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Home > Taxes > Investors: 5 Tips For Your 2011 Tax Return

Investors: 5 Tips For Your 2011 Tax Return

We are approaching another tax season. If you are an investor with taxable accounts, there is additional work you need to do on your tax return. From my point of view, I like filing out my tax return because I’m a numbers kind of person. Even if you dread filing out your return, there are worse things I could think of you could be doing with your time: like going to work! Considering that investors pay less taxes than workers, I think that it’s well worth the time to make money with investments even if the tax return if more complicated.

Today, I’m going to cover a few tips to make sure you don’t forget the important things as well as red flags you should look out for that could cause you to pay more than your should.

For 2011, there is a huge change that is going into effect, the reporting of cost basis for your investments. This change will eventually cover all types of investments you can purchase from your broker, but it is being phased in slowly. For 2011, the only thing you need to report is the cost basis for stocks positions that were bought and sold in 2011. Your broker was required to collect cost basis information starting in 2011; however, only sales of stocks are impacted this year (in subsequent years, mutual funds and options, e.g., will be part of the requirement).

Here are the important forms that most investors need to consider. Form 8949 is the new form to report cost basis. Less common is the reporting of partnership income/loss on the so-called K-1 which would be relevant if you bought units of a Master Limited Partnership (MLP). If you are interested in some help for filing your MLP K-1, check out this recent article.

Schedule A: Margin Interest Itemized Deductions
Schedule B: Interest and Dividend Income
Schedule D: Capital Gains/Losses
Form 8949: New for 2011, Capital Gains including Cost Basis

Tip #1: Entering Your Dividends

If you earned dividends, your broker will report them in two lines, such as:

Ordinary Dividends: $2,000
Qualified Dividends: $500

This type of reporting is confusing because you might think that your dividends totaled $2,500. But, the Qualified dividends are a subset of the total, so your Ordinary dividends are $1,500 while your Qualified dividends are $500 (total is still $2,000). Fortunately, the broker reports these dividends exactly how they need to show up on your return (a total with a carve out for the Qualified dividends).

The dividends are reported this way so that the lower tax rate for Qualified dividends can be calculated, while still maintaining the full value for total income reporting purposes. So, copy the Ordinary Dividend total to Schedule B as your broker reported them. The Qualified Dividend total goes on Form 1040, line 9B.

Tip #2: Total Sales Don’t Match Your 1099-B

The IRS gets a copy of your 1099-Bs that your broker provides you. These statements summarize all your investment sales during the tax year. It is a relatively easy step for the IRS to compare what was reported on the 1099-B to what you reported in your tax return on Schedule D.

Make sure that these two numbers match. For example, lets say that you had three sales transactions:

  1. Apple (AAPL): $4500.
  2. ExxonMobil (XOM): $2200.
  3. Gold ETF (GLD): $3400.

Let’s say that these were all long term gains. The total sales of $10,100 would be in the long term gains section, column (e) of Schedule D.

New for 2011, you also need to report costs basis for any stock sales that occurred in 2011 for shares purchased in 2011. If you are unsure if you actually did this contact your broker. It’s possible that you sold older shares (if you have accumulated a position over time) instead of the newest ones. The broker is required to report those sales on your 1099-B.

Tip #3: Not Adding Reinvested Dividends To Cost Basis

If you have a Dividend Reinvestment Plan (DRiP) from your broker or transfer agent, this is one issue to look out for. When you report your capital gain for an investment you need to subtract the sale price from the costs basis, which gives you your taxable gain. The transaction stream might look like this:

Jan 1 2010, Bought XOM: $2000.
Jan 1 2011, Bought XOM: $2000.
Dec 1 2011, Sold XOM: $5,000.

When looking at these transactions, your gain is $1,000 ($5,000-$4,000). Don’t forget the the shares added through your DRiP! When you receive a dividend, you pay taxes on this amount so that it adds to your cost basis. You don’t want to pay taxes twice. If you look at the full history of your investment, your broker should provide the following transaction history (this is simplified as if you received only one dividend per year):

Jan 1 2010, Bought XOM: $2000.
Jun 1 2010, Bought XOM: $50 – Dividend reinvestment.
Jan 1 2011, Bought XOM: $2000.
Jun 1 2011, Bought XOM: $100 – Dividend reinvestment.
Dec 1 2011, Sold XOM: $5,000.

When looking at these transactions, your capital gain is $850 ($5,000-$4,150).

Tip #4: Carry Over Investment Losses

If you have a net loss in in your investments during a tax year, you can deduct those losses from your income up to $3,000. The limitation of $3,000 is ridiculously low, it hasn’t been changed in years. If your losses are more than this, you can carry them over the next year to apply to any gains in the future. Don’t forget to do this! You want to make sure you are able claim the full amount of any losses that you incur.

Since short term gains are taxed at a different rate than long term capital gains rates, you need to keep track of two separate carry over numbers.

Tip #5:  Deduct Margin Interest

Taxpayers are able to deduct the interest they pay on their home mortgage. In the past credit card interest was also deductible, but that is no longer the case. If you borrow money to buy stocks, you can also deduct that interest on your tax return. In order to benefit from this deduction you need to first be able to itemize your deductions instead of taking the standard deduction. Also, the amount of margin interest you deduct can’t be greater than your interest or dividend income.

Put another way, you can deduct your margin interest up to the amount of interest income or unqualified dividend income you have (if the income is from qualified dividends it doesn’t count  because this income already has favorable tax treatment).

A typical scenario is that an investor will borrow money to buy stocks that pay income. The difference between the margin interest rate and the income yield on the investment is the earnings spread. Since the margin interest is deductible against the interest income, the investor can get a return and only pay taxes on that interest spread.

Margin interest is reported as an itemized deduction on Schedule A.

Disclosure: I am not a licensed accountant nor do I perform tax return filing in any professional capacity.

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  1. March 10th, 2012 at 23:16 | #1

    Great tips SFI! I’m going to print this off and use as a reference when I stop being lazy and do my own taxes! 😉