Tax forms. (Photo: Eileen Blass, USA TODAY)

For many Americans, a tax-deferred account like a 401(k) or IRA is the primary way they invest.

But while these have big advantages, allowing your gains to compound without the sticky fingers of the IRS, they typically require you to be patient; Most 401(k) or IRA investors are subject to steep penalties if they withdraw money before age 59½.

The good news is there are no time constraints placed on mutual fund or ETF purchases in a taxable account.

But there are, however, more complicated tax rules if you go this route.

Determining your cost basis and purchase date

The first order of business is to establish your cost basis, because investors are only taxed on the gains they cash out. And the second order of business is to establish whether these profits are short-term or long-term capital gains based on your time of purchase.

Long-term capital gains taxes apply to any investment held for a year and one day, and commonly tally a 15% rate. By comparison, short-term capital gains taxes typically range 25% to nearly 40% of your profits, depending on your income bracket.

As such, it’s important to establish as long an ownership period as possible in order to avoid short-term taxes at a higher rate.

There are three basic ways to do this:

• First-in first-out: Typically, the default method for mutual fund providers, with the catchy acronym FIFO, this method involves selling your shares in the same order you purchased them. FIFO can be favorable when you have a smaller amount of lots purchased with limited differences in price per share for basis, Lyon said.

• Average cost: The average cost method averages the purchases, including reinvested dividends, and sales price of a security over time and produces a cost basis equal to the average of the purchase and sales transactions, said Leslie Thompson, a certified public accountant and managing principal at Spectrum Management Group in Indianapolis. If all your positions are older but vary greatly in purchase price, it sometimes can reduce your cost basis to average them together.

• Specific Identification: Each purchase you made has a designated number of shares, date and price. If circumstances are right, you can target each individual lot with an individual sale. Of course, you better be sure you have good records if you’re going to get that specific with the IRS.

There’s a fair amount of math involved with comparing cost bases and plotting the most tax-efficient strategy.

But Lyon, a registered investment adviser, stresses that a sound investing strategy should always come first — and calculating your taxes much later.

I have seen clients hold on to investments because they didn’t want to incur additional taxes, resulting in a loss for not selling based on fundamental reasons, he said. Typically the tax savings that could be generated by trying to play the tax game too much does not outweigh making fundamental investment decisions.

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