As a homeowner, you should be aware of the many tax benefits that go along with ownership. At Dagley & Co., we compiled a list of tax benefits that will be helpful for the current and next year’s tax season:
Mortgage Interest Deduction – Although it may seem that you will never get that mortgage paid off, keep in mind that unmarried taxpayers and married couples can deduct, as an itemized deduction, the interest on up to $1 million of acquisition debt plus $100,000 of equity debt on their first and second homes, provided the loans are secured by the homes. A married taxpayer filing separately is limited to deducting the interest on $500,000 of acquisition debt and $50,000 of equity debt.
Home Improvement Loan Interest Deduction – If you took out a loan secured by your home to make improvements on your main or a second home, that mortgage is treated the same as home acquisition debt, and the interest you pay on that loan is deductible as acquisition debt, so long as the combined total acquisition debt of the two homes does not exceed the $1 million limit on acquisition debt. Even if it does exceed the $1 million limit, the excess interest on up to the $100,000 equity debt limit may still be deductible. However, if you used the loan money to make repairs rather than improvements, the debt would only qualify as equity debt.
Equity Debt – If you used the equity in your home to borrow money to buy a car, take a vacation, or for another use, interest paid on that debt is deductible up to the $100,000 equity debt limit. That is why it is sometimes better to finance large purchases with a deductible home equity loan rather than a non-deductible consumer loan.
Property Tax Deduction – If you itemize your deductions, you can deduct the property taxes you paid during the year on your home. However, be careful; generally property taxes are billed on a fiscal year basis, so the amount billed may cover parts of two years. You can only deduct what you actually paid during the year. If you have an impound account (sometimes called an escrow account) with your mortgage lender, the amount paid will be included on the lender’s annual statement. Also be aware that if you are subject to the alternative minimum tax (AMT), a deduction for taxes is not allowed when computing the AMT.
Private Mortgage Insurance Premiums – Generally when home buyers are unable to make a 20% down payment when purchasing a home, the lender will require them to obtain private mortgage insurance (PMI) and the insurance premiums that go along with it. To be deductible, the insurance contract must have been issued after December 31, 2006. Those premiums are deductible if incurred for the purchase of your first or second home, and they are not limited by the $1 million limitation on home acquisition debt.
The deductible amount of the premiums phases out ratably by 10% for each $1,000 by which the taxpayer’s AGI exceeds $100,000 (10% for each $500 by which a married separate taxpayer’s AGI exceeds $50,000). If AGI is over $109,000 ($54,500 married separate), the deduction is totally phased out.
Congress failed to extend this deduction, and thus 2016 is the last year for it. If you are stuck with a PMI and your equity in your property has grown to be greater than 20% (you’ve paid down the mortgage balance to 80% of the home’s original appraised value), you may want to contact your lender about removing the PMI, refinancing to get rid of it, or obtaining an updated appraisal. When the balance drops to 78%, the mortgage servicer is required to eliminate PMI. (These rules generally don’t apply if your loan is guaranteed by the Federal Housing Administration (FHA) or Department of Veterans Affairs (VA).)
Solar Energy Credits – Through 2021, taxpayers can get a tax credit on their federal tax return for purchasing and installing solar electric or solar water heating systems. The credit is 30% of the cost through 2019, at which time it begins to phase out and the credit is reduced to 26% for 2020 and 22% for the final year of 2021.
The credit is nonrefundable, which means it can only be used to offset a taxpayer’s current tax liability, but any excess can be carried forward to offset tax through 2021. Both the solar electric and the solar water systems qualify for credit if installed on a taxpayer’s primary and secondary residences. However, no credit is allowed for heating water for hot tubs and swimming pools.
Impairment-Related Home Expenses – If you, your spouse or a dependent living in your home has a physical handicap and you make modifications to the home or install special equipment to alleviate that disability, those costs may be deductible as a medical expense. The portion of the cost of permanent improvements that increases the value of the home is not deductible, but the difference can be included as a medical expense. However, home modifications made to accommodate a home for an individual’s handicap generally do not increase the value of the home and can be included in full with your medical deductions. These improvements include, but are not limited to, the following items:
- Constructing entrance or exit ramps for the home,
- Widening doorways at entrances or exits to the home,
- Adding handrails, support bars and grab bars,
- Lowering or modifying kitchen cabinets and equipment, and
- Installing porch and stair lifts.
Points Deduction – Points are a form of prepaid interest; one point is equal to 1% of a loan amount. Points are often labeled “loan origination fees,” “premium charges,” etc. At times, certain loan charges may be called points but are really amounts lenders charge for setting up a loan. Such “service charge points” aren’t normally deductible.
Generally, prepaid interest must be amortized (deducted) over the life of a loan; however, tax law carved out a special rule that allows points incurred for purchase of a primary residence to be fully deducted on the return for the year in which they are paid. This special rule also applies to loan points incurred for home improvement loans.
Home Office Deduction – If you are self-employed, you may qualify for a deduction for the business use of your home, commonly known as the home office deduction. You may also qualify if you are an employee and the use of the home is for the convenience of the employer. In either case the portion of the home used for business qualifies for the deduction only if it is used exclusively for business.
There are two methods that can be used to determine the deduction: (1) the actual expense method, where you prorate the home expenses such as utilities, insurance, maintenance, interest, taxes and depreciation, or (2) a simplified deduction, which is $5 per square foot of office space, with a maximum square footage of 300. If the latter method is used, mortgage interest and real property tax deductions may be claimed as usual as part of itemized deductions, but a proration of other home-related expenses isn’t deductible. In either case, the deduction is limited to the income from the business activity.
If you have questions about any of these tax related home ownership deductions/issues, give Dagley & Co. a call. Or, are you considering purchasing a home? Dagely & Co. will help you to understand how the home ownership will impact your taxes.
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A Roth IRA can provide tax-free retirement income, but it doesn’t just happen. Before its earnings can be withdrawn tax-free, the account must be “aged.”
Unlike traditional IRA accounts, contributions to Roth IRAs provide no tax deduction when they are made, and unlike traditional IRAs, earnings from Roths are tax-free if a distribution is what the IRS refers to as a “qualified distribution.”
A qualified distribution is one for which: One, the account has satisfied a five-year aging rule AND meets one of the following conditions: the distribution is made after the IRA owner reaches the age of 59.5, the distribution is made after the death of the IRA owner, the distribution is made on account of the IRA owner becoming disabled, OR the distribution (up to $10,000 lifetime, or $20,000 if filing jointly and the spouse also has a Roth IRA) is for a first-time homebuyer purchasing a home.
Figuring the five-year aging period can be tricky, and the holding period can actually be significantly less than five years. The five-year period:
Begins on the earlier of: the first day of the individual’s tax year for which the first regular (i.e., non-rollover) contribution is made to any of the individual’s Roth IRAs, or the first day of the individual’s tax year in which the first conversion contribution is made to any of the individual’s Roth IRAs; and ends on the last day of the individual’s fifth consecutive tax year beginning with the tax year described in either (a) or (b) above.
What complicates this a bit is the fact that a contribution to an IRA for a particular year can be made through the filing due date for the tax year in which the contribution applies. For example, an IRA contribution can be made as late as April 17, 2017, for the 2016 tax year. Thus, the five-year holding period would begin January 1, 2016, and end on December 31, 2020, so any distributions made January 1, 2021, and later would meet the five-year aging period. Each time a contribution is made to the Roth account, the aging period does not start over.
The five-year aging requirements apply separately for traditional IRA conversions to a Roth IRA referenced in (b) above.
If for some reason you decide to take a non-qualified distribution from your Roth IRA, i.e., one that does not meet the definition of a qualified distribution (discussed above), then the distributions are treated as made in the following order: from funds originally contributed as Roth contributions (which have no tax consequences), then from conversions of other retirement funds to a Roth IRA (which would be subject to early withdrawal penalties), and finally from earnings (which would be both taxable and subject to early withdrawal penalties).
If you are planning early retirement or planning to tap your Roth IRA account and wish to explore your options while minimizing taxes and penalties, please call Dagley & Co. for an appointment.
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The IRD deduction is one of the most overlooked tax deductions. IRD is the acronym for income in respect of a decedent. So what is IRD income? It is income that is taxable to the decedent’s estate and also taxable to the beneficiaries of the estate.
Estate tax is a tax on property transfers. Thus, when an individual dies, the value of all of his property is added up and the amount that exceeds the lifetime estate tax exclusion (currently at $5.45 million) less any prior taxable gifts is subject to estate tax. In some cases the estate includes items that are taxable both to the estate and to the beneficiaries, such as a traditional IRA, uncollected business income, and accrued bond interest. To make up for this double taxation, the beneficiaries are allowed an itemized deduction for the portion of the estate tax attributable to the double-taxed income.
The problem is that the beneficiaries do not receive anything from the estate to make them aware of an IRD deduction or the amount of the deduction, if one exists. A beneficiary must recognize when there is an IRD and a possibility of a deduction and make further inquiries.
The first clue is, did you as a beneficiary of the estate receive a Form 1099-R or Schedule K-1 with taxable income from the estate? If so, you need to inquire whether a Form 706 Estate Tax Return was filed, and if so, whether it resulted in tax due. If there was a tax due, then there is a good chance you are entitled to an IRD deduction. Request a copy of the 706 Estate Tax Return and provide it to this office so we can determine whether you are entitled to a deduction and if so, how much it is worth.
The deduction is generally the difference in the estate tax figured with and without the double-taxed income. Please call Dagley & Co. if you need additional information.
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It’s 2015, and it is becoming increasingly common for couples to live together and remain unmarried – which can lead to potential tax problems when they share the expenses of a home while only one of them is liable for the debt on that home.
Home mortgage interest can generally be deducted only by a person who is legally obligated to pay the mortgage (in other words, a person who is named as an obligor on the mortgage document). However, there is an exception to the preceding general rule for interest paid on a real estate mortgage when a person is a legal or equitable owner of the real estate but is not directly liable for the debt.
For example, if the one who is not liable on the mortgage makes the payment, that individual is not allowed to deduct the interest portion of the payment, nor is the other person, because he or she did not pay it. This can lead to some complications when one person in a couple earns significantly more income and would benefit tax-wise from an interest deduction, but the other person is the liable party on the loan. It is not uncommon for couples who both work to share mortgage payments in the mistaken belief that they can each deduct their share of the mortgage interest on their individual tax returns.
Although state law governs what constitutes equitable ownership, equitable ownership can generally be established if both parties are on title to the property, even if only one is liable on the loan. The premise behind equitable ownership is that an individual is protecting his or her ownership in the home by making some or all of the mortgage payments.
This position was upheld in a Tax Court decision when the court denied a taxpayer’s home mortgage interest deduction that she paid until she became co-owner of the property with her boyfriend and was legally obligated to make the mortgage payments.
If you are in a similar situation and have questions related to sharing potentially tax-deductible expenses, please get in touch with Dagley & Co.
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