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Tax deductions

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Valuing noncash contributions

Valuing noncash contributions such as these at a Goodwill store
Brad K., Goodwill, under Creative Commons license, on Flickr

So you are preparing your income taxes or getting your information ready for your tax preparer and you are wondering what value to place upon that load of household items, clothing and furniture you gave to charity. Valuing noncash contributions is a common problem. Your tax preparer should not value them as the preparer has not seen the items, does not know the brands and is seldom an expert on the value of used property.

Options for valuing noncash contributions

  • Go into a local thrift shop such as The Dorcas Shop, Goodwill or Salvation Army and look at the prices they charge for items similar to what you are giving to them. Often they will have a price list posted and you can start with that.
  • Try Fun With Taxes valuation table, remember your donation is based on local values which is why they show a range
  • Salvation Army Valuation guide, again remember you need the value in your area
  • Check online used prices at places such as eBay
  • Try local consignment shops
  • Intuit offers an online calculator called ItsDeductible (TM ). Intuit even has a mobile app for Apple.

What not to do

  • Do not include any value for items that are not in good or better condition. Actually, just throw those items out as most charities do not want things in bad condition. You can include items that are not in good used condition if you have a qualified appraisal and the value is more than $500. A qualified appraiser is generally licensed and charges for her appraisal. Uncle Joe’s opinion does not count.
  • Do not use the original cost as a guideline for the current value. There is a bad rule of thumb that used clothing, furniture and household items are worth a third of original cost. If your two men’s suits that costs $3,000 total are worth a $1,000 then why are you not selling them? Salvation Army has $60 as the high range for the value of used men’s suits.
  • Make sure the organization you donate to is really a qualified charity. Some for profit companies put out clothing drop boxes. Contributions to them are not deductible.

What to do

  • Use a reliable valuation method such as one of those mentioned above
  • Make sure your receipt is complete – Charity name, address, date, and a list of what was given. Three bags of clothes is not enough detail.
  • Prepare a list before you go showing what is in each bag or box. If you can, get the charity to sign and date your itemized list indicating they received the items. The higher the value, the more important a detailed list and acknowledgement of that detailed list by the charity.
  • Make sure your receipt is in hand and in acceptable form before you file your return. You can find more about the requirements for receipts from my post here.
  • If the total value of similar items will exceed $5,000 for the year, get an appraisal from a qualified appraiser before you make each donation.

Conclusion

Noncash contributions provide a lot of money to charities, the charities provide shops for people to purchase affordable used items, and the charities provide local jobs at their collection centers and shops. Beyond that, a contribution of good or better quality used items reduces the waste stream by recycling the items. Just be careful valuing noncash contributions.

Do you have any tips or web sites for valuation? Please add them in the comments.

 

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Repair and capitalization relief!

On November 25, 2015 IRS provided small businesses and landlords with repair and capitalization relief. Please see Notice 2015-82 (PDF). The 2013 regulations provided guidance on what is a repair and what had to be capitalized. Bullet point four of this post mentions the 2013 changes.  The regulations allowed businesses to treat amounts up to $500 as supplies. Previously, taxpayers would have had to justify deducting new property costing under $500. The new notice changes the amount from $500 to $2,500.

Looks like this car requires more than $500 in work!

This car needs repair and capitalization relief!
Kaz Andrew, 1976 Lincoln Town Coupe, under Creative Commons license, on Flickr

Some background

Tangible property is just what it sounds like. It is property you can touch. Intangible property – such as a patent – cannot be touched. The copyright document can be touched but not the actual idea. For a long time, taxpayers and IRS have argued about whether or not a piece of tangible property is a repair or subject to capitalization. The distinction matters because businesses can immediately deduct repair and maintenance costs, with some exceptions. On the other hand, something that has to be capitalized is typically depreciated over anywhere from a few years to 40 years.

Depreciation is a method of claiming part of the cost of the capitalized asset each year for several years.

  • Repair = 100% deducted in year one (there are some exceptions which are beyond the scope of this post)
  • Capitalized = deduct as little as 2.5% of the cost each year for 40 years, sometimes even less per year.

Qualifying taxpayers

Taxpayers that have an applicable financial statement got a $5,000 safe harbor in the 2013 regulations. Taxpayers without an applicable financial statement (AFS) only received the $500 safe harbor. An AFS is one that is audited or required to be filed with a regulatory agency. If the only reason for audited AFS was to get the $5,000 safe harbor then the taxpayer was still stuck with the $500 safe harbor.

An example

XYZ Company built a $2,500 storage shed. Prior to the 2013 regulations, IRS would have wanted the taxpayer to deduct an average of $65 a year for the next 39 years. Assume XYZ Company has an AFS. If the shed was constructed in 2014 or after, then XYZ could claim the entire $2,500 as a supply deduction in the year built.

Assume ABC Company does not have an applicable financial statement and it builds the $2,500 shed in 2014.  Under the 2013 regulations, ABC was stuck with claiming an average of $65 a year for 39 years. Notice 2015-82 changes this for 2016 (and for many also for 2015). If ABC builds a new shed in 2016 for $2,500, it can claim a supply deduction in 2016 of $2,500. A much better deduction than $65 a year for 39 years.

Repair and capitalization relief for 2015?

The notice states it “is effective for costs incurred during taxable years beginning on or after January 1, 2016.” This seems to say no businesses qualify for the $2,500 safe harbor under the notice until 2016. However, the notice goes on to say

AUDIT PROTECTION

For taxable years beginning before January 1, 2016, the IRS will not raise upon examination the issue of whether a taxpayer without an [applicable financial statement] can utilize the de minimis safe harbor … for an amount not to exceed $2,500 per invoice (or per item as substantiated by invoice) if the taxpayer otherwise satisfies the requirements ….

IRS is saying that if a taxpayer uses the $2,500 safe harbor in 2015, then IRS will not deny the supply deduction as long as it is less than or equal to $2,500. The taxpayer still has to meet all the other requirements that existed when the amount was $500.

How is this for some repair and capitalization relief? Audit protection, nice.

 

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Mileage logs stink – try an app

2013 Ford Taurus SHO
2013 Ford Taurus SHO by That Hartford Guy, under Creative Commons license, on Flickr

Keeping mileage logs is an aggravating requirement in order to claim vehicle expenses for most small business owners. There are some exceptions to a log – hearses, ambulances and 18 wheel trucks come to mind – but most people have to keep a written contemporaneous record or there is no vehicle deduction. Written contemporaneous record is IRS code for a mileage log. You can read more about the requirements in this post.

This post is about a way to make keeping a log a bit less taxing (sorry, pun intended).

Smartphone Apps substitute for mileage logs

Here is one that is popular with accountants – MileIQ. It works on Android smartphones and iPhones. Sorry, BlackBerry and Windows users you need to look elsewhere. Since I have a Windows Phone, I do not have personal experience with this app so please try before you buy. The application eases mileage tracking by:

  • Logs every trip automatically
  • Calculating the mileage automatically
  • Syncs with the cloud so you have a backup in case you lose your phone. IRS does not forgive you for losing your paper log.
  • Swipe to tell the app whether the trip is business or personal
  • Saves location names for those frequent destinations
  • Space to enter the extra information IRS wants – e.g. purpose of trip
  • It adds up total business miles so no manually totaling hundreds of entries

Currently, the monthly fee is $5.99 or annually you pay $59.99. If you have 40 or fewer a month, MileIQ is free.

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Meal and entertainment tax rules

Britannia Restaurant
Cunard QM2. Britannia Restaurant, under Creative Commons license, on Flickr

Special rules for Meals and Entertainment

Congress decided there was a higher chance for fraud or errors in deducting meals and entertainment. Consequently, Congress enacted Section 274 of the Internal Revenue Code in 1962 creating special meal and entertainment tax rules. There have been quite a few changes to Section 274 but this post will only cover the current rules. Beyond the normal documentation to claim any business deduction Congress added these additional documentation requirements:

  • The amount of each separate expense
  • The date of the event
  • The name, address or location, and designation of the type of activity. For example, dinner or theater, if that information is not apparent from the other information.
  • The business reason for the expense or the nature of the expected business benefit. Include the nature of any business discussion or activity before during and immediately after.
  • The occupation or other information relating to the person(s) attending. Include their name(s), title(s), or other designations, sufficient to establish business relationship to the taxpayer.

Leave something out, IRS will deny the deduction and the courts will uphold the IRS. Congress allowed no leeway for IRS or the courts. A perfect example where Congress needs to allow IRS and the courts some discretion. If you agree, please contact your Representative and Senator.

Per Diem rules

Per Diem expenses must be documented the same as all other meal expenses. If the Per Diem exceeds the federal amount then the employee has to return the excess, or the entire amount, not just the excess, must be included in the employee’s wages.

Conclusion

To sum this post up, want a deduction for meals and entertainment then keep the proper documentation. This is a brief summary of the rules so please contact us for more details or post a question or other comment in reply to this post.

 

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Business mileage deduction vs. commuting

2013 Ford Taurus SHO
2013 Ford Taurus SHO by That Hartford Guy, on Flickr, under Creative Commons license, on Flickr

Business mileage deduction

Expenses for qualified business use that are properly documented are deductible using either actual expenses or the mileage method.

  • Qualified business use is travel for ordinary and necessary business travel
  • Documentation must include:
    • Amount – the mileage for each business use, date you started using the vehicle for business and the total miles (business and personal) for the year. You do not have to write down each personal trip, just the business ones. For personal miles you can track the odometer at the beginning and end of the year and from that calculate total miles. Subtracting business miles from the total gives you personal miles.
    • The date of each use
    • Business destination
    • Business purpose of the use

The actual expense method requires you to track all vehicle expenses, yes all, for the year. You take the percentage of business miles are of the total miles and multiply it by the total expenses. I find many taxpayers new to the business vehicle expense deduction only keep fuel purchases while out on business trips. You still have to apply the business use % to these “business” only fuel purchases. That is why you need the total of all vehicle expenses.

Many taxpayers will ask why they cannot just keep the fuel purchases while on business trips. Let us look at an example. Sally Smith has an SUV that gets 12 miles to the gallon that she drives personally and for business. Sally’s only business miles are when she drives from her store to the Post Office, a two mile round-trip. Conveniently, there is a gas station between her store and the Post Office. Any time Sally needs fuel, she volunteers to make the daily trip to the store’s Post Office box. She stops and fills her SUV up with 35 gallons of gas at $3.00 per gallon or $105. With 35 gallons she can drive an average of 420 miles of which two are business. Her actual cost of fuel for the round-trip is $0.50 ($105/420 miles * 2 miles) but deducting the fuel purchased on a business trip would give her a $105 deduction. IRS says that her method does not reflect economic reality and only allows the $0.50 of fuel.

Commuting

Commuting from your residence to your principal place of business is generally not deductible. IRS has made three exceptions (Revenue Ruling 99-7) :

  1. “A taxpayer may deduct daily transportation expenses incurred in going between the taxpayer’s residence and a temporary work location outside the metropolitan area where the taxpayer lives and normally works.” (Emphasis added) While I am not aware of IRS blessing it, the Office of Management and Budget defines Metropolitan Areas (downloads as PDF) for statistical purposes. The Raleigh Metropolitan Statistical Area is composed of  Wake, Johnston and Franklin Counties.
  2. “If a taxpayer has one or more regular work locations away from the taxpayer’s residence, the taxpayer may deduct daily transportation expenses incurred in going between the taxpayer’s residence and a temporary work location in the same trade or business, regardless of the distance.” (Emphasis added) In Walker V. Commissioner (101 T.C. 537) the Tax Court ruled that since Mr. Walker regularly worked at his residence. Even though he did not qualify for the home office deduction (see item 3), he could deduct travel to temporary locations within the same metropolitan area as his residence. This case was decided under Revenue Ruling 90-23 which has been superseded by Revenue Ruling 99-7. If a taxpayer wants to take the position in the Walker case, they should consider completing Form 8275 – Disclosure Statement alerting the IRS that you are taking a position IRS does not agree with.
  3. “If a taxpayer’s residence is the taxpayer’s principal place of business within the meaning of section 280A(c)(1)(A), the taxpayer may deduct daily transportation expenses incurred in going between the residence and another work location in the same trade or business, regardless of whether the other work location is regular or temporary and regardless of the distance.” Section 280A(c)(1)(A) discusses the requirements to claim a home office deduction.

The Revenue Ruling defines temporary as a work location that is realistically expected to last, and does last, one year or less.

These rules apply the same to employees and self-employed taxpayers. There is nothing magical about being self-employed that makes commuting mileage deductible.

 

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Closing statement tips for new home buyers

HUD-1, also known as a closing statement and as a settlement statement
HUD-1, also known as a closing statement and as a settlement statement

Most closing agents will complete a Settlement Statement (HUD-1) (PDF) for the purchase of residential real estate (a residence). In NC closing agents are typically attorneys or paralegals under the supervision of an attorney. In many states, title companies and others can act as the closing agent (HUD calls them settlement agents).

There is some variety in how closing agents complete the HUD-1 which makes it more difficult for people to find what is and what is not deductible on their personal tax returns. This post will deal only with people purchasing a residence that will serve as their principal residence. Rental properties, commercial space, vacant land and second homes are treated somewhat differently or have additional considerations.

For the buyer

Keep in mind that only the amounts in the buyer column concern you unless otherwise noted.

Property taxes:

hud-1-tax-proration
HUD-1 tax allocation section

Lines 106 and 107 on page 1 are supposed to list your share of the real estate taxes for the current year/period that the seller already paid. You are reimbursing them for your share for the time you own the residence. You should be able to deduct these taxes on your Schedule A, if you itemize. From here forward, I am assuming you will itemize. In theory you will see the same amounts on lines 406 and 407 for the seller but sometimes the seller has not yet paid the tax and the closing agent will put the seller’s share on lines 510 and 511 and sometimes they do something else with the seller’s share.

If you do not see the taxes on lines 106 and 107, try looking on the lines below 107. The assessments on line 108 or seldom qualified real estate taxes. If you think they might qualify, find out more about them and then look at IRS Publication 17 for the definition of real estate taxes. If the seller has not yet paid the real estate taxes, look at lines 210 and 211 on page 1. This is the seller’s share of the real estate taxes you will pay on their behalf. They deduct this portion not the buyer. In this case, you take the total real estate tax you paid the year of closing on the new home and reduce them by this amount.

You may also find your share of real estate taxes on page 2 of the HUD-1. Most commonly they are listed on lines 808 to 811 or 1302 to 1305. Rarely I see them on other lines. You need to watch out for the amounts in the lender reserves/escrow section, lines 1001 to 1007.

Escrow section
Escrow section/Lender Reserves

These are deposits made with your escrow agent and are not deductible until paid to the tax authority. You can find what your escrow agent paid to the tax authority on your annual escrow reconciliation, on Form 1098 with your mortgage interest (not always there though), or on your monthly statements typically available online from your lender.

Interest:

When you purchase your principal residence, you can deduct reasonable charges for points and origination fees. You will almost always find them on page 2, lines 801 to 803. Sometimes the line 803 net is negative, meaning you chose a higher interest rate in exchange for lower closing costs. You do not get to deduct the negative amount because that is an amount the lender paid to you to cover other closing costs. You effectively deduct the negative amount via the higher amount you pay in interest as shown on your Form 1098. You do not need to track the negative amount. Points and origination fees paid by the seller are still deductible by the buyer. The theory is that the buyer paid them via a higher purchase price so you have to reduce your cost basis by origination fees and points paid by the seller. The IRS has endorsed this theory.

You may find some deductible interest on page 2, line 901. This amount plus the net points and origination fees are supposed to be on your annual Form 1098 from your mortgage company. Sometimes they are not because the total is under $600 and the mortgage company is not required to issue a Form 1098 in that case. This usually happens when the mortgage company sells the loan immediately to another lender or when you close near the end of the year. Sometimes your Form 1098 is wrong and omits part or all of the deductible origination fees, points and interim interest. You need detail from the mortgage company on how they calculated the amount on Form 1098 to see if they missed the interim interest from line 901.

Mortgage insurance premiums:

On page 2 you want to again ignore the line 1003 escrow amounts. These are on deposit for you until paid and should show on your Form 1098 once paid to the insurance company. However, make sure the amount on line 802 is reported on your Form 1098. If not, you may be able to deduct it depending on the rules for the year you buy. Congress cannot make up its mind about this deduction and it expires quite often only to be later renewed. Who can deduct mortgage insurance premiums is income based and depends on the year the loan was opened.

That is it for buyers. Sorry, the prorated homeowner association fees, prorated utility bills, homeowner’s insurance, title charges, recording fees and other loan fees are not deductible on a principal residence. Some of these charges, such as the title charges and deed recording fees, are added to your cost but not immediately deductible.

Sellers

Property taxes:

This is very similar to the above section for buyers on property taxes except you are only interested in the amounts in the seller column.

Interest:

You should look at your Form 1098 to find the mortgage interest you paid. Sometimes this amount is wrong if you used a relocation company when your employer pays for your move. The relocation company may hold onto your house and pay your mortgage for several months after you “sell” it to the relocation company. You only get to deduct the interest you pay, not that paid by the relocation company. A history of the payments for the year can help you figure out your share.

Mortgage insurance premiums:

Sorry, these are for the buyer’s benefit. The seller cannot deduct them as an itemized deduction even if the seller pays them.

Cost of selling

Assuming you do not get to exclude your entire gain from your income taxes (see Schedule D instructions for details), you will need to know the costs of selling you can deduct. Typically, you can deduct everything you paid except your share of real estate taxes, the payoffs of mortgages and other debts, and operating costs (ex. utility bills, repairs, homeowner’s association fees, etc.). Some examples are the real estate commission, title charges, and closing costs for the buyer (ex. you paid part of the buyers points). If you sell through a relocation company, look at your settlement statement with them and not the settlement statement between them and the buyer.

As most people can exclude the gain from selling their house, I have kept this section brief. If you will owe tax on some or all of the gain you will need to check with a tax professional or do more reading.

Conclusion

Most people do not have a lot of experience reading HUD-1 settlement statement. I hope this post helps you find the itemized deductions your are entitled to. Keep in mind that there are other limitations and rules regarding how much mortgage interest and mortgage insurance premiums you can deduct. This post is already long, so I have not covered them here.

I hope you are enjoying your new home and will have many happy years there.