Capital Gains Without Tax Pain

For active investors, knowing when to hold 'em and how to fold 'em can help limit your tax ability

and local income tax as well,” advises Haywood. “Otherwise, the interest from a national municipal bond fund may be subject to state and local income tax.” Bolton says that there are also national and single-state tax-exempt money market funds that can provide tax-free interest on cash you’re parking for the short- term.

The same principle holds if you buy individual municipal bonds–local bonds may have double or triple tax-exempt status, while out-of-state bonds are subject to state and local income tax. “If you have $25,000 or more to invest and a knowledgeable broker to work with, you might want to look into buying munis directly,” says McEvilley. “You avoid paying mutual fund fees, and you’ll know that you’ll get your money back at maturity.”

Be meticulous about paying the tax you owe. “You should receive a 1099 form each year from every bank where you have an account, every mutual fund you own and so on,” says Bailey. “If you don’t get them all, ask for the missing ones. You don’t want to underreport your investment income and cause the IRS to pay extra attention to your tax return.”

Tax relief or complication?
Depending on your circumstances and income, this year’s new tax bill could either be a welcomed relief or leave you in a conundrum.

Figuring the tax on capital gains has never been easy. You have to determine which gains are short-term, where assets are held one year or less and taxable at your regular rate, and which are long-term and eligible for favorable tax treatment. The new tax law makes this calculation even more complicated.

“Depending on the holding period and the date of sale, some long-term gains in 1997 will be taxed up to 20%, while others will he taxed up to 28%,” says Larry D. Bailey, a partner at Coopers & Lybrand in Washington, D.C.

These technicalities also apply to capital gains distributions from mutual funds. “The funds will have figure out a way to report which gains fall into which category,” adds Bailey. “Otherwise, investors will not be able to accurately prepare their tax returns.”

For clarification, speak to an accountant specializing in taxes or a tax attorney. You can also check the IRS Web site at www.irs.gov./hot/taxlaw.html.

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