September 16, 2013

It takes money to make money. Even the IRS understands that; which is why most business expenses are tax deductible. The same goes for investment accounts, such as mutual funds and 401(k) individual retirement accounts. Investment accounts generally come with hefty running costs, several of which are tax deductible. This is good news; because even the most basic investment accounts have fees of 1 to 1.5 percent. That may not sound like much, but — as we show below — it translates into big bucks over the years and has a serious dampening effect on the profitability of investment accounts.

The “A” Word

Sadly, many investors are losing out on the juicy tax savings these tax deductions offer because they don’t know which investment related fees are deductible and are afraid an honest mistake will trigger an audit. To clarify any doubts you may have on investment expenses, let’s briefly review the IRS literature on the subject and set the record straight on which kind of investment expenses are deductible and which you are just going to have to learn to live with.

Deductible Investments

Deductible investment expenses must be filed under “Other Expenses” on line 23 of Schedule A of your 1040 Form. According to the IRS’s instructions for line 23, these expenses include “the total amount you paid to produce or collect taxable income and manage or protect held for earning income,” such as “your share of the investment expenses of a regulated investment company.”

However, this does not mean all investment related expenses are deductible. According to Ben Clement, lead tax attorney for Optima Tax Relief, “deductible investment expenses generally include fees from your accountant, lawyer or broker for investment recommendations and advice. However, investors can also deduct expenses for safe deposit boxes, investment books or publications, the cost of insurance premium to protect investments and certain investment related travel expenses. In this way, the tax code incentivizes investment activities by reducing taxable income by the amount of deductible expenses. Investors should be aware that direct costs for buying/selling an investment (ex, broker’s commission) are added to the basis of the property rather than immediately deductible.”

Investor Beware

To better understand the complexities of filing for investment expenses, consider this example. If you invested $50,000 over a 10-year period (assuming a conservative 6 percent return on your investment) in a mutual fund with an expense ratio of 1.11 percent (the industry average in 2013), you would pay a total of $9,457 in expenses. These costs will usually include various types of expenses, such as marketing and distribution fees, sales loads, broker’s commissions and account service fees. If you declared the entire $9,457 as an investment expense, you risk including non-taxable expenses such as broker’s commissions. To avoid this, request an itemized invoice from your investment account manager.

Although you can’t control financial markets or the performance of your investment fund, you can make choices that reduce the cost of investing your hard earned savings. One way is to take advantage of IRS incentives for investors, such as deducting declarable investment expenses from your taxable income. Investment expenses make a big dent in the profitability of your savings and can, over the years, cost you thousands of dollars, even in accounts with relatively modest balances.

Photo: mikey burton