Most of us know with a fair amount of certainty that we will have to pay taxes in the future. The question is how much. By planning ahead, you may be able to lessen your investment-related tax burden by a considerable amount. Here are three simple tax-savings tips for investors with taxable accounts.
1. Mutual funds pay out capital gains and income, creating potential tax liability. Be tax efficient by putting different kinds of investments in different kinds of accounts. Consider index funds in your taxable accounts because they have very low turnover and therefore lower capital gains distributions. Position the tax-inefficient assets with high turnover ratios (e.g. real-estate investment trusts) or any interest or dividends that do not get favorable tax treatment to your retirement accounts.
2. Monitor and track your cost basis throughout the year. A wise investor will know their estimated capital gain or loss on each investment, enabling them to offset a capital gain on one investment by selling another at a loss, (i.e. tax loss harvesting).
3. Track your investment purchase dates. If you sell an investment before holding it for one year plus one day, it is considered a short-term capital gain. Short-term gains are treated as ordinary income, taxable at the taxpayer’s highest marginal rate.