Investors often get excited for anything that may reduce their tax liability, including deductions and write-offs. Tax deductions, however, in many cases can be like a hairy lollipop. From a distance the lollipop looks delicious, but as you get closer you start to see that appearances can be misleading.
There’s a funny episode of Seinfeld where Kramer explains “write-offs” to Jerry but as he attempts to explain how business works, Jerry fails to grasp any of the details. A write-off is another way of saying a tax deduction. Although write-offs can be very beneficial for most people, they are not always a benefit to every situation.
A misconception about tax deductions
I am not suggesting that you avoid tax deductions altogether, because they can be an everyday part of most people’s financial spending or their businesses. If you qualify for deductions, then the correct course of action is to take them. You never want to leave money on the table. Even the staunchest supporters of raising tax rates still pay the absolute minimum they are required to pay.
From just $107.88 $24.99 for Kiplinger Personal Finance
Be a smarter, better informed investor.
Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
What I am suggesting is this: Don’t go out of your way to accumulate tax deductions.
A few years back a couple in their 40s requested a meeting with me to review their financial situation. When going through the client discovery process they were excited to tell me that they had paid off their house.
This was extremely impressive, because their home was a single-family house in a pleasant neighborhood that happened to be in the top half of home values in the area. They informed me that they took out a 15-year mortgage while purchasing the house and consistently overpaid the mortgage payments.
Whether that was a good idea or not is a topic for another day, but the couple were ecstatic. A sense of pride shone through as they told me that they bought another home “for the tax deductions.” Both nodded their heads in approval as the sentence came out of their mouths.
I asked them, “You celebrated paying off your house by buying another house?”
“Yea, you know… for the tax deduction.”
As they once again nodded their heads in approval, I was shaking my head in disappointment. That’s like celebrating your child’s college graduation by having another baby! They were overly joyed about the tax deduction but neglected to take a look at what a deduction really meant for them.
What exactly are tax deductions?
A tax deduction is an expense that you can use to offset income in some way. The issue is that you will always pay more in expenses than you receive in tax savings.
The celebratory house had a new mortgage attached to it. Based on mortgage amortization schedules, most of their payment went toward interest.
To keep numbers simple, let’s say the monthly interest on the mortgage is $1,000 and they are in a 24% tax bracket. The couple pays the bank $1,000 in interest and the IRS lets them save $240 in taxes. That’s a bad deal. Pay $1,000 to get $240 back.
Bad decisions with good intentions
As I explained this to them, they shifted to saying the new house was an investment. It was in a resort town, and they planned to rent it out. They then complained about how high the rental management company fees were, how much the renters trashed the place and how little time they had to use the property themselves. To make matters worse, the housing bubble burst and their $300,000 second home dropped to a value of $200,000.
But now if the couple sold the property for the new lower value, they would get one heck of a tax deduction! This is because you can claim deductions on rental properties but not on primary residences.
It is extremely important to clear this myth up of how great tax deductions are, because there are plenty of people who will make bad decisions with good intentions. They are ill-informed and do not think through the progression.
If you want to buy a second home, a big, fancy truck for your plumbing business or any other large purchase (especially one that’s unnecessarily large) that’s one thing, however, do not justify this expense to others by saying it’s for the tax deduction. I have helped with too many people who have made mistakes based on bad information.
Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through SFG Wealth Management, a registered investment advisor. SFG Wealth Management and Harford Retirement Planners are separate entities from LPL Financial.
-
Investors Buy the Nasdaq's Big Dip: Stock Market TodayStocks are up and down again to end an up-and-down week ahead of big earnings announcements and the eventual return of regular economic data flow.
-
What to Know About Portable MortgagesA closer look at how portable mortgages would work, who might benefit and why the concept is gaining attention amid high rates and limited supply.
-
Here's How to Plan This Year's Roth Conversion, From a Wealth ManagerWhile time is running out to make Roth conversions before the end of the taxable year, consider taking your time and developing a long-term strategy.
-
Four Times You Need a Second Opinion on Your Financial PlanIs your financial plan fit for purpose — or is your adviser peddling an outdated strategy? When you see these red flags, it's time for a second opinion.Evan
-
3 Ways High-Income Earners Can Maximize Their Charitable Donations in 2025Tax Deductions New charitable giving tax rules will soon lower your deduction for donations to charity — here’s what you should do now.
-
Seven Practical Steps to Kick Off Your 2026 Financial PlanningIt's time to stop chasing net worth and start chasing real worth. Here's how to craft a plan that supports your well-being today and in the future.
-
An HSA Sounds Great for Taxes: Here’s Why It Might Not Be Right for YouHealth Savings Even with the promise of ‘triple tax benefits,’ a health savings account might not be the best health plan option for everyone.
-
What the 2026 Tax Landscape Means for Advisers, From a Financial PlannerThe OBBB's impacts on 2026 are taking shape, amplifying the need for financial advisers' expertise in transforming stability into strategy for their clients.
-
I'm a Financial Planner: This Is How You Can Get Started With RMDsThe IRS will come knocking for its share of your tax-deferred retirement savings when you hit 73, but planning ahead for RMDs will ensure you're ready.
-
The Clock Is Ticking: Take Advantage of These Retirement Tax Benefits While They LastRecent tax changes, including an extra $6,000 deduction for those 65 and older, present a golden opportunity for retirees to reduce their tax bills.
