The political debate on tax reform touches many topics, including the federal tax deduction for interest on home loans. There is no way to determine if this deduction will continue or at what level, but we thought it would be a good time to review current federal law on deducting residential interest.
Interest paid on qualified residence debt is deductible, but limitations apply. Qualified residence debt can be either (a) home acquisition indebtedness, or (b) home equity indebtedness. Qualified residence interest expense incurred on up to $1 million ($500,000 for married filing separately) of home acquisition indebtedness is fully deductible for regular tax purposes as an itemized deduction. Taxpayers generally can deduct interest on up to $100,000 ($50,000 for married filing separately) of home equity indebtedness. However, there are restrictions on the deductibility of qualified residence and home equity interest for AMT purposes.
Mortgage interest is only deductible when paid by the taxpayer who is the legal or equitable owner of the property. Thus, a taxpayer cannot deduct interest he or she pays on the mortgage of another person. This may occur, for example, if parents make mortgage payments for their adult children. Similarly, a taxpayer who holds a mortgage generally cannot deduct the interest if it is paid by another person.
A qualified residence (for determining if the underlying debt is qualified residence debt) can be the taxpayer’s principal residence and one other residence selected by the taxpayer for the tax year. In other words, if the taxpayer has several vacation homes in addition to a principal residence, the taxpayer can designate a different vacation home as the second qualified residence for different tax years. A residence is defined as (a) a house, (b) a condominium, (c) a mobile home, (d) a boat, (e) a house trailer, or (f) other property that under all the facts and circumstances can be considered a residence. Vacant land used for occasional camping does not qualify as a residence.
Planning Tip: Taxpayers with more than two homes should consider keeping a mortgage on their principal residence and one other residence selected as a qualified residence and paying off debt on any house(s) for which interest will not be deductible.
Spouses who file a joint return may treat their common principal residence, as well as property that otherwise qualifies as a second residence, whether it is owned jointly or by one spouse only, as a qualified residence. Conversely, spouses who file separate returns may each take into account only one residence as the qualified residence, regardless of how the properties are owned. However, a deduction for a second residence is available if both spouses consent in writing to one of them taking into account both the principal and the second residence.
A residence under construction can be treated as a qualified residence for up to 24 months, but only if the residence actually becomes a qualified residence when it is ready for occupancy. However, the land a home is constructed on does not qualify as a residence under the above rule until construction begins. Interest on debt to acquire a lot that is incurred before construction begins would be personal interest. However, that interest could be deductible if a home equity loan is used to acquire the lot.
Please contact us to discuss the tax treatment for interest on your home loan or any other tax compliance or planning issue.
Monday, July 11, 2011
Current Favorable Long-term Capital Gain Rates
Congress continues to discuss tax reform and whether taxes and spending should be raised or lowered. One of the topics being bantered about is whether long-term capital gain rates should be increased. Although it is difficult to say where tax rates will go in the future, we have a pretty good idea of where they will be until the end of 2012, when the current lower rates are set to expire.
The present preferential tax treatment of long-term capital gains is creating a significant planning opportunity. Clearly, for taxpayers in higher ordinary income tax brackets, shifting to investments that generate long-term capital gains rather than ordinary income should reduce taxes.
To qualify for the preferential long-term capital gain rates, the taxpayer must hold the asset for more than 12 months. The holding period generally begins the day after an asset is purchased and runs through (and includes) the date of sale. These rules must be followed exactly, because missing the required holding period by even one day prevents the taxpayer from using the preferential rates. However, the downside of holding assets (e.g., stocks) for a longer term is the risk that the price or value will fall and money will be lost on that investment.
Note that it is important to consider owning assets that generate capital gains outside of qualified (e.g., pension or profit-sharing) plans or IRAs. Distributions from those retirement accounts are almost always ordinary income, so the benefit of the lower long-term capital gain rates may be wasted.
Generally, your ordinary income assets should be held inside the qualified plan or IRA, and capital gain assets should be held directly in taxable accounts. However, a careful analysis of your investment policy is necessary to determine how to allocate investments between your qualified accounts and taxable accounts.
Please contact us to discuss how to qualify for long-term capital gain treatment.
The present preferential tax treatment of long-term capital gains is creating a significant planning opportunity. Clearly, for taxpayers in higher ordinary income tax brackets, shifting to investments that generate long-term capital gains rather than ordinary income should reduce taxes.
To qualify for the preferential long-term capital gain rates, the taxpayer must hold the asset for more than 12 months. The holding period generally begins the day after an asset is purchased and runs through (and includes) the date of sale. These rules must be followed exactly, because missing the required holding period by even one day prevents the taxpayer from using the preferential rates. However, the downside of holding assets (e.g., stocks) for a longer term is the risk that the price or value will fall and money will be lost on that investment.
Note that it is important to consider owning assets that generate capital gains outside of qualified (e.g., pension or profit-sharing) plans or IRAs. Distributions from those retirement accounts are almost always ordinary income, so the benefit of the lower long-term capital gain rates may be wasted.
Generally, your ordinary income assets should be held inside the qualified plan or IRA, and capital gain assets should be held directly in taxable accounts. However, a careful analysis of your investment policy is necessary to determine how to allocate investments between your qualified accounts and taxable accounts.
Please contact us to discuss how to qualify for long-term capital gain treatment.
Friday, July 8, 2011
Rollovers from Qualified Plans to IRAs
Deciding whether it is advantageous to roll over a qualified retirement plan account [e.g., 401(k) account] to an IRA depends on the taxpayer’s specific circumstances. However, there are some general advantages:
1. Postmortem Tax-deferral Opportunities. Beneficiary designations as of the date of the owner’s death control the availability of various postmortem tax-deferral opportunities. Therefore, it is important to set up these designations to maximize those opportunities. Greater flexibility generally is afforded in beneficiary designations for IRAs and in stretching out the tax-deferral period.
2. Investment Choices. Although some qualified plans offer self-directed accounts, many restrict the available investment choices. However, most IRA providers offer their entire investment portfolio for the participant to choose from.
3. Availability of Taking Withdrawals. While most qualified plans restrict the availability of withdrawals, IRA withdrawals are available at any time and in any amount.
4. Investment Advice. While in recent years the availability of investment advice offered to qualified plan participants has expanded, IRAs generally will offer greater availability. However, the cost of that advice should be compared to the services that are being provided.
5. Control over Funds. When funds are maintained in a qualified plan, the employer has the right to amend discretionary provisions in the plan, including the right to terminate it. This is not the case with an IRA.
Please contact us if you have questions about qualified plan rollovers or the tax aspects of retirement saving.
1. Postmortem Tax-deferral Opportunities. Beneficiary designations as of the date of the owner’s death control the availability of various postmortem tax-deferral opportunities. Therefore, it is important to set up these designations to maximize those opportunities. Greater flexibility generally is afforded in beneficiary designations for IRAs and in stretching out the tax-deferral period.
2. Investment Choices. Although some qualified plans offer self-directed accounts, many restrict the available investment choices. However, most IRA providers offer their entire investment portfolio for the participant to choose from.
3. Availability of Taking Withdrawals. While most qualified plans restrict the availability of withdrawals, IRA withdrawals are available at any time and in any amount.
4. Investment Advice. While in recent years the availability of investment advice offered to qualified plan participants has expanded, IRAs generally will offer greater availability. However, the cost of that advice should be compared to the services that are being provided.
5. Control over Funds. When funds are maintained in a qualified plan, the employer has the right to amend discretionary provisions in the plan, including the right to terminate it. This is not the case with an IRA.
Please contact us if you have questions about qualified plan rollovers or the tax aspects of retirement saving.
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