We routinely remind investors about these deductions arising from investments and along with certain basis additions that tend to be missing from the piles of tax information they provide us. It’s important to take a step back and ensure we maximize benefits to our clients. We thought sharing them here would be appreciated.
If you purchased a taxable bond for more than its face value—as you might have to capture a yield higher than current market rates, you get to deduct that premium. That’s only fair, otherwise, the IRS would get to tax that extra interest that the higher yield produces, which you supplemented with your upfront investment.
You have two choices about how to handle the premium. First, you can amortize it over the life of the bond by taking each year’s share of the premium and subtracting it from the amount of taxable interest from the bond you report on your tax return. Each year, you also reduce your tax basis for the bond by the amount of that year’s amortization. This is the more time consuming and generally money saving choice.
The other is that you can ignore the premium until you sell or redeem the bond. At that time, the full premium will be included in your tax basis, so it will reduce the taxable gain or increase the taxable loss dollar for dollar. But any loss may not be fully deductible so it may be deferred.
The amortization route may be a pain because it’s up to you to both figure each year’s share and keep track of the declining basis. But it tends to be more valuable because the interest you don’t report will avoid being taxed in your top tax bracket for the year—as high as 40.8%, while the capital gain (assuming you have a gain) you reduce by waiting until you sell or redeem the bond would only be taxed at 0%, 15% or 20%.
By the way, if you buy a tax-free municipal bond at a premium, you must use the amortization method and reduce your basis each year, however you don’t get to deduct the amount amortized. This is because the interest is nontaxable. Then the amortized basis is used when you sell, so that premium isn’t deductible then either.
While reinvested dividends are not a tax deduction, they can ultimately be an important subtraction. If, like many investors, you have your mutual fund dividends automatically reinvested to buy more shares, remember that each and every new purchase increases your tax basis in that fund. That, in turn, reduces the potential taxable capital gain or increases the loss when you redeem the shares. It is easy to forget to include reinvested dividends in your basis, which results in double taxation of the dividends – once in the year when they were paid out to you and immediately reinvested out of your pocket, and then later as those shares are included in the proceeds of the sale.
If you might not be sure what your basis is, ask the fund for help. Many funds report to investors the tax basis of shares redeemed during the year since 2012. So it’s the reinvested dividends before that date which are the most likely to have been missed.
Whether you are a business, individual, or non-profit – we will outline specific steps you can take to minimize taxes, maximize loan eligibility, or enhance the value of your property. With one call or email we will provide you with a professional, complimentary financial Statement evaluation – no obligation. Just visit Czarbeer.com/tax-offer or contact us at info@czarbeer.com, or call (212) 397-2970 and we will be happy to help you and answer your questions.