Tax Savings for Empty-Nesters
Roll over an inherited 401(k), help your children earn a credit for retirement savings and rack up tax savings in the process.
Empty-nesters should make these moves throughout the year to keep their bill low at tax time. Here are the areas where you should look for savings:
A tax credit is available for homeowners who install alternative energy equipment. It equals 30 percent of what a homeowner spends on qualifying property such as solar electric systems, solar hot water heaters, geothermal heat pumps, and wind turbines, including labor costs. There is no cap on this tax credit, which is available through 2016.
Second homes can offer a vacation from taxes.
If you're trying to figure whether you can afford a second home, remember that you'll get some help from the IRS. Mortgage interest on a loan to buy a second home is deductible just as it is for the mortgage on your principal residence. Interest on up to $1.1 million of first- and second-home debt can be deducted. Property taxes can be written off, too. Things get more complicated — and perhaps more lucrative — if you rent out the place part of the year to help cover the bills.
Watch the calendar at your vacation home.
If you hope to deduct losses attributable to renting the place during the year, be careful not to use the house too much yourself. As far as the IRS is concerned, "too much" is when personal use exceeds more than 14 days or more than 10% of the number of days the home is rented. Time you spend doing maintenance or repairs does not count as personal use, but time you let friends or relatives use the place for little or no rent does.
Take advantage of tax-free rental income.
You may not think of yourself as a landlord, but if you live in an area that hosts an even that draws a crowd (a Super Bowl, say, or the presidential inauguration), renting out your home temporarily could make you a bundle — tax free — while getting out of town when tourists overrun the place. A special provision in the law lets you rent a home for up to 14 days a year without having to report a dime of the money you receive as income.
Tote up out-of-pocket costs of doing good.
Keep track of what you spend while doing charitable work, from what you spend on stamps for a fundraiser, to the cost of ingredients for casseroles you make for the homeless, to the number of miles you drive your car for charity (worth 14 cents a mile). Add such costs with your cash contributions when figuring your charitable contribution deduction.
Roll over an inherited 401(K).
A recent change in the rules allows a beneficiary of a 401(k) plan to roll over the account into an IRA and stretch payouts (and the tax bill on them) over his or her lifetime. This can be a tremendous advantage over the old rules that generally required such accounts be cashed out, and all taxes paid, within five years. To qualify for this break, you must be named as the beneficiary of the 401(k). If the account goes to the owner’s estate and then to you, the old five-year rule applies.
INVESTMENTS AND RETIREMENT SAVINGS
Check the calendar before you sell.
You must own an investment for more than one year for profit to qualify as a long-term gain and enjoy preferential tax rates. The "holding period" starts on the day after you buy a stock, mutual fund or other asset and ends on the day you sell it.
Don't buy a tax bill.
Before you invest in a mutual fund near the end of the year, check to see when the fund will distribute dividends. On that day, the value of shares will fall by the amount paid. Buy just before the payout and the dividend will effectively rebate part of your purchase price, but you'll owe tax on the amount. Buy after the payout, and you'll get a lower price, and no tax bill.
Mine your portfolio for tax savings.
Investors have significant control over their tax liability. As you near the end of the year, tote up gains and losses on sales to date and review your portfolio for paper gains and losses. If you have a net loss so far, you have an opportunity to take some profit tax free.
Alternatively, a net profit on previous sales can be offset by realizing losses on sales before the end of the year. (This strategy applies only to assets held in taxable accounts, not tax-deferred retirement accounts such as IRAs or 401(k) plans).
Consider tax-free bonds.
It's easy to figure whether you'll come out ahead with taxable or tax-free bonds. Simply divide the tax-free yield by 1 minus your federal tax bracket to find the "taxable-equivalent yield." If you're in the 33% bracket, your divisor would be 0.67 (1 - 0.33). So, a tax-free bond paying 5% would be worth as much to you as a taxable bond paying 7.46% (5/0.67).
Keep a running tally of your basis.
For assets you buy, your "tax basis" is basically how much you have invested. It's the amount from which gain or loss is figured when you sell. If you use dividends to purchase additional shares, each purchase adds to your basis. If a stock splits or you receive a return-of-capital distribution, your basis changes. Only by carefully tracking your basis can you protect yourself from overpaying taxes on your profits when you sell. If you're not sure what your basis is, ask your brokerage or mutual fund company for help. (Financial services firms must now report to investors the tax basis of shares redeemed during the year. For the sale of shares purchased in 2012 and later years, they must also report the basis to the IRS.)
Beware of Uncle Sam's interest in your divorce.
Watch the tax basis — that is, the value from which gains or losses will be determined when property is sold — when working toward an equitable property settlement. One $100,000 asset might be worth a lot more — or a lot less — than another, after the IRS gets its share. Remember: Alimony is deductible by the payer and taxable income to the recipient; a property settlement is neither deductible nor taxable.
Help your children earn a credit for retirement savings.
This credit can be as much as $1,000, based on up to 50% of the first $2,000 contributed to an IRA or company retirement plan. It's available only to low-income taxpayers, who are often the least able to afford such contributions. Parents can help, however, by giving an adult child (who can not be claimed as a dependent) the money to fund the retirement account contribution. The child not only saves on taxes but also saves for his or her retirement.