Have all your children grown up and moved on? Are you considering downsizing? If you are approaching retirement with a lot of equity in a big home that can help fund your retirement plans when you sell, you might want to first consider the tax aspects of such a move. Under the current tax rules, you may no longer defer the gain into your next home. Instead, assuming you qualify, you can exclude $250,000 of gain ($500,000 for married couples) and anything in excess of that becomes taxable.

Many also overlook the fact that they had previously deferred a gain from a prior home or homes under the home sale rules in effect before May 7, 1997. Under those rules, gains from previous home sales generally rolled over into the tax basis of the replacement home. Thus, your current home’s gain may be much more than you thought once the gains deferred from prior homes are taken into consideration. Suppose your current home cost $225,000, but you had deferred (rolled) a gain of $110,000 from a prior home sold before May 7, 1997 into your current home. As a result, your tax basis in your current home is only $115,000 ($225,000 - $110,000), and you would measure your gain from that value.

Whatever your reason for selling your home, be aware that Uncle Sam is standing in line waiting for his share if your gain exceeds the exclusion limits. However, there are things you can do to soften the tax bite:

Home Improvements - First and foremost, keep records of any home improvements, including the receipts. Examples of home improvements include remodeling, landscaping, room additions, etc.

Utilize Capital Losses – If you have capital loss carryovers, they will offset your home sale gain. If you don’t, or if they are not enough, you should sift through your capital-asset portfolio to determine if you have stock, bonds, or depreciated assets that can be sold in the same year to generate offsetting capital losses.

Time the Sale – Time the sale to be in a year where some portion of your income is in the 10% or 15% tax bracket, thus achieving the 5% capital gain tax rate for part of the gain. For one year — 2008 — the 5% rate actually goes down to 0%. However, absent Congressional action, these preferential capital gain rates expire after 2008.

Utilize an Installment Sale – If you can afford to, you might also consider carrying the first trust deed or a second trust deed yourself, thus deferring some portion of the gain to another year where it may be taxed more favorably. The risk in an installment note is that property values might decline and you might get your home back, which is why commercial lenders require a large down payment. Another issue is interest rates. If they climb, the note on your home might not be earning as much as the banks will be paying; that is why it is sometimes important to limit the note’s term to 5 to 10 years. If interest rates were to drop or property values were to rise substantially, the buyer might refinance for lower rates or cash out and pay you off sooner than you planned.

Wait for a Step-Up in Basis – If you are not in need of the cash that selling your house would bring, are comfortable in your home, and are getting on in years, then postponing the sale of your home until after you’ve passed away might be the best way to prevent Uncle Sam from sharing in the gain. This is because the survivor or beneficiary who inherits the home does so at its fair market value as of your date of death. Selling the home soon thereafter would probably result in no gain. This option could have estate tax consequences, however.

All of these issues can be complex and may require substantial prequalification and tax planning before execution. Please call this office for assistance.

If you volunteer your time for a charity, you may qualify for some tax breaks. Although no tax deduction is allowed for the value of services performed for a charity, there are deductions permitted for out-of-pocket costs incurred while performing the services. The normal deduction limits and substantiation rules also apply. The following are some examples:

Away-from-home travel expenses while performing services for a charity, including out-of-pocket costs for round-trip travel, taxi fares, and other costs of transportation between the airport or station and hotel, plus lodging and meals at 100%. These expenses are only deductible if there is no significant element of personal pleasure associated with the travel, or if your services for a charity do not involve lobbying activities.

The cost of entertaining others on behalf of a charity, such as wining and dining a potential large contributor (but the cost of your own entertainment or meal is not deductible).

If you use your car while performing services for a charitable organization, you may deduct your actual unreimbursed expenses directly attributable to the services, such as gas and oil costs, or you may deduct a flat 14 cents per mile for the charitable use of your car. You may also deduct parking fees and tolls. If you use your vehicle in providing donated services to a charity for relief related to Hurricane Katrina during the period between August 25, 2005 to December 31, 2006, you can compute your charitable mileage deduction using a standard mileage rate equal to 70% of the business mileage rate in effect on the date of the contribution, rather than the charitable standard mileage rate.

You can deduct the cost of your uniform when doing volunteer work for the charity, as long as the uniform has no general utility. The cost of cleaning the uniform can also be deducted.



No charitable deduction is allowed for a contribution of $250 or more unless the contribution is substantiated with a written acknowledgment from the charitable organization. To verify your contribution:

Get written documentation from the charity about the nature of your volunteering activity and the need for related expenses to be paid. For example, if you travel out of town as a volunteer, request a letter from the charity explaining why you're needed at the out-of-town location.

You should submit a statement of expenses if you are out-of-pocket for substantial amounts and, preferably, a copy of the receipts to the charity and arrange for the charity to acknowledge in writing the amount of the contribution.

Maintain detailed records of your out-of-pocket expenses—receipts plus a written record of the time, place, amount, and charitable purpose of the expense.

Bank Account – Take for instance, an inherited bank account worth $25,000, where the funds are not immediately distributed to the heir. The $25,000 account earns $375 of interest income after the decedent’s date of death. Out of the $25,375 that is received, the $25,000 is tax-free but the $375 is taxable as interest income.

Capital Asset –The basis for gain or loss from the sale of an inherited capital asset, such as stock, real estate, collectibles, etc., is generally based on the value of the asset at the time of the decedent’s death. That is one reason that qualified appraisals are so important.

To explain this further, let’s assume that a vacant parcel of land is inherited with a date of death appraisal that values it at $15,000. If that property is sold for a net price of $15,000, there is neither gain nor loss and the $15,000 is tax-free to the beneficiary. If, on the other hand, the net sales price is more or less than the $15,000, there would be a reportable capital gain or loss. For capital gains tax purposes, the holding period is important. Assets held over one year are generally taxed at substantially less than those held for a shorter period of time. However, for inherited property, the beneficiary receives long-term treatment immediately, whether or not the decedent or the beneficiary had held it over one year. If there are expenses associated with selling the asset, then those expenses are deductible in figuring the gain or loss.

IRA or other Qualified Plan – Suppose the decedent had a traditional IRA account and the distributions from that account were taxable to the decedent. If you inherit that account, the distributions will be taxable to you as the beneficiary. Why is that? Because the decedent had never paid taxes on the income that went to fund the traditional IRA and therefore you, the beneficiary, will be stuck with the tax liability. The good news is that there are options for taking the income over a number of years which can soften the tax blow.

Life Insurance Proceeds – Generally, the proceeds from a life insurance policy are tax-free to the heirs. However, if the policy is not paid immediately, as most are not, the insurance company will include interest. That interest is taxable to the heirs.

Annuities and Installment Sale Notes – If the decedent purchased an annuity or had an installment sale note from the property he previously sold, the decedent’s basis will be tax-free, but the heirs will be obligated to pay tax on any amount received in excess of the decedent’s basis. For an annuity, the decedent’s basis would be what he paid for it. For an installment note, payments include: (1) a return of a portion of the asset’s cost (basis) which is not taxable, (2) a portion from the prior sale of the asset which is taxable as a capital gain, and (3) taxable interest on the note.

A trust or estate is required to file an income tax return and to report income earned by the estate or trust after the decedent’s passing and before the assets are distributed to the heirs. Each heir will generally receive a form called Schedule K-1(1041). It will include that heir’s share of income and must be included on the heir’s individual tax return. Although infrequent because the taxes are generally higher, the trust or estate may pay the income tax on the income. The executor or trustee is responsible for making sure the required tax returns are filed and for sending K-1s to the heirs.
There may be taxable income to the heir even though the inheritance has not yet been received. In addition, there are other factors to consider that have not been discussed. Therefore, during your tax appointment, it is important to let us know if you are expecting an inheritance.

Although there are a variety of sophisticated tax shelters available, our tax laws also afford special tax treatment to certain common types of investments. Used appropriately in conjunction with sound tax and investment planning, these special benefits may produce a higher after-tax return on your investment dollars.

Dividends: Beginning in 2003, dividends received by an individual shareholder from domestic corporations (and certain foreign corporations) are treated as net capital gain for purposes of applying the capital gain tax rates. This means dividends are taxed at 15% for taxpayers whose marginal rate is above 15% and 5% for those in the 10% and 15% Tax Brackets. This net tax savings for each marginal tax bracket is illustrated below.

Even though dividends are taxed on the Schedule D, dividend income cannot be offset with capital losses. Dividends on stock held in a retirement plan or traditional IRA will not benefit from the new lower rates; distributions from these plans continue to be taxed at ordinary income rates.

Municipal Bonds: Although they generally pay a lower interest rate, their "after- tax" return can be higher than other similar investments such as corporate bonds, CDs, etc. Taxpayers in higher tax brackets and children subject to the "kiddie tax" frequently use this investment. If your state has income tax, you should note that most states will only allow the exclusion of interest on municipal bonds issued from that particular state. Municipal bonds can be purchased directly or investments can be made through a variety of municipal bond funds, many of which specialize in bonds from a specific state. Taxpayers drawing Social Security benefits should be reminded that even though municipal bond income may be tax-free, it is still used as income for purposes of determining the taxable portion of Social Security income.

Capital Gains: Gain from investments such as stocks, mutual funds, land, real estate, etc., are taxed at rates lower than an individual's regular tax rate if they are held over one year. Gains from such assets are taxed at 10% if you are in the 15% tax bracket or 20% if you are in the 28% or higher tax bracket. Assets held over five years get an even bigger break. There are exceptions to the requirement to hold the asset over one year in order to receive the beneficial long-term treatment. If the asset is a gift, your holding period includes the holding period of the giver, and if the asset is inherited, it is always treated as long-term.

Interest for Direct U.S. Government Obligations: This category includes U.S. Savings Bonds, T-Bills, H Bonds, etc. Interest earned on these obligations is taxable only for Federal purposes. Federal law prohibits states from taking a bite out of this income. Taxpayers that wish to reduce their state tax liability will greatly benefit from these investments. In addition, Savings Bond interest can be deferred until the bonds are cashed or reach maturity, providing a valuable tool for deferring income to some future tax year. Children, who are still dependents of their parents and have a lower standard deduction, can use the bonds to defer their income to a year when they get benefit of the full standard deduction, personal exemption, and lower tax rate. If that same child attends college, they may be able to offset the income with education credits.

Education Savings Bonds: Interest you receive from the redemption of U.S Series-EE savings bonds purchased after 1989 and after attaining the age of 24, held in your name or jointly with your spouse, may be excluded from income to the extent you pay qualified higher education expenses. The expenses must be for you, your spouse or a dependent and must have been paid during the same year the bonds were redeemed. The tax benefit has limited application since the benefit is phased out for taxpayers with higher incomes. Generally, the phase out begins around $52,000 for singles and $78,000 for those filing jointly. The exclusion is completely phased out by the time singles reach about $68,000 and $108,000 for joint filers. If you are considering this strategy, keep in mind the income phase-out is based on the year the bonds are redeemed and not the year they are purchased.

If we can assist you with the application of any of these strategies to your particular situation, please give us a call.

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You may have heard that Congress tightened the loophole for writing off SUVs bought for business. Well, they tightened it, but by no means closed it. Although they did limit the Section 179 expense deduction to $25,000 for heavy SUVs, taxpayers can still get a substantial first-year write-off because the rules that limit the amount of annual depreciation that can be deducted on passenger automobiles do not apply to heavy SUVs (those with a gross or loaded vehicle weight of over 6,000 pounds and built on a truck chassis). Thus, heavy SUVs are eligible for regular depreciation allowances, on top of the $25,000 that is allowed to be expensed.

Let’s say that you bought a heavy SUV that costs $70,000 in June 2006 and used it 100% for business driving. Assuming the SUV qualified, you would be allowed a $25,000 Sec. 179 election deduction. In addition, you would be able to take normal depreciation on the balance of the purchase price, $45,000 ($70,000 - $25,000) at 20%, which results in an additional $9,000. Thus, the first-year deduction for the SUV is $34,000. If the SUV is used partially for business and partially for personal purposes, the deduction will be prorated.

As you can see, purchasing an SUV for business purposes can still yield a substantial deduction. There are other limitations applicable to the Sec. 179 deduction and business-use percentage of the vehicle. Please call if you are contemplating such a purchase, so that we may determine what the tax benefit will be for your specific circumstances.

When it comes to deducting a spouse’s travel costs for business, the rules are very restrictive. Generally, you cannot deduct the spouse’s travel costs unless the spouse is a bona fide employee of the business. This requirement prevents deductibility in most cases.

Even if your spouse is an employee, his or her presence must be for a bona fide business purpose. Generally, a spouse’s presence must be “necessary” to meet the bona fide purpose test and just being “helpful” does not meet the requirement. Being there for goodwill purposes, such as serving as a hostess, is generally insufficient to satisfy a business purpose. An exception to that rule would be if your spouse's presence is necessary to care for a serious medical condition that you have.

If your spouse’s presence does meet the bona fide business purpose rule, then the normal deductions for business travel away from home can be claimed. These include the costs of transportation, meals and lodging, and incidental costs such as dry cleaning, phone calls, etc.

But all is not lost if your spouse does not meet the qualifications. You may still be able to deduct a substantial portion of the trip's costs. This is because the rules don't require you to allocate 50% of your travel costs to your spouse. You need only allocate to him or her any additional costs that are incurred. For example, the single rate for a room is not so different from the cost for double occupancy. If you were driving, no allocation would be required because the cost would be fully deductible even if your spouse did not accompany you. If you used public transportation, only your cost would be deductible. Any meals and separate costs incurred by your spouse would not be deductible.

Most everyone dreams of making a living from doing things they enjoy. Many successfully turn hobbies or vocations into a business. However, the IRS has a watchful eye out for taxpayers who attempt to deduct hobby expenses as business expenses. If your business is profitable, you won’t have any unusual tax consequences. Where you run afoul of the IRS is when an enterprise consistently has a loss for the bottom line. That’s when the IRS may step in and say it is a hobby and not a for-profit business.

Under the hobby loss rules, deductions are limited to the income from the activity. In addition, those deductions that would be allowed whether or not the activity is for-profit (such as state and local property taxes) are deducted first. Then, if any net income remains, expenses up to the amount of the remaining income can be deducted as a miscellaneous itemized deduction subject to a 2%-of-AGI “floor.” By contrast, if the enterprise wasn’t affected by the hobby loss rules, all otherwise allowable expenses would be deductible on Schedule C, even if they exceed the income from the enterprise.

There are two ways to avoid the hobby loss rules. The first way is to show a profit in at least three out of five consecutive years (two out of seven years for breeding, training, showing, or racing horses). The second option is to run the venture in such a way that it shows your intention of turning it into a profit-maker rather than to operate it as a mere hobby. The IRS regulations state clearly that the hobby loss rules don’t apply if the facts and circumstances show that you have a profit-making objective.

Please call our office for more details on whether your venture may be affected by the hobby loss rules.

Self-employed taxpayers should consider their options carefully when it comes to applying tax benefits for their own education tuition and expenses. Tax law provides multiple ways to benefit from the educational expenses and one may provide more benefit to you than another based on your particular set of circumstances. In addition, your tuition may qualify for one tax benefit while other education expenses qualify for another.

As a Business Expense – Generally, if the education qualifies, it is better to take the cost as a business expense since it will offset both income taxes and self-employment tax. The expenses can include tuition, books, supplies, and allowable travel for the education. To qualify as a business expense, the education must either be to maintain or improve your skills or be required in your business. You may, however, not wish to use the education’s costs as a business expense when doing so limits your net profit and consequently limits your pension plan contribution. Another situation when you may not want to claim the education costs as a business expense is when your Schedule C only has a very small profit or shows a loss for the year.

As an Adjustment to Income – If the education expense is tuition at an institution of higher education and you are under the AGI phase-out limit for this deduction, you have the option to deduct up to $4,000 as an adjustment to overall income for the year. You can take this deduction whether or not the education maintains or improves your skills required in your business. Other expenses related to this education such as books, supplies, and travel can still be deducted on your Schedule C as long as the education maintains or improves your skills required in your business. The deduction is a maximum of $4,000 if AGI does not exceed $65,000 ($130,000 for married couples filing jointly) or a maximum of $2,000 if AGI doesn’t exceed $80,000 ($160,000 for married joint filers). 2005 is the last year this deduction is available.

As a Tax Credit – As with the adjustment to income above, if the education expense is tuition at an institution of higher education, you might qualify for the lifetime learning credit. It may be more beneficial than the business expense or AGI adjustment for the tuition portion of the expenses, especially if you are in a lower tax bracket or the business profits are low. The lifetime learning credit allows you a credit of 20% of the cost of your tuition (up to $10,000 of costs) as a tax credit. It, too, has an AGI phase-out limitation. For 2005, the credit for single taxpayers phases out between $43,000 and $53,000 and $87,000 to $107,000 for joint filers. Please note that beginning in 2006, this credit will not be allowed if you are taxed by the Alternative Minimum Tax (AMT).

If you have any questions regarding these various options, please call our office.

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Homeowners with variable mortgages could be unpleasantly surprised when the rates start adjusting upwards. No one can predict where the rates will go, but it has slowly started creeping up. With some media sources predicting that the real estate market will soon slow down, you might want to explore your options early in the game. It may be difficult to secure a new loan if real estate values were to decline, and you would be stuck with a substantial mortgage payment (at least for awhile).

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Teach Your Children How to Save for Retirement

It’s never too early to start educating your children about retirement savings. With company pension plans heading out the door, they will have no choice but to provide a big portion of their own retirement income. Go ahead and stress that issue with them. If they start now, consider how much they would save by the time retirement age rolls around. Imagine if your 16-year-old child or grandchild contributed $2,000 of his or her own earnings (or provided by parents or grandparents) to a Roth IRA until age 67? Their IRA would be worth well over one million dollars. Think of the retirement savings they could accumulate by contributing more? Don’t delay any longer…tell them to start saving today.

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