The Internal Revenue Service generally taxes everything you earn. At the same time, it generally lets you write off anything that you spend to make money. These general principles apply to your investments in equity funds, with one key distinction. Many of the fees and costs that you incur in equity fund ownership are hidden or are contained in your trading activities. They technically aren't deductible, but they do reduce your taxable income.
For many equity funds, the primary fee is the management fee the fund company builds into its return. This fee, usually referred to as the expense ratio, comes right off of the top of what the fund earns. If you have an equity fund investment that yields 9 percent per year, and the expense ratio is 1.15 percent, you'll end up with a 7.85 percent return. The IRS only taxes you on what you actually make, so you'll just be be taxed on the 7.85 percent return without having to claim deductions.
Any trading expenses you incur, such as mutual fund sales loads or brokerage commissions for the sale and purchase of exchange-traded fund, get tacked onto your purchase and sale price, potentially reducing your capital gains. For instance, if you buy a fund with a $10.50 net asset value and a 3 percent sales load, your cost basis will be $10.82 per share -- which includes the 32 cent load. If you sell it for $14.50 per share and don't pay a load, your taxable profit will be $3.68 per share. Commissions work the same way. In an account with a flat $35 commission, if you buy a block of shares for $5,000 and sell them for $7,000, you'll actually pay $5,035 and net $6,965 after the commission. Your taxable gain will be $1,930.
Miscellaneous Fees and Expenses
Many of your other investment expenses are deductible as miscellaneous expenses as long as you itemize your deductions on Schedule A. Money you spend for portfolio management and advice services and for subscriptions to investment research publications is deductible. You can also write off investment-related legal and accounting fees. You can't, however, write off the cost of traveling to investment related seminars, conventions or even stockholders meetings. Furthermore, along with your other miscellaneous itemized deductions, you can only write off the portion of your investment expenses that exceed 2 percent of your adjusted gross income. If your AGI is $200,000, your investment expenses are $5,500 and you have no other miscellaneous deductions, you'll be able to claim a $1,500 write-off, which is the amount that is more than $4,000 (2 percent of the $200,000 AGI).
Retirement Account Fees
When your mutual funds are held in a tax-advantaged retirement account such as an individual retirement account, the rules change a bit. Since your retirement accounts are tax-free either for the money you put in or, in the case of a Roth, for the money that you take out, anything that happens inside of them isn't tax-deductible. However, if you pay any investment or management fees for those accounts with money from outside of the account, you can deduct that expense with your other investment expenses on Schedule A.
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