Long-term rates are significantly lower and can be zero under certain income thresholds.

Best tax deferred investments

Little tweak to help with taxes

Drake Qualls, CFP™

If you find yourself paying taxes every year, and you already take advantage of tax deferred investments strategies, you should look closer at what is happening in your portfolio. A few tweaks to how you invest could help a lot come tax time.

For many, stocks make up the largest proportion of their portfolio as they seek to make consistent investment returns in today’s ever-changing market. Returns from stock investing take two primary forms, realization of capital gains and dividend income.

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When you sell a stock position (realize a gain/loss), you lock-in the way the transaction will be taxed. This is also true of many tax deferred investments, not just stocks (bonds, real estate, etc.). So, make sure you understand the implications of the sale. Are you locking in a short-term gain (taxed at ordinary income rates) or a long-term gain (taxed at long-term capital gain rates)? Long-term rates are significantly lower and can be zero under certain income thresholds. The difference can be massive. In fact, I just recommended delaying a distribution for a client by a month to take advantage of the lower long-term rates.

Less known, but just as important, are the dividends your stocks pay out each year. Are they qualified (taxed at long-term capital gains rates) or non-qualified dividends (taxed at your ordinary income tax rate)? You can imagine the difference in your net return is fairly large. If dividend investing is your focus, make sure you know how it will get treated and seek tax deferred investments that maximize your net return.

If you have a need for bond income, consider municipal bonds within any account where you are investing with after-tax dollars (individual, joint or trust accounts). The interest from these bonds is not taxable at the federal level and may not be taxable at the state level if you are buying muni bonds for your current state of residence. This can be a welcome change if you have been paying taxes on your already low (historically) yields.

Remember that muni bonds do not make sense for everyone and in-fact sometimes it is better to use taxable bonds depending on your tax-rate. If you are not in one of the highest tax-brackets it might not make sense to use munis at all (unless it makes more sense tactically). There is a bit of math involved here, as well as a look at your tax bracket, but the term to remember is tax-equivalent yield. With this formula, you can equate tax-free, partially tax-free and taxable bond interest income (look at yield as well) to get an apples-to-apples comparison.

Income is only part of the picture with bonds. If you are selling bonds before maturity, you will have some capital gain/loss to consider as well. This gain/loss is treated the same way stock gains and losses are. The focus here would be on holding the bond for over a year to get the lower long-term capital gains tax rate.

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If you have a stock/bond that has an unrealized loss, consider selling the holding to offset your gains overall (you can even carry these losses forward into future tax years). After selling, you can buy a similar investment that may be in the same industry or that has similar characteristics. If you do not buy that holding back within 30 days, you avoid something called a wash-sale rule. After that period, feel free to purchase the holding back. This might not always be the best decision depending on what happens in that month especially when we are talking about a single stock position. However, ETFs or mutual funds typically have many alternatives that can serve as surrogates for a month or so.

If you are selling investment real estate, and interested in buying another property, consider a 1031 exchange. 1031 exchanges are useful for those looking to completely avoid current tax liability (or partially avoid) but pay close attention to the detail and ensure you have an accountant involved in the process. These transactions can involve complexities whenever debt is involved among other things.

As always, be sure to talk with your Henry+Horne tax accountant as they can help provide you with the insight you need to improve your returns and hopefully reduce your tax bill.

Drake A. Qualls, CFP™ is a Certified Financial Planner for Henry+Horne Wealth Management. He can be reached at (480) 483-3489 or DrakeQ@hh-wm.com.

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