Buying a new home? Do you think the federal taxes you'll save help you afford the monthly payment? Think again.

I hope everyone enjoyed the Fourth of July holiday.  We made the most of it, watching the local parade, doing a little barbecuing with friends and briefly viewing the fireworks so we could get to bed at a decent hour.  Still, it's a relatively relaxing holiday and doesn't require much work to prepare for. I am thankful for the bravery our founding fathers had when they signed the Declaration of Independence, looking to put an end to Taxation without Representation (of course, taxation with representation came sometime later).

One thing that wouldn't exist without our nation's independence is the American dream, a significant part of which is buying a family home.  Sometimes I wonder whether owning a home is truly worth all the pride of ownership associated with it. There are times I miss simply being able to call my landlord when something needs to be repaired instead of waiting hours for a contractor to show up and praying I won’t have a heart attack when I see the bill.  Nevertheless, besides owning a place I enjoy, I hope the equity I am building will be a sound investment for a better retirement someday.

This brings me to the subject of this post.  Clients in the process of buying their first home often contact me to find out what effect the purchase, with its theoretically deductible mortgage interest and local property taxes, will have on their federal and state taxes and ultimately, if there will be a decent tax savings to boot.  After I congratulate them on reaching the important milestone, I'll say what I've said before - taxes should not be one of the major driving forces behind any important life decisions.  A home is to enjoy and build equity in an investment; any tax savings you get out of it are just a minor bonus.  Not only do you need to properly budget to pay the mortgage and property taxes every month, the increased standard deductions and limitations on state & local tax deductions under the new tax laws have made buying a home less likely to be much of a tax savings vehicle.

Let's take a look at a relatively simple example.  The standard deduction for a married couple is $ 24,000 in 2018.If you itemize, the most common deductions are mortgage interest, state and local taxes and charitable gifts.  In 2018 state and local taxes paid are limited to a deduction of $ 10,000.  Most people who own a home will pay more than $ 10,000 in state income taxes alone, and thus local property taxes paid will not affect their taxable income on the federal return.  Even those who pay less than $ 10,000 in state income taxes will likely hit the $ 10,000 maximum when local property taxes are factored into the calculation.

Since the standard deduction for married couples is $ 24,000, to save any federal taxes mortgage interest and charitable donations must amount to more than $ 14,000 per year.  While the data I found suggested that the average married couple donated approximately $ 4800 to charity in 2017, for couples earning less than $ 200,000 (representing over 94% of the United States per census data), charitable giving fell to an average of about $ 2300 annually (source: Internal Revenue Service data). Adding donations of $ 2300 to the $ 10,000 state and local tax deduction gives us $ 12,300. This means mortgage interest must amount to $ 11,700 before making any impact on a married couple's federal tax liability.

Today's mortgage interest rates are hovering around 4% (a little higher in most places, but 4% is a nice round number to work with). The means you would need to borrow at least $ 292,500 before the interest paid reduces your federal tax liability.  If you plan to make the 20% down payment that most banks require (to avoid paying private mortgage interest), you will need to purchase a home with a price of at least $ 365,625.  National Association of Realtors data indicates that more than 2/3 of all homes sold in 2017 were for $ 400,000 or less.  While home prices may change in 2018, I do not think there will be a huge upsurge in home prices (especially since the last real estate bubble is still fresh in many peoples' minds).

So let’s look at a quick snapshot of a married couple who buys a $ 400,000 home, financing it with an $ 80,000 down payment and a $ 320,000 mortgage at 4% interest:

• Projected mortgage interest deduction: $ 12,800

• Maximum state and local tax deduction: $ 10,000

• Average charitable donation for couples earning less than $ 200,000: $ 2300

• Total itemized deductions on the 2018 return: $ 25,100

The $ 25,100 in itemized deductions for a couple buying a home at a slightly higher than average price and donating an average amount to charity comes to just $ 1100 above the $ 24,000 standard deduction.  This will not set you up for much of a tax savings, even in the highest 37% federal tax bracket.  Rules for deducting mortgage interest and/or property taxes on state tax returns have not changed much yet (and in many states, there is already little or no deduction for them), and in my experience, the amount of tax savings at the state level was always nominal anyway.

Let's not forget that some fortunate families who are able to afford payments on a mortgage of over $ 750,000 on a home they purchase this year and in the future will not be able to deduct any interest on the portion of the mortgage that exceeds $ 750,000 and no one (regardless of how much they borrow) will be able to deduct mortgage interest on a separate Home Equity Line of Credit, further taking away the incentive to purchase larger homes with any creative financing.

This has been a long post, and I hope you have been able to follow it.  Feel free to contact me for any questions you might have.  The bottom line? Buying and financing a new home is perfectly fine, but unless your income and the home you buy is at the highest end of the spectrum, any federal tax savings you realize from owning the home should not be a factor in considering the monthly payments you can afford.

Back from Busy Season!

Hello Everyone,I'm happy to say that busy season is over, and although there are still more returns being prepared, I can finally sleep civilized hours again. The weather is getting a lot more pleasant and I'll be firing up the grill real soon!If you've already had your return prepared, great for you! If you haven't get your materials to me as soon as possible so you can be enjoying your refunds or at least minimizing the late payment interest and penalties.  Even if you think you don't have the money to pay what you owe, it's better to file and pay as much as you can rather than delaying the inevitable contact from the IRS or state tax agency, which is much more painful.  Although I automatically file extensions for most of the clientele I haven't yet heard from, an extension does not extend the time to pay the tax, it just prevents the IRS from imposing late filing penalties, equal to 5% of the amount you owe - if you are getting a refund, there are no such penalties.  But if you are due a refund, you'd probably want the money in your pocket sooner rather than later.  I hope to hear from all the stragglers soon!

Tax Cuts and Jobs Act - Final Version

Happy New Year Everyone! Before the insanity of tax season sets in, it's important that I review the Tax Cuts and Jobs Act in its final form, which will affect the majority of my clientele in one form or another.  While I do feel the final version is something of an improvement over the old House and Senate versions, the new laws are hardly a simplification of our old tax code.  I've already received a lot of questions about the new laws and expect many more, and my existing clientele has also referred new business to me, as some of their friends and coworkers are confused by the new rules and consequently are looking for a tax professional for the next tax season, no longer trusting themselves with their own taxes.  At the most, the changes to the laws might result in a few of my clients no longer itemizing their deductions and perhaps a few of my higher income clientele no longer paying the Alternative Minimum Tax (AMT), and thus maybe one less form or schedule being filed with their returns.  But the simplification of our tax code, which our new President and Congress have heavily touted to garner public support for the new laws, has hardly occurred.  Whether the new laws represent a fairer tax code is for you to decide.  Here is a summary of the new laws, as they affect most people as well as a few comparisons to the old version of the laws (which were discussed in my November 17, 2017 post):

• Despite our President's pledge to simplify our different rate brackets, first originally proposing just three different tax rates and then later four rates, the number of tax rates, like the old law, remains at seven.  The lowest rate of 10% remains the same, one the next bracket, a rate of 12% replaces the old 15% rate, a rate of 22% replaces the old 25% rate, a rate of 24% replaces the old 28% rate, a rate of 32% replaces the old 33% rate, the next rate of 35% remains as before and a rate of 37% replaces the highest old rate of 39.6%.  The income brackets for each rate have also changed somewhat.  Most importantly, the first five rates now affect taxpayers with incomes of $ 200,000 or less, whereas before the first the five rates affected taxpayers with incomes of $ 416,700 or less.
• For taxpayers who itemize their deductions, the older versions of this law eliminated the state income tax deduction and limited property tax deductions to $ 10,000; the new law allows all state income and local property taxes to be deducted, but the maximum deduction is still limited to $ 10,000.
• Because our President despises it so much, the old version of the proposed law repealed the AMT; however, given the amount of potentially lost tax revenue, the new law retains the AMT, although it will not apply to as large a base of taxpayers as before.  For 2018, the larger AMT exemption will be $ 70,300 for single taxpayers and $ 109,400 for married taxpayers (versus $ 55,400 and $ 86,200, respectively, under the old system), and it will be phased out for single taxpayers with more than $ 500,000 of income and married taxpayers with more than $ 1 million of income (versus $ 123,100 and $ 164,100, respectively, under the old system).
• Taxpayers who own a home and itemize their deductions would also only be able to deduct the mortgage interest on the first $ 750,000 of their mortgage balance, versus $ 1.1 million under the old system.  The older version of the proposed law sought to limit the mortgage deduction to the first $ 500,000 of the mortgage balance, however, the National Association of Realtors and National Association of Home Builders have had at least some success with their lobbying efforts.
• The standard deductions will increase considerably in 2018, which will ultimately result in fewer people itemizing their deductions.  The deduction for single filers and those that are married but filing separately will increase from $ 6350 in 2017 to $ 12,000 in 2018, for married couples it will increase from $ 12,700 from $ 24,000, and for heads of household it will increase from $ 9350 to $ 18,000.
• Your 2017 tax return will have a $ 4050/person exemption, although this begins to phase out at higher income levels.  For 2018, there will be no more exemptions to reduce your taxable income, so the number of children and other relatives that your family supports will not impact your taxable income; however, to make up for this change, some families will be eligible for a tax credit of up to $ 2000 per child and $ 500 for other dependents (more on this later).
• One part of the old proposed law that remained the same in the newly passed law is the repeal of the moving expense deduction.  The old taxation system allowed deductions for moving expenses up to $ 5000, provided you were moving at least 50 miles to take a new job or start a new business (typically), while the new law does not allow for any moving expense deduction, except for military related moves.
• Originally, the President and Congress had proposed repealing the deduction for student loan interest, which is up to $ 2500 annually for taxpayers whether they itemize or not.  Fortunately, the final version of the law retains the deduction, with no changes from the old system.
• It appeared that our President and Congress were not very accommodating to the educational field, as the old version of the Tax Cuts and Jobs Act sought to tax the value of free tuition received by graduate students (who typically do research and teach undergraduate students for the university during the time they are working on their Masters or PhD).  Graduate students, who are already taxed on their teaching stipends, would been heavily burdened by having to pay the additional tax on their free tuition; fortunately, Congress backed off on making such a devastating change and the old system remains in effect.
• Under current law, the child tax credit is $ 1000 per child, which begins phasing out for singles whose income exceeds $ 75,000 and married couples whose income exceeds $ 110,000, completely phased out at $ 95,000 and $ 130,000, respectively.  For 2018, the child tax credit will be $ 2000 per child, and begins phasing out for singles whose income exceeds $ 200,000 and married couples whose income exceeds $ 400,000, completely phasing out at $ 240,000 and $ 440,000, respectively.  This helps make up for the $ 4050/person exemption that is being eliminated in 2018.
• To replace the $ 4050/person exemption that will be eliminated in 2018 for people who have dependents other than their own children (i.e. indigent parents and other relatives), there will be a $ 500 credit permitted.  This credit phases out under the same levels of income as the new Child Tax Credit.
• Individuals who receive self-employment income from their own business, partnership or Sub-chapter S corporation  in which they are actively involved will still pay the standard 15.3% self-employment tax on all their income (this is to cover Social Security and Medicare), but only 80% of the income will be subject to regular income taxes, which may encourage the development of new and further expansion of small businesses.
• Miscellaneous itemized deductions such as un-reimbursed job expenses, financial advisor fees and legal fees related to the production of income will also no longer be deductible on the 2018 return.  These deductions will not be missed by many of my clients, as only the portion of the deductions exceeding 2% of income are deductible and few of my clients ever meet the necessary 2% threshold to make these deductions.
• Finally, the last major change to the tax code of concern to my clientele is the repeal of the Shared Responsibility Payment for taxpayers without health insurance.  For 2017 it was up to 2.5% of income with a $ 695 minimum; taxpayers will no longer be penalized on their tax return for not having health insurance.

While I believe the final law is an improvement over the old versions of this law, it is hardly a simplification over the old tax code. This is probably the longest list of tax law changes I have written about since I began my practice.  Chances are there is at least one thing on the list that personally affects you, for better or worse.  It is estimated that these changes will reduce federal tax revenue by around $ 125 billion annually over the next ten years, and for this reason, I do not expect all of these changes to still be in place in subsequent years.  Hopefully, your tax professional can make them work best for you.

Pre-paying Your 2018 Property Taxes

I hope everyone had a nice holiday and is looking forward to their New Year's parties in just a few more days. Before that ball drops on Times Square and the confetti rains down, there is one last possibility for some federal tax savings on the 2017 return that I've already received a lot of calls and emails about.

One of the changes to federal tax deductions that was solidified into the Tax Cuts and Jobs Act of 2017, signed on December 20 and effective for your 2018 return, is a limitation on the total amount of state income and local property taxes that can be deducted on your Schedule A, Itemized Deductions. No more than $ 10,000 in total state income and local property taxes will be deductible for those who itemize their deductions on their federal returns. Just about all my clientele that file a Schedule A to itemize their deductions on the federal return will "max out" on the amount of state income and local property taxes they can deduct in 2018 and going forward. As a result, there have been a lot of questions over whether these state income and local property taxes normally due in 2018 could be paid early in 2017 to take advantage of an extra deduction on the 2017 return that will likely not be available on the 2018 return.

First, the answer to the question about prepayment of 2018 state income taxes is a definite no. The law Congress passed specifically addresses that issue and has stated that you cannot deduct any prepaid 2018 state income taxes on your 2017 federal return. But Congress did not address the issue of whether prepaid 2018 property taxes could be deducted on the 2017 federal return, so it is ultimately up to the Executive agency that enforces the law to determine the answer to that question. Naturally, after the law was passed on December 20, the IRS was deluged with questions on this issue by practitioners and individual taxpayers alike. Many people have chosen to prepay their 2018 property taxes already, in hopes that the IRS would permit it, either by officially addressing it or remaining silent on the topic. Just yesterday, the IRS issued directive IR-2017-210, which states, with a couple of caveats, that this will be permitted. But between the guidance issued by the IRS and other existing regulations that already determine your taxable income on your return, there are some points you need to consider before writing that extra check for any 2018 property taxes.

First, if your total itemized deductions - for most people, that's mortgage interest, charitable donations, state income taxes and local property taxes (both 2017 and 2018 prepaid taxes) - are less than the standard deduction ($ 6350 for individuals, $ 12,700 for married couples), then there will be no advantage to prepaying your 2018 property taxes. This is a most common situation with my retired clients who own their typically smaller homes free and clear with a senior citizen reduction on the normal property tax assessments, and whose retirement incomes are often taxed at lower state rates.

Second, the IRS directive states that property taxes for 2018 must be formally assessed on the property owners in order to deduct them. Typically, municipalities set their tax rolls on mid-year cycle that starts in July and ends in June. One half of the property taxes are being assessed either six months ahead or six months behind. So if a municipality has set their tax rolls starting in July 1, 2017 and ending June 30, 2018, you may pay those taxes that cover the period ending June 30, 2018. But if a municipality hasn't yet set any portion of its tax rolls for 2018 during the 2017 tax year, i.e. works on a cycle going from January 1 to December 31, 2017, you will not be able to deduct any portion of prepaid property taxes. Simply sending in a payment in speculation to cover all or part of your 2018 property taxes and having it credited later will not result in an extra deduction on the 2017 tax return. Your town clerk's office can tell you whether or not property tax rolls have been set for any part of 2018 yet.Finally, if you typically pay the Alternative Minimum Tax (AMT) on your return, property tax deductions are disallowed. Estimates vary and change from year to year, but about 60% of AMT taxpayers are in the $ 200,000 to $ 500,000 total income range, with smaller shares of taxpayers below and above this range also paying the AMT. If you normally pay the AMT and you don't expect your income to change radically from 2017 to 2018, then there will be no benefit to prepaying local property taxes in before December 31, 2017.

If you've managed to clear all three of these hurdles and are all set to make an extra property tax payment before the new year, remember one more thing. Most people pay property tax on a monthly basis with their mortgage, which the bank then puts into an escrow and then makes a quarterly property tax payment for you. You need to contact your bank and inform them about the extra property tax you paid as soon as possible so they are not collecting too much from you during the year and over-funding the escrow account. Then you'll need to call the bank at some point mid-year and request them to increase your mortgage payment again so the escrow will build up sufficient funds to make the property tax payments for later in the year. I predict a lot of problems with this, as banks will be sending extra bills toward the end of the year to people who forgot to call them, in order to sufficiently fund the escrow account and pay the final property tax payments of the year.

Our tax code is changing dramatically for 2018, and just like any other tax law changes, some taxpayers will benefit while others will pay more, but I have not seen as many people affected as I have with other tax law changes. This is one last chance to squeeze a benefit out of the old 2017 tax law rules. Have a Happy New Year!