Archives for November 20, 2018

If you own a vacation home that you use for both rental and personal purposes, now is a good time to plan how to use it for the rest of this year with tax savings in mind. Here’s what you need to know:

Rented less than 15 days during the year with more than 14 days of personal use

For a vacation home in this category, the tax rules are really simple. You need not report any of the rental income on your Form 1040. However, you cannot deduct expenses directly attributable to the rental period (rental agency fees, cleaning, and so forth). If your vacation home happens to be located near a major event — like a PGA golf tournament or a big multi-day concert — you may be able to rent the place out for a short period even at high rates and pay zero federal income tax.

Tax-smart year-end strategy: The more rental days between now and year-end, the better — as long as they don’t exceed 14 days for the year.

Rented more than 14 days with substantial personal use

Your vacation home falls into this category if you rent it for more than 14 days during the year and your personal use exceeds the greater of:(1) 14 days or (2) 10% of the rental days. For example, a vacation home that’s rented for 180 days during the year and used by you and family member for 60 days falls into this slot.

Personal usage includes use by you, other family members (whether they pay fair market rent or not) or anyone else who pays less than market rent. Personal use also includes time spent at your place by another party under a reciprocal sharing arrangement (“I use your place in exchange for you using my place”) whether the other party pays market rent or not.

Days devoted principally to repairs and maintenance are considered days of vacancy and are disregarded, even if family members are present while you work away.

The tax drill

Vacation homes in this category are treated as personal residences for federal income tax purposes. Follow this six-step procedure to account for the property’s rental income and all the expenses.

Step 1: Report 100% of rental income on Schedule E of Form 1040.

Step 2: Deduct 100% of any direct rental expenses (such as rental agency fees and advertising) on Schedule E.

Step 3: Allocate mortgage interest and property taxes between rental and personal use. See below for how to do that.

Step 4: Deduct as Schedule E rental expenses the allocable mortgage interest and property taxes from Step 3.

Step 5: If there’s any net rental income left after Step 4, deduct as rental costs allocable indirect expenses — maintenance, utilities, association fees, insurance, depreciation and so forth on Schedule E — but only to the point where you zero out rental income. In allocating these indirect expenses, consider only actual rental and personal-use days during the year, and ignore days of vacancy. For example, if you rent your vacation home for 90 days during the year and use the property 60 days for personal purposes, allocate 60% of the maintenance, utilities, and so forth to rental usage and 40% to personal usage. The 40% is non-deductible. Even so, the bottom line on Schedule E will often be zero, because the rental income will often be fully offset by deductible expenses.

Step 6: Write off the personal-use percentage of mortgage interest and property taxes as itemized deductions on Schedule A of Form 1040, subject to the new Tax Cuts and Jobs Act of 2017 (TCJA) limits for 2018-2025 (see “TCJA changes affecting vacation-home owners” below).

You are allowed to carry over any disallowed allocable indirect expenses to future years when you can deduct them against rental profits (if you ever have any).

Controversy regarding how to allocate mortgage interest and property taxes

The IRS says you should use only actual days of personal and rental usage to allocate all non-direct vacation-home expenses, including mortgage interest and property taxes. However, two Appeals Court decisions say you can allocate mortgage interest and property taxes differently, by treating actual rental occupancy days as rental days and all other days — including days of vacancy — as personal days.

Before the TCJA, the Appeals Court method was often more beneficial because (1) it allocates more mortgage interest and property taxes to Schedule A (where you could usually fully write off these expenses as allowable itemized deductions under prior law) and (2) it allocates less mortgage interest and property taxes to Schedule E, which usually allowed you to currently deduct more of the other expenses allocable to rental usage (property insurance, utilities, etc.) on Schedule E when applying the rental income limitation.

But after the TCJA changes, some vacation-home owners may benefit from using the IRS-approved method instead of the Appeals Court method. That’s because you will never get any tax benefit from allocating more interest and taxes to Schedule A than you can currently deduct after the TCJA changes. Your tax pro can run the numbers at tax return time and figure out the best allocation method for interest and taxes.

Tax-smart year-end strategy: If your property fits solidly into this category for 2018 and your expenses will comfortably exceed rental income (the usual situation), you will probably come out ahead by renting it out for some additional days between now and year-end. That way, you’ll receive more rental income (good for cash flow), and you can probably still offset all the rental income with direct expenses, allocable mortgage interest and property taxes, and allocable indirect expenses. So you’ll have that much more tax-sheltered rental income, which is always a good thing.

The bottom line

As you can see, the tax rules for vacation homes are complicated.

If you have a vacation home that is rented for more than 14 days during the year and your personal use does not exceed the greater of (1) 14 days or (2) 10% of the rental days, the home is classified as a rental property for tax purposes. (I’ll cover the tax rules for vacation homes that are classified as rental properties in next week’s column. So please stay tuned.)

TCJA changes affecting vacation-home owners

New limit on property-tax deductions: Before the TCJA, you could claim itemized deductions for an unlimited amount of personal state and local property taxes. For 2018-2025, however, the TCJA limits itemized deductions for personal state and local property and income taxes to a combined total of only $10,000 ($5,000 for those who use married filing separate status). This limitation can affect your ability to claim itemized deductions for property taxes on a vacation home.

New limits on home-mortgage interest deductions: The TCJA also places new limits on the amount of home mortgage debt for which you can claim itemized qualified residence interest expense deductions. These limits can affect your ability to claim itemized deductions for mortgage interest on a vacation home.

For 2018-2025, the TCJA generally allows you treat interest on up to $750,000 of home acquisition debt (incurred to buy or improve a first or second personal residence) as deductible qualified residence interest. If you use married filing separate status, the limit is halved to $375,000. Thanks to a grandfather provision for pre-TCJA mortgages (explained below), this change will mainly affect new buyers.

TCJA change for home-equity debt: For 2018-2025, the TCJA generally eliminates the prior-law provision that allowed you to treat interest on up to $100,000 of home-equity debt as deductible qualified residence interest ($50,000 if you used married filing separate status).

TCJA grandfather rules for up to $1 million of home-acquisition debt: Under one grandfather rule, the TCJA changes do not affect qualified residence interest deductions on up to $1 million of home-acquisition debt that you took out: (1) before 12/16/17 or (2) under a binding contract that was in effect before 12/16/17, as long as the home purchase closed before 4/1/18. If you use married filing separate status, the limit is halved to $500,000.

Under a second grandfather rule, the TCJA changes do not affect qualified residence interest deductions on up to $1 million/$500,000 of home-acquisition debt that you took out before 12/16/17 and then refinanced later — to the extent the initial principal balance of the new loan does not exceed the principal balance of the old loan at the time of the refinancing.

Home-equity debt treated as home-acquisition debt: Say you spent or spend the proceeds of a home-equity loan to build, buy, or improve your first or second personal residence. The loan counts as home-acquisition debt for which qualified residence interest deductions are allowed, as long as the applicable home acquisition debt limit ($750,000/$375,000 or $1 million/$500,000) is not exceeded.

Bigger standard deductions: For 2018-2025, the TCJA almost doubled the standard deduction amounts. For 2018, they are:

• $24,000 for married joint-filing couples.

• $18,000 for heads of households.

• $12,000 for singles.

This seemingly benign change can adversely affect vacation-home owners, because their allowable itemized deductions (including those for vacation home mortgage interest and property taxes) may not exceed their standard deduction amount for 2018-2025.

Student-loan debts are crippling the finances of Americans and seriously stressing them out, according to a new survey.

It’s no secret there are widespread hazards with hefty student loans, but a new report from Student Debt Crisis, a nonprofit organization, and Summer, a start-up geared at helping student-loan borrowers figure out repayment, paints a stark picture on just how crushing the obligations can be as Americans try repaying $1.5 trillion in student debt.

The survey found:

· 80% of participants ­— with average debt loads of $87,500 versus average annual incomes of $60,000 — said their student-debt obligations prevented them from saving for retirement.

· 59% said they couldn’t make large purchases because of their student-loan bills and 56% said they couldn’t buy a home

· Student loans were a “major source of stress” for 86% of the respondents and one-third said student debt was the No. 1 cause of their stress

Monthly student loan payments topped expenses for necessities like food and health care, according to the majority of the 7,095 survey participants.

· 65% said their monthly student-loan bills were bigger than their food budget

· 56% said their monthly student-loan bills were more than health insurance

“It’s frustrating and honestly makes me feel completely defeated,” confessed Colleen from Pennsylvania. She was one of the people quoted in the report, talking about their struggles after incurring debt to get a good education.

Another woman in Texas, Melissa, said, “Regularly, I contemplate selling everything and living in my car to help free up money to pay off the debt sooner.”

The survey respondents are a sliver of the people on the hook for education bills.

Right now, 44 million American are repaying an outstanding $1.5 trillion in student debt, the report notes. That debt number has skyrocketed, tripling since 2005.

The Great Recession, following the collapse of Lehman Brothers and the burst housing bubble, created the perfect storm for massive student debt.

Some observers have called the student-loan industry a “failed social experiment.” And it doesn’t help that debts crash down while many people are already stretched thin, with just a few having rainy day funds for emergencies and unplanned expenses.

“This debt has been a huge burden and point of contention throughout our last 10 years,” Sean, a married Maine resident, told the researchers. “I think my wife and I will both weep the day we are debt free.”

Did your credit card limit unexpectedly decrease? If so, would you believe the good economy is the reason why?

Capital One and Discover, two of America’s largest credit card issuers, recently announced a tightening of credit card limits despite the strong economy. Both companies cite risk management as the reason.

While the economy may be strong now, Americans have taken on levels of debt that may not be sustainable in tougher times. According to Federal Reserve data, total consumer (non-mortgage) household debt is over $3.9 trillion. Total revolving debt (mostly credit card debt) is just over $1.04 trillion.

Both Capital One and Discover have a relatively high percentage of borrowers with lower credit scores – according to The Wall Street Journal, approximately one-third of Capital One’s card balances are held by borrowers with subprime credit scores. Consequently, both companies must be more pre-emptive at lowering risks.

By tightening credit limits, both companies are signaling concern that current economic growth is unsustainable, and their customer base will feel the most pain.

Capital One has focused on reducing spending limits for new cards and scrutinizing requests for existing spending limits, while Discover is reducing the number of higher-risk balance transfer offers and shutting down inactive cards. Discover has reduced their overall spending limits by almost $30 billion over the last two years.

Can a credit card company simply lower your credit card limit at any time, without a specific reason? They can, as long as they don’t violate any of the terms in your credit card agreement. However, they must notify you of the decrease and allow 45 days before charging fees if the decrease drops your new limit below your current balance.

Credit limits are more likely to be decreased if you are showing signs of trouble like increasing balances, approaching your credit limit, or missing payments. However, limits may also be decreased through lower activity or inactivity. Either way, your credit score may be harmed because lower limits increase credit utilization – the amount of credit you’re using compared to your credit limit.

What can you do if your credit limit has decreased?Ask your credit card issuer for the reason. You may find out that your limit has been decreased by mistake, reflecting an error in your credit report or fraudulent use of your account. In that case, dispute the charges with your issuer and the credit reporting agencies to start the redemption process. If you would like to monitor your credit to prevent identity theft and see your credit reports and scores for free, join MoneyTips.

If the reason is valid, try to make a case that the situation is temporary (a one-time unexpected large expense or setback). Explain how you plan to overcome the situation. You may be able to talk the issuer into restoring your limit if you follow through on your plan or meet a separate set of conditions that the credit card issuer suggests.

The best policy is prevention. Manage your credit cards wisely and avoid giving credit card issuers a reason for decreasing your limit.

Stay below 30% of your credit limit on all credit card accounts. For secondary cards, place regular small charges on the accounts to maintain activity. Don’t close the older accounts – you’ll reduce your credit score by reducing the length of credit history as well as increasing credit utilization. Make all payments on time and avoid a pattern of steadily increasing balances. Keep spending and your overall debt limits under control, and in proportion to your income.

By taking these actions, you’ll make a credit limit decrease less likely and a credit score increase more likely. Who wouldn’t want that?

If you want more credit, check out our list of credit card offers.

If you’ve reached age 70½, you can make cash donations to IRS-approved charities out of your IRA. These so-called qualified charitable distributions (QCDs) are now a permanent feature of the tax law — unless Congress changes its mind. To take maximum advantage for 2018, you should replace some or all of this year’s IRA required minimum distributions with tax-smart QCDs. Here’s what you need to know.

Qualified charitable distribution basics

Qualified charitable distributions (QCDs) can be taken out of your traditional IRA(s) free of any federal income hit. In contrast, other traditional IRA distributions are taxable (wholly or partially depending on whether you’ve made any nondeductible contributions over the years).

Unlike garden-variety charitable donations, you can’t any claim itemized deductions for QCDs. That’s OK, because the tax-free treatment of QCDs equates to a 100% deduction — because you’ll never be taxed on those amounts, and you don’t have to worry about any of the tax-law restrictions that apply to itemized charitable write-offs.

A QCD must meet all the following requirements.

1. It must be distributed from an IRA, and it cannot occur before you, as the IRA owner or beneficiary, are age 70½.

2. It must meet the normal tax-law requirements for a 100% deductible charitable donation. If you receive any benefits that would be subtracted from a donation under the normal charitable deduction rules, (such as free tickets to an event), the distribution cannot be a QCD. Beware of this rule!

3. It must be a distribution that would otherwise be taxable. A Roth IRA distribution can meet this requirement if it’s not a qualified (meaning tax-free) distribution. However, making QCDs out of Roth IRAs is generally inadvisable for reasons explained later in this column.

Important Point: If you inherited an IRA from the deceased original account owner, you too can do the QCD drill with the inherited account if you’ve reached age 70½.

$100,000 annual limit

There is a $100,000 limit on total QCDs for any one year. But if both you and your spouse both have IRAs set up in your respective names, each of you is entitled to a separate $100,000 annual QCD limit, for a combined total of $200,000.

Tax-saving advantages

QCDs have five potential tax-saving advantages.

1. QCDs are not included in your adjusted gross income (AGI). This lowers the odds that you will be affected by various unfavorable AGI-based rules — such as those that can cause more of your Social Security benefits to be taxed, less of your rental estate losses to be deductible, and more of your investment income to be hit with the 3.8% Medicare surtax (the so-called net investment income tax). QCDs are also exempt from the rule that says your itemized charitable write-offs cannot exceed 60% of your AGI (any donations disallowed by the 60%-of-AGI limitation are carried forward for up to five years).

2. QCDs always deliver a tax benefit while “regular” charitable donations might not. The TCJA almost doubled the standard deduction amounts, and you only get a tax benefit from a charitable donation if your total itemizable deductions exceed your standard deduction. So higher standard deductions make it that much harder to claim itemized charitable write-offs. For 2018, the standard deductions are:

* $12,000 if you are single or use married filing separate status (up from $6,350 for 2017).

* $24,000 if you are a married joint-filer (up from $12,700).

* $18,000 if you are a head of household (up from $9.350).

3. A QCD from a traditional IRA counts as a distribution for purposes of the required minimum distribution rules. Therefore, you can arrange to donate all or part of your 2018 required minimum distribution amount (up to the $100,000 limit) that you would otherwise be forced to receive before yearend and pay taxes on. But hurry, because you must either take your 2018 required distribution by yearend or take the alternate tax-smart QCD route.

4. Say you own one or more traditional IRAs to which you have made nondeductible contributions over the years. Your IRA balances consist partly of a taxable layer (from deductible contributions and account earnings) and partly of a nontaxable layer (from those nondeductible contributions). Any QCDs are treated as coming first from the taxable layer. Any nontaxable amounts are left behind in your IRA(s). Later on, those nontaxable amounts can be withdrawn tax-free by you or your heirs.

5. QCDs reduce your taxable estate, although that is not an issue for most folks now that the federal estate tax exemption has been supersized to $11.18 million for singles and effectively $22.36 million for married couples.

Are you a good QCD candidate?

If you can afford to donate IRA money, you can benefit tax-wise if you match one or more of the following profiles.

1. You don’t itemize deductions (under the normal rules only itemizers get any income tax benefit from charitable donations).

2. You itemize, but part of your charitable deduction would be delayed by the 60%-of-AGI restriction.

3. You want to avoid being taxed on the required minimum distribution amount that you must take from your IRA(s).

4. You are looking for a quick and easy estate tax reduction strategy.

Should you consider Roth QCDs?

Generally, the answer is no. Why? Because you and/or your heirs can take federal-income-tax-free Roth IRA withdrawals after at least one Roth account owned by you has been open for at least five years. Also, for original account owners (as opposed to account beneficiaries), Roth IRAs are not subject to the required minimum distribution rules until after you pass on. Bottom line: because the tax rules for Roth IRAs are so favorable, it’s generally best to leave your Roth balances untouched rather than taking money out for QCDs.

The bottom line

The QCD privilege is a tax-smart opportunity for well-off seniors with more IRA money than needed for retirement. However, this is also a timely opportunity, because you want to arrange for QCDs to replace IRA required minimum distributions for this year.