Investments

           

          

          

                                Investments

          

          

          46) The biggest mistake made by stock market and mutual

          fund investors is not to "earmark" the shares sold. 

          When shares are purchased over a period of time, they

          are purchased at different prices.  At the time some

          shares are sold, you can control which shares are

          considered to have been sold.  The choice will not

          affect the amount of money received on the sale, since

          the shares are all being sold at the same price.  But

          it can affect your tax bill, and thus the amount of

          money you end up with.  Suppose you bought 10 shares at

          $10 each and later bought 10 more shares at $15 each. 

          Now the stock is at $20 and you want to sell 10 shares. 

          If you write your broker a letter stating that the

          second 10 shares are to be sold, your gain will be $5

          per share.  But if you do not designate which shares

          are sold, the IRS will treat it as though the first

          shares purchased were the first ones sold.  So your

          gain will be $10 per share.  This makes a sizable

          difference in your tax burden.

               Mutual fund shares also can be earmarked in

          writing when they are sold.  But the results are a

          little different if you do not earmark the shares. 

          Instead of the first-in, first-out method, you use an

          averaging method to determine the basis of your shares. 

          You add up the cash you've invested plus dividend

          reinvestments, and divide that by the number of shares

          you owned before the sale.  The result is the basis for

          each share sold.  By using this method, you lose the

          ability to influence the amount of your gain or loss

          for tax purposes.

          

          47) You can earn interest and dividends tax free.  Many

          taxpayers with high investment income can control

          whether or not they pay taxes on that income.  One of

          the few interest deductions left after 1990 is the

          deduction for investment interest expense to the extent

          of net investment income.  Suppose you have investment

          income, such as interest and dividends, of $10,000 for

          the year.  This is included in Schedule B and added to

          your gross income.  If you itemize deductions and paid

          $10,000 of investment interest, the investment interest

          expense deduction offsets the investment income.  This

          means that if you can generate investment interest

          expenses, you can shelter the investment income from

          taxation.  The deduction for investment interest also

          is not subject to the new itemized deduction reduction. 

          Any investment expense that you cannot deduct because

          the interest expense for the year exceeds net

          investment income can be carried forward to future

          years.

               Net investment income is investment income minus

          directly connected noninterest expenses, such as

          investment counsel fees, accounting expenses,

          insurance, subscriptions, and legal expenses. 

          Investment income includes interest, dividends,

          royalties, rents from net lease property, and amounts

          recaptured as ordinary income.  Investment interest

          includes interest incurred to purchase or carry

          investment property, other than tax exempt bonds and

          insurance policies.  Margin account interest is the

          usual source of investment interest expenses.  Interest

          on rental properties that qualify as passive activities

          does not count as investment interest.  But in most

          cases interest on debt incurred to purchase undeveloped

          real estate counts as investment interest and shields

          investment income.  Another approach: Instead of buying

          a consumer item such as a car with debt and purchasing

          stocks for full price, pay cash for the car and buy the

          stocks on margin.  You should consider factors other

          than taxes, but when only taxes are considered you come

          out ahead with this strategy.

               Capital gains used to be included in net

          investment income.  But the 1993 tax law eliminated

          that in most cases.  You can, however, elect to include

          capital gains in your net investment income if you

          agree that your net long term capital gains will be

          taxed at your regular income tax rate instead of having

          a 28% cap.  This can be an advantage if your regular

          tax bracket is 28% or 31% anyway.  It can also be an

          advantage if your investment interest is high enough to

          shelter most of the capital gains from tax.

               Remember that any unused investment expense can be

          carried forward to future years.  So if you expect a

          lot of interest and dividend income in the future, it

          might be better to take the 28% rate against your

          capital gains and let the investment interest expense

          carry forward to shelter the other investment income.

          

          48) Upgrade your insurance policy and get favored tax

          treatment.  New insurance policies provide investment

          and tax benefits that are far superior to older whole

          life insurance policies.  Some policyholders are afraid

          that if they cash in their old policies they will have

          to pay taxes on the accumulated earnings of the cash

          value.  That's not true.  The tax code allows you to

          exchange insurance policies tax free.  You can exchange

          life insurance for life insurance, an endowment

          contract for another endowment or annuity contract, and

          an annuity for another annuity.  All these exchanges

          are tax free whether or not the policies are with the

          same company.  Many insurance companies have programs

          that allow you to trade in the policy of a different

          insurer when you take out a new policy.  A recent Tax

          Court case makes the exchange even easier.  The

          taxpayer's old insurer refused to transfer the cash

          value of her old annuity to the new insurance company

          selected by the taxpayer.  Instead, the old insurer

          issued a check to the taxpayer, and the check was

          immediately reinvested in the new annuity.  The IRS

          claimed that there was income when the check was

          received because the taxpayer was not bound to reinvest

          it.  The Tax Court disagreed.  It said that the

          tax-free exchange provision is to be broadly

          interpreted.  You can cash in your old policy and use

          the proceeds to buy a new policy immediately.  (Green,

          85 TC No. 59 (1985).

               The IRS ruled that the tax-free exchange of

          insurance policies applies when you exchange an U.S.

          annuity for a foreign annuity.  There is no requirement

          that either or both of the insurance policies exchange

          be issued by insurers doing business in the United

          States (Letter Ruling 9319024).

          

          49) Not all foreign accounts have to be reported to the

          IRS.  When your foreign bank accounts do not exceed

          $10,000 at any time during the year, you do not have to

          report them.  In addition, a reportable account is any

          foreign financial account over which you have signatory

          authority.  A bank account and a brokerage account are

          considered reportable accounts.  But the Swiss GoldPlan

          account has been designed so that it is a precious

          metals purchase-and-storage account that does not have

          to be reported.  You can protect your privacy by

          purchasing and storing gold abroad.  SwissPlus is a

          very flexible annuity that is both tax-deferred and

          non-reportable, and cannot be seized by creditors. 

          (Information on both GoldPlan and SwissPlus can be

          obtained from JML Investment Counsellors, Dept. 212,

          Germaniastrasse 55, 8033 Zurich, Switzerland.  They can

          also arrange tax-free exchanges as described in idea

          #48.)  

          

          50) Are you sitting on bonds that have appreciated

          substantially?  Many investors are sitting on gains

          after the bull market of the last few years.  There's a

          cute trick you can use if the bonds are currently

          selling at a premium over their face values.  Sell your

          bonds and take the gain.  Then you can buy the same

          bonds back.  You bought these bonds at a premium, and

          the tax law allows you to amortize a premium over the

          life of the bond.  So you get a tax deduction to offset

          the interest earned on the bonds.  The closer a bond is

          to maturity, the higher the deduction will be.

          

          51) You can deduct the loss on a bad stock investment,

          without taking yourself out of the market.  Normally

          you cannot sell a stock, take the loss, then buy the

          stock back.  The "wash sale" rules prevent you from

          taking the loss if the stock is purchased within 30

          days of the sale.  But the wash sale rules don't apply

          if you sell the stock and contribute the cash to your

          IRA.  If you still like the stock, you can have the IRA

          repurchase it.

          

          52) You may have purchased bullion coin investments in

          the 1970s and 1980s at prices substantially higher than

          today's levels.  For instance, gold is now trading in

          the $400 per ounce range, less than half of its

          historic high of more than $800 per ounce.  Silver is

          also trading much lower than its previous peaks.  These

          low prices in tangible assets may not last for long.

               Because stock "wash sale" rules do not apply to

          coins, International Financial Consultants (IFC) has

          developed a program that enables you to take advantage

          of today's low prices to reduce your tax burden by

          taking losses on your coin investments to offset

          current ordinary income, or to shelter gains that you

          have realized on your other investments.   Investors

          owning bullion coins that have declined in value can

          sell those coins to IFC, thereby creating a deductible

          loss, and will have the option, but not the obligation,

          to buy the same coins back from IFC, or can buy other,

          materially different coins or metals from IFC. 

               Provided that the transaction meets the criteria

          set forth in the laws and regulations, any loss

          resulting from your sale or exchange can be deducted up

          to $3,000 of ordinary income, or can be deducted

          against capital gains on other investments, with the

          ability to carry unused losses forward to future years. 

          This deduction will be available even if you exercise

          your option to repurchase the coins from IFC.  Contact

          International Financial Consultants Inc., Suite 400A,

          1700 Rockville Pike, Rockville MD 20852.  (More

          information on IFC is at idea #79).

          

          53) Buying into new passive investments also avoids the

          passive loss limit.  Instead of buying new tax shelters

          in the future, you buy into new passive activities. 

          But remember that passive activities are different from

          investments or portfolio income.  You want to buy into

          partnerships or directly into businesses.  Parking lots

          are frequently mentioned as good for the purpose

          because they produce high, reliable income and there is

          no question that they will be passive activities. 

          Other passive investments, such as real estate income

          partnerships, have higher risk and even under the best

          assumptions will not produce much more income than the

          money market.

               A sideline real estate investment still reduces

          taxes for most taxpayers.  The passive loss limitation

          does not apply to the first $25,000 of losses each year

          from real estate investments in which the investor

          actively participates.  This means that the

          professional or salaried employee with one or two

          rental properties on the side can shelter a lot of

          income from taxes.  The rental activity should be

          arranged so that there is no question of your

          participation being active.  This means you should

          collect rents and arrange for repairs to be done.  If

          you have reliable properties and tenants this shouldn't

          cause too many headaches.  But the $25,000 loss

          allowance is reduced for investors with over $100,000

          of other adjusted gross income.  The loss is eliminated

          at $150,000 of adjusted gross income.  If your income

          is beyond that, you are subject to the regular passive

          loss rules.

          

          54) Oil and gas investments come through recent tax

          changes relatively untouched.  Intangible drilling

          costs are still deductible as before, except for costs

          related to foreign properties and those incurred by

          integrated oil producers.  The percentage depletion

          also is still intact except it is not allowed to offset

          lease bonuses, advance royalties, or any other amount

          payable without regard to production.  In other words,

          you don't take the percentage depletion deduction until

          you actually start to receive income from the property. 

          Oil and gas investors also get an exemption from the

          passive loss limitation.  But the investor must have a

          "working interest" in the business and the form of

          ownership must not limit the investor's personal

          liability for the project.  IRS regulations will later

          flesh out the definition of working interest, and it

          remains to be seen how active an investor must be

          before taking the oil and gas writeoffs against

          non-passive income.  In short, oil and gas investments

          generally retain the rules in effect before tax reform. 

          One rule worth recalling is that a cash investment in a

          drilling program is deductible in the year made only if

          the money is spent within that year and the first two

          and a half months of the next year.  Investors should

          be able to find tax reduction opportunities in oil and

          gas.  The question is whether these opportunities are

          worth the economic risk.