Editor's note: The first two questions are answered together.
Jim Wilhelm, a partner with SC&H Group, leads the income tax department, providing tax compliance and consulting services to private and public companies throughout the region.
Stuart Rudo is a tax partner with SC&H Group, focusing his practice on individual and corporate tax services and cost segregation studies.
Greg Horning is a founding partner of SC&H Group. He provides comprehensive tax, investment advisory and financial planning services to high net-worth individuals.
James, Bel Air: A few years ago we bought a timeshare. We recently sold it, at a loss, to a company that buys up timeshares. They made much of the loss that could be written off. My reading of tax info and a call to the IRS indicate that it is personal use property and the loss cannot be taken on taxes. The tax advisor (an enrolled agent and former IRS employee) for the company that bought the timeshare said that if we bought it with the idea of being able to sell it in the future at a gain (which the initial sales presentation indicated could be done), then the loss is deductible. Is this deductible or not?
SC&H Group: In general, the Tax Code allows taxpayers to claim losses and deductions so long as such losses and deductions are not excluded by another section of the Code. An individual's ability to claim losses recognized are limited to those losses incurred in a trade or business, or a transaction entered into for profit. Further illustrating this point, the Tax Code provides that no deduction is allowed for "personal, living, or family expenses." IRS regulations provide that losses recognized upon the sale or disposition of property held for personal use are not deductible.
In order to determine whether loss recognized on the disposition of a timeshare is deductible, the taxpayer must consider how the timeshare was used and the reason it was held. If the timeshare was used solely for "personal" purposes (e.g., a vacation destination for the taxpayer and the taxpayer's family, friends, etc.), then the loss recognized on the disposition of the timeshare should not be deductible. On the other hand, if the timeshare was purchased solely as an investment asset with the intention of turning a profit, the loss recognized on the disposition of the timeshare should be deductible.
In certain cases, the same asset is used for both personal and business (production of income) purposes. In such cases, IRS regulations appear to provide for an allocation of loss recognized on the disposition of the asset between the personal use and business use portions of the property. However, this regulation seems to indicate a "division" of the property in question between personal and business use portions (e.g., different rooms in a residence). On the other hand, previous court cases have held that in transactions with both personal and business elements, the personal element takes precedence.
Therefore, if the timeshare was held for personal use (whether in whole or in part), loss recognized on the disposition of the timeshare likely is not deductible.
Jane, Baltimore: My husband and I bought our first home in 2006. Knowing we'd have tax-deductible interest on the loan and equity line, we adjusted the withholding amounts in our paychecks to have more money in our pockets during the year rather than wait for a refund. We used a calculator at IRS.gov to determine the number of exemptions we claimed on our W-4s, but we must have done something wrong because we now owe more than $5,000. What are our options for offsetting this payout using an IRA contribution retroactively for 2006? I have an existing, traditional IRA (not a Roth) from a 401(k) rollover. It would be nice to pay some of this to ourselves rather than Uncle Sam.
SC&H Group: You have until April 17, 2007, to make a maximum $4,000 contribution ($5,000 if you were age 50 by the end of 2006) to your Individual Retirement Account (IRA). This contribution can be taken as a deduction, but the deduction may be limited or phased-out completely, depending on your income, filing status and the existence of an employer retirement plan. Also keep in mind that your eligibility to even make a contribution to your IRA hinges on the factors previously listed.
You mentioned that you purchased a home in 2006. Any real estate tax or points paid as a result would be deductible, and this could help to minimize your tax liability. You may have made certain energy efficiency improvements to your home that could generate federal and/or state income tax credits. In addition, if this is the first time you are filing Schedule A, make sure you capture all charitable contributions, state taxes paid with your returns last tax season and employee business expenses.
Reg, Baltimore: You normally file 1040A, head of household, standard deductions. Maryland tax based on the 1040A is filed online. You earn just over $1,500 at the beginning of the year in a slot jackpot, but can also provide a loss statement offsetting your wins by the end of the year. Which tax form (Federal and Maryland state) must or can be used, and what lines are these amounts listed.
SC&H Group: Due to the fact that you have received gambling winnings and losses you are not eligible to file Federal form 1040A in the current year. Rather you must file Federal form 1040. You may have received a W-2G that includes the $1,500 that you won. The $1,500 jackpot should be included on line 21 of your federal Form 1040 as other income. If you elect to itemize your deductions rather than take the standard deduction, you may deduct the gambling losses that you incurred on Schedule A line 27. Be sure to compute your other itemized deductions when completing Schedule A. However, the amount of gambling losses that you may deduct is limited to your winnings.
If it is not beneficial to itemize your deductions for Federal purposes then you may file Maryland Form 503. However, if you are able to itemize for federal purposes, then you should file Maryland Form 502 so that you can utilize your itemized deductions for Maryland purposes as well.
Hank, Columbia: I have been two years late in filing my tax return but made sure that I had paid my taxes on the due date (April 15 for the previous year), although I also was lax in making all the four required estimated tax payments. Can I be charged a penalty even though I had paid my all my taxes by April 15. If so, what is the penalty and what is the amount based on?
SC&H Group: The IRS requires taxpayers to pay their taxes rateably throughout the year. Absent withholding from wage income, taxpayers should make quarterly estimated payments on April 15, June 15, September 15, and January 15 of each year. Use the worksheet provided in the instructions to Form 1040-ES to calculate the amount of tax due with each payment. If you fail to make proper estimated payments each quarter then the IRS can assess a penalty to you even if you are overpaid by the time you file your tax return. The penalty is imposed on each underpayment for the number of days it remains unpaid. See the instructions for Form 2210 for more information on this penalty, exceptions to the penalty and the fact that the IRS will compute this penalty for you if you would like.
Sharon, Timonium: I incorrectly answered a question about Long Term Care Insurance on past Maryland tax returns. Therefore I had to pay Maryland interest and taxes for 2003, 2004 and 2005. In November 2006, I sent a check for $3,600. Can I put this amount anywhere on this year's federal and state returns? What line does it go on? Form 1040 Schedule A? Thank you.
SC&H Group: State and local income taxes are deductible on Line 5 of Schedule A in the year in which the tax is paid. Add that payment to your current year payments for state withholding and/or estimated tax payments. The tax year to which the tax expense applies makes no difference. However, interest and penalties incurred are not deductible, so keep that in mind when calculating your deduction.
Answers to selected questions are published on Mondays.