Back to Basics Part IV – Even More Sch. A

Originally published in the Cedar Street Times

November  28, 2014

In this issue, we are continuing our discussion on Schedule A – Itemized Deductions.  Prior articles are republished on my website at www.tlongcpa.com/blog if you would like to catch up on our Back to Basics series on personal tax returns.

The third section on Schedule A covers deductible interest you have paid.  For most people the big item here is the mortgage interest on their principal residence.  You can also deduct mortgage interest on one other personal residence as well.  A lot of people assume that if the interest shows up on a Form 1098 that it is deductible.  Contrary to popular belief, that does not determine deductibility.  People with rental and personal properties, for instance, that refinance and pull money out of one property and put it into another are especially at risk of having made a major mistake.

The home mortgage interest deduction requires the debt to be secured by a qualified home and have been used to acquire, construct, or improve the home up to $1,000,000 of debt and up to $100,000 of additional debt for any purpose.  Assume someone refinances a rental property and pulls $200,000 out of it to buy a personal residence.  The interest on the $200,000 is not a rental property deduction on Schedule E because the funds did not go into the rental property activity.  It is also not deductible on Schedule A as home mortgage interest because the debt is not secured by a qualified personal residence – it is secured by the rental property!  Oops – nondeductible personal interest!  There are some work-arounds to this, but they are not always easily accomplished, and the problem is more likely to be found in an audit when it is too late.

Another common problem crops up for people on personal residences who take out a second loan, open a line of credit, or do a cash-out refinance and do not use the cash to improve the home.  This portion is called home equity debt.  You can only deduct the interest on up to $100,000 of total home equity debt.  Anything beyond that becomes non-deductible personal interest, and would need to be tracked properly.  If you later refinance your primary loan and the home equity loan into one loan, the character of the debt remains the same.  This means you have to keep track of the portion of the debt that is home equity debt versus acquisition debt that comprises the one loan.

Other deductible interest would include points paid during a purchase or refinance.  Often these are not included on the 1098 and you must look to the escrow closing statement to pick them up.  New purchases allow 100% deduction of the points in the year purchased.  Refinances, require amortizing and taking a portion of the deduction each year over the life of the loan term.  Private Mortgage Insurance (PMI) used to be deductible as interest, subject to limitations, but is not currently slated for a deduction in 2014.  Investment interest is another item that falls into this section of Schedule A.  A simple example would be borrowing money to invest in the stock market – like a margin loan.  However, investment interest expense is only deductible to the extent that you have investment income (Form 4952).  So, if you paid $1,000 of interest, you better have made a $1,000 of investment income, otherwise the excess gets suspended and carried forward for the future.

The fourth section on Schedule A deals with gifts to charity.  Volumes have been written on this topic!  Gifts to charity must be made to qualifying organizations for U.S. tax purposes.  There is a 50 percent of your adjusted gross income limit each year regarding regular donations to charities.  There are also 30 percent and 20 percent limitations for donations to certain types of organizations and types of property donated.  So if you gave a very large gift, it could get suspended and carried over to the future.  There is generally a five-year carryover limit, at which point any remaining deductions would be lost.

All donations must have substantiation, no matter how small.  Cash donations under $250 must be substantiated with a properly worded letter from the organization, a cancelled check, a bank statement, or a credit card statement.  Cash donations over $250 require a letter from the organization.  Noncash donations have a lot of rules.  Every noncash donation requires a receipt from the organization.  Noncash donations over $500 require the filing of an 8283.  Noncash donations over $5,000 require a qualified appraisal as well.  It would be in your best interest to ensure you have properly planned when making (or anticipating to make) a donation over $5,000.  The $5,000 threshold is cumulative throughout the year for similar items.  This means that many trips throughout the year of donating to the local charitable thrift store of household goods would retroactively require an appraisal to claim over $5,000.  And it is hard to appraise items you no longer have!  As you can see there can be much to consider.

You can deduct out-of-pocket charitable volunteer expenses such as uniforms or gear necessary for the volunteer work.  If you travel on your own dime overnight, and you have substantial duties and very little personal activities, you may be able to deduct airline tickets, meals, lodging, etc.  Volunteer excursions that are not away from home overnight do not qualify for meal deductions.  If you use your vehicle for charitable purposes you can deduct the mileage at 14 cents per mile, or track gas and oil expenses.

A few things that are definitely not deductible but are commonly misunderstood by individuals as well as by small charitable organizations: 1) gifts to needy or worthy individuals –  even if you give to a qualified organization be sure you do not earmark your donation for a particular person or family, or your deduction is not legitimate ,  2) gifts of your time or services – like the artist trying to deduct a self-created painting at “fair market value” – you can only deduct hard costs such as the canvas and paint costs.  Since you never included in income and paid tax on your services, you cannot take a deduction for them,  3) charity raffles, bingo, lotteries  4) charitable auctions or other donations to the extent of the value you received in return – such as paying $75 in a charity silent auction, but you get a $100 gift certificate – no deduction allowed.  Or the local public radio station sends you a set of CDs they value at $100 in return for your $125 donation – you only get to deduct $25.

In two weeks we will continue our discussion regarding Schedule A.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

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