Investors: Avoid These 5 Common Tax Mistakes

For many investors, and even some tax professionals, sorting through the complex IRS rules on investment taxes can be a nightmare. Pitfalls abound, and the penalties for even simple mistakes can be severe. As April 15 rolls around, keep the following five common tax mistakes in mind ? and help keep a little more money in your own pocket.

1. Failing To Offset Gains

Normally, when you sell an investment for a profit, you owe a tax on the gain. One way to lower that tax burden is to also sell some of your losing investments. You can then use those losses to offset your gains.

Say you own two stocks. You have a gain of $1,000 on the first stock, and a loss of $1,000 on the second. If you sell your winning stock, you will owe tax on the $1,000 gain. But if you sell both stocks, your $1,000 gain will be offset by your $1,000 loss. That's good news from a tax standpoint, since it means you don't have to pay any taxes on either position.

Sounds like a good plan, right? Well, it is, but be aware it can get a bit complicated. Under what is commonly called the "wash sale rule," if you repurchase the losing stock within 30 days of selling it, you can't deduct your loss. In fact, not only are you precluded from repurchasing the same stock, you are precluded from purchasing stock that is "substantially identical" to it ? a vague phrase that is a constant source of confusion to investors and tax professionals alike. Finally, the IRS mandates that you must match long-term and short-term gains and losses against each other first.

2. Miscalculating The Basis Of Mutual Funds

Calculating gains or losses from the sale of an individual stock is fairly straightforward. Your basis is simply the price you paid for the shares (including commissions), and the gain or loss is the difference between your basis and the net proceeds from the sale. However, it gets much more complicated when dealing with mutual funds.

When calculating your basis after selling a mutual fund, it's easy to forget to factor in the dividends and capital gains distributions you reinvested in the fund. The IRS considers these distributions as taxable earnings in the year they are made. As a result, you have already paid taxes on them. By failing to add these distributions to your basis, you will end up reporting a larger gain than you received from the sale, and ultimately paying more in taxes than necessary.

There is no easy solution to this problem, other than keeping good records and being diligent in organizing your dividend and distribution information. The extra paperwork may be a headache, but it could mean extra cash in your wallet at tax time.

3. Failing To Use Tax-managed Funds

Most investors hold their mutual funds for the long term. That's why they're often surprised when they get hit with a tax bill for short term gains realized by their funds. These gains result from sales of stock held by a fund for less than a year, and are passed on to shareholders to report on their own returns -- even if they never sold their mutual fund shares.

Recently, more mutual funds have been focusing on effective tax-management. These funds try to not only buy shares in good companies, but also minimize the tax burden on shareholders by holding those shares for extended periods of time. By investing in funds geared towards "tax-managed" returns, you can increase your net gains and save yourself some tax-related headaches. To be worthwhile, though, a tax-efficient fund must have both ingredients: good investment performance and low taxable distributions to shareholders.

4. Missing Deadlines

Keogh plans, traditional IRAs, and Roth IRAs are great ways to stretch your investing dollars and provide for your future retirement. Sadly, millions of investors let these gems slip through their fingers by failing to make contributions before the applicable IRS deadlines. For Keogh plans, the deadline is December 31. For traditional and Roth IRA's, you have until April 15 to make contributions. Mark these dates in your calendar and make those deposits on time.

5. Putting Investments In The Wrong Accounts

Most investors have two types of investment accounts: tax-advantaged, such as an IRA or 401(k), and traditional. What many people don't realize is that holding the right type of assets in each account can save them thousands of dollars each year in unnecessary taxes.

Generally, investments that produce lots of taxable income or short-term capital gains should be held in tax advantaged accounts, while investments that pay dividends or produce long-term capital gains should be held in traditional accounts. For example, let's say you own 200 shares of Duke Power, and intend to hold the shares for several years. This investment will generate a quarterly stream of dividend payments, which will be taxed at 15% or less, and a long-term capital gain or loss once it is finally sold, which will also be taxed at 15% or less. Consequently, since these shares already have a favorable tax treatment, there is no need to shelter them in a tax-advantaged account.

In contrast, most treasury and corporate bond funds produce a steady stream of interest income. Since, this income does not qualify for special tax treatment like dividends, you will have to pay taxes on it at your marginal rate. Unless you are in a very low tax bracket, holding these funds in a tax-advantaged account makes sense because it allows you to defer these tax payments far into the future, or possibly avoid them altogether.

David Twibell is President and Chief Investment Officer of Flagship Capital Management, LLC, an investment advisory firm in Colorado Springs, Colorado. Flagship provides portfolio management services to high-net-worth individuals, corporations, and non-profit entities. For more information, please visit www.flagship-capital.com.

---

Find a Methodology and Minimize Investment Madness

There are many reasons to be investing these days, and... Read More

Credit Scores = ROI Profits for Real Estate Investors

Strong credit saves real estate investors money on mortgage finance... Read More

The Benefits of Laddering Your CD Investments

If you've decided to stock some money away in a... Read More

Global Markets: A Window on the World Economy

Expectations drive the market. Every stock price is driven by... Read More

Trading Systems

A trading system consists of a set of rules for... Read More

Angels, Are They Real?

They're real, but few survive. High risk investing is dangerous... Read More

Oil and Gasoline Price Uncertainties

The Light Crude Continuous Contract hit an all-time high at... Read More

Realistic Investing Expectations

Over the long term stocks have provided us with great... Read More

Real Estate Clubs Hot Among Investors

Six or seven years ago, the stock market was booming,... Read More

Getting Started In Investing

Are you ready to open your pathway to financial independence?Well... Read More

Before You Invest You Must Read This

It is important to answer the following questions before you... Read More

Caveat Emptor: You May Owe Taxes Despite 401(K) Losses!

One among many ways you lose money in non-indexed mutual... Read More

Evaluating A Money Manager

Scams and frauds are designed to take your money through... Read More

The Economys Greatest Depression Downturn Ever Is Now Just A Few Years Away

What really controls the economy? Forget interest rates, forget deficits,... Read More

What If You Absolutely Positively Could Not Lose - Would You Play the Stock Market?

Seniors on fixed incomes face a unique problem. Where do... Read More

Out-Of-State Investors Check List of Questions

The following lists of questions are suggested questions to ask... Read More

A Gadfly On A Dinosaurs Butt, Or The Hood-winking Of The American Investor

Have you ever noticed how some words in the English... Read More

The Realities Of Market Timing

Market timing systems are based on patterns of activity in... Read More

Your Worst Enemy To Successful Investing - The Media

How do you make your investment decisions and where do... Read More

Forex market offers opportunity and information

The forex market is what is called an international exchange... Read More

The Key Ingredient To Increase Preconstruction Profits By Over $20,000

One of the greatest preconstruction investing issues that I hear... Read More

Poll Names Coin Laundries Best Investment For 2005

According to Morton Pollack, CEO of PWS, The Laundry Company... Read More

Trading Baskets Part I

Q. What is a basket?A basket is a group of... Read More

Begging Your Trust in Africa

The syntax is tortured, the grammar mutilated, but the message... Read More

The Convertible Craze Brightens The Future Of Equities

Convertibles are stealing the show with their safe investment image... Read More

Everybody Wants to Know How to Invest

Those unfamiliar with the process of making and managing investments... Read More

Investing As A Sport?

I said last week that money doesn't generally buy happiness,... Read More

Easily Finding A Good Stock

There is a tremendous amount of software, complicated high priced... Read More

Creating a Financial Future - Putting Your Plan Into Action Part 1

This column has previously discussed "picturing the future that we... Read More

Why You Need To Buy and Sell Gold Coins (Part 2)

How to Collect Rare Coins For Fun and ProfitTime has... Read More

A Safe Port For Mutual Funds But Not You!

Soft dollars, a form of legal kickback, is a sly... Read More

Fundamentals of Option Pricing

When one begins to consider an option, it is very... Read More

How to Use Annual Report

There are many steps in calculating the fair value of... Read More