Individual stocks, stock funds, and stock index shares are generally more tax efficient than bonds and other income-generating investments because of the preferential tax rates on dividends and capital gains. You should consider this when deciding whether to own stocks in your retirement accounts — which defer taxes until money is withdrawn and then tax withdrawals at higher income tax rates — or taxable accounts that expose transactions to taxes right away but also allow you to take advantage of tax losses and the lower capital gains tax rate.

Many people don't have large enough portfolios to follow this suggestion to the letter, but remember if you keep your riskier stock investments in your taxable account, you'll be more tax efficient. Riskier investments such as small- and mid-cap stock don't usually pay dividends, so they are, in effect, tax deferred. If you lose value you can sell and report the tax losses on your tax return, cutting the amount of tax you must pay.

Statements to Keep and What to Look For

Many people overpay their taxes on investment gains because they forget to keep good records. Keep your statements showing your purchase until you sell the investment. Then store the statement in your tax records for the year of the sale. Keep monthly mutual fund and brokerage statements throughout the year, and then shred them once the year-end statement arrives. If the year-end statement doesn't include a report of all reinvested dividends and interest from your funds, you'll need to keep each of the monthly statements. The idea is to keep all the statements that establish the cost of your investment — your basis.

Calculating Taxes when You Sell

The difference between what you paid for an investment and what you sell it for is your profit, or your capital gain. Keeping track of your total cost is essential to making sure you don't overestimate your profit and pay too much capital gains tax. Your total cost is the total of all your deposits, plus any taxable distributions such as dividends or capital gains, that you have paid tax on and reinvested. Reinvestments are most common in mutual funds, but you may also have your brokerage account set to reinvest dividends from stocks or ETFs. Additionally, your individual stock account might reinvest dividends.

You might not notice reinvestments because you don't receive any money. The transaction is noted on your account statement and on the year-end Form 1099 that you'll use on your tax return. Many brokerage websites will allow you to keep track of your basis by giving you the chance to enter your cost right on their site. They will usually add additional transactions to your page if the transactions happen through them. Some brokerages will include this info on your Form 1099, making tax filing easier.

Calculating Taxes

Qualified dividends are taxed at a lower rate than interest. Your Form 1099 will tell you if any of your dividends qualify for this special treatment. Individual stock dividends and dividends passed through to you from ETFs are often qualified. Mutual fund dividends are seldom qualified — another appeal of ETFs if you pay income taxes in a tax bracket above 27 percent.

If you sell an investment within one year of buying it, your profit or loss is considered short-term; investments held longer than one year are long-term. Long-term gains are taxed at a lower, preferred rate than short-term gains, which are taxed at income tax rates. If you have both gains and losses in one year, you can count them against each other, dollar for dollar, under a strategy called harvesting your gains. If you need to sell investments to rebalance your portfolio or to withdraw cash, paying attention to the capital gains and losses can save you money. The IRS website, www.irs.gov, has more-detailed information on how this works. Tax laws vary from state to state. Check with your state's treasury department's website or counselors for the tax laws in your state.