Are investments tax deductible?
In general, the answer is no because an investment is an asset.
Investing is purchasing an asset that you’re hoping will go up in value. For example, you buy Apple stock for a couple thousand dollars and hold it for a few years and then it’s worth $3,000.
Now you want to sell it because it’s at a gain, but you also pay taxes on the gain. You sold it for $3,000 and you bought it for $2,000.
You are actually taxed on that $1,000 gain. You did not get to deduct the $2,000 when you actually bought the asset, but on the other hand, when you sold the asset that $2,000 became your cost basis and you only pay taxes on the $1,000 gain.
Capital gains are not all bad because they are at a lower tax rate. There’s a 0% rate, a 15% rate and a 20% rate.
2018 Federal Capital Gain Rates
Single Taxpayers
| Taxable Income | Tax Bracket | Short-term Capital Gains Rate |
| Up to $9,525 | 10% | 10% |
| $9,526 to $38,700 | 12% | 12% |
| $38,701 to $82,500 | 22% | 22% |
| $82,501 to $157,500 | 24% | 24% |
| $157,501 to $200,000 | 32% | 32% |
| $200,000 to $500,000 | 35% | 35% |
| $500,000 and over | 37% | 37% |
| Taxable Income | Long-term Capital Gains Rate |
| Up to $38,600 | 0% |
| $38,601 to $425,800 | 15% |
| $425,801 and over | 20% |
Married, Filing Jointly Taxpayers
| Taxable Income | Tax Bracket | Short-term Capital Gains Rate |
| Up to $19,050 | 10% | 10% |
| $19,051 to $77,400 | 12% | 12% |
| $77,401 to $165,000 | 22% | 22% |
| $165,001 to $315,000 | 24% | 24% |
| $315,001 to $400,000 | 32% | 32% |
| $400,001 to $600,000 | 35% | 35% |
| $600,001 and over | 37% | 37% |
| Taxable Income | Long-term Capital Gains Rate |
| Up to $77,200 | 0% |
| $77,201 to $479,000 | 15% |
| $479,001 and over | 20% |
With the 0% rate, you read that right – 0% – You don’t pay any federal taxes on capital gains.
If you’re in the 10% or 12% ordinary income tax bracket then it goes to 15%, and the 15% bracket goes up to about $425,000 or so for a single taxpayer and about $480,000 for a married taxpayer.
Learn How to Pay 0% in Capital Gains Tax [Video]
Something important to note is investment expenses, like tax prep fees, adviser fees, investment publications, safety deposit boxes, etc. used to be deductible under the old tax law.
You can no longer deduct these under the new 2018 tax law. Miscellaneous itemized deductions are a thing of the past.
Retirement Accounts
There are some exceptions though because some investments are tax deductible. The first one you probably are aware of is retirement accounts.
In many cases with retirement accounts, you make a contribution and receive a tax deduction. There are a few different kinds of retirement accounts.
There are retirement accounts that you control yourself like an individual retirement account or IRA and there are ones that are from your employer.
Let’s start with the ones you control.
IRA
You can put $5,500 per year into an IRA or $6,500 if you’re 50 and older. For an IRA, you, or your spouse, have to have an earned income and you have to be younger than 70 ½.
You may or may not get a tax deduction because, the truth is, it depends on whether you or your spouse are already in a retirement plan and your income levels. Although, be aware that you can always put money into an IRA, whether you get a tax deduction or not.
The better retirement plans are through your employer.
Simple IRA
This is where you hope you have an employer that has a pension plan. To start, a simple IRA is usually one of the first things a small business might do. This allows you to put up to $12,500 of your paycheck into this simple IRA and that’s a deduction from your salary.
If you make $100,000 in salary and $12,500 goes to the simple IRA, you’re going to pay tax on about $87,500. You don’t pay taxes on the $12,500.
Now if you’re 50 and older, you can contribute $15,500 to a simple IRA. It is important to note that these assets, although it’s a tax deduction, initially grow tax-deferred. This means when you pull those assets out in your retirement, you will pay taxes at that time.
401(k)
If your employer is a bigger company, you might have a 401(k) plan, that’s a little bit better than a simple IRA because you can put more money into it. Your limit is $18,500 or $24,500 if you are 50 and older.
403(b)
In many cases, your employer is going to make a match. If you work for public schools or nonprofits you may have a 403(b), that is the same idea as a 401(k), it has the same limits, $18,500 and $24,500.
457 Plans
Some of you may be state or municipal employees and have a 457 plan, or in some cases like teachers, for example, may have both plans. With this, you can actually put $18,500 into both plans and double up.
TSP Plans
Then there are TSP plans for federal employees with the same limits, $18,500 and $24,500. Typically, you get a tax deduction when you put the money in and it becomes taxable when you pull it out.
Real Estate
The second kind of investment that is tax deductible in a way, is real estate. When you buy rental real estate, the IRS says you can write off that property slowly over time, creating a deduction.
If you buy a rental house or residential rental, you get to write off the cost of the building. You do have to allocate between land and building; however, you can write off the cost of the building over 27 ½ years. It’s going to take you a long time but you can write it off.
If it’s a commercial property, like an office building or retail, then it’s 39 years.
Natural Resources
Probably one of the best ways to get a tax deduction, at least from a tax standpoint, is when you invest in oil and gas exploration partnerships. Although this is a way to have an investment you can write off, this strategy is not currently recommended due to the fact that they have not done very well over the last decade.
However, from a tax standpoint, they’re fantastic as long as they’re drilling for new oil. You can usually write off the intangible drilling cost 65%, 70%, 80%, in some cases, 90% of your investment in the first year.
Those are three ways you can actually write off your investment.
But maybe that’s not even the best question.
How can you have tax free income?
That is, arguably, an even better question because you know with retirement plans, you put money in, you get a tax deduction, but you have to pay tax later. What about tax-free income?
Roth IRA
Probably the best way to get tax free income is a Roth IRA. A Roth IRA is not too complicated. It’s like a regular IRA; you, or your spouse, have to have earned income and you can put in $5,500 per year or if you’re 50 and older $6,500 per year.
In certain cases, you get phased out of a certain income level, so not everybody can do this, but, there’s no age limit. Meaning, you can be over 70 and a half and still do this.
The second way to get money into a Roth IRA is a Roth conversion. With a Roth conversion, you take some of your IRA, or in some cases, your 401(k), and you convert it from IRA to Roth.
The good thing about this is once it is in a Roth IRA, all future growth, income, and principal is 100% tax-free. The problem with that, of course, is you have to pay tax on what you convert.
Consequently, you want to be careful how much you convert depending upon your tax brackets. If you have a strategy where you’re converting gradually over time, by the time you get to retirement you’ve got a tax-free pool that you can manage your taxes in a significantly better way.
Roth Conversion
Roth conversions do not have an age limit. You can be any age as long as you have an IRA or a 401(k); you can be working, or you can be retired.
Often times, there is quite a bit of confusion. On a conversion you don’t have to be working; however, on a contribution, you or your spouse do have to be working.
Additionally, for a conversion, there is no earned income limit causing there to be no dollar amount limit.
In other words, you can convert as much as you want, but you want to be a little careful because if you convert too much you might go into a higher tax bracket. Many people realize tax-free income is the best way to go.
How to Get the Most Out of Your Roth IRA
Now, just a couple strategies on how to get money to a Roth IRA efficiently.
1.
One way is to convert when you’re in lower tax brackets.
Sometimes you’re self-employed and you have a year where you don’t make much income. This puts you in a low tax bracket so you should convert to fill up those low tax brackets.
Sometimes one of the spouses has left their job and they’re out of work for six months or longer. Again, your income is lower and it might be good to fill up those lower brackets with a Roth conversion.
2.
Another option is, you retire and before you take Social Security and before you take the required minimum distributions on your IRAs or 401(k)s at 70 ½, maybe you’re in a lower bracket. You could fill up those lower brackets.
3.
Another way is to convert up to your current bracket. After you do a little analysis you might figure out, “You know what, the bracket I’m in today is the bracket I’m going to be in at all times in the future”. So why not convert in that same bracket to get some tax-free income and flexibility in the future?
4.
Then finally, many folks are able to create tax deductions. Whether you’re a business owner with deductions, a rental property owner, your employed and you max out your 401(k) or your 403(b), or maybe you have some charitable strategies where you give extra money to charity, all lower your taxable income. That allows you to do a much higher Roth conversion.
2018 is perhaps the best time ever, considering Roth conversions have only been around since 1997.
Why?
As of 2018, tax brackets are relatively low.
For a married taxpayer, you can have taxable income up to $315,000 and still be in the 24% bracket, for a single taxpayer it is half of that, $157,000. That’s a very good tax rate.
2018 is really a great time to be doing Roth conversions because the rates are low. Who knows how long we’re going to have these rates – we know they are set to expire in 2025. Nevertheless, there are no guarantees they may change sooner than that.
Maybe we get these low rates longer, but we know they’re here right now. Roth conversions are definitely a great strategy for having a tax-free income in the future in retirement.
Summary
Many investments are in fact tax deductible. Retirement accounts oftentimes receive a tax deduction or may be tax-deferred. Conversely, real estate is tax deductible and can be written off over time, as are natural resources – although natural resource investments are not currently recommended. Arguably, tax-free income is the best way to go through a Roth IRA or Roth conversion. If you would like to learn more about this topic, read our blog post on tax efficiency tips that you need to know.
