10 legal ways to reduce your taxes - Amazon S3Legal+Ways+to+… · for rent while not in use for their own personal purposes. The interest on rental property can also qualify as deductible

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10 Legal Ways to Reduce Your Taxes

Most Financial Planners Miss

10 Legal Ways to Reduce Your Taxes Most Financial Planners Miss 1

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For the grunt work of dotting all the i’s and crossing all the t’s of a tax return, accountants are indispensable. Studies have shown that individuals (especially those with incomes in excess of $100,000) reduce their chances of being audited by the IRS when they have their returns signed by a certified public accountant.

Unfortunately, accountants often aren’t so good at saving you money. They are flooded every year around tax time with piles and piles of paperwork. They simply don’t have the time (or the financial incentive) to prospect for all the tax breaks to which you may be entitled.

Moreover, they can’t do any actual tax planning for you. They can only go by what you hand to them.

If you sold a home one day too early to be able to enjoy tax-free gains because you didn’t know about the “two years out of five rule” (which will be explained in this special report), there’s probably nothing an accountant can do, short of cheating, to get you back the money that could have been yours tax-free had you known the rule.

A home is one of the best legal tax shelters there is, but only if you know the rules and the strategies for exploiting it. In this special report, you’ll learn exactly how to take full advantage of the tax shelter that is your home. You could quite possibly save yourself hundreds or even thousands of dollars on your next tax bill by exploiting legal tax breaks even seasoned financial planners often miss.

1. Take Charitable Gift Deductions on Your Home’s Value Without EVER Having to Sell or Move Out During Your LifeIf you’d rather be generous toward charitable causes instead of the Internal Revenue

Service, then tax-deductible charitable giving is something to strongly consider. The more you give of your money, the less the government gets of it. For those who take itemized deductions, contributions to charities are fully deductible up to 50% of adjusted gross income. There is even a way to use your home to get an immediate charitable tax deduction without having to write a check to a charity.

The strategy is known as deferred giving. You and your spouse would designate a charity to receive a remainder interest in your house. You get an immediate deduction based on the value of the charity’s interest in your house and the expected length of time before the charity assumes ownership (your accountant will use special IRS tables to figure out your allowable deduction).

Under a deferred giving scheme, you retain the right to live in your home until you die. If your spouse outlives you, he or she still retains ownership of the home for as long they live.

This strategy isn’t for everyone – consult with your accountant before attempting it – but it can work well for a couple that is in the top tax bracket and wants to maximize current take- home income. You could use a portion of the extra income to buy additional life insurance in lieu of leaving your home to children or grandchildren. (Life insurance benefits are always tax- free to beneficiaries.)

10 Legal Ways to Reduce Your Taxes Most Financial Planners Miss2

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2. Maximize Your Mortgage Interest DeductionIt is generally well known that interest on mortgage payments is tax deductible (for

those who itemize their deductions). Yet because of confusion about the tax code, many filers mistakenly take the standard deduction and therefore fail to claim the mortgage interest deduction to which they are entitled.

Just because you are entitled to it doesn’t mean you should claim it. In some cases, you are better off taking the standard deduction (this has become truer in recent years as mortgage rates have dropped and the standard deduction has risen). Be sure to bring the matter up with your accountant if you have any doubts. Some savvy taxpayers alternate between taking the standard deduction and itemized deductions. In one year, they’ll bunch deductible expenses such as charitable contributions, medical deductions, and mortgage interest deductions so that they can maximize itemized deductions. In the next year, they’ll take the standard deduction. Your mortgage lender may allow you to make additional mortgage payments in a year in which you take itemized deductions, thus maximizing the tax benefit.

Did you know that you can take out tax-deductible mortgages not only on your primary residence, but on second homes, vacation homes, and condominiums as well? You can even deduct interest on a loan used to buy a boat or RV! As long as it has sleeping quarters, a bathroom, and a kitchen, it qualifies as a home.

Many people own second homes in resorts and vacation spots and offer those homes for rent while not in use for their own personal purposes. The interest on rental property can also qualify as deductible interest. To qualify, you must use the property for your own personal purposes at least fourteen days or 10 percent of days during the year the property is rented, whichever is greater.

Mortgage interest is tax-deductible for your primary and secondary house or “qualified residence.” But if you=re thinking of buying a third home B perhaps as a summer vacation retreat B caution is in order. The IRS says that only two of your properties can enjoy the mortgage interest deduction. But there=s a trick you can use to effectively finance your new property with tax-deductible interest. You=d take out tax-deductible home-equity loans on your first two properties (up to $100,000 per property) to provide funding for the third. Always work with your tax advisor when attempting a major tax move such as this.

3. Tap Your Home’s Equity to Leverage Tax SavingsInterest on a variation of the traditional mortgage — the home equity loan — is usually

also tax deductible. If you have a lot of equity in your home, you can borrow against it to buy a new car, a new boat, or even to take a vacation. Interest on car loans, boat loans, and credit card balances is not tax deductible, but by taking out a home equity loan instead, you can take advantage of the mortgage-interest deduction to reduce your tax burden.

Home-equity loan interest is deductible only if the debt does not exceed the fair market value of your home minus the current acquisition debt on the residence. Tax expert Dan Pilla



provides this example from his Smart Tax Manual:

Suppose you own a home you purchased twenty-five years ago for $75,000. Its current fair market value is $300,000. You owe $15,000 on the original mortgage. You need money to pay off credit card debt and for other reasons so you obtain a home equity loan of $150,000, secured by the house. Only $100,000 of this debt qualifies as home equity debt. The interest on the portion of the loan that exceeds $100,000 is not deductible.

Lending standards have loosened in recent years, and some financial institutions will now let you borrow more than 100% of the value of your home. When you opt for one of these offers, you lose some tax deductibility. You also generally end up paying a higher interest rate.

Home equity loans and home equity lines of credit have the same tax deductibility. With a line of credit, you can essentially write yourself a loan anytime you wish. Just be sure you keep track of all your loan amounts and dates along with loan payments and the portions that represent deductible interest.

4. Receive Tax-Free Income from the Sale of Your HomeThe money you make when you sell your home can be tax free. To qualify, you must

have used your home as your primary residence for at least two of the past five years (it does not have to be two consecutive years). You can then rake in up to $250,000 ($500,000 for married couples) in profits from the sale of your home without having to report a dollar of it as taxable income!

If your career requires you to move periodically, try to arrange to always stay in a home for at least two years. If you=re close to meeting the two-year threshold but must immediately start a new job elsewhere, consider having your spouse stay in the home a little while longer so that you can continue to claim it as your primary residence. And most definitely don=t complete change-of-address forms or close on the sale of your old house until the two-year period is up.

A winter home or other seasonal residence can meet the two years out of five requirement. Six months per year as a primary residence for four years is equivalent to two full years in a row. Instead of selling a home after having lived in it for a year, you might rent it out for three years and then move back in for another year to qualify for the two out of five rule.

If the real-estate market is booming, you could reap potentially huge, tax-exempt profits when you sell.

If you own more than one home, IRS stipulates that you can exclude gain only from the sale of your main home. Gains on the sale of any other home would be taxable. If you own two houses and live in both of them, you’ll have to decide which is your primary residence.

There are loopholes that might enable you to exclude at least some of your gains from taxation even if you haven’t lived in the home for a full two years. As Forbes (June 9, 2003) reported:

The law says you can claim a pro rata share of the $250,000/$500,000 capital gains




exclusion if you sell a home you’ve lived in for less than two years for reasons of health, a change in place of employment or “unforeseen circumstances.” After one year, for example, a single taxpayer could claim a $125,000 exclusion and a couple $250,000.

What’s an acceptable “unforeseen circumstance”? In the proposed rules, the IRS put death, divorce, job loss and multiple births on the list, but rejected pleas that it include bankruptcy or imprisonment. The IRS also expanded the health category to include moves you make to take care of a sick family member.

5. Become a Real Estate Investor and Enjoy Perpetual Tax Deferral

Section 1031 of the Internal Revenue Code provides for one of the single greatest tax benefits that exists. Mainly, it applies to real estate investors.

Real estate has been the source of a great many fortunes in America, thanks in part to favorable tax treatment. Adding property to your investment portfolio of stocks, bonds, gold, etc., will give you a powerful means of preserving and growing your wealth over time, and with tax advantages that other investments won’t afford you.

Normally, when you sell a piece of property that has appreciated in value, you‘ll owe capital gains taxes (you’ll get hit with the heaviest taxes – “short-term capital gains” – if you’ve held the property for less than a year). But by following certain guidelines set forth in Section 1031 of the tax code, you can use your gains to trade up to a new property and defer capital gains taxes indefinitely!

The basic rule for a so-called “1031 exchange” is that you must make an exchange of the old property for a new property of equal or greater value that you’ve identified within 45 days (you=re allowed an additional 135 days to close the deal and take possession of the new title).

Both properties must be business or investment properties (your personal home can=t be involved). You then roll your gains from the old property into the new property and owe no taxes. You can even designate up to three replacement properties to roll the proceeds of your old property into.

You can repeat this process again and again on future properties, building up perhaps millions of dollars of wealth which will not be taxed until you finally decide to cash out (you won=t ever have to pay taxes as long as you keep “exchanging” and never sell for cash).

To execute a 1031 exchange properly, you must not touch the cash proceeds of your sale.

You should therefore hire a “qualified intermediary” (sometimes referred to as an “exchange accommodator” or simply an “escrow agent”) to hold on to the funds until you are ready to have him or her apply the cash directly to your next home purchase. There are actually professional qualified intermediaries who make their living off navigating real estate investors through this particular peculiarity of the tax code. You can locate such a person through the Federation of Exchange Accommodators (215-320-3881; http://www.1031.org). Regardless of



how you find a qualified intermediary, make sure that he is bonded and insured so that you are protected against negligence and fraud. Expect to pay up to $1,000 for his services.

It may seem like you’re throwing money away, since the intermediary is doing little more than make-work tax compliance. Such expenditures may be wasteful from an economist’s macro perspective, but they are necessitated by the IRS. From your perspective, a thousand bucks is a small price to pay for sheltering hundreds of thousands or perhaps millions of dollars from capital gains taxes. And if you don’t go through every step of the process according to IRS rules, an IRS official could nix your entire 1031 exchange.

When attempting a 1031 exchange, it is essential that you work with a certified public accountant who is experienced in this area of tax law. It is highly advisable, too, that you consult with a real estate attorney to ensure that you go through the exchange process without any mishaps.

6. Start a Home-Based BusinessYou can operate a business right out of your own home and use your home as a tax

write- off. A home-based business allows you to claim a deduction for a portion of the costs of maintaining your home. Your deduction is based on the percentage of space used for business.

For example, if the space you use is 250 square feet and the total square footage of the home is 2,500, you can deduct 10 percent of costs of maintaining your home. This includes utilities, trash removal, lawn care, insurance, repairs, routine maintenance, etc., and most importantly, your mortgage payment (or rent).

If you use any part of your home regularly for business, you=re entitled to claim a home- office deduction. Depending on the value or your home, a single room that is converted into a home office can yield thousands of dollars in tax deductions year after year.

In recent years, the rules for claiming a home office have been relaxed. You now have greater leeway to claim the deduction. You can claim it even if your office isn’t its own room and even if you only do business there part-time. Your home office must, however, be your “principal place of business,” however part-time your business is.

Anyone can start a home-based business. You don’t need a business degree or any special training. Examples of common home-based businesses include:

● consulting; ● writing; ● arts and crafts; ● day care provider; ● independent travel agent; ● computer repair; ● web site design;




● online auctions seller; ● day trader; ● real estate investor; ● network marketing; ● handyman; ● professional services (bookkeeping, psychologist, etc.).

You may have heard that in order to write off business expenses, you must form a corporation. That’s a myth. In some situations, it may be advantageous to incorporate (for example, if your business produces heightened liability exposure). But for tax purposes, you’ll often do just as well remaining unincorporated, especially when you’re first starting out.

Your business need not be profitable in order to claim business deductions. However, you must have a profit motive.

The IRS says that all business expenses must be documented by receipts, canceled checks, journal entries, and other written evidence as applicable. If you don’t want to hassle with keeping good business records and filling out additional tax paperwork every year, then a home- based business may be more trouble than it’s worth. But the tax benefits are so great, that it is likely to be well worth the trouble.

7. Make Your Property Taxes Less TaxingLocal and state property taxes you pay on your home are tax deductible at the federal

level. Be careful here. The IRS will hit you with interest and penalties if it finds that you’ve overstated your deduction. Local assessment information is stored on local government files which, of course, the IRS can easily access. The 335,000-member National Taxpayers Union (703-683-5700; http://www.ntu.org) advises as follows:

If you’re a homeowner looking to maximize your deduction for real estate taxes, remember that not all the amount your mortgage company escrows for such payments may be deductible. Only “taxes based on the assessed value of the property” which are “made uniformly throughout the community” and are “used for general government purposes” are deductible. That means you can’t write off “itemized charges for services to specific property” (like trash or water fees).

Property taxes are generally assessed by counties. A county appraiser will assess the value of a home or a piece of land and bill the owner accordingly. Of course, any estimation of value is just someone’s opinion. The true dollar value of anything can only be determined by putting it on the market and finding out how much money is offered for it.

Oftentimes, assessments are made by simply taking the initial selling price and then adding on to it the amount that the county claims your property has appreciated. But how much your home has actually appreciated or depreciated is dependent upon the circumstances unique to it. Just because your neighbors’ homes have gone up in value doesn’t mean yours has.



Perhaps you experienced severe flooding or a lightning strike. Perhaps your home is sitting in a bad location. Perhaps new construction surrounding you has ruined the views, the quietness, and the privacy that you once enjoyed. Myriad factors may be relevant to your property’s actual value that the county may have conveniently overlooked.

Don’t take the government’s appraisal of your home as the final word. If you believe you have been over-assessed, you can appeal. County bureaucrats may at first try to stonewall your appeal in the hopes that you’ll give it up. A good tactic is to threaten to appeal to the state agency governing tax assessments or to a court of law. If they learn that you’re persistent and that you’re willing to give them as much trouble as they give you, they’ll be more likely to do what it takes to placate you.

If the local tax collectors refuse to give any ground, your best bet may be to hire a private appraiser and, if necessary, a tax lawyer. There are actually companies that specialize in helping individuals reduce their property taxes. Through a property-tax company, you can obtain information about assessed property values throughout the county and have your home appraised. When faced with the raw data, officials will often have no choice but to adjust your assessment. You’ll get a tax reduction, and the property-tax company will get a portion of it as payment for their services.

It is possible that the county will actually under-estimate your property’s value to begin with. In such a case, you are under no obligation to help the local tax collectors figure out their error.

You may increase the value of your home through painting, repairs, renovations, and the addition of new features or structures. The county won’t necessarily know about these things if your home improvements don’t require a building permit. Most anything you do within the perimeter of your own walls won’t be detected by the property-tax assessors (although you may be required by your local law to report them). But remodeling efforts could dramatically increase your home’s value to you and to potential buyers down the road.

8. Make Your Next Residence a Low-Tax JurisdictionMinimizing the IRS’s take on your earnings is important. So, too, is minimizing the take

of local and state politicians.

What part of the country you reside in can make a huge difference in the amount of taxes you’ll have to fork over. If you’re tired of forking over your hard-earned money to state and local bureaucrats, you can “vote with your feet” by moving to a less taxing location.

Some states permit individuals to be state residents even if they’re not actually residing there most of the year. Texas, for example, permits residency if a person resides in the state for at least 24 hours each year. You could conceivably establish a Texas mailing address and then stay in Texas overnight at least one day per year to become a citizen of the Lone Star State (it has no income tax). If you have your “income” sent to you at your Texas address, and then forwarded to you where you live most of the year, you may be able to avoid having income taxes assessed by your home state. This is a very aggressive tax-reduction strategy, and it is not without risks. It




may be considered illegal tax evasion in the state where you actually work. Therefore, don’t try claiming residency in another state for tax purposes without first consulting with a lawyer.

Unfortunately, there’s not much you can do to legally avoid paying property taxes on your home. The local authorities that have jurisdiction over your property will collect taxes on it regardless of whether you’re officially a resident somewhere else.

When considering your home’s tax situation, consider not only just income and/or sales tax rates, but also property taxes. Also, comparing marginal tax rates from state to state can be misleading, since they all have different rules regarding deductions and the taxability of retirement income. Twenty-six states do not tax Social Security benefits at all. Some states do not tax other types of pension benefits. Some don’t tax certain types of IRA distributions. And some (such as Virginia) offer special deductions for seniors.

Taxes should not be your primary reason for choosing a particular area. You should choose an area because you like it. But if you’re trying to decide, for example, between rural New York and rural New Hampshire, and you find each state equally attractive, then the lower taxes New Hampshire affords might tip the scales in its favor. If you cannot easily determine which state among the ones you are considering would offer the lowest tax bill for you, don’t hesitate to contact a tax accountant in each state you are considering. A few hundred dollars worth of advice customized for your particular financial situation will give you what you need to make the best choice and could save you many thousands of dollars down the road.

Maine, New York, and Hawaii exact the highest average levels of taxation (as of 2005 data). Alaska, New Hampshire, and Delaware offer the lowest tax rates overall.

Your hard-earned dollars go much further in low-cost cities. According to a 2005 study by a major financial magazine, the “The Most and Least Expensive Cities” are:

Most Expensive Least Expensive 1. New York, N.Y. 1. Wichita, Kan. 2. Boston, Mass. 2. Sioux Falls, S.D. 3. Los Angeles, Calif. 3. Billings, Mont. 4. Greenwich, Conn. 4. Fargo, N.D. 5. Englewood, N.J. 5. Cheyenne, Wyo.

9. Take Advantage of the Unlimited Marital DeductionThe so-called unlimited marital deduction is a provision in the tax code that allows an

individual to transfer an unlimited amount of assets to a spouse without incurring federal estate or gift taxes. The transfer can be made at any time or upon the death of one spouse.

For tax purposes, it typically makes sense for a couple’s home to be in the name of the spouse most likely to die first. The reason is that the house then gets transferred to the surviving spouse free of estate taxes. Another benefit, and one that most people don’t consider, is that upon inheriting a house from a deceased spouse, the surviving spouse automatically gets a step- up



in cost basis. This is more than just an accounting formality; this could mean that hundreds of thousands of dollars of potential capital gains liabilities are nixed.

Suppose that you and your spouse originally bought your house 15 years ago for $500,000. Today it’s worth $1 million. In another 15 years – who knows? – it might be worth $2 million or more. If a spouse inherits the home when it’s worth $1.5 million and decides to sell a year later when it’s appraised at $1.6 million, the spouse’s capital gains for tax purposes are only $100,000. Alternatively, $1,100,000 in gains would be registered on a $1,600,000 sale (against a $500,000 cost basis) if the house remains in the ownership of the surviving spouse from the very beginning.

You and your spouse would be wise to sit down and talk about your long-term plans for your home should one or the other of you die. If one of you is much older than the other, or in poorer health, or otherwise at the greatest risk of dying the earliest, you may wish to consult with your financial advisor about keeping ownership of the home in the hands of the person least likely to live the longest. In general, women tend to live longer than men. That’s something to think about, too, if you and your spouse are roughly the same age and same medical health.

10. For Senior Citizens Only: Receive a TAX-FREE Stream of Income from Your Home

Your home can be a sizable source of income during retirement. After you turn 62, you can actually work out an arrangement with the bank to have it make regular payments to you based on the value of your home — without ever having to move out.

If it sounds too good to be true, there is of course a catch. By opting for this arrangement, which is known as a “reverse mortgage,” the bank will acquire ownership of your home after you die. A reverse mortgage thus reduces the size of your estate. If your home is your largest asset, then a reverse mortgage can effectively leave the bank with more “inheritance” than your own family.

But there are ways to ensure that your family is taken care of after you’re gone, even as you enjoy the income that the reverse mortgage provides during your golden years. You might use a portion of the money you receive from your reverse mortgage to pay life insurance premiums or set up trusts with children and/or grandchildren as beneficiaries.

According to the National Reverse Mortgage Loan Association (NRMLA), this relatively new financial instrument is exploding in popularity. Nearly 38,000 reverse mortgages are being taken out annually, and trends indicate more and more will be originated as our population of aging home owners grows into the 2010s.

Not everyone will even be eligible for a reverse mortgage. In fact, strict rules put in place by the US Department of Housing and Urban Development (HUD) stipulate as follows:

To be eligible for a HUD reverse mortgage, HUD’s Federal Housing Administration (FHA) requires that the borrower is a homeowner, 62 years of age or older; own your home outright, or have a low mortgage balance that can be paid off at the closing with proceeds




from the reverse loan; and must live in the home. You are further required to receive consumer information from HUD- approved counseling sources prior to obtaining the loan. You can contact the Housing Counseling Clearinghouse on 1-800-569-4287 to obtain the name and telephone number of a HUD-approved counseling agency and a list of FHA approved lenders within your area.

You do have some choice as to how you will receive payments for your mortgage.

Although monthly payments are common, you can actually choose to take out money on your own schedule via a line of credit. According to HUD, your options are:

●● ●Tenure — equal monthly payments as long as at least one borrower lives and continues to occupy the property as a principal residence.

●● ●Term — equal monthly payments for a fixed period of months selected.●● ●Line of Credit — unscheduled payments or in installments, at times and in amounts of borrower’s choosing until the line of credit is exhausted.

●● ●Modified Tenure — combination of line of credit with monthly payments for as long as the borrower remains in the home.

●● ●Modified Term — combination of line of credit with monthly payments for a fixed period of months selected by the borrower.

Payments received from a reverse mortgage are tax-free. So rather than cash out stocks and mutual funds and take a big tax hit, you can use a reverse mortgage for income and let your investments continue to appreciate. If you never have to draw on your investment principal, than it (rather than your house) will be the bulk of your estate.

To estimate what a reverse mortgage might be worth to you, check out the American Association of Retired Persons online reverse mortgage calculator (http://www.rmaarp.com).

Only take out a reverse mortgage if you intend to use it for a regular stream of income. If you just need some cash temporarily, then consider a home-equity line of credit instead. The reason? Reverse mortgages carry hefty up-front fees, closing costs, and extensive paperwork.

When considering a decision as big as this, don’t rely solely on what the bank tells you. Work with a financial planner or a trusted friend who has experience with reverse mortgages. He or she can help make sure the mortgage company doesn’t give you a bad deal.

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10 legal ways to reduce your taxes - Amazon S3Legal+Ways+to+… · for rent while not in use for their own personal purposes. The interest on rental property can also qualify as deductible