How to Simplify Investment Related Taxes

By Stephen L. Nelson

For some people, investment activity greatly complicates annual tax return preparation. In fact, without too much trouble, some people manage to so complicate their tax returns due to their investing, that the investor has no hope of preparing such a return themselves . . . and may even need to go to high-priced professional for tax preparation return.

Fortunately, a few simple tricks can greatly simplify the tax accounting related to person’s investment activities. And the tricks may allow an investor to prepare his or her return him or herself or at reasonable cost.

Trade in tax advantaged accounts

If you are going to actively trade (regularly and actively buying stocks and bonds), locate that activity in a tax deferred account such as a self-directed IRA.

Taxable trading creates lots of work on a tax return — including lots of detail on a Schedule D and the related 8949. But by moving the trading into tax deferred account, all of this work evaporates. This approach also eliminates one of the common triggers for IRS correspondence audits: mismatched broker proceeds due to investment activities.

Trade a given security within a single account

If you must trade in a taxable account, be sure to trade any given security (shares in Apple Computer for example) only in a single account.

In other words, if you have a Schwab account, an e*Trade account and a Fidelity account, don’t trade shares in Apple Computer across all three accounts. You won’t able to easily apply the wash sale rules if you spread your trading. And you won’t be able to avoid having a competent accountant check for wash sales — which will be expensive.

Avoid foreign accounts

Congress had greatly increased the cost of US investors investing money in offshore accounts.

Accordingly, you want therefore to avoid these options (so you can to avoid annually preparing the form 8938 and the form TDF 90.22.1.)

Don’t DRIP in a taxable account

Lots of people like to use dividend reinvestment programs, or DRIPs, to grow their investments in dividend paying stocks. Such programs are convenient and add up over time.

However, if you participate in DRIPs inside a taxable account, you create a bunch of work for yourself. You need to careful tracking the increments in basis over the decades you hold the shares and reinvest the dividends so you can someday calculate your gain or loss.

The trick here, then, is to either avoid DRIPs… or use them inside tax-deferred accounts where you don’t have to worry about the capital gain calculations.

Learn how partnership accounting works before investing via a partnership

Before you invest in a partnership be sure you understand how partnership accounting works. Most small investors don’t. And as a result, they sometimes get terrible surprises at tax time.

For example, you probably owe any of the states in which an investment partnership operates a nonresident tax return. So be sure you’re ready for that.

And another example: None of the complexity of what’s going on inside a partnership is hidden. That complexity simply flows through the partnership tax return and then onto the individual partner’s tax returns via the partnership K-1.

Accordingly, if you’re investing in oil and gas partnership with depletion allowances or hedge funds with reportable transactions, you want to first make sure you know how to deal with all of this stuff — or, barring that, that you’re comfortable paying someone else to deal with this stuff.