Tax Strategies for 2012
BY LISA SCONTRAS
Did you feel like Warren Buffett’s secretary after filing your income taxes last week? Buffett’s employee, Debbie Bosanek, was made famous because her tax rate was 35 percent, while her billionaire boss – with all his deductions – paid at a rate of 17 percent. Like Bosanek, maybe you’re missing out on deductible expenses that could save you thousands of dollars in tax savings each year.
“Tax planning certainly isn’t only for the wealthy,” says Brad Konishi, a CPA and expert on tax strategy. For the average taxpayer, the most valuable deductions – hands down – have to do with homeownership.
“In most cases that I’ve seen, it really makes sense to buy a home as opposed to renting one – especially over the long term,” says Konishi. “Besides the tax advantages, there are also other financial considerations that make owning a home so desirable.”
Mortgage interest, which accounts for a significant portion of your monthly payment, is generally deductible, for as long as you have a mortgage. If you opted to pay down your interest rate by paying points, that is considered prepaid interest and may also be deductible.
Property taxes are also an itemized tax deduction for homeowners.
“There are also some lesser-known tax incentives for owning a home,” says Konishi. “The Mortgage Credit Certificate program allows qualified homebuyers to convert 20 percent of their mortgage interest into a tax credit to offset their federal tax liabilities. I have a number of clients who have received MCCs, and the additional tax savings they’ve realized resulted in thousands of dollars in their pockets. It is like a mortgage interest deduction with a turbo-charger attached.”
The number of MCCs issued every year is limited and certain conditions apply, so interested homebuyers are advised to talk with a knowledgeable loan officer or tax professional.
One of the most substantial benefits of homeownership comes when homeowners sell their home.
“Single taxpayers who are selling their main home may be entitled to exempt up to $250,000 in capital gain ($500,000 for married taxpayers filing jointly),” says Konishi.
The general rules to be eligible for this gain exclusion are as follows: Within the five-year period ending on the date of the home sale, the taxpayer must have owned the home for at least two years, and lived in the home as their main residence for at least two years.
“In addition, within the two-year period ending on the date of the sale, the taxpayer may not have used the gain exemption on any other home sale,” clarifies Konishi.
Real estate investors have even more tax deductions available to them.
“Similar to the owner of a principal residence, they are also eligible for a tax deduction for mortgage interest as well as real property taxes,” says Konishi. “However, unlike the owner of a principal residence, they are also eligible to take tax deductions for repairs, maintenance fees, unreimbursed utilities and depreciation.”
Another benefit of owning a rental property is that if an owner sells the property they have owned for more than a year at a loss, they may be able to use that loss to offset other types of income, such as salaries, bonus or self-employment income.
Investors who sell their rentals at a gain can defer paying capital gains tax by way of a 1031 tax exchange, which defers the recognition of capital gains on investment properties.
“I have many clients who started investing in rental real estate with small, inexpensive properties, and by using 1031 exchanges, they have moved further and further up the property ladder,” Konishi says. “Now, a number of them have rental property portfolios worth millions, and have been able to build their portfolios deferring their capital gains for decades!”
Running the numbers to see how these deductions could put money into your pocket is what Konishi helps his clients do. Particularly during times of inflation, a home is a very good shelter for wealth.
“Interest earned on cash in the bank is often not enough to keep pace with inflation, and that’s especially true in today’s market,” he says. “However, homeowners can take advantage of their growing equity, which happens when they pay down their mortgage debt as well as when property values increase. Then, if they need it, they can turn that equity into cash with a home equity line of credit, a refinance or even a second mortgage. Renters don’t have those sort of options.”