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Selling your home – ask a tax pro BEFORE you sign

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It’s been a busy year, and kind of an unusual one. The regular job (AKA “the one that pays the bills”) has been eating into my writing time, and what time I’ve been able to spend on tax matters has been mostly occupied answering questions on . However, there is one issue that has come to the forefront, more or less, and it’s prompted me to write this post.

The housing market still hasn’t recovered from the great meltdown of 2006-2007. Would-be buyers find that they can’t qualify for a mortgage, and would-be sellers find themselves stuck with a home that they can’t sell and can’t afford to keep. It’s not a surprise that people are looking for ways out of their predicaments – and not a surprise that there are others out there who are more than willing to “help” them – for a fee, of course.

For the first time in my 20+ years of doing tax prep, I’ve actually had to deal with people who have become sufficiently concerned about the situation that they are willing to do some form of seller-financed deal. What sellers – and buyers – don’t always realize is that those deals come with tax consequences (surprise!), and the tax consequences can be sticky for both parties.

If you are the seller in one of these deals, you must:

  • Claim the interest portion of the payments you receive from the buyer as interest income on Schedule B of Form 1040.
  • List the name, address, and Social Security number of the buyer as the payer of the interest on Schedule B.
  • Not deduct interest on an existing mortgage that you still have on the property as home mortgage interest on Schedule A. That interest is deducted as investment interest on line 23 instead, and only the amount of that interest (plus other Line 23 expenses) that exceed 2% of you AGI can be deducted.
  • Figure your gain on the sale (if any), and determine whether you want to treat this as an installment sale for tax purposes. Normally, if you have a gain on the sale of a personal residence, all or part of the gain will be excludable. If you can’t exclude the gain (either because it’s not a personal residence or because you didn’t live in it long enough), you can spread it over the life of the contact by using Form 6252, Installment Sale Income, in the year of the sale and each year thereafter.
  • If you are a buyer, the one thing that you need to be sure happens is that the seller records the mortgage in accordance with state law. If the seller does not do that, you will not be able to deduct the interest that you pay the seller. You will also need to list the the name, address, and Social Security number of the seller on your Schedule A to claim the mortgage interest deduction. Note that this is reported on line 11 of Schedule A, not line 10.

    Both buyers and sellers need to be aware that the vast majority of mortgage agreements include a “due on sale” clause – which means simply that the balance of any current mortgage on a property being sold is due to the current mortgage holder when title to the property is transferred. Most mortgage holders, in the current climate, are willing to look the other way as long as they are being paid – but if interest rates start going up, look out, because there’s a good chance the mortgage holder will be more inclined to call the loan if they can get a better deal with someone else.

    Don’t just take the deal to an attorney – get your tax pro involved if you’re thinking about doing a wraparound mortgage, a land contract, or even a straight seller-financed mortgage. You’ll be happy that you did.

    Written by nctaxpro

    March 25, 2012 at 9:43 am

    “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

    “Can I deduct…?” part 1

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    At this time of year, we start getting a steady stream of clients who are worried about owing come April 18. The most common question we get starts out with three little words:
    “Can I deduct…??”

    There are two different classes of deductions: above the line deductions, which can be taken by any taxpayer who qualifies, and itemized deductions, which can be taken by any taxpayer who chooses to file Schedule A instead of taking the federal standard deduction. There is a third category of tax preferences – tax credits – which are deducted directly from the tax that you owe, rather than being deducted from your income before the tax due is determined, and which can also be taken by any taxpayer who qualifies.

    So – what “can you deduct…”? These are above the line deductions, sone of which are well known, some of which are not:

  • Moving expenses. I wrote about this last year, so you can read Part 1, Part 2, Part 3, and Part 4 for details.
  • Educator expenses. If you are an eligible educator (defined as a kindergarten through grade 12 teacher, instructor, counselor, principal, or aide who worked in a school for at least 900 hours during a school year), and you had out-of-pocket expenses for books, supplies, equipment, and other materials used in the class, you can deduct up to $250 of those expenses on line 23 of your 1040. You need proper documentation to substantiate those expenses, and you can’t deduct for anything that would not be considered to be a common expense for an educator.
  • Self-employment. You not only get to deduct half of the self-employment tax that you are required to pay, but you may also get to deduct contributions to a SEP or SIMPLE plan that you establish for yourself, and you may also get to deduct the cost of health insurance that you paid for yourself and you family. You can only deduct these if you have net earnings from self-employment. Check out IRS Publication 560 for details on setting up a retirement plan.
  • If you had a penalty for an early withdrawal of savings from a CD or other savings instrument, you can deduct that penalty on line 30 of form 1040. Your 1099-INT (or 1099-OID if you have one of those) will show the amount of the penalty.
  • If you paid interest on a student loan, and your adjusted gross income was less than $75,000 ($150,000 if married and filing jointly), you can deduct up to $2500 of the interest you paid. You cannot file as married filing separately, and no one else can be claiming you as a dependent. The loan must have been for yourself, your spouse, or your dependent, and must have been for expenses paid during the time in which the individual was enrolled at least half-time in a degree program.
  • If you paid tuition and fees for higher education in 2010, you are not married filing separately or qualify as a dependent of someone else (whether or not that person actually claims you is immaterial), and you cannot take, or choose not to take, an education tax credit for those expenses, you can deduct up to $4000 of those expenses. These expenses must be for you or your spouse or dependent, must be required by an eligible institution as a condition of enrollment, and your adjusted gross income cannot exceed $80,000 ($160,000 if married filing jointly). You must file Form 8917 with your return.
  • If you (or your spouse if married filing jointly) had earned income in 2010, and contributed to a traditional IRA, you may be able to take a deduction for those contributions. Note that this does not include 401(k) contributions or rollovers from another retirement plan. If you are covered by another retirement plan, either through work or as a self-employed individual funding a SEP or SIMPLE plan, your contributions to an IRA may be nondeductable as well. See IRS Publication 590 for details.

    I’ll talk about itemized deductions and credits in later posts.

  • Written by nctaxpro

    March 12, 2011 at 12:51 pm

    Helping the tsunami victims

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    Remember that for your contribution to be tax-deductible it must be directed to a US-based charity. Check out this link at About.com for more information.

    UPDATE: Stacie Clifford Kitts has some more suggestions for you.

    Written by nctaxpro

    March 11, 2011 at 2:03 pm

    Energy-efficient, tax-inefficient

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    Scott Hodge of the Tax Foundation Tax Policy Blog (italics mine):

    Bloomberg recently reported that:

    “Whirlpool Corp. will claim $300 million this year in U.S. tax credits for making energy- efficient appliances, collecting almost four times the government’s estimate for what all companies would receive from the tax incentive.

    The credit will generate about one-third of Whirlpool’s earnings this year, according to the company’s projections.

    Company filings show that as of Dec. 31, 2010, Whirlpool had $555 million in stockpiled business credits and $2 billion in tax losses. Both can typically be used to offset up to 20 years of future income and taxes.”

    There are so many issues raised by this story it is hard to know where to begin. But it provides a good learning moment for why we should not use the tax code to incentivize economic behavior – no matter how noble the cause.

    I couldn’t agree more. Unfortunately, it’s all too easy for our elected representatives to give the appearance of doing something by inserting a preference into the tax code to achieve some desired behavior – only to find that it becomes difficult or impossible to sunset the preference later without blowing up someone’s means of livelihood.

    Written by nctaxpro

    February 24, 2011 at 12:12 pm

    Deducting moving expenses, part 4 – how to report them (federal and state)

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    Part 1 – can expenses be deducted
    Part 2 – what expenses can be deducted
    Part 3 – handling employer reimbursement

    Now we come to the last step – how do you report moving expenses on your return?

    For your Federal return, that’s the easy part. You record your moving expenses and employer reimbursements on IRS Form 3903. You report the total amount you paid to move your personal effects and household goods on line 1, and your deductable travel expenses on line 2. Line 3 is the sum of lines 1 and 2. On line 4, put the amount of your employer reimbursement (reported in box 12 with Code “P”). Subtract line 4 from line 3, put the result on line 5 and (if positive) transfer the total to line 26 of Form 1040. That’s it! Note that if the result is negative, you must report the excess reimbursement as part of your wages on line 7 of your form 1040.

    What about state returns? Rules vary from state to state. Some states, like New Jersey, don’t allow them to be deducted at all (although in NJ you can exclude taxable reimbursements for moving expenses from your income). Some states, like Pennsylvania, allow them to be deducted only for moves into or within the state, but not for moves outside the state. Some states, like North Carolina which bases its tax structure off the Federal taxable income, allow them to be deducted regardless of the nature of the move. The general rule, if you are not sure, is that moving expenses go on the return of the state that you are moving to – but check with a tax professional first!

    Written by nctaxpro

    February 20, 2010 at 11:12 am

    Deducting moving expenses, part 3: handling employer reimbursement

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    In the prior entries, I told you

    how to determine if you qualify to deduct moving expenses, and

    what you can and cannot deduct.

    It’s far less frequent now, but in the past employers would often offer prospective employees an incentive package that included reimbursement of some or all of their moving expenses. For example, when I moved from Pennsylvania to Maryland in 1982, the company that hired me paid the cost of moving and shipping my household goods and personal effects, and provided a 30-day housing allowance. So how do you handle employer reimbursements when figuring your expenses?

    You might think that you don’t report any expenses that were reimbursed by your employer. That’s not necessarily the case; it depends on the method your employer uses to reimburse you. Let’s consider several ways that your expenses can be reimbursed:

    1. The employer pays a third party (such as a moving company) directly. In this case, you have no cost or direct reimbursement, and those expenses are not reported.

    2. Your employer reimburses you directly, but you are required to file an expense report within 60 days of incurring your expenses, and the employer remiburses you only for the expenses that you are allowed to deduct. The employer may pay you an advance, but if the advance is more than your actual expenses you are required to return any excess to the employer. In this case, you are very likely reporting your expenses under an accountable plan. You can confirm this by looking at your W-2; there should be an entry in Box 12 with Code “P” for the amount of your reimbursement. If the employer’s reimbursement was for 100% of your deductable moving expenses, you do not report either the expenses or the reimbursement. If the employer’s reimbursement was for less than 100% of your deductable moving expenses, you report both the total of the expenses and the reimbursement you received, and you can deduct the difference.

    3. Any other reimbursements – including reimbursements for non-deductable expenses, such as my 30-day housing allowance – are reimbursements under a non-accountable plan. The employer is required to include those in your income (box 1 of your W-2) and deduct Social Security and Medicare taxes. In this case, since you have been taxed on the reimbursement, you report all of your deductable expenses but only those reimbursements (if any) that show in box 12 of the W-2 with code “P”.

    If you are not sure where your reimbursements fall – especially if your W-2 does not have a Box 12/Code “P” entry – ask your employer. If your employer did not include your reimbursements in either Box 1 or Box 12, then you must include those reimbursements on Line 7 of your Form 1040 – they are considered to be part of your compensation.

    If you were reimbursed in 2009 for moving expenses that you incurred and deducted in 2008, on the other hand, and those reimbursements show up on your 2009 W-2 in Box 12/Code “P”, you report that reimbursement as other income on Line 21 of your Form 1040.

    In the next – and final! – installment, I’ll discuss how moving expenses are deducted on your Federal return, and how they are treated on state returns.

    Written by nctaxpro

    February 17, 2010 at 10:46 am