When it comes time to take your tax deductions at the end of the year, investment fees can be a bit complicated. Certain fees are considered part of the transactional cost of trading, while other fees are considered expenses incurred while generating taxable income. Your tax deduction varies depending on the type of fee and whether the asset is a mutual fund.
Types of Fees
To determine exactly what you may deduct on your income tax and how it is deducted, first determine what type of fee you have. Most investment advisors charge fees in one of two ways, although they may use both methods. The first option is a transaction-based fee schedule. These fees, commonly known as commissions, are charged when you buy or sell a trade. You may also have a processing fee for each transaction. These fees go to pay various entities, like the stock exchange, for the cost of actually executing a trade. The second fee system is an investment management fee. This is a fee you pay to your advisor to manage your account and make recommendations. These fees are usually based on the value of assets in your account and are not related to any particular transaction.
The Internal Revenue Service sees commissions and other transaction-based fees as part of the cost of the asset. If you buy or sell a stock, the extra amount you pay for commissions and processing becomes part of the cost basis for the asset. This means that when you sell the asset, those costs are deducted from the total profit you made on the sale and reduce your taxable capital gain. You cannot write off commissions and processing fees as a line item deduction; they are only accounted for upon the sale of the asset.
Investment management fees are a bit different. The IRS considers these fees, charged by an expert for professional advice, to be like accountant's fees and other expenses incurred while making money. Therefore, you may deduct investment management fees as a line item on your 1040 form. The fee must be incurred while producing taxable income, and is recorded on line 23 as a "miscellaneous expense not subject to the two percent limit." Account custodial fees, trustee fees and fees incurred when you collect interest or dividend payments from your advisor are also deductible.
Mutual funds operate somewhat differently. The investment management and operating fees for the fund are built in to the share price, and are part of the asset's cost basis like commissions. These fees are deducted from the total value of any profit you make on the fund and reduce your taxable capital gain. If you pay an advisory or custodial fee on an account holding mutual funds, however, you may still deduct that fee on line 23 of your 1040 form.
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