THERE'S NO PLACE LIKE HOME

by Andrew D. Schwartz, CPA

We're all familiar with Dorothy's famous words in the Wizard of Oz, "There's no place like home."  When it comes to financial planning, Dorothy's sentiment rings true. 

Advantages of Home Ownership

First, owning your home saves you taxes.  Unlike rent, which isn't tax deductible, paying a mortgage and real estate taxes is deductible on your federal tax return.  Let's say you have a $400,000 mortgage with an interest rate of 6%, and you pay $3,000 in real estate taxes each year.  If you're in the 30% tax bracket, you'll save $8,100 in federal taxes this year.  That's a tax savings of $675 per month.

Home ownership also provides you with a tax-free way to accumulate wealth.  Under the current tax rules, when you sell your principal residence, you won't be taxed on the first $250,000 of appreciation if you're single, or the first $500,000 of appreciation if you're married, as long as certain conditions are met. 

What does that mean to you?  Unless you sell your home for more than $500,000 ($250,000 if you're not married) above what you paid for the home plus improvements, you won't pay a dime in taxes.  It's important to note that the home sale rules changed in 1997 and you no longer need to roll over the proceeds from the sale of your principal residence into a more expensive home within two years to avoid paying taxes on the gain realized.

When you own a home, you also have a nice hedge against inflation.   Think back to your days as a renter.  How many years can you remember that your landlord didn't increase your rent?  When you own a home, if you have a fixed rate mortgage, your monthly payment remains fixed over the life of the loan.   As inflation causes the price of everything else to increase (including your salary), it's nice to know that your largest monthly bill will remain constant. 

Potential Pitfall

There are times when owning a home might not make sense.  If you're not sure where you'll be living in two or three years, you might be better off remaining a renter for now.   With the transaction costs of buying and selling a home as high as 10% of the cost of the home, unless your home appreciates by 10%, you could end up losing money when you sell it to move to a new city.

Is now a good time to buy your first home or to upgrade to a more expensive home?  While interest rates are still pretty low (but apparently on the rise), home prices are generally quite high throughout the U.S.  In the short-term, therefore, you might overpay for a home if there is a correction in the housing market.  In the long-term, however, owning a home (that doesn't break the family budget) is a key ingredient to most people's financial well being. 

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CHECKLIST TO CUT YOUR TAXES

by Andrew D. Schwartz, CPA

It's not too late to cut your 2005 tax bill.  Prior to December 31^st:

• Increase your 401(k) and 403(b) contributions if you haven't been contributing at the maximum rate all year.  This year you can put up to $14,000 into your 401(k) or 403(b) plan.  If you’re self-employed, consider setting up a Solo 401(k) by 12/31.  Contributing to a 401(k) or 403(b) plan at work is one of the best tax shelters available to you during your working years.

• Take a look at your withholding and instruct your employer to withhold additional taxes if you haven’t had enough taxes withheld during the year to avoid getting hit with an underpayment penalty.

• Consider selling your investments held in non-retirement accounts that have decreased in value since your capital losses can offset other capital gains realized during the year (including from your mutual funds).  Excess losses can then be used to offset up to $3,000 of wages and other income.  Make sure to wait at least 31 days before buying back a security sold at a loss, or the IRS will disallow the loss under the "wash sale" rules.

• Send in your January, 2006 mortgage payment early enough so it will be processed prior to 12/31/05.  By sending in your payment a few weeks early, you can deduct the interest portion of that payment a full year earlier.

• Clean out your closets and donate your clothing and household items to a charitable organization, since "non-cash" contributions are deductible if you itemize.  Don’t forget to get a receipt.  For gifts of money, making your donation by credit card before December 31st allows you to deduct the donation on this year's return, even if you don't pay your credit card bill until 2006.  And you always have the option of donating appreciated investments to charities. You get to claim your donation based on the value of the assets donated, without paying any capital gains taxes on the appreciation.

• Pre-pay your projected state tax shortfall if you'll be itemizing your deductions and not subject to the alternative minimum tax.

• Pay off your medical bills if your total medical expenses exceed 7.5% of your income and you itemize.

• Evaluate whether you'll save any taxes by postponing 2005 income or deductions into 2006 or by accelerating 2006 income or deductions into 2005.

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TAX AND FINANCIAL PLANNING CALENDAR FOR DECEMBER, 2005

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2005 & 2006 TAX FACTS

• For 2005, the standard deduction for a single individual is $5,000 and for a married couple is $10,000. A person will benefit by itemizing once allowable deductions exceed the applicable standard deduction. Itemized deductions include state and local income taxes (or sales taxes), real estate taxes, mortgage interest, charitable contributions, and unreimbursed employee business expenses. Our March, 1998 newsletter  explains itemizing your deductions.
• For 2004, the personal exemption is $3,100. Individuals will claim a personal deduction for themselves, their spouse, and their dependents. 
  
• The maximum earnings subject to social security taxes is $90,000 for 2005, and increases to $94,200 in 2006.
  
• The standard mileage rate is $.485 per business mile as of September 1, 2005 (after being $.405 per mile through August 31, 2005), up from $.375 per mile for 2004. Deducting automobile expenses was addressed in our March, 1996 newsletter .
  
• The maximum annual contribution into a 401(k) plan or a 403(b) plan is $14,000 for 2005.  And if you'll be 50 or older by December 31, 2005, you can contribute an extra $4,000 into your 401(k) or 403(b) account this year.  The maximum annual contribution increases to $15,000 ($20,000 if 50 or older) in 2006.
• The maximum annual contribution to your IRA is $4,000 for 2005.  And once you turn 50, you can contribute an extra $500 into your IRA this year.  You have until April 15, 2006 to make your 2005 IRA contributions. 

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copyright - 2005 - The MDTAXES Network

Tax and financial planning calendar for December, 2005


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