Tax Planning Opportunities
There are several tax planning opportunities within the topics covered in this chapter.
Itemizing “normal living costs.” For several decades, it has been the goal of most Americans to get rid of their monthly rent and own their own home. Part of the lure is being able to deduct part of the cost of home ownership—the interest and real estate property taxes. But home ownership is an individual lifestyle decision, as well as financial planning and tax avoidance decision. It is very difficult to compare living in a rented house or condominium compared to owning them because of many subjective factors, but we can compare the financial ones because we can measure them.
Example
Deanna is considering buying a townhouse. She can rent one for $2,200 per month in the same general neighborhood as the one she is considering buying. She can buy a two bedroom, one-and-a-half bath unit for $230,000. She plans on putting 5% of the purchase price down and financing the rest with a mortgage (which includes extra insurance for a low down payment) at 6.5%. Here are the comparative costs:
Rental costs: $2,200 × 12 months = $26,400.
Mortgage loan (1st year): principal $2,444 + interest $14,129 + homeowners insurance $980 + real estate taxes $2,400 = $19,953.
Since Deanna is in the 25% tax bracket, she will be able to itemize and save $4,132 = 25% × ($14,129 + $2,400). This would leave a net cost of the mortgage at $19,953 – $4,132 = $15,821. It was assumed that the itemized deductions would be greater by $14,129 than the standard deduction for a single taxpayer. The net ownership cost does not account for earnings on the down payment of $11,500 (at 5%, the earnings would be $575), repair and maintenance costs borne by Deanna, and the increase in equity being from the monthly principal payments and increase in real estate values, if any.
Choosing not to itemize. The new standard deduction add-on for property taxes could result in the decision not to itemize deductions. When a taxpayer’s itemized deductions slightly exceeds the basic standard deduction, the new deduction could affect the choice made.
Example
The Carpenters have total itemized deductions in 2008 of $11,500 including $2,300 in property taxes on their home. Prior to 2008, the Carpenters have itemized deductions but using the standard deduction will result in a deduction $400 higher than itemizing. The standard deduction includes the $10,900 basic plus $1,000 (amount paid up to a maximum of $1,000 on a joint return), totaling $11,900.
No benefit from monthly payments. The post–World War II baby boom is retiring. For taxpayers who have been making monthly mortgage payments, itemizing deductions has been an annual habit. Now however, the interest on those payments is much smaller and the sum of mortgage interest and other itemized deductions may be less than the standard deduction. In this situation, no tax benefit is received from the mortgage interest payments.
Taxpayers may wish to pay the mortgage off as quickly as possible since few investments earn a guaranteed tax free return equal to the interest rate on a home mortgage.
Donating property. Many common items, like clothing, furniture, rugs, and appliances, can have a value and become a contribution and itemized deduction. Taxpayers can contact charitable organizations to determine if certain items are wanted and then carefully document the gifts.
Donate appreciated property. Taxpayers may wish to donate appreciated stock or other appreciated property to charity rather than cash. If the gift is properly structured, a full deduction may be taken for the fair market value of the donated property, while tax on the appreciation is avoided completely.
Timing itemized deductions. A cash basis taxpayer may charge year-end expenses on a credit card and still deduct the expenses even when payment on the credit card is not made until the next year. Instead of paying medical bills, charitable contributions, or even property taxes by check at the end of the year, the taxpayer may prefer to charge the expense. Note, however, that the credit card may not be issued by the company supplying the deductible goods or services, but must be a card issued by a third party.
Combining business and pleasure while traveling. The rules for deducting travel and education costs do not prevent a taxpayer from combining a business trip with a trip for pleasure (vacation, visiting family and friends). Not all the costs will be deductible, but if structured correctly, the majority of the cost can be deducted.
