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How Stocks Can Lower Your Taxes

With the right education, stock trading can produce major tax benefits

People who make a lot of money in the stock market are well educated about how the market works—as one might expect. As Robert Kiyosaki preaches, they understand how to make money whether the stock market is going up, down, or sideways. They don’t rely on the strategy of buy, hold, and pray the stock goes up. Instead they understand how to use options, futures, and other hedges to reduce their risk.

Even though these people are highly educated when it comes to the stock market, they are often less educated about taxes.

Before I get into the tax benefits of stock trading, let me first tell you about a major trap to avoid—the mutual fund trap.

The Mutual Fund Trap

Mutual funds are the most common form of stock market investing. The problem is that mutual funds contain a tax trap that many people don’t know about. The income earned in a mutual fund is not taxed to the mutual fund, instead it’s taxed to the investor.

If you invest in a mutual fund, you will likely buy into a fund that has been around for many years. Over the years, the investors have come and gone while the fund has purchased many stocks over that same period.

For example, let’s say you made the decision to invest in Mutual Fund A at the beginning of the year. The fund bought Stock B for $10 per share fifteen years ago. When you joined the fund at the beginning of the year, Stock B had a parket value of $50 per share. The day after you joined, the fund managers decided to sell the stock. So there is a gain to the fund of $40 per share on Stock B. Who pays the tax on the $40 gain? You do.

The Benefits of Options Trading

Due to the complexity of these special rules, please be sure to work with a qualified tax advisor in your country to determine whether you qualify.

In business, a way to make expenses deductible is to make them an ordinary and necessary business expense. This is difficult to accomplish trading stocks because you aren’t investing for other people, so aren’t technically a business.

There is an exception to the business requirement, however, for people who are in a trade. A trade includes doing work only for your benefit so long as it is a major part of your time and wealth building activities. When you are in a trade, you get to deduct your expenses just like you would if you were a business.

You get to deduct your expenses as ordinary deductions, and your trading gains are capital gains—not ordinary income which is taxed at a higher rate. This is even better than if you were a business owner.

The Benefits of Active Stock Investing

Unlike the passive mutual fund investor, the active stock investor can receive many tax benefits. The most obvious is that gains in active stock investing are capital gains, and unlike mutual fund gains, you only have to pay tax when you sell them.

In many countries, like the United states, you get a lower tax rate when you have long-term capital gains. Meaning, that you held the asset for a time specified by your country’s tax law. In some countries like Australia, Japan and the United States, long-term is considered one year and a day.

 

The Better the Tax Benefit, the More Complicated the Rules

This is a general rule for all tax benefits and it’s why the wealthy depend so heavily on tax advisors. The reason is because the government wants to limit tax benefits to very specific circumstances. In order to define those circumstances, the rules can get a little complex. You don’t need to understand the detailed rules, just be sure your tax advisor understands the rules that apply to you.

To learn more about tax benefits, read my book Tax Free Wealth.