How do I Reduce My Taxes on Investments?

by Rocco Pendola, Demand Media

    You can save money by ditching the daily latte, but that's no fun. Employ other savvier strategies that have a similar effect. By paying attention to your investments, thinking logically and acting accordingly, you can trim your tax bill, which ultimately puts more money in your sock.

    Step 1

    Contribute to a traditional IRA. As IRS Publication 590 details, Uncle Sam allows eligible taxpayers to deduct traditional IRA contributions--up to an annual limit--from their taxable income, thereby reducing their federal tax due.

    Step 2

    Increase the amount of your paycheck you invest in a 401(k). The money you put into a 401(k) reduces your taxable income.

    Step 3

    Don't trade stocks, mutual funds and other equities excessively. While it's nice to realize gains from a winning stock pick, if you make the trade in a taxable account--such as a brokerage account--you produce a capital gain. The IRS taxes capital gains annually.

    Step 4

    Sell losers. If you're looking for a tax break, sell stocks that have produced a negative return. You can report up to $3,000 in capital losses to the IRS each year, as of 2010. First, use capital losses to "offset" capital gains, then deduct the losses from your taxable income, up to the $3,000 threshold. You can even carry over losses greater than $3,000 into future tax years.

    Step 5

    Keep dividend paying stocks and bonds, and mutual funds with high yields, in a tax-deferred account, such as an IRA. If you receive dividends, capital gains and interest in a taxable account, the IRS requires you to pay taxes on these earnings--your investment's "yield"--yearly. However, if you keep them in an IRA, you can reinvest them and hold off on paying taxes until you access the money.

    Tip

    • Roth IRAs don't offer the same up-front tax benefit of traditional IRAs. With a Roth, you cannot deduct contributions from your taxable income, however, you can remove contributions tax- and penalty-free at any time. And, come age 59-1/2, the IRS permits tax- and penalty-free withdrawals of Roth earnings as well.

    About the Author

    As a writer since 2002, Rocco Pendola has published numerous academic and popular articles in addition to working as a freelance grant writer and researcher. His work has appeared on SFGate and Planetizen and in the journals "Environment & Behavior" and "Health and Place." Pendola has a Bachelor of Arts in urban studies from San Francisco State University.