Can you deduct your home office?

Do you have a home office?  Do you know if it qualifies for the home office deduction?

The IRS has actually relaxed it’s position on home office in the last few years, so you may qualify, even if you didn’t previously.

To qualify for the home office deduction, your home office must:

1. Be your principal place of business, or
2. Be used to meet clients, customers or patients, or
3. Be a separate structure not attached to your home.

Most solo professionals have their home office in their home, so we’ll focus on the first two requirements:

Meeting clients, customers and patients is pretty self explanatory.  If you use your home office to meet with clients, you qualify.

Place of business is a little harder to define.  Basically, you have to use your home office regularly and exclusively for management and administrative duties of your business, and you must not have another location where these activities can be conducted.

Still not sure if your home office qualifies?  Check out IRS Publication 587 - Business Use of Your Home, or the article The Home Office Tax Deduction.

Tags: taxes, home office deduction, self employed

The AMT to be repealed?

A bill has been introduced into the Senate to repeal the AMT tax this week.

If you’re not familiar with AMT, it is the Alternative Minimum Tax, created to keep higher income taxpayers from paying too little income tax.  Unfortunately, the AMT has never been adjusted, so many middle income taxpayers have fallen victim to the AMT in recent years.

The Tax Increase Prevention and Reconciliation Act of 2005 provided some AMT relief by increasing the AMT exemption amount, but this is just a one-year fix.

Without permanent changes to the AMT tax, more and more middle income taxpayers will be subject to this tax each year.

The legislation that was introduced into the Senate calls for the death of the AMT tax.  Click here to read more.

Tags: income tax, AMT, alternative minimum tax

PMI Insurance: New Tax Break Helps with Mortgage Insurance Premiums

Uncle Sam is now going to help you pay your mortgage insurance premiums! 

Mortgage insurance is typically required when home buyers purchase a new home with less than 20 percent down. 

The newest tax legislation allows taxpayers to deduct premiums paid for mortgage insurance.  Mortgage insurance premiums typically range from $50 to $150 per month, which could mean a $600 to $1,800 deduction on your tax return.

This deduction is only available to taxpayers who itemize, but many home owners (especially if you’ve just purchased your home) have enough mortgage insurance, real estate tax, and other deductions to itemize.

Prior to this tax law, only the interest paid on a mortgage was deductible. 

This deduction won’t help everyone.  The deduction will be limited to taxpayers with adjusted gross income below $110,000.

Finally, you’re out of luck if you are already paying mortgage insurance.  This deduction will only apply to mortgage insurance contracts issued in 2007, and it’s set to expire on December 31, 2007.

For more information on the mortgage insurance premium deduction and the tax law, please visit:
http://www.mercurynews.com/mld/mercurynews/business/personal_finance/16217445.htm

Educator Expense Deduction Extended

If you are a teacher, you probably know about the $250 deduction that is allowed on your income tax return.  While this is a very small tax break, every little bit helps. 

So, I was glad to see that Congress extended this deduction for two more years, until the end of 2007. 

If you’re not familiar with this tax deduction, here’s a brief summary:

Teachers can deduct up to $250 that they spend out of pocket to buy classroom supplies.  The deduction is an above the line deduction, which means you don’t have to itemize to take the deduction. 

The deduction is available to teachers, instructors, counselors, aides and other educators who work with classes from kindergarten through grade 12.

Costs that are deductible include books, supplies, computer equipment, software and other materials used in the classroom. 

To learn more, please visit:
http://www.bankrate.com/BRM/itax/tips/20030213a1.asp or
http://www.irs.gov/taxtopics/tc458.html

IRA withdrawal for 1st time home purchase

Q. I am making my first home purchase. Can I take money out of my IRA to help with the down payment?

A. Generally, withdrawals from a traditional IRA before the age of 59 ½ are subject to income tax and a 10% penalty. There are several exceptions to the 10% penalty, one of which is a distribution for a first time home purchase.

You can take up to $10,000 from your traditional IRA to purchase your first home without incurring the 10% penalty.

There are some rules to keep in mind, however:

1. The purchase must be for a principal residence – qualified costs include costs to build, buy or rebuild a home.

2. The person purchasing the residence must be the IRA account owner or a family member (within limits).

3. To qualify as a first-time homebuyer, you must not have owned a home at any time during the two years prior to the IRA withdrawal. If you are married, your spouse must also meet this requirement.

4. The 10% penalty exception only applies to the first $10,000 you withdraw from your IRA (this is a lifetime limit) – if you are married and both spouses qualify as first time homebuyers, you can each withdraw $10,000 from your IRAs penalty free.

5. You must use the IRA funds within 120 days of the withdrawal to qualify for the exception.

Will I Owe Taxes on the Sale of My House?

Q:  How do capital gains taxes work?  I want to sell my home, but have only been there for 18 months.  How much will I have to pay in capital gains tax?  Is two years the shortest time I can stay in my house without having to pay capital gains tax?

A:  Generally, the sale of your principal residence is not reported on your tax return unless you have a gain on the sale and you do not qualify to exclude the gain. 

Exclusion:  You can exclude from your income up to $250,000 ($500,000 for taxpayers filing Married Filing Joint) of the gain from the sale of your home if you meet the following conditions:

• If you have owned and used the home as your principal residence for at least two out of the last five years prior to sale, and
• You have not sold another home in the last two years.

Click here to read more…

Stricter Rules for Gifting

If you give money or non-cash donations to charity, you’ll be interested in some of the provisions of the new Pension Protection Act.

There are two changes affecting charity:  the first is that you are now required to maintain written documents for any cash gifts in order to claim a deduction.  Most churches will send you a statement at the end of the year, if you use the envelopes provided, or write a check.  But gone are the days of dropping cash into the collection plate or the Salvation Army bucket.

Second, if your donated non-cash items aren’t in "good" condition, you won’t get a deduction.  This is to keep people from taking large deductions for items that really belong in the trash.  Of course, no-one has defined what "good" condition is yet, so use your common sense when donating items.

Resources:
New pension law closes loopholes in charity deductions - LA Times
The Pension Protection Act of 2006 offers retirement tax breaks, tough rules on charity - About.com

Deducting Roth IRA Losses

Recently, someone asked me if they could deduct losses they incurred in their Roth IRA.  Here’s my response…

You can deduct losses in a Roth IRA, but the rules and treatment are different than you might expect.  First, in order to claim a loss in any IRA investment, you must withdraw the entire balance from all of your IRAs of the same type.  So, if you have a loss in your Roth IRA, you must liquidate all of your Roth IRAs in order to deduct the loss on your tax return.

Second, your basis in your Roth IRA includes your contributions plus conversions (from a traditional IRA) less any withdrawals you have previously taken from your Roth.  Form 8606, Non-Deductible IRAs, is used to determine the basis in your account and to

report withdrawals.  Note that reinvested dividends and capital gains are not part of your basis in a Roth IRA.

Finally, losses in a Roth IRA are deducted on Schedule A – Itemized Deductions, rather than on Schedule D – Capital Gains and Losses, which is where most people would expect to report the loss.  Roth IRA losses are a miscellaneous deduction, subject to a 2% floor.  This means that the deduction is only available if you itemize your deductions, and only the amount greater than 2% of your adjusted gross income (AGI) is deductible.  In addition, miscellaneous deductions are not allowed for purposes of the alternative minimum tax (AMT), so you could lose the benefit of the deduction if you are subject to AMT taxes.

Whether it makes sense to liquidate your Roth IRA to claim the loss will depend on several factors, such as whether you itemize or not, how large the loss is compared to 2% of your AGI, whether you’re subject to AMT tax, and other factors.  You should also consider how much will you lose in potential earnings if you liquidate your Roth IRA.  You may want to consult with your tax advisor and financial planner to determine the best decision for you at this time.

401K Options

Whether you’re switching jobs or retiring completely, chances are you have a 401K or other company sponsored retirement plan that you’ll need to make a decision about.

There are several options on how to handle your 401(k) money when you leave a job:

• Take the Money and run
• Leave the money in the 401(k) plan
• Transfer the funds directly to your new employer’s retirement plan
• Transfer the funds directly to an IRA account (direct rollover)
• Have the check made out to you, and then deposit the funds into an IRA account (indirect rollover)

To read the full article, click here.

Backdoor into Roth

You may have heard that the new tax law eliminates the $100,000 income limit for Roth conversions beginning in 2010.  If you haven’t been able to contribute to a Roth IRA because your income is too high, you now have a back door into the Roth IRA. 

You should start planning now to take full advantage of the new tax law.  How?  Contribute the maximum to a non-deductible IRA now (and every year up to 2010).  The limit in 2006 is $4,000 ($5,000 if you are 50 or older). 

In 2010, when the income limit for Roth conversions goes away, you can convert your traditional IRAs to Roth IRAs.  Because you made non-deductible contributions, only your earnings will be subject to income tax. 

Even better, taxes owed on conversions made in 2010 don’t have to be paid until 2011 and 2012, which allows you to spread the tax burden over several years.

What are the benefits of this strategy?  Tax free income in retirement, no Required Minimum Distributions at age 70 1/2, and tax free income for your heirs. 

Need help determining if this is the right strategy for you?  Check out or Tax Review.

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