Growing Without Rain

News and Views about Taxes

“Can I deduct…?” part 2

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In Part 1, I talked about “above the line” deductions – deductions available directly on form 1040 for any taxpayer who qualifies. There are other deductions that are available to taxpayers who itemize on Schedule A.

Let me start with some things that are NOT deductible, and about which I get asked:

    Personal loan interest. This includes interest you pay on your credit cards, car loans, and most other types of borrowing other than student loan interest (deducted above the line) and the types of interest mentioned below.
    The value of your time or services that you donate to charitable organizations. You might spend a couple of days per week volunteering at your child’s school, and you might work very hard in doing so while saving the school some money on teaching assistants – but the cost of your time isn’t deductible.
    Donation of the right to use property, as opposed to the property itself. For example, if you have a week at a timeshare, and one year you decide to donate it to your church to be auctioned off, you can’t deduct the FMV of the timeshare for that year, because you are retaining the property and only donating the right to use it.
    Homeowner association dues. Even though the HOA might act like a government agency, it’s not one.
    Donations to foreign charities. If the charity is registered in the US, you can deduct the contribution even though it’s for use overseas; if the charity is not registered in the US (except for certain Canadian, Mexican, and Israeli charities), you cannot. This is especially important now with the relief efforts going on in Japan.
    Vehicle registration fee. Again, this might seem like a tax, but when they are not based on the value of the vehicle being registered (and usually they are not), they are not deductible.

So what can you deduct on Schedule A?

    Qualified home mortgage interest. To qualify, the mortgage must be secured by your main home or a second home and either (a) the mortgage proceeds were used to build, buy, or improve the home – AKA acquisition debt; or (b) the mortgages totaled $100,000 or less ($50,000 or less if married filing separately), and no more than the fair market value of your home reduced by any acquisition debt.

    Example: You buy a house for $150,000, paying cash for it. Two years later, the FMV of the home is $200,000, and you find yourself need cash to invest in your business, so you take out a loan for $150,000, secured by the house. Because you did not use the proceeds from the loan to build, buy, or improve the home, you can only deduct the interest on $100,000 of the loan.

    Investment interest. If you borrow money to buy property that you hold for investment – stocks, bonds, collectibles, unimproved land that you are holding for some future unspecified use – the interest on that loan is deductible, up to the amount of your net investment income.
    State and local income taxes. Any income taxes that you paid in 2010 to your state or local taxing authority can be deducted here. This includes withholding from your paycheck, any amount due you paid when you filed, any prior-year refund that you applied to your 2010 taxes, and any estimated taxes that you paid during the year. If you live in a state that requires your employer to withhold taxes for certain benefit funds, such as unemployment insurance or disability insurance, those are deductible as well. In my experience, these are often included as notes in box 14 of the W-2; look for notations such as “SDI” and “SUI”.
    If you got a refund in 2010 for state taxes paid in a prior year, you usually have to include some or all of the refunded taxes back into your income in the year in which you receive it if you took this deduction in that prior year.
    Real estate taxes. This includes any tax that is imposed on the assessed value of real property and imposed at a uniform rate to all such property by the taxing authority. Note that if you bought or sold property during the year, you are allowed to deduct only the taxes paid during 2010 that applied to the period of time during which you owned the property (with the buyer considered to have owned the property beginning on the date of sale), regardless of who actually paid those taxes. Most of the time, this is addressed in closing – one reason to bring the closing statements for the property you bought and sold in the tax year with you when you visit your tax professional.
    Personal property taxes. Like real estate taxes, they are deductible when they are imposed on the assessed value of personal property, and imposed at a uniform rate by the taxing authority to all such property. As an example – in Wake County, North Carolina where I live, we pay a rate of 0.614% on the assessed value of vehicles (whether licensed in NC or not), boats, mobile homes, and aircraft.
    Qualified medical and dental expenses. Broadly, medical expenses include any cost related to diagnosing, curing, mitigating, treating, or preventing disease or that affect any part of the body, as well as any equipment, supplies, and/or diagnostic devices needed for these purposes, plus most health insurance premiums that you pay out-of-pocket with post-tax dollars. You can only deduct these expenses to the extent that they exceeds 7.5% of your adjusted gross income.
    The caveats on deductible medical expenses are worthy of a blog post in and of themselves. Most people with employer-provided health care plans don’t have enough expenses out-of-pocket to reach the 7.5%-of-AGI threshold.
    Charitable contributions. You can deduct charitable contributions that are made to a qualified organization based in the US. Both cash donations and the fair market value of property donations made to an organization or for its use can be claimed. If you benefit from a contribution (e.g. you buy a ticket to a charity ball, or a box of Girl Scout cookies), only the portion of your contribution beyond the FMV of the benefit you receive can be deducted. You can also deduct the costs of driving your personal vehicle to and from volunteer work that you perform for a qualified organization, either the actual costs of gas and oil or 14 cents per mile (keep a written record).
    You have to be able to substantiate any charitable contribution you make. IRS Publication 1771 describes the substantiation requirements.
    Nonbusiness casualty and theft losses. If you lost personal property as the result of a casualty or theft, you may be able to deduct some or all of the lost value. “Casualty”, in this context, refers to a loss from a sudden, unexpected, and unusual event, not something that results from gradual wear and tear. Termite damage to your house wouldn’t be considered a casualty – but a tree falling on your roof during a sudden windstorm would be. You need proof that the loss actually resulted from a casualty or theft (the mere disappearance of money or jewelry isn’t enough proof), and there are a number of reductions that you must apply before you can take any deduction.
    Miscellaneous deductions subject to 2%-of-AGI. To the extent the total exceeds 2% of your adjusted gross income, you can deduct:
    Unreimbursed employee expenses. These are expenses related to your work as an employee that you pay out of pocket and for which your employer does not reimburse you. This can also include costs related to a job search, dues to professional societies to the extent that those help you carry out your job responsibilities, and professional licensing fees. It includes protective gear, and work clothes and uniforms only to the extent that those are required by your employer and are not suitable for regular wear.
    Tax preparation fees. This includes the cost of software or an online provider, if you file that way.
    Expenses of producing taxable income. If you have a hobby that generates taxable income, for example, this is where you’d deduct expenses related to that hobby, up to the limit of your hobby income.
    Miscellaneous deductions not subject to 2%-of-AGI. This is where casualty and theft losses go, also gambling losses up to the level of gambling income declared on line 21 of form 1040. There are some other things that can go here – you can look them up in IRS Publication 17 if you are interested.

    If after you’ve done all of this, the sum total exceeds your standard deduction – itemize. Otherwise, take the standard deduction – but check your state’s laws, too, because some of these may become deductible on your state’s return if you don’t itemize.

    Next: tax credits.


Written by nctaxpro

March 21, 2011 at 3:43 pm

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