Big changes for itemized deductions?

Tax reform talk is heating up again as legislators discuss the proposed tax code overhaul. One of the key proposals would repeal most itemized deductions currently on the books. Although enactment is hardly guaranteed, taxpayers should be aware of the potential impact.

Under current law, some of the most popular itemized deductions include the following:

  • Donations made to qualified charitable organizations are deductible under generous limits, subject to strict substantiation requirements.
  • State and local taxes, including income taxes and property taxes, are fully deductible. State and local sales taxes may be deducted in lieu of income taxes.
  • Qualified mortgage interest, including amounts paid on an acquisition debt up to $1 million, is deductible.
  • Investment interest may generally be deducted up to the amount of your net investment income for the year.
  • You can deduct the excess unreimbursed medical and dental expenses above 10 percent of your adjusted gross income (AGI) for the year.
  • You can deduct the excess miscellaneous expenses (e.g., unreimbursed employee business expenses and tax advisory fees) above 2 percent of your AGI for the year.
  • You can deduct unreimbursed casualty and theft losses above 10 percent of your AGI for the year (after subtracting $100 for each casualty and theft loss).

Under the proposed House plan unveiled on Nov. 2, the deduction for charitable donations and disaster-area casualty losses would be preserved, while certain modifications would be made for mortgage interest and state and local property tax deductions. Other itemized deductions would be repealed.

Selling real estate? Lower your tax bill with this move

Are you trying to sell investment or commercial real estate? If you use an installment sale to help sell real estate, you can benefit from tax deferral and possibly lower your overall tax bill. But watch out for a little-known tax trap.

Here’s what to know

Generally, installment sale treatment is automatic for a sale where you receive payments in the tax year of the sale and at least one other tax year. For instance, if you sell real estate in 2017 and receive payments in both 2017 and 2018, you qualify. Part of the tax due on your gain is taxable in 2017 and part is taxable in 2018.

Note that real estate held longer than one year qualifies for favorable treatment of the capital gains tax. The maximum tax rate on long-term capital gains is only 20 percent, compared with the top ordinary income tax bracket of 39.6 percent.

Why an installment sale may be worthwhile

With an installment sale, you may benefit from the lower tax rate in several years by spreading out payments over time. This reduces your overall tax liability.

Caution: If you sell property to a related party that is then disposed of within two years, all the remaining tax comes due (barring certain exceptions). The tax law definition of “related parties” is more expansive than you might think. It includes:

  • A spouse
  • Children
  • Grandchildren
  • Siblings
  • Parents
  • A partnership or corporation in which you have a controlling interest
  • An estate or trust you’re connected to

Avoid any dire tax results by stipulating in the contract that the property can’t be disposed of within two years.

Finally, be aware that installment sale treatment is only available for gains, not losses. Other special rules may apply, so contact Dye & Whitcomb and we can take a look at your specific your situation.

When fully funding your 401(k) isn’t the best option

Maxing out contributions to your company’s 401(k) plan is almost always a good idea. After all, when you contribute to a traditional 401(k) plan, your current tax bill is lowered. You aren’t taxed on contributions until the money is withdrawn in retirement, allowing your investments to compound tax-free until then. And if your employer matches a percentage of your contributions, you get an immediate return on investment. These are all good reasons to make regular contributions your 401(k) plan.

But sometimes forgoing 401(k) contributions, at least for a while, is the more prudent choice. Consider these three scenarios:

  1. You haven’t established an emergency fund. The rule of thumb is to have enough cash readily available to cover six months of expenses. Otherwise, unexpected events such as job losses, medical emergencies, or personal crises may force you into excessive debt. You may find yourself paying off high-interest credit cards or personal loans long after the misfortune is over, which will set you back in your plans to save for retirement. So, before maxing out 401(k) contributions, set aside enough money from each paycheck to protect yourself with an emergency fund.
  2. You’re laboring under a load of debt. A few hundred dollars on credit cards is no big deal. But high-interest balances of several thousand or tens of thousands of dollars may be cause for concern. It’s usually better to pay off some or all of those balances before contributing extra to a 401(k).
  3. Your company’s investment options are limited. Any matching contribution your company offers should be considered free money. But beyond the company match, survey other places to park your retirement money such as a Roth IRA or indexed mutual fund. Your company may offer funds invested in large-cap American companies exclusively. To diversify your portfolio, look outside your firm’s 401(k) plan for additional investment choices, such as emerging market or international funds that may garner higher returns over time.

Bottom line? Save regularly for retirement, but take a hard look at your overall financial situation before maxing out contributions to your company’s 401(k) plan.

Consider these tax moves before January 1st

Under the tax reform plan recently announced by the Trump administration, most itemized deductions would be eliminated, except those for charitable donations and mortgage interest.

Because of this potential change, you may decide you want to accelerate certain deductible expenses you would have had in 2018 into 2017. Here are three key deductions to consider:

  1. State and local income taxes. This is often a big-ticket item for residents of states with high tax rates. If payments are due on Jan. 1, 2018, pay them in December.

    Alternatively, you may elect to deduct state and local sales taxes. This deduction, which is often a better option for residents of low-tax states, can be claimed in one of two ways:

    • Deduct the actual sales tax paid during the year based on your records and receipts.

    • Use the IRS table. In addition to the table amount, you can deduct tax paid on certain big purchases like cars and boats.

  2. Mortgage interest and property taxes. As with state and local income taxes, you may be able to increase your current deduction by prepaying mortgage interest and property taxes. (Note that the proposed tax reform plan would repeal property tax deductions, but not mortgage interest.)

    You may even consider using a home equity loan to consolidate debts if the interest would qualify as deductible mortgage interest. The loan is secured by your home, so use this technique sparingly.

  3. Charitable donations. Although charitable donations aren’t on the list of proposed tax reform cuts, you can bolster your deduction by making donations late in the year. Be aware that you must observe strict recordkeeping requirements for monetary gifts of $250 or more.

    Suppose you charge a donation on your credit card on Dec. 31. The gift is still deductible in 2017, even though you won’t pay the charge until 2018.

Finally, remember that itemized deductions are reduced for high-income taxpayers. Dye & Whitcomb can help you figure out what deductions are most beneficial for you.