Kiplinger Today

Tax Tips

10 Tax Breaks for Investors

Kathy Kristof

Remember, it’s not just how much you make but how much you keep. With these investments and strategies, you get to keep more.

The U.S. tax code holds many breaks for investors. You'll likely be familiar with some of them, such as tax-free income on municipal bonds. Others are far more obscure. Yet, during tax season, it's helpful to review all the breaks you can take — even if you missed them in 2012. They may help trim your tax bill in the future.

Some of the tastiest tax treats were originally designed for a rarefied clientele: venture capitalists and multimillionaire "angel" investors, who make a living finding and financing small companies. But new rules allowing corporate "crowd funding" arrangements may make these tax rules far more pertinent to average investors, who might become tempted to help finance a friend's or neighbor's new enterprise.

SEE ALSO: Tax Tips for Your 2012 Return

Here's a guide to ten sweet tax treats for investors — some ordinary, some extraordinary.


Preferential rates: Marginal income tax rates rose to a maximum of 39.6% in 2013, from 35% last year. But profits on the sale of stocks and bonds held for more than a year are taxed at preferential rates that cap at 23.8% for those in the highest income brackets and drop to 15% for middle-income filers and to zero for those in the 10% and 15% marginal tax brackets.

Most dividend income is also taxed at these lower rates. But beware selling investments before you've owned them longer than a year. Short-term gains get hit with higher ordinary income tax rates. And some types of dividend income, such as the income thrown off by real estate investment trusts, are taxed at those higher rates, too.

Capital-gains exclusion: If you buy stock in a "qualified small business" and hold that stock for at least five years before selling, you don't have to pay tax on the gain at all. The profit is excluded from your income. What's a "qualified small business"? The definition is long, but the main qualification is that it must have less than $50 million in assets both before and after issuing stock. Additionally, you must have purchased the stock at original issue or received it as payment for services provided to the company. Incidentally, this tax break officially expired at the end of 2011, but Congress reinstated it recently in the legislation to avoid the "fiscal cliff." Now the break covers stock purchased in 2012 or 2013. As long as you buy before the expiration, you qualify for the exclusion if you hold on for at least five years, says Mark Luscombe, principal tax analyst with CCH Inc., a Riverwoods, Ill.–based publisher of tax information.

Capital-gains rollover: Don't want to hold that qualified small-business stock for five years, but you're interested in buying shares in another qualified small business? Then there's another tax provision designed just for you. Assuming that you held the first stock for at least six months, you can defer the tax on your gain by rolling the proceeds from the sale into the purchase of another qualified small business. Philip J. Holthouse, partner in the Los Angeles tax firm of Holthouse, Carlin & Van Trigt, says this law was specifically designed to help angel investors, affluent investors who provide capital to start-ups, sometimes making a fortune and other times losing a fortune. The law allows these angels to keep more of their profits for reinvestment, and net their gains and losses over a longer stretch.

Valuable losses: If you invest in a really small company — one with less than $1 million in assets — and lose your shirt, you may be able to write off the loss as an ordinary loss rather than a capital loss, says Holthouse. Based on "1244" rules, up to $50,000 in losses on a qualified small domestic corporation can be used to reduce your ordinary income, which otherwise would be taxed at a maximum rate as high as 39.6%.

Tax-free income: If you invest in municipal bonds issued by an entity in your state, the income earned on those bonds is likely to be "double tax-free" — exempt from both federal and state income taxes. If you buy out-of-state munis, the interest is usually free from federal tax. However, there are a few caveats. The most noteworthy is that tax-free muni-bond income is added into the calculations that determine how much of your Social Security benefits are taxable. For middle-income seniors, that can push thousands of otherwise untaxed income into the taxable column, making municipal income a little less tax-free than it might appear.

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