Continuation: 32 (26-32 last batch) Fool-Proof Federal Income-Tax-Saving Strategies
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Here’ s the last batch of our 32 Fool Proof Tax Saving Strategies.
26. Don’t forget about the exclusion from taxes on the sale of your home. In the past, many home sellers felt trapped by the IRS because they knew that if they didn’t buy another home costing as much or more, they’d owe taxes on their home-sale profits. (There had been one exception to this rule, too: If you were 55 or over, you could exclude from taxes once in your lifetime up to $125,000 in capital gains on the sale of your principal residence, as long as you had lived there for at least three of the past five years). But the 1997 tax law changed all that. Now a couple can exclude from taxes up to $500,000 in profits ($250,000 if you’re single) from selling a home and you can take this exclusion once every two years. The age-55 special exclusion has disappeared, though.
27. Write off points when you refinance. Usually points you pay to refinance a mortgage must be written off over the life of your new loan. But refinance a principal residence a second time before all the points are written off on the first refinance and you can typically deduct the entire remaining balance in that year. That could produce an instant write-off worth several thousand dollars.
28. Count the days if you plan to roll over a pension. You have just 60 days to deposit a pension distribution into an IRA account without paying tax. Neglect can cost you a bundle. For example, if you are under age 59 1/2, missing the deadline on a $10,000 lump sum distribution will raise your tax bill by $4,100 if you’re in the 31% bracket ($3,100 income tax and a $1,000 penalty for premature distribution). Caution: There is a 20% withholding tax on lump-sum distributions. Take $10,000 out of your pension plan and you will get only $8,000 ($10,000 minus $2,000 withholding). You must roll over the full $10,000, however, to avoid tax and penalty. That means you’d have to come up with an extra $2,000 out of your own pocket. You can avoid the 20% withholding trap by instructing your employer to transfer your pension distribution directly to your IRA trustee.
29. Swap, don’t sell. If you are thinking of selling rental estate you own, consider a nontaxable like-kind exchange instead. If you sell, you may well have a huge capital gain because of the depreciation you have claimed over the years. For example, if you sell for $1 million a building with an adjusted basis (its cost minus depreciation) of $100,000, you would pay a 28% capital gains tax, or $252,000, on your $900,000 gain; any gain attributed to earlier depreciation deductions may qualify for a 25% maximum tax rate. But if you intend to reinvest in a similar property, you can avoid paying the tax now by having the buyer deposit the money with an independent third party, usually an escrow company. You then identify another building, purchased with the money in escrow. As long as you don’t get any cash or other property out of escrow and your new mortgage balance equals or exceeds the balance on your old one, you will defer the capital gains taxes until the new building is sold. To make sure the complex requirements of the tax law are met, hire a real estate or tax pro who specialize in like-kind exchanges to arrange the transaction.
30. Spend insurance earnings tax-free. Unlike annuities and traditional deductible IRAs, which tax your withdrawals and often penalize them, cash-value life insurance policies let you pull out earnings without paying a penny in tax. Within limits, you simply borrow the money from your policy. No payback is required; the amount of any unpaid principal and interest will be subtracted from your death benefit. If you choose to pay the interest, you can do so whenever you wish.
31. Take advantage of the new IRAs. The 1997 tax law created two types of IRAs, described in more detail elsewhere in the book. A brief rundown: The new Roth IRA doesn’t let you deduct your annual contribution of up to $2,000. But your earnings are tax-deferred while they grow in the account, just like a traditional deductible IRA. And, best of all, your withdrawals are fully tax-free as long as you have had the IRA for at least five years and you are 59 ½ or older, are disabled, or will use the cash to buy a first home. To open a Roth IRA, your income cannot exceed $110,000 if you’re single or $160,000 if you’re married. The Education IRA (yes, that’s a contradiction in terms; blame it on Congress) lets you put aside up to $500 a year per child in a nondeductible but tax-free account whose proceeds will be used to pay for college. Maximum income to open an Education IRA: $160,000 for married couples and $110,000 for singles.
32. Deduct long-term care costs if you can. A little-known 1996 law now lets some of the premiums or fees you pay for long-term care insurance or services qualify as a tax-deductible itemized expense. Only the expenses combined with other medical outlays that exceed 7.5% of your adjusted gross income can be written off, though. The amount you can deduct rises with your age and the medical-cost inflation rate. Lately, people 61 to 70 could write off up to $2,000, while those 71 and older could claim up to $2,500.
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