What Do Changes in Tax Deductible Investments Mean for Your Investment Strategy?

January 29, 2020 · 7 minute read

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What Do Changes in Tax Deductible Investments Mean for Your Investment Strategy?

The federal tax reform bill, officially known as the Tax Cuts and Jobs Act (TCJA), made headlines when it passed in December 2017. The legislation is the most dramatic tax overhaul that the United States has seen in several decades. With all the changes that the bill introduced, you might be confused about how it actually affects you.

Championed by President Donald Trump and the Republican majority in Congress, the bill ushered in substantial tax cuts for individuals and corporations, increased the standard deduction and child tax credit, and limited limited local and state deductions to $10,000 . The bill also increased the size of inheritances that are protected from taxes and did away with the Affordable Care Act’s individual mandate, which used to penalize individuals who didn’t have health insurance.

With all those adjustments in the works, you may have missed another aspect of the bill: It eliminated deductions for investment-related expenses.

If you’re an investor or are thinking of becoming one, you may have already noticed the short-term effects of the Tax Cuts and Jobs Act on your tax bill, but what is the long term outlook?

Below, we explain some of the changes and get into a few investment strategy implications.

limited local and state deductions to $10,000

What Investment Expenses Were Tax Deductible Before 2018?

Before the tax reform bill passed, individuals could deduct “miscellaneous” investment-related expenses and fees on their taxes if they itemized deductions.

These investment expenses included:

•   Fees paid for management of IRAs (individual retirement accounts) or Keogh pension plans

•   Fees for investment advice

•   Subscriptions to investing publications

•   Tax or legal advice

•   Trustee fees

•   Rental fees for a safety deposit box

•   The cost of software or online tools for managing investments

•   Anything directly related to the production of investment income

You couldn’t deduct certain other expenses, such as fees for buying or selling stocks. And there was a limit: You could only deduct expenses that exceeded 2% of your adjusted gross income.

If you weren’t deducting these expenses in your tax filings, you can amend previously filed tax returns for three years to include them.

Individuals were also able to deduct investment interest expenses. This refers to the interest paid on loans used to purchase taxable investments, which includes most stocks. You could only deduct as much as your net investment income.

Your net investment income is your investment income (proceeds from selling a stock, shareholder dividends, rental income on a property you own, etc.) minus any commissions or fees associated with the investments.

How Did the Tax Reform Law Affect Deductible Investment Expenses?

The 2018 tax law had some unwelcome news for investors: It eliminated the above mentioned deductions for miscellaneous investment-related expenses between the years 2018 and 2025.

That means, during that span of seven years, investors will not be able to deduct any of the expenses like tax preparation fees or financial advisor fees. If Congress does not make the new tax law permanent, it will expire at the end of 2025.

Because you can no longer deduct the fees you pay to investment advisors, the new tax law provides an incentive to consult advisors who work on commission rather than charging fees.
Commission-based advisors get commissions based on the products they sell you and the transactions you make.

It’s not all bad news, though: For some people, other changes in the tax law, such as reduced tax rates, could make up for the fact that you can no longer deduct things like tax preparation fees.

In fact, investors may not have been benefiting from the existing tax code. Three major limitations were in place that caused investors to lose some or all of their potential deductions:

•   Itemized deductions were reduced if you earned more than a certain amount of income with the 3% Pease limitation .

•   The 2% adjusted gross income (AGI) limitation made it so that you couldn’t receive any benefit until your miscellaneous itemized deductions were greater than 2% of your AGI.

•   If your income and deductions reached a certain level, the alternative minimum tax (AMT) applied. This resulted in a significant or complete loss of your itemized deductions.

With all of these limitations in place, many taxpayers who hoped to get a deduction only got a small one, or none at all.

Investment-Related Expenses Taxpayers Can Still Deduct

Not all tax benefits for investment expenses were changed. There are still some investment-related expenses you can deduct:

Using Capital Losses to Offset Income

Although nobody likes to lose money on an investment, there is an upside. When investors lose money on a security, they have a capital loss. The loss is based on the original value of the asset. If an investor sells and incurs a capital loss, it can offset their income so they pay lower taxes.

Some investors actually sell assets that have gone down in value at the end of a year so that they can use this loss during tax season. If an investor’s capital losses exceed their capital gains, up to $3,000 of the loss can be used to offset income and reduce taxes. Losses greater than $3,000 can offset gains in future years.

Deducting Investment Interest Expenses

Investment interest expenses is the interest on money borrowed to purchase taxable investments, such as stocks. If an investor takes out a margin loan, (money they borrow against stocks or bonds they own,) they can deduct the interest expense from that. They can also deduct interest expenses from other types of borrowed money used to purchase investments.

In order for this deduction to be applicable, there are a few requirements:

•   The investor’s net investment income must be more than the interest expense. For example, if an investor has interest expenses of $500 and investment income of $1,000, they can deduct the interest expense of $500. Additional investment interest expenses can carry forward as deductions in future tax years.

•   The investor must itemize their deductions. To benefit from itemizing and receive the deduction, itemized deductions must exceed the standard deduction, which has nearly doubled. Standard deductions are $24,000 for married couples filing jointly, $18,000 for heads of households, and $12,000 for singles and married couples filing separately.

•   Investors can’t deduct interest from money they borrowed to invest in tax-exempt income, such as municipal bonds.

Turning Qualifying Dividends Into Regular Income

If an investor buys dividend-paying securities, they can turn some of them into income. The dividends that qualify for this don’t count as net taxable investment income and are taxed at 15%.

This is much lower than the rate other dividends are taxed at, which can be as high as 37%. This isn’t something investors usually do unless they have investment interest expenses they are unable to write off.

Investing With SoFi

Since you can no longer deduct investment expenses such as management, you may be looking for a less expensive option. If you’re looking to avoid paying hefty fees to advisors, you could consider opening an investment account with SoFi Invest®. You can open a Traditional, Roth, or SEP IRA, or a general investment account with as little as $1.

Using the SoFi suite of investment tools, you can access all of your financial information in one place. With SoFi Invest®, you can automatically invest a certain amount of money into pre-selected stocks, or hand-select each stock you want to add to your portfolio.

The SoFi platform has zero fees and is easily accessible on your phone. You can also use it to keep track of your monthly expenses, set financial goals, and stay informed about the latest investing news.

And members get complimentary advice from a credentialed advisor. Advisors can help you figure out what mix of investments works best for your goals and risk tolerance, and they adjust your portfolio at least quarterly to make sure it stays aligned with those preferences.

Investing with SoFi means you get the benefits of an automated account and access to a human advisor when you need one.

Does the tax law have you rethinking financial advisor fees? SoFi Invest lets you avoid the high fees while still accessing investment options and personalized advice.

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External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . The umbrella term “SoFi Invest” refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.


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