Thursday, August 8, 2013

Investing Tactics I use to Minimize my Tax Bill

Every investor should think about the tax implications of their investment choices.  Following a sound tax minimization strategy will keep more money in your pocket and help boost profits.  Here are some specific tactics I use (or will use in the future) as part of my tax saving strategy.

ROTH IRA Investments:
1) Corporate Bonds:  Interest gained on corporate bonds is fully taxable according to your tax bracket.  Same with interest on foreign bonds and also CDs.  Note that these types of bond mutual funds pay non-qualified dividends.

2) REIT Preferred Stocks:  These dividend payments are non-qualified just like REIT common stock dividends.  The difference is that preferred dividends are typically 100% non-qualified without the return of capital component. 

3) Canadian Corporations:  The last time I checked, Canada withholds a 15% dividend tax on US investors.  An easy way to get around this pesky withholding tax is to place Canadian corporations in a ROTH.  It is my understanding that this applies to corporations only (not Canadian royalty trusts), however I do not have any experience or references to back up that claim.

4) REITs:  Real Estate Investment Trusts pay non-qualified dividends.  Since this income will be taxed at your full marginal rate, IRAs make sense here.  However, many people fail to realize that part of the typical REIT dividend is classified as a return of capital.  You will not be taxed on the full dividend in most cases.  Here is an example:

Realty Income's dividend was 25% ROC for tax purposes in 2012.  The other 75% was fully taxable at the marginal rate.  With that in mind, REITs are well suited for a ROTH, but not the highest priority.

Taxable Account Investments:
1) Municipal Bonds:  Muni interest is always exempt from federal tax and sometimes state/local tax too.  No reason what so ever to put these types of investments in a tax advantaged account!

2) Master Limited Partnerships:  To be honest, the tax implications here are fairly complex.  "Experts" do not always agree.  In my experience, MLPs pay a return of capital which is not taxable but instead reduces the cost basis of the position.  There are some other things going on, but effectively income taxes can be deferred until the asset is sold.  Since MLPs are inherently tax advantaged, it makes sense to hold them in taxable account in order to delay the tax bill as long as possible (perhaps decades).  Also under certain circumstances, it is possible to owe a tax bill with a MLP held in an IRA.  Best to avoid that scenario.

3) Most Foreign Stocks: Most foreign countries slap a withholding tax on dividends paid to US investors.  However, it is possible to claim a credit on this withholding during income tax season.  In order to claim the credit, it would be wise to place foreign stocks in a taxable account (I don't believe it can be claimed in an IRA).  Some countries, the UK for example, do not withhold dividends at all.  As described above, Canadian Corporations can be held in a IRA/ROTH to avoid the annoyance all together.

4) Government/Agency Bonds*:  Investors can side step state and local taxes with government bonds interest which is taxed at the federal level only.  This tax saving feature is redundant in retirement accounts*!  Be sure to do your homework with government agency bonds as some have tax advantages, some do not.
*Certain states do not levy income taxes.  Tax saving benefits of government bonds isn't applicable for residents of those particular states.

5) Dividend Stocks & Non-REIT Preferred Stocks: Take advantage of qualified dividends by placing them in a taxable account.

6) Speculative/High Risk Stocks:  Personally, I would put speculative ideas such as FB, AAPL, TSLA, LINE/LNCO, and most tech stocks in a taxable account in case of a capital loss.  Ideas do not always pan out, at least realizing capital losses in a taxable account would soften my tax burden.  Realizing capital losses in an IRA is not beneficial in any way! 


  1. Compounding Income,

    It is good to keep in mind the tax status of the dividends. The ROTH structure is wonderful the way it stands right now too! I mainly just documenting my taxable brokerage on my blog.

    I prefer long term dividend investing, but with limited capital to buy larger blocks of shares I just speculated with some call options and got a decent profit within last 2 days to put towards some high quality dividend paying stock. I may use long puts and calls strategy from time to time to try and accelerate gains. It is more risky, but I will never use margin for anything.

    1. Personally I do not trade and I would only consider writing covered call options. However, my best friend is a day trader and it is absolutely possible to make money trading (he does extremely well percentage wise). People who think it is not possible to make money trading are wrong! I don't know how to do it, and I don't have time for it, but that doesn't mean others can't.

      Best of luck with your endeavors!

  2. Are you saying that Canada does not withhold 15% of the dividend from stocks that are held in a US Roth IRA? But it would if they were held in a taxable account?

    1. Correct. I have received over 30 dividends from Canadian corporations in my Fidelity ROTH IRA account, nothing has ever been withheld. The corporations paying these dividends are: Toronto-Dominion Bank (TD), Exchange Income Corporation (EIFZF/EIF on TSX) and Bank of Nova Scotia (BNS). Said corporations pay ordinary dividends, nothing exotic. Obviously payments fluctuate with exchange rates.

      I am willing to post screen shots or what ever you want if that would help you out. Finding the actual tax treaty is very difficult. I have attempted to locate it without success.

      Another thought worth noting, Fidelity seems to always be on point with special cases like this. I really like Fidelity in that regard and I highly recommend them. I am willing to pay a little bit extra ($8 commission isn't the best deal) for superior service.