Investment Tax Deductions You May Have Overlooked
Here Are Some Tax Deductible Investment Expenses You May Not Have Considered
As a new investor, you might not realize there are a number of investment tax deductions for which you might qualify, lowering your overall tax burden. This simple guide was designed to help you discover some of those potential investing tax deductions you may not have known existed so you can ask your qualified accountant or tax attorney if it is something of which you can avail yourself, keeping more cash in your pocket.
You Might Be Able to Take Advantage of an Investment Tax Deduction for Investment Advisory Fees
Although you cannot deduct the commissions you pay to your stock broker on trades executed in your brokerage account — those are added to the cost basis of your individual tax lot positions and eventually used to calculate any applicable capital gains or capital losses, on which you will pay taxes or potentially receive a tax deduction — there are a number of fees, expenses, and other advisory charges on which you might be able to take an investment tax deduction depending upon the circumstances including, in some cases, how large of an expense they represent to your taxable or adjusted gross income.
For example, if you are like many affluent or wealthy Americans, you may work with a registered investment advisor. Many registered investment advisors operate on a fee-only basis, meaning that unlike other financial institutions or professionals, they don't make money from referring you to certain financial products nor do they generate any revenue from executing trades on your behalf. Instead, they charge you investment advisory fees, often a percentage of assets under management, flat fees, or hourly fees depending upon the firm with which you are working, your specific needs, and the nature of the services you are being offered.
Typically, fees can range anywhere from 0.05 percent to 3 percent or, in some cases if you are a qualified client, a percentage of performance, say 15 percent to 25 percent of the net realized and unrealized appreciation in a custody account.
You know I'm a big fan of using real-world examples to drive points home because I think it makes it easier to understand concepts. To provide such an illustration, the private asset management company I'm establishing later this year to manage my family's wealth along with the wealth of affluent and high net worth individuals, families, and institutions who have at least $500,000 to invest alongside us, Kennon-Green & Co., is currently in the planning stages but our preliminary business model anticipates our fee schedule ranging somewhere between 0.25 percent and 1.5 percent depending upon the portfolio specifics and other relevant considerations.
We will be a true asset management company, though, and not what most people think of when they think of a financial planner whose primary business activity includes creating financial plans, charging a fee, then investing money in mutual funds, index funds, and exchange-traded funds, which themselves have their own fees included in the expense ratio on top of the advisory fee. Instead, we will be building bespoke portfolios for successful people who want to own their securities themselves; that, with only rare exceptions, don't want their money held in pooled vehicles but would prefer to have the individual stocks, bonds, and other securities in a private account.
The rules for writing off investment advisory fees and asset management fees in taxable accounts come down to this:
- Investment advisory fees are tax deductible only on portions that exceed 2 percent of your adjusted gross income. You write them off by listing them on Schedule A under "Job Expenses and Certain Miscellaneous Deductions"
- Investment advisory fees are considered a tax preference item as defined in the calculation of the Alternative Minimum Tax, or AMT. If you get hit with the alternative minimum tax, a portion or the entirety of your investment advisory fee deduction will be disallowed so you can't take advantage of the write-off.
There isn't agreement among professionals about whether or not you can take the investment advisory fee tax deduction for non-taxable accounts, such as a Roth IRA or Rollover IRA so you can try but there is no telling whether or not it will be accepted. One technique used by some wealth managers and asset management companies to attempt to help clients deduct this from their taxes is to allow them to pay the advisory fees from outside by the tax-free or tax-deferred account by deducting all of the fees from a brokerage account or billing the client directly and having the client write a check.
You Might Be Able to Take a Deduction for Your Accounting Fees
The fees you pay for tax preparation are usually tax deductible. Unfortunately, a lot of households don't qualify to avail themselves of the deduction because the rules are comparable to those for the investment advisory fee tax deduction — only those fees in excess of 2 percent of your adjusted gross income are deductible.
You Might Be Able to Take an Investment Tax Deduction for Investment Newsletters, Magazines, and Publications
Can’t live without your daily Wall Street Journal? How about Fortune, Forbes, or The Financial Times? Keep your receipts and you might be eligible to take the same tax deduction we've been discussing thus far; any amount over 2 percent of your adjusted gross income getting written off your tax bill with the potential exception of triggering the Alternative Minimum Tax.
You Might Be Able to Take a Tax Deduction for Some Legal Fees
For businesses that are deducting business legal fees, such as those incurred as part of establishing or running a limited liability company, limited partnership, or other entity, legal fees are ordinarily fully tax deductible. As these entities are ordinarily pass-through, the investors will receive a K-1 statement and their share of the allocation tax deduction. Usually, legal fees of this nature are fully tax deductible, including not being subject to the Alternative Minimum Tax.
Whether or not you can deduct other legal fees from your taxes varies depending upon the circumstances and situation. It can get really messy quickly so it's best to speak with a qualified accountant. For example, certain fees, such as those involved in a liquidity event where you sell a long-held family business, have to be capitalized and added to the cost basis. On the other hand, legal fees from a tax attorney helping you mitigate your tax burden or do tax planning are usually fully deductible.
You Might Be Able to Take an Investment Tax Deduction for Safe Deposit Box Rental Costs
Do you actually store your investments in physical forms such as paper stock certificates or savings bonds? If you keep a safe deposit box at a local bank to protect your securities, you can probably deduct it as an expense on your taxes.
You Might Be Able to Take an Investment Tax Deduction for Interest Expense Tied to Your Investing Activities
The Internal Revenue Service allows a deduction for investment interest expense, which includes margin interest expense you pay for money borrowed to purchase investments such as stocks and bonds. There are very, very strict rules that must be followed if you want to avail yourself of this particular investment tax deduction. For one, you can only deduct investment interest expense up to the limit of your “net investment interest”. This includes non-qualified dividends and capital gains (you can include qualified dividends, which are those that pay only the lower dividend tax rates originally established during the Bush tax cuts but then you give up their special qualified status and would have to pay your regular tax rate on them in any amount exceeding your margin interest expense).
You also have to deduct any investment expenses such as those we’ve already discussed. The result, net investment income, is the maximum amount of margin interest expense you can write off your taxes. In some cases, you may be able to carry forward your investment interest expense deduction if you can't fully take advantage of it in a single year. As with everything else in this article, you need to consult with your CPA or other qualified professional tax representative to help you calculate and understand your options based on your unique circumstances, opportunities, situation, and other relevant factors.