property will be subject to recapture of depreciation (the depreciation that you took or had the option to take will be added back thus reducing your overall gain) and will be taxed at your ordinary income rate if held for less than one year and your “capital gains rate” if held for one year or more (see capital gain rates below).
A 1031 exchange may allow you to avoid or delay taxes and is an effective tool that is utilized by serious seasoned real estate investors and may be worth considering–depending on your goals.
Long-Term Capital Gains Rate:
0% if you are single and your taxable income is $38,599 or less or if you are married $77,199 or less
15% if you are single and your taxable income is between $77,200 and $425,800 or if you are married and your taxable income is between $77,200 and $479,000
20% if you are single and your taxable income is above $425,800 and married above $479,000
Note: If your modified adjusted gross income is above $200,000 if you are a single filer and $250,000 if you are married filing jointly you have to pay a 3.8% net investment income tax, potentially bumping your capital gains rate to 18.8% or 23.8% respectively.
If on your K-1 (if you have holdings in a trust, partnership or S-corporation) some portion is a return of capital—you may not owe taxes on that amount—your tax professional should be aware of whether you will owe taxes based on the data on your K-1.
FUTURES & PRECIOUS METALS
Profits from futures trading are generally taxed at 60% long-term capital gains and 40% short-term gains no matter how long you held the contract.
When you buy or sell option contracts on an exchange, the tax rules are the same as for stocks that was mentioned earlier in this discussion.
The taxation of options can be tricky and is beyond the scope of this discussion, however it is worth mentioning that you will need a tax professional who is familiar with option taxation.
Precious metals are often classified by the IRS as a collectible—rather than an investment and they would be taxed at 28% (long-term).
ETF’s or exchange traded funds that invest in precious metals are also taxed at the 28% rate. Funds and ETF’s that invest in mining stocks of precious metals generally get the same capital gains rate as any stock fund!
OTHER
With the advent of cryptocurrency such as bitcoin, block chains and other more complex investments, the taxation is not clear in some instances at this time as regulations are underway or the tax treatment is not clearly defined.
Most investments will normally be taxed in the U.S. if a gain is going in your pocket or it is traceable and it is important that you have a tax professional who has experience in handling the type of investments you now invest in—or you anticipate investing in during your lifetime.
CONCLUSION
You have a vast number of investment choices available and it is important that you have mastered your credit, you understand your life stage, you have an emergency fund that will add an additional layer of protection in case your investments don’t materialize as you planned, you are on track with your retirement income and you review your finances on a consistent basis.
Another key point worth mentioning is you “must know” how the taxation of your investment income will occur in the state that you now reside in–and/or anticipate moving to in your future!
By doing all of the above you will put yourself on a serious path toward wealth building and you will enjoy life along the way.
You can build wealth in a worry-free way and win throughout your financial life because you took the time (when others chose not to) to look at investments on the front end and knew ahead of time the tax ramifications that lied ahead in your future.
All the best toward your investment choices and future success…
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