Edward A. Lyon, JD
TaxTuneup.com, Inc.
3416 Shaw Ave #5
Cincinnati OH 45208
513.321.2821
elyon@taxtuneup.com
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Passive
Activity
Passive activities are a special
category of business activities where you don't "materially participate."
Congress imposed the passive activity rules in 1986 to stop abusive tax
shelters. Now, passive losses are deductible only against passive income. If
passive losses exceed passive income, the excess losses are "suspended"
until there is passive income to shelter or you dispose of the passive
activity.
You're considered to materially
participate in an activity if you're involved in operations on a "regular,
continuous and substantial" basis. This usually means performing
substantially all the work of an activity or participating more than 500
hours per year. However, rental real estate is considered a passive
activity, so rental income and losses are passive income and losses. You can
deduct passive losses against nonpassive income only if you qualify for the
rental real estate loss allowance.
Example 1:
You're a physician and a partner in a partnership that rents a building to
your practice. You report $150,000 income from your medical practice,
$10,000 from investments, and a $10,000 loss from the partnership. The
partnership loss is a passive loss, so you can't deduct it against your
medical income or investment income.
Example 2:
You're an attorney and you own a four-family apartment building you manage
yourself. You report $80,000 in legal income, $5,000 in investment income,
and a $12,000 loss from the apartment building. You can write off the
$12,000 loss against your $85,000 nonpassive income.
Passive activity losses may
also be limited by the "at-risk" rules. Amounts "at risk" are amounts that
you can actually lose in an investment: cash contributions, your cost
basis in property contributions, and loans for which you're personally
responsible. You can deduct as much in expenses as you have income to
offset. Beyond that, you can only deduct as much as you actually have "at
risk" in the investment. You can carry forward losses disallowed by the
at-risk rule to offset future income.
Example:
Your adjusted gross income from your primary position is $80,000 and you
actively manage a four-family apartment. You've contributed $10,000 in
cash and signed a $10,000 note for which you're personally responsible. In
year one, the venture takes in $36,000 and pays out $50,000, for a net
loss of $14,000. You can deduct the full $14,000 as a rental real estate
loss allowance. In year two, the venture also loses $14,000. Since you've
already deducted $14,000 of your $20,000 at risk, your rental real estate
loss deduction is limited to $6,000. You can carry the disallowed $8,000
forward to offset next year's operating income, but not below zero.
The passive loss rules are
some of the most complicated in the entire tax code. It's important to
understand how they work so that you can make informed investment choices.
But you'll probably want a qualified tax professional for the heavy
lifting.
Report passive income and
losses on
Form
8582. For more information, see
IRS
Publication 925, "Passive Activity and At-Risk Rules."
Passport
Passport application and renewal
fees may be deductible for trips you take for a deductible purposes:
Penalty on Early Withdrawal
Penalties you pay for early
withdrawal of bank CDs are deductible as
an Adjustment to Income on
Form 1040.
The bank will report the amount that you can deduct. You might think this is
a nice tax break. But in fact, the whole penalty is just one of the reasons
bank CDs make such lousy investments. If you have cash that you'd like to
save, rather than invest, and you want better after-tax results, consider
Treasury Securities, insured
Municipal Bonds, and
Annuities backed by top-rated insurers.
Personal Exemptions
Personal exemptions are deductions you take from adjusted gross income to help figure
taxable income. You get one personal exemption for yourself, one for your
spouse, and one for each dependent you can claim. A dependent is someone who
gets more than half of their support from you, and meets certain other
tests. Each personal exemption cuts your adjusted gross income by $3,500
(2008).
Dependents include:
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your child, stepchild,
grandchild, parent or stepparent, sibling or stepsibling, in-law,
aunt/uncle, niece/nephew, or anyone else not breaking state law by living
with you (in some states, same-sex couples can declare each other
dependents),
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earning less than $3,500 in
taxable income (not including
Social Security benefits,
Municipal Bond interest, etc.),
except for children under age 19 or full-time students under age 24,
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who doesn't file a joint
return with their spouse (except where each spouse's income is below the
filing threshold and they file solely to claim a refund).
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You'll need to provide a
Social Security number for each dependent you claim.
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A dependent doesn't have to be
alive for a full year to qualify for the full personal exemption. Children
born during the year and people who die during the year qualify for
personal exemptions. If you care for a foster child and you can show that
actual expenses top the allowance you get from the state, claim the excess
as an itemized deduction.
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If your adjusted gross income
tops certain thresholds, your personal exemptions phase out by 2% (4% if
married filing separate) for each $2,500 or fraction over the threshold.
For 2008, those thresholds are $159,950 for single taxpayers, $199,950 for
heads of households, $239,950 for joint filers, and $119,975 for married
couples filing separately.
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Generally, the custodial
parent gets to claim the personal exemption for a child following divorce.
However, the custodial parent can release the exemption by signing
Form
8332, which must accompany the noncustodial parent's return.
For more information, see
IRS
Publication 501, "Exemptions, Standard Deduction, and Filing Information."
Physical Therapy
Deductible Medical
Expense subject to the 7.5% floor.
Physician
Deductible Medical
Expense subject to the 7.5% floor (any
licensed medical doctor).
Points
Points you pay to secure a loan
to buy or improve your primary residence are deductible if they meet these
tests:
-
Paying
points is an established practice in your geographical area.
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The points
you pay don't exceed the points generally charged in the area.
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The points are figured as a percentage of the loan amount.
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They're specifically
itemized as points, loan origination fee, or loan discount fee.
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They're paid directly to the lender.
If points you pay don't meet
these tests, you can still amortize them over the life of the loan. Your
lender will report the amount of deductible points on Form 1098.
Points you
pay on a second home, home equity loan, or line of credit, are deductible
over the term of the loan. If you prepay the loan before you've deducted the
points you paid, deduct any remaining points the year the mortgage ends.
Points you pay as a seller
are nondeductible.
Political Contributions
Political contributions are generally considered a nondeductible personal expense. However, there is
a limited deduction for some
Lobbying Costs your business pays for its own lobbying activities.
Pooled Income Funds
Pooled income funds are an
alternative to charitable trusts for donors who want to avoid the
administrative difficulties involved in setting up a trust. These funds are
charitable trusts set up to accept donations from several donors. You
transfer cash or property to the trust and get an up-front deduction based
on the value of the gift and your life expectancy. The trust pays you an
income, now or later, in proportion to your share of the trust's total
contributions. At your death, the assets pass to the charity.
Postage
Postage and shipping you pay are
deductible under the following rules:
Prenatal/Postnatal Care
Deductible
Medical Expenses subject
to the 7.5% floor.
Prenatal Vitamins
Deductible
Medical Expense subject to the 7.5% floor.
Prepaid Expenses
(See Bunching Deductions and
Business Expenses)
Prepaid Legal Plans
Prepaid legal plans you sponsor for your business and your employees are
a deductible
Business Expense on
Schedule C,
Form 1065, or
your corporate return.
Prepaid Tuition Plan
(see Section 529 Plans)
Prescription Drugs
Deductible Medical
Expense subject to the 7.5% floor.
Prime Rate Fund
(See Loan
Participation Fund)
Private Foundation
A private foundation is a
perpetual, irrevocable trust that has to distribute at least five percent of
its assets per year to whatever charities the trustees choose. None of the
income comes back to you, as it would with a charitable remainder trust,
pooled income fund, or charitable gift annuity. You, the donor, control the
foundation, its board of directors, and the causes the donor chooses to
support. You can also use a private foundation to shift income to your
family, by naming them as officers and trustees and paying them for their
services. At your death, the trustees will continue to manage foundation
assets under the terms of the trust.
Private foundations can be
expensive to establish and maintain. This makes them most appropriate for
gifts in the half-million dollar range or more to give.
Private Mortgage Insurance
Private mortgage insurance, or
PMI, is deductible, along with
Mortgage Interest, as an
Itemized Deduction
on
Schedule A.
Professional
Association Dues
Professional association dues,
such as bar association dues, are deductible as follows:
Professional Education
Professional education costs for
your trade or business are deductible as follows:
Profit Sharing Plan
(See Qualified Plan)
Property Taxes
Property taxes you pay on real
estate and personal property are deductible as follows:
-
Deduct property taxes you pay on your primary
residence and any additional residences as an
Itemized Deduction on
Schedule A.
But beware--these are a preference item for the
Alternative Minimum
Tax, so you can't assume that they'll give you the benefit you
would otherwise expect.
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Property taxes you pay on
business real estate are a deductible
Business Expense on
Schedule C,
Form 1065, or
your corporate return.
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Property taxes you pay on
rental real estate are a deductible real estate expense.
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Property taxes you pay on
personal property, such as cars, may be deductible if they are based on the
value of the property and charged on a yearly basis. This includes
registration fees if they are actually based on the value of the property.
Psychologist
Deductible Medical
Expense subject to the 7.5% floor.
Pure Trust
(See Trusts)
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