Top 10 “saves” for tax year 2009 – Part Two

In my last post, I shared the first half of my Top Ten list for most valuable savings I found from reviewing tax returns that clients had prepared using tax software. All of the savings so far have been in the $2,000-$5,000 range. This time, the savings get quite large.

5) $8,000. Use an amended return to claim Homebuyer Credit when AGI was too high in year of purchase. Many taxpayers take distributions from retirement accounts to purchase a new home. Of course, these distributions get treated as income, which increases your Adjusted Gross Income. Numerous taxpayers, as a result of these distributions, suddenly found themselves with an AGI too high to qualify for the Homebuyer Credits. Fortunately, the IRS allows homebuyers to claim the credit for the year prior to the year of purchase. For many taxpayers, this is the difference between qualifying for $8,000, and getting nothin’.

4) ~$8,000-9,000. Avoid stock purchases within a retirement account during wash sale window. This one’s kind of cheating because the client didn’t come to me in time; I include it to point out the value of consulting a tax advisor before making big financial decisions. In a nutshell, the client sold a lot of stock, put the proceeds in a retirement account, and then bought the exact same stock within 30 days. Bad move. The original stock sale is now considered a “wash sale” and the loss on the stock can’t be taken as a capital loss. Long story short, the taxpayer lost over $8,000 in tax benefit by purchasing the stock too soon after selling. And unlike an ordinary wash sale, because the replacement stock was bought in a retirement account, he doesn’t even get benefit from the stock when it’s later sold. (I suspect this may one day be challenged in tax court, and the disallowed loss may be treated as basis in a retirement account…but the fact that one day a court case *might* allow him to receive some benefit is small consolation.)

4a) (OK, 4 wasn’t quite a save, and I remembered this one after publishing the first half of the list.) $4,000. Claim the full Homebuyer Credit even when you’re only a partial owner of a home. Unmarried individuals who purchase a home together may split up the Homebuyer Credit any way they want. I’ve talked to several people who thought each person could only claim half the total. If one person didn’t qualify for the credit, that part of the credit was just lost. Fortunately, wrong. If two unmarried people buy a home, and only one qualifies as a First-Time Homebuyer, that person can claim the entire $8,000 credit, not just $4,000.

3) ~$12,000. Use the best filing status when married. Most tax preparers, myself included, advise married couples it’s nearly always better to file jointly than separate. However, this couple had, in previous years, been in one of those rare situations where separate filing was better…and I saved them several hundred dollars at the time by pointing that out. A couple years later their situation changed, dramatically. Had they continued filing separately, it would have cost around $12,000 extra in 2009. Fortunately for them, they always have me review their return.

2) $15,000-$20,000. Used Section 121 (Primary Residence gain exclusion) to exclude gain on sale of rental property. This one’s not nearly as straight-forward as it sounds. In this situation, the taxpayer had converted a personal residence to a rental property, and then sold it at a gain. Naturally, he wanted to take the Primary Residence exclusion that he qualified for on the property. However, he noticed he reduced his taxes MORE by NOT taking the exclusion. He almost filed this way, but then decided to get a second opinion to understand why this was the case. The details are messy, but it basically came down to the types of losses freed up from other properties, and the fact his gain on the property sale was a long-term capital gain. While it was true he could save a few thousand dollars in the current year by not using the exclusion, in the long-term this was clearly the wrong move. The losses he “freed up” from other properties would remain available if he used the exclusion, and when those were later used they would be worth around $20,000, as opposed to only a few thousand now. (Yeah, the details would take several pages to explain, so I’ll just leave it at that.)

1) ~$30,000. Step-up basis in inherited property. Most people, when they inherit property, are advised that they can use the fair market value when the property was inherited as the basis of the property. This usually means the gain when the property is later sold is much lower. However, in some cases this advice is missed. In this case, a widow sold the home she and her husband had bought decades earlier. She had a taxable gain (after exclusion) of over $200k. Even at favorable capital gains rates, this still amounted to a tax bill of about $30,000. What she didn’t realize is that, living in the community property state of California, she received an increase in basis in the property when her husband died to the fair market value at that time. Based on the increased value, her gain on the sale was small enough to be excluded using the Primary Residence Exclusion, and she has $0 in additional tax as a result of the sale.

I review hundreds of returns every year, so you shouldn’t expect to save thousands just by having a professional review your tax return. But, my experience suggests that about 5-10% of taxpayers are leaving $1,000 or more on the table based on how they handle their taxes. Is that a risk worth taking to save $100 or less? All of the clients described above are certainly glad they didn’t take the risk.

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