Right now most homeowners are too busy preparing for the holidays and getaway trips to the slopes, the beach–or Northwestern’s bowl game in Pasadena–to focus on anything as unfestive as tax planning.
But those who can find a little time amidst the season’s festivities to ponder their tax situation may be able to save themselves hundreds or even thousands of dollars next April 15.
There are several things homeowners can do between now and the singing of Auld Lang Syne to trim their 1995 tax bills.
For some home sellers, year-end tax planning is especially important this year given the tax-cut package approved last month by Congress. Lawmakers included several provisions that would provide some home sellers with immediate tax relief. But in some cases, getting the relief may require postponing the closing until after Congress and the White House settle on a final tax bill.
Following are some ideas for pruning 1995 tax bills and for positioning yourself to take maximum advantage of the likely tax changes ahead.
Pay January’s mortgage
One easy way to pick up hundreds of dollars in extra itemized deductions for 1995 is to pay your January mortgage installment by Dec. 31.
Paying early will allow you to deduct the payment on your 1995 tax return instead of having to wait until April 1997 to reap the tax savings.
The tax code normally doesn’t permit deductions for prepaid interest. But January’s installment is an exception. The reason is that mortgage installments usually contain an interest charge for the preceding month. So, if you pay your January 1996 installment by the end of this month, you’ll be able to deduct the December interest charge included in that installment on your 1995 return.
Technically, your mortgage payment can be mailed as late as Dec. 31 to qualify for a 1995 deduction. But try to mail it as soon as possible so that your lender can record the payment and cash the check before the end of December, advises Thomas Beneventi, a senior manager at the accounting firm of McGladrey & Pullen in Schaumburg.
In case the IRS later questions the deduction, the cleared check and the paper trail at your mortgage lender’s office will provide proof that your payment was, indeed, eligible for a 1995 deduction. “It just makes it easier if everything was taken care of in 1995,” says Beneventi.
And don’t panic if your prepayment doesn’t show up on the year-end tax statement that your mortgage lender will send you next month.
Late-December payments sometimes get left off the Form 1098 report. All you’ll need to do is attach a note to your tax return explaining the discrepancy between your figure and the amount your lender reported on Form 1098 (“Mortgage Interest Statement”).
Property tax bills
Another way some homeowners can pick up extra itemized deductions for their 1995 return is to pay their property tax bill by Dec. 31, even though the taxes may not be due until early next year.
Not everyone will benefit from paying early, however. Only those homeowners who normally pay their property taxes directly to the tax collector will be able to claim a 1995 deduction for early payment of their property tax bill.
If you normally send your property tax payments to your mortgage lender as part of your monthly mortgage payment, paying the taxes early won’t get you a 1995 deduction. The reason is that property taxes can’t be deducted until the money is turned over to the tax collector. And lenders won’t take your money out of escrow and turn it over to the tax authority until the taxes are due next year.
Paying early is counterproductive for upper-income homeowners who expect to be subject to the “alternative minimum tax.” Under the minimum tax computation, property taxes aren’t deductible. (The minimum tax is designed to reinflate the tax bills of those who claim sizable amounts of certain tax benefits.)
If you want to pay your property taxes early, but haven’t yet received a bill from the tax collector, Beneventi recommends sending a letter along with your check explaining what period the payment covers.
Home office deduction
If you’re eligible for home-office deductions, refurbishing and refurnishing your place can bring in some extra deductions.
Repairs made to your home office, such as hanging new wallpaper, are fully deductible as a home-office expense.
What’s more, repairs made to other parts of your home can be partly written off if the work partly benefits your home office. Examples include fixing the furnace and patching the roof, since they help keep your home office warm and dry.
Buying new furniture or equipment for your office can add hundreds or thousands of dollars to your 1995 deductions.
Paying some outstanding household bills by Dec. 31 can also yield some last-minute deductions. A portion of your utilities, homeowner insurance premiums and other upkeep expenses can be written off as a home office expense.
But before you start refurbishing or writing checks, be sure your efforts won’t be wasted. Generally, home-office deductions are limited to the amount of income generated by your business. How much furniture or equipment you can write off as a business expense may also be limited by your income and other depreciation rules.
If you’re about to sell real estate that would be immediately subject to capital gains tax–such as a vacation home or investment property–consider delaying the closing until after Dec. 31.
There are a couple advantages. For one thing, delaying the closing until next year will give you up to an extra year to pay the tax on your profits. Instead of the tax being due by next April 15, the full tax won’t be due until April 1997.
Another reason for delaying the closing is that you’ll have greater assurance that your profits will be eligible for any capital gains tax cut that eventually gets approved by Congress and the White House.
Under the House-Senate tax plan approved last month, the capital gains cut would apply retroactively to real estate sales on or after Jan. 1, 1995. Lawmakers are likely to feel great pressure to stick to that effective date, says Thomas Ochsenschlager, a tax partner at the accounting firm of Grant Thornton in Washington, D.C. But he is advising clients not to ignore the possibility that the effective date might be moved to some future date in the final bill negotiated by Congress and the Clinton administration. As a result, he is advising clients to delay closing real estate sales, if possible, until Congress and the administration reach final agreement and the effective date of the capital gains cut is certain.
Another option is to arrange an “installment sale.” This arrangement allows you to close the sale now but defer tax on most of your profits until a time when a capital gains cut is certain to be in effect. Based on the House-Senate bill, installment payments received after the effective date of the capital gains cut would be taxed at the lower rates–even if the sale took place before the effective date, according to Ochsenschlager.
In an installment sale, the buyer agrees to pay you in installments over more than one year. Instead of having to pay tax on your entire gain immediately, the installment method allows you to pay tax on your profit as you receive the money year by year.
Special relief ahead
Most homeowners don’t need to worry about installment sales, delaying closings or effective dates. That’s because capital gains tax on the sale of a principal residence can be deferred indefinitely so long as you buy a replacement residence that costs at least as much. In addition, homeowners age 55 and over can permanently escape tax on up to $125,000 in home-sale profits. Vacation homes don’t qualify for either tax break, nor do rental properties.
But some home-sellers do have incentive to ensure they are eligible for certain tax breaks that are being proposed by Congress, which may mean delaying the closing until a final bill is approved.
For example, one proposal would help homeowners who sell their residence at a loss. Under current law, losses on the sale of a principal residence generally aren’t deductible. But the House-Senate bill would allow home-sale losses to be deducted as a capital loss. (Capital losses can be used to offset any capital gains you have plus up to $3,000 of other income, such as salary from your job. Excess losses can be carried forward for use in a future year.) The House-Senate bill would cover home sales since Jan. 1, 1995.
The House-Senate bill also would loosen eligibility guidelines for the $125,000 exemption. Older homeowners would no longer be barred from claiming the one-time exemption if they marry someone who previously claimed the break. The congressional proposal would apply to sales after Sept. 13, 1995.
In some cases, you’ll need to wait until the President signs the final bill into law to have any chance for tax relief. That’s because a few homeowner proposals would apply only to home sales closed after the legislation is enacted.
Under one such proposal, homeowners would no longer need to worry about the tax consequences of moving too frequently. Under current law, homeowners can defer capital gains tax on the sale of only one principal residence in a two-year period unless the move is job-related. The congressional plan would allow deferral for more than one home in a two-year period, regardless of whether the move is job-related.
Another measure that would apply only to home sales closed after the legislation becomes law would help couples who are divorcing. The change would simplify the rules for deferring tax when a home is sold pursuant to a divorce.
