Making a Market

Q: What's a "market maker"? — T.F., Lake City, Fla.

A: We tend to imagine that when we buy stock we're getting those shares directly from a shareholder who's selling, but that isn't quite the case. Stocks are generally bought and sold through market makers. They maintain a fluid market and earn their keep by pocketing some or all of the spread between the purchase and sale price. They'll typically keep some shares in inventory, too. That way, if someone wants to buy shares and no one wants to sell at that time, they can sell from inventory.

Q: On my tax return, can I deduct brokerage trading commissions from my net capital gain?

— A.B., Atlantic City, N.J.

A: Yes, you can — and you should. The costs of buying or selling a capital asset (stock, in this example) are capital costs, and they need to be factored in to your cost basis and proceeds.

Imagine buying $3,000 of stock and paying a $30 commission. Your actual cost is $3,030. You sell the stock later, when it's worth $4,000, paying another $30 to the brokerage. Your "net" sales proceeds (generally, the amount reported to you by your broker at year-end on your Form 1099B) would be $3,970 ($4,000 less $30). On your tax return, you would report a gain of $940 ($3,970 less $3,030 equals $940). By ignoring the cost of commissions, your gain would be $1,000, and your taxes higher.

This exercise can help you focus on how much you're paying in commissions. For many investors, it's too much. Many reputable brokerages charge just $10 or less per trade. For tips on finding a good brokerage, visit www.broker.fool. com and www.sec.gov/answers/ openaccount.htm.

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