LOSSES EVERYWHERE
By cpa | January 20, 2009
The first African-American to become U.S. president will take his oath against a backdrop of a deep downturn, a trillion dollar federal deficit and fears of more crippling bank losses.
Nothing is changing in terms of the 2009 recession
the Obama presidency could not shake Wall Street from its dejection over the banking industry’s growing problems. After hearing the new president’s inaugural address Tuesday, investors went back to unloading stocks, sending the major indexes down more than 4 percent and the Dow Jones industrials down more than 300 points.
Stocks have pulled off their session lows, but continue to trade amid broad-based weakness. With stocks down, select commodities are showing relative strength.
Traders on the floor of the New York Stock Exchange paused at times to watch the inauguration ceremony and Obama’s remarks, but the transition of power didn’t erase investors’ intensifying concerns about the struggling economy.
U.S. bank shares sank on Tuesday, with Citigroup Inc and Bank of America Corp hitting their lowest levels since the early 1990s, as a series of analysts cut their forecasts for both banks for the rest of 2009.
NYSE LAST CHANGE
BAC 5.13 28.55%
C 2.83 19.14%
UYG 2.77 27.86%
WFC 14.18 24.09%
JPM 18.19 20.77%
Topics: STOCK | 66 Comments »
The panic on Wall Street of Lehman’s death
By cpa | September 15, 2008
September 15, 2008 is the U.S. financial history historic day.
That is the truth.
Dow Plunges 504 Points on Lehman Bankruptcy, Merrill sold, AIG Woes.
A stunning makeover of the Wall Street landscape sent stocks falling precipitously Monday, with the Dow Jones industrials sliding 500 points in their worst point drop since the September 2001 terrorist attacks. Investors reacted badly to a shakeup of the financial industry that took out two storied names:
Lehman Brothers Holdings Inc. and Merrill Lynch & Co . AIG.
Since the weekend the Bank of America and Barclays withdraw from Lehman Brothersthe acquisition of negotiations, Lehman Brothers Holdings plans in accordance with United States Bankruptcy Code Chapter 11, Southern District of New York to the United States Bankruptcy Court for bankruptcy protection. The application does not include its various subsidiaries and broker dealers of any other affiliates, all subsidiaries of the brokerage dealers will continue to operate. Including subsidiaries of Neuberger Berman Holdings LLC, the company, all customers will be able to continue to use their account transactions.
Topics: STOCK | 49 Comments »
Capital Gain and Loss Tax Issues
By cpa | May 15, 2008
Investors
Whenever you sell an investment at a profit, you will probably owe the IRS a tax known as a capital gains tax. This is true for most investments, including stock, mutual funds, bonds, options, or business. Capital gains are the amount by which an asset’s selling price exceeds its initial purchase price. A realized capital gain is an investment that has actually been sold at a profit. The term capital gain is often used to mean realized capital gain. An investment that hasn’t been sold yet usually does not have capital gain tax issues.
Most investors’ federal long-term capital gains taxed at 15 percent. Taxpayers in 15% or lower income brackets pay only 5 percent on most investment earnings. To take advantage of the low 5% or 15% tax rate, you should try to hold more than one year to qualify.
If you’re an investor, you already know how to report your income and related investment expenses. You should have received a 1099-B if you sold stocks or mutual funds in 2007. You should keep a record of all your stock transactions, and report all of the investments sold on Schedule D. You can only take up to $3,000 capital loss exceeding net capital gain from other types of income. You carryover the unused loss to offset capital gains or you can use $3,000 loss to offset your other types of income in the future.
If your stock declared dividends in 2006, you should have received 1099-Div. You have to report dividend income under schedule B. A reader asked if a foreigner who was already withholds 30% from its dividend income, is he required to file tax return. I advice the taxpayer to file a return, because he could possible receive a nice refund. I will write an separate article for international tax issues.
You report any margin interest expense paid on Schedule A as an interest expense deduction. You also report any related investment expenses (such as investment newspapers and publications, stock analysis computer programs, etc. on Schedule A as an itemized deduction, subject to the 2% Adjusted Gross Income (AGI) limitation.
You also have to be careful about wash sale. In general you have a wash sale if you sell stock at a loss, and buy substantially identical securities within 30 days before or after the sale. You cannot deduct your loss.
The unfortunate fact is, if you don’t itemize your deductions or your AGI is high relative to your investment expenses, your investment expenses could be rendered useless.
Example: Scott has $2,200 of investment expenses related to her stock portfolio. Sally doesn’t itemize her deductions. Therefore, the $2,200 of expenses will not reduce Sally’s taxes.
Traders
If you buy and sell stocks very frequently, you may be able to qualified as a trader instead of an investor. There is a different tax-reporting world open up to you. IRS does not have a clear guideline about who is an investor and who is a trader. The general rules are as follow:
The trader generally holds positions 30 days or less. Virtually none of the trader’s positions are held for more than a year.
The trader’s goal is to profit from short-term swings in the market and the associated stock price.
The trader spends a lot of time doing just trading stocks!
If you qualify for trader status, your stock gains or losses are still reported on Schedule D, but your trading expenses are reported on Schedule C, and there are no AGI restrictions or limitations thwarting the deduction of these expenses.
If Scott on the above example is qualified as a trader, he can deduct his $2,200 of trading expenses on his schedule C without limitation on Schedule A. However, traders are still subject to many of the same rules as the investor, such as $3,000 capital loss rules, wash sales rules.
According to IRC 1402, capital gains and losses are not subject to the SE tax. Many people overpaid SE taxes should consult a CPA specializes on stock trading and possible claim the past-overpaid taxes.
Mark-To-Mark Election
The IRC 475, allows traders to make an election that allows them to “mark” their stock holdings to the fair market value (FMV) at the end of the tax year. If the election is made, all securities held by the trader are deemed to have been “sold” at the end of the tax year, and then immediately repurchased. This causes the trader to realize tax profits on stocks that haven’t really been sold yet.
Why in the world would anyone want to make an election that would cause her to pay taxes on “paper” profits each year? For two very good reasons: Making the election will remove the annual $3,000 limitation on net capital losses and the wash sale rules no longer apply to the trader.
If you determine that you’re a trader and you’re looking forward to making the MTM election for the current tax year, in general, you are required to file the appropriate election and you’ll have to follow the procedures 99-17 with 2007tax return if you want to election to be effective in 2007. There are special rules for new taxpayers, corporation and Limited Liability Company.
Topics: TAX | 27 Comments »
Rental Property Tax Issues
By cpa | April 25, 2008
When you purchase property and rent it out, you’re essentially running a business. You receive rental income and incur expenses from the property. You hope that, your revenue exceeds your expenses so that your real estate investment produces a profit for all the money and time you’ve invested. You also hope that the market value of your investment property appreciates over time.
You could possible having positive cash flow but taxable loss on the return because of depreciation. Depreciation expense is a tax deducible expense, but doesn’t involve your cash outflow. After depreciation, you are possible to show a loss for the year, but you are able to deduct the loss on your tax return. If you actively participate in managing the property, you’re possible to be allowed to deduct your losses against your other taxable income and save taxes.
Deductible Expenses
In addition to the deductions allowed for mortgage interest and property taxes, you can also deduct almost all of the money that you spend on the property. For example, insurance, maintenance, management, advertisement incurred in finding tenants, traveling expenses (mileage) to look after the properties, legal & accounting professional expenses, commissions paid to find tenants, utilities, repairs and capital improvement.
IRS agents pay close attention to repair and maintenance deductions claimed on the very aggressive tax returns. Most taxpayers would prefer to classify the expenditure as a repair and taking a current year deduction, rather than by capitalizing the expense and depreciate the cost over the applicable years.
Here I would like to point out the differences between repairs and capital improvement. The Internal Revenue Service, has defined the difference between repairs and improvements in Pub.527as follows:
“A repair keeps your property in good operating condition. It does not materially add to the value of your property or substantially prolong its life.”
“An improvement adds to the value of property, prolongs its useful life, or adapts it to new uses.”
Capital improvement need to be depreciate over the applicable years. Depreciation is an accounting deduction that the IRS allows you to take for the overall wear and tear on your building. The idea behind this deduction is that, over time, your building will deteriorate and need upgrading, rebuilding, and so on. The IRS tables now say that for residential property, you can depreciate over 27-1/2 years, and for nonresidential property, 39 years. Only the portion of a property’s value that is attributable to the building. Please note that land can not be depreciated.
For example, suppose that you bought a residential rental property for $300,000 and the land is deemed to be worth $100,000. Thus the building is worth $200,000. If you can depreciate your $200,000 building over 27-1/2 years, that works out to a $7,272 annual depreciation deduction.
If you have large mortgage, after depreciation and all other expenses, you are possible to show a taxable loss for the year. If your adjusted gross income is less than $100,000 and you actively participate in managing the property, you’re allowed to deduct your losses on operating rental real estate for up to $25,000 per year.
If you make more than $100,000 per year, you start to lose these write-offs. At an income of $150,000 or more, you can’t deduct rental real estate losses from your other income. People in the real estate business (for example, agents and developers) who work more than 750 hours per year in the industry may not be subject to these rules.
Suppose that you purchase a rental property many years ago and now the property worth much more than you originally paid for it. However, when sell the property, you owe taxes on your gain or profit. For example, if you bought the property for $100,000 and sell it for $150,000, you not only owe tax on that difference, but you also owe tax on an additional amount, depending on the property’s depreciation. The amount of depreciation that you deducted on your tax returns reduces the original $100,000 purchase price, making the taxable difference that much larger. For example, if you deducted $25,000 for depreciation over the years that you owned the property, you owe tax on the difference between the sale price of $150,000 and $75,000 ($100,000 purchase price minus $25,000 depreciation).
All this tax may just motivate you to hold on to your property. But you can avoid paying tax on your profit when you sell a rental property by “exchanging” it for a similar or like-kind property, thereby rolling over your gain. The section of the tax code that allows rollovers is a 1031 exchange. We will talk about it in detail in a separate article.
Another strategy is to utilize IRC 121 gain exclusion. You may convert the rental property to your residence. The basic gain exclusion qualification rule is simple. You must have owned and used the home as your main residence for at least two years out of the five-year period ending on the date of sale. If you are married, the full $500,000 break is available as long one or both of you satisfies the ownership test and you both satisfy the use test.
Say you are married and own three homes. First there’s your current main home, which qualifies for the $500,000 exclusion and could be sold for a $400,000 gain. You sell it tax-free and move into your vacation home in
If you do not mind keeping moving to different homes, you can repeat the gain exclusion every two years.
Topics: Investing in Real Estate | 42 Comments »
Tax Issues For Foreign Students – F Visa & Opt Status
By cpa | April 15, 2008
Tax issues for foreign students are often very complicate and difficult. What do you do when the first paycheck, scholarship check or loan disbursement check is received and taxes are withheld?
First of all, is the student is a “resident alien” or “non-resident alien” for
Resident Alien vs. Nonresident Alien
An individual who is not a
· lawful permanent resident test which is also known as the green card test,
· substantial presence test, if such individual is present in the
· such alien elects to be treated as a resident. An individual can make an election to be treated as a resident. To qualify for the election the individual must be a resident under the substantial presence. Most foreign students should not attempt to make this election, as it will ordinarily have adverse tax consequences. Students often prefer nonresident alien status on account of the associated exemption from employment taxes.
Resident and nonresident aliens file different types of income tax returns. Resident aliens complete Forms 1040 and are taxed on their worldwide incomes in a manner identical to that of
On the other hand, nonresident aliens need to file tax returns Forms 1040NR and is only taxed on the US connected income. In general, the
Social Security and Medicare Taxes
Generally, services performed as a nonresident alien admitted into the
Tax Treaties
The
A student, business apprentice or trainee who is or was immediately before visiting [the U.S.], a resident of the [P.R.C.] and who is present in the [U.S.] solely for the purpose of his education, training or obtaining special technical experience shall be exempt from tax in the [U.S.] with respect to:
(a) payments received from abroad for the purpose of his maintenance, education, study, research or training;
(b) grants or awards from a government, scientific, educational or other tax-exempt organization; and
(c) income from personal services performed in [the
The benefits provided under this Article shall extend only for such period of time as is reasonably necessary to complete the education or training.
Treaty provisions are not limited to simply determining whether income is taxable in one country or not. They may also provide special rules for determining whether the individual is considered a resident alien or not. Also, treaty provisions often reduce the rate at which taxes are withheld upon the payment of certain types of income. For example, the withholding rate reduces from 30% to 15% for
Students who are considered to be nonresident aliens should provide their employers with Form W-8233 or Form W-8BEN to establish that they are foreign persons. You should also provide your employers with a Form W-4. However, special rules apply to nonresidents filing out Forms W-4. All nonresident aliens should claim single status on Form W-4 even through they are actually married and claim only one allowance on line 5 except residents of Canada, Mexico, Japan or South Korea. Also you need to request your employer withhold an additional $7.60/week because non-resident are not qualify to take standard deduction.
Alien students with U.S. source income may consider consulting with a very qualified tax professional because these tax rules are unfortunately very complex.
Topics: Individuals | 7 Comments »
Tax Tips for Small Businesses
By cpa | April 8, 2008
Most of unincorporated business are considered “sole proprietors.” A sole proprietor is just another way of saying “self-employed,” “independent contractor,” or “freelancer.” Income and expenses related to your self-employment is reported on your 1040, Schedule C.
However, IRS is fully aware of the tax benefits of being self-employed. They are on the lookout for individuals who (1) have a high business loss, or (2) have business losses year after year.
If you are in one of these situations, you need to start thinking about how to protect yourself in case the IRS audits.
The basic tax planning strategy goes like this: reduce your taxable income, shift taxable income into nontaxable income, take advantage of tax credits, and pay the right amount of estimated taxes.
The first step to getting organized is to separate your freelance income from other types of income. Keep a record of all your business-related income. Have a separate business bank account and a separate credit card.
Your clients may send you a Form 1099-MISC to report 2007 payments to you. Form 1099-MISC is like a W-2, it is used to report income you received. The IRS also gets a copy of any 1099s. Your total business income on Schedule C Line 1 must be greater than or equal to the total amount of income reported on your 1099-MISC forms. If you report less income on your Schedule C than reported on your 1099s, you will get an audit notice. The easiest way to avoid an audit is to report all your income, whether you received a Form 1099 or not.
The second step to getting organized is taking a look especially at the various types of business-related expenses you can report. I highly recommend you start tracking your business-related expenses using different categories. For example, advertising, insurance, legal and professional services, auto, office expenses, repair, rent, supplies, education, due and subscription, computer, travel, meal and entertainment, utilities, telephone, home office and others. You can track your expenses using folders to sort receipts, or using a spreadsheet program, or using a personal finance program such as Excel, Quicken, QuickBooks, Microsoft Small Business.
You need to make sure your expenses are necessary and ordinary. That way the IRS auditor will see that your expense was clearly related to your business activity.
Claiming expenses for your home office need to follow the IRS rules.
Accounting for Your Business Assets. A business asset is any property with a useful life longer than one year and which is used to produce income. Thus your website, computer, software programs, and office furniture can all be considered business assets. You have two choices for accounting for these purchases. You can treat them as ordinary expenses and deduct the full cost of purchase in the year the property is bought by using Section 179, or you can treat them as capital expenses and spread out the cost of the purchase over a number of years.
The basic equation for a Schedule C, is income minus expenses equals profit. If the profit figure is a positive number, it increases both your regular income tax and your Self-Employment Tax. The Self-Employment Tax, figured on Form 1040 Schedule SE , is 15.3% of your net profit and represents the Social Security and Medicare taxes owed on your business profit. As an employee (on a W-2), you only pay half of the Social Security and Medicare taxes (7.65%), and your employer pays the other half. As a self-employed, you are your own employer, so you pay both halves.
Most self-employed people get into tax trouble because of the Self-Employment Tax. You need to set aside money at least every quarter, or better yet every month, towards your Self-Employment Tax. Let’s say you anticipate having a net profit of around $1,000. Well, your Self-Employment Tax would be ($1,000 x 15.3%) $153. If you divide that into four quarterly payments, you should be paying $38.25 every quarter to the IRS as an estimated tax payment. You should also calculate your anticipated regular income tax. If you are in the 25% tax bracket, the additional income tax on your business profit would be ($1,000 x 25%) $250. So you should set aside $403 ($153 + $250) over the course of the year towards your estimated taxes. Freelancers who fail to make reasonable estimates of their future taxes often end up owing at the end of the year. Paying a balance due can be a hardship for struggling freelancers. Protect yourself from tax troubles by planning ahead, and making a sincere effort to pre-pay your taxes.
If the net profit figure on your Schedule C is a negative number, you have a business loss. Your business loss reduces your total income. If you have a W-2 job, you can use the business loss to offset your W-2 income. This means you will get a bigger refund compared to someone who earned the same amount of wages but did not have a side business.
Reducing your taxes in this way is an excellent tax strategy. However, the IRS disallows a hobby loss. What is a Hobby Loss? The IRS expects new businesses to incur a loss. It is normal for a business to have a year or two of losses before becoming profitable. But if a business reports a net loss in 3 out of 5 years, it is presumed to be a hobby.
You can still be fine if you can still prove your profit motive using the following nine factors:
- You carry on the activity in a businesslike manner,
- The time and effort you put into the activity indicate you intend to make it profitable,
- You depend on income from the activity for your livelihood,
- Your losses are due to circumstances beyond your control (or are normal in the start-up phase of your type of business),
- You were successful in making a profit in similar activities in the past,
- The activity makes a profit in some years, and how much profit it makes, and
- You can expect to make a future profit from the appreciation of the assets used in the activity.
An audit to defend your business losses can be a very expensive and time consuming. If you lose, the IRS will disallow the loss and expenses. You will have to repay some of your income tax, plus penalties and interest. You also have a higher chance to be audited.
If you are self-employed, you must carry on your freelance work in a very businesslike manner. This means keeping good records, keeping a business diary showing meetings with clients, deadlines, and projects, having business cards and a web site that promotes your business, and so forth.
The hobby loss rule-of-thumb applies to sole proprietors filing a Schedule C. One of the surest ways to prove you are serious about doing business is to form some sort of separate business entity. Businesses are separate entities for tax purposes, and so setting up a business for your freelance will provide a way for you to separate your personal income and expenses from your business income and expenses.
Incorporating your business in a formal way for you to separate your business activities from your personal activities. I will discuss incorporating your business and protecting your losses in a separate article.
Topics: Businesses | 22 Comments »
How do you get audited?
By cpa | April 1, 2008
The IRS uses a system called DIF (Discriminate Income Function) to identity tax returns to examine. The scoring system is set up to identify specific returns that, if audited, will generate additional income tax. Sometimes, the IRS computer selects returns for audit on a random basis. Your income, deductions or where you live could be irrelevant.
The IRS computers automatically correct mathematical errors. I recommend typing up your returns or use a computerized tax preparation program.
You do not want to give the IRS any additional reasons for them to look at your return.
3: Don’t stand out
Economic Reality: There is an economic reality that must be kept in mind when preparing a return. A certain amount of money is needed to support yourself and your family. Did you report enough adjusted gross income to cover normal and everyday living expenses such as rent, food, and clothing? If the answer is no, then the IRS will question the validity of the return simply because the income figures are not realistically possible. For example: If you live in a rich area, but you only claimed you earned $15,000 that year, this is a red flag for an audit.
- Offshore credit card users
- High risk, high income taxpayers
- Non-filers
4: Always Prepare for an Audit
Always keep your receipts, you will do fine if you are unlucky enough to get audited. The rule is simple: no receipt, no deduction.
7. When to filecertainly recommend that you have your return prepared early. If you have a big refund and are unconcerned with audit issues, file early and get your money back.
I always said, if your return has more than a 10% chance of being audited, you would be audited 5 times (10% x 50 years) in your life. Is that the kind of risk you want to take?
Topics: Individuals | 43 Comments »
Business Tax Overview
By cpa | March 28, 2008
When you have your own corporation, you are responsible for many other tax obligations. Many new entrepreneurs are overwhelming with many complex and burdensome bookkeeping and tax obligations.
The IRS imposes employment taxes on both employer and employees. Employers and employees are each required to pay 6.2% Social Security on the first $97,500 of an employee’s annual wages. The ceiling for the Social Security tax and 1.45% Medicare taxes on all wages. However, there is no such limit on the Medicare tax: Both you and the employee must pay the 1.45% Medicare tax on any wages.
Topics: Businesses | 29 Comments »
Home Office Tax Saving
By cpa | March 24, 2008
Do you spend a lot of your time working from home? If you do, you may find not only it is convenient, low overhead, but more importantly, it allows you to deduct the business use of your home and take the advantage of tax saving.
Your personal household expense are generally not deductible. By utilize your home office, you are able to convert part of your personal household expense to business deductible expense.
The home office deduction is available to both homeowners and renters. You home can be a house, condo, co-op or even a mobile home. Not only you can use the office space, but also garage, storage space.
In order to qualify the home office deduction, IRC 280 states that a home office deduction is available only to the extent that a portion of your home is used exclusively and on a regular basis as your principal place or at least you must be able to show business at least one of the following:
- You meet patients, clients, or customers at home.
- You use a separate structure on your property exclusively for business purposes. If you write legal briefs at a desk in your den where your kids also play, you won’t pass the “exclusive use” rule. It is important to shows that you are serious about the business and do not mix personal stuff to the home office area. You do not want to fool the IRS.
You also need to meet the following requirements:
· If you are self-employed, your gross income is more than your related deductions.
· If you’re a company employee, the home office need to be “for your employer’s convenience”. That means if you are encouraged to work at home to save the company office space, you could claim a deduction for the expenses your company doesn’t reimburse. But not if you negotiated with your boss to work from home a few days a week.
Although it is not required that all activities taking place at home, it is important that your home office is used for book keeping, ordering goods, administration and meeting clients.
The following are strategies to increase your bottom line when you work at home:
· Convert your furniture to business use: If you purchased the desk, file cabinet and chairs two years ago, you can still convert the assets to business.
· Use your home office for storage: A deduction is allowed if you use your home for inventory or product samples.
The example of the deductible expenses are:
· utilities
· phone bills – IRC 262 does not allow deduction for the first telephone into your personal residence. Local charges are deductible only if you install a second phone in your home. Long distance charges are deductible and should be documented.
· rent
· insurance
· depreciation – if you have taken any depreciation on your home, you must pay tax on the depreciation deduction you have taken regardless of the gain is within the exclusion amount.
· mortgage interest
· real estate taxes
· repairs and improvements.
Please note that your home office deduction is limited to the net income from the activity conducted from your home. However, any expenses disallowed solely because they exceed your business income can be carried forward.
Since a home office deduction can sometimes trigger IRS flags, we highly advice that you always have the following proofs ready:
1. A diagram or photographs to show that part of your home is being used as your office.
2. You home address is your business mailing address. You business card and stationery should show the same address as your home address.
3. Have a separate phone line installed in the business part of your house.
4. Keep a guest books of your clients’ visits.
If you don’t qualify for the home office deduction, you can still deduct ordinary and necessary business expenses that you incur at home — for example, long-distance phone calls, a separate business telephone line, and the cost of office supplies and equipment. The home office rules only apply to the expenses of actually running and maintaining your home, such as utilities, rent, depreciation, home insurance, mortgage interest, real estate taxes, and repairs.
Topics: Businesses | 2 Comments »
Tax Planning and Home
By cpa | March 20, 2008
Should I rent or buy a place to live? How much money do you have to pay for housing? Should I buy it now or should I wait? Many people have asked these questions.
Buying a house is a big dream for most of people. However, it is very complicated and it requires a tremendous commitment.
There are many issues need to be taking into consideration while you are buying a house.
- A substantial down payment is needed.
- There are a lot of costs associated with owning a house, such as insurance, property taxes, maintenance and repairs.
- Unexpected loss of income due to job termination or unemployment may limit money available for the mortgage.
However, there are many advantages to owning your own home as well:
In recent years, Congress and the Internal Revenue Service have made your home potentially the greatest tax shelter. You can deduct mortgage interest and property taxes. Also, you can usually keep all of the gains when you sell your home. It’s even better if you use your home for your business.
Since these tax breaks took place, home prices have shot up in real estate markets. Many people’s gain from the sale of a home exceeds their lifetime savings. People have more reasons and incentives than ever to own their homes.
How long these breaks stay in place is a question mark. President Bush’s Advisory Panel on Tax Reform thinks we should limit the exclusions on some of the gains. But these changes would take at least a few years to become law. So enjoy it now.
Property Taxes
You can deduct all the real property taxes you pay. If your bank escrows the taxes, you get the deduction when your bank makes the payment. You should receive Form 1098 at the end of the year from your bank.
Even if you’re a shareholder in a co-op apartment building, you get to deduct your share of any property taxes paid under Internal Revenue code section 216. A letter is provided to you by the co-op explaining how much is deductible per share owned.
Deductible taxes include all state or local taxes for the general welfare of the state or locality. However, it doesn’t count any trash or garbage collection fees or homeowner association charges.Owned More than One Residency? There’s no limit on the number of properties for which you can deduct taxes paid. If you have 10 homes, you can deduct the taxes on all 10. However, if your deductions are too great, you could be subject to the alternative minimum tax.
Interest
Interest paid on the purchase of your principal residence is deductible. You can deduct the interest you pay to buy a second residence or vacation home as well. The residence interest deduction is limited to the first $1 million of debt.
If you have a mortgage of $400,000 at an interest rate of 6%. You get to deduct $24,000 interest from your income.
If you’re in the 25% tax bracket, $24,000 in interest paid only takes $18,000 out of your pocket. Uncle Sam subsidizes the other $6,000.Gain exclusion
The 2–out-of-5 Rule: To qualify for the $250,000 ($500,000 on a joint return) exclusion, you must have owned and occupied a home as your principal residence for at least two years during the five-year period ending on the date of sale.
One-Time Exclusion? This is not a one-time exclusion. You can get another full exclusion every two years. You don’t have to buy a new house from the money you receive from the sale of your home. You can even rent after you sale your home.Partial Exclusion? You can even get a partial exclusion based on the time of use and ownership. But you need to be able to justify the sale of your residence based on the following reasons:
-
Change of employment: “Change in employment” covers anyone who lives in the household. The person doesn’t even have to be an owner of the property. The “change in employment” must be the primary reason for the move. There’s a “safe harbor” that assumes that it was the primary reason if your new job is at least 50 miles farther from the residence sold than where you used to work.
- Health reasons: Health reasons include advanced-age-related infirmities, the need to move to care for a family member, or to obtain or provide medical or personal care for a qualified individual suffering from a disease, illness or injury.
- Unforeseen circumstances: Unforeseen circumstances include divorce, death, multiple births from the same pregnancy and even a change in employment or self-employment status that results in your inability to pay the costs and living expenses of your household. So, if your income goes down, or even if your spouse or other co-owner’s income goes down, you can qualify for a partial or even a full exclusion.
If you don’t meet the “safe harbor” test all is not lost. You may want to talk to your CPA. He or she might be able to help you to prove that it was the primary reason for the move based on the facts and circumstances of your case.
The partial exclusion is based on the maximum exclusion, not on the basis of your actual realized profit.
If you (single) bought a residence for $250,000 and sold it for $350,000, because of a job change, after only one year.
You are qualifying for a partial exclusion. It was your principal residence for one year out of two.
$250,000 Maximum Exclusion x 1 year / 2 Years = $125,000 – Maximum Exclusion
$350,000 Sold Price – $250,000 Purchased Price = $100,000
You can exclude the whole $100,000 gain.
Home offices
In the past, it’s a red flag to use home offices. IRS is getting friendlier with home office taxpayers. Let’s say you use 20% of your house as a home office. You can deduct depreciation and expenses (utilities, repair, etc.) for working in that part of the house.In the past, when you sold your house, 20% of the gain wouldn’t qualify for the exclusion because that 20% wasn’t used as a “residence.” Now, the IRS doesn’t care even if you used your home 90% for business as a home office. You can now exclude as much as 100% of your gain, up to the $250,000/$500,000 limit.
You only need to recapture the gain to the extent of depreciation taken on the building. That’s taxed at 25%.
Many people who work out of their homes and don’t claim home offices may begin to consider taking the advantage of home offices. If you are not sure how to maximize your tax benefits, please consult your CPA.
Topics: REAL ESTATE | 54 Comments »
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