Dan, Edgewood: I bought a home in 2006 and I was wondering what taxes from the settlement I can claim on my taxes. Is there a resource available for this information?
SC&H Group: There are a number of items that you should look for on your settlement sheet that should be examined to see if they are deductible expenses.
First, you will need to look at the real estate taxes. As a general rule, property taxes must be apportioned between the buyer and the seller based on the number of days that each held the property. If the property taxes were paid by the previous owners before the settlement date, you should see a section on the front of your settlement sheet entitled "Adjustments for Items Paid by Seller in Advance." If there is an amount listed in this section for real estate taxes, you can deduct these real estate taxes on Schedule A, Line 6 of your Form 1040.
Second, you will need to look to see if you paid any points (also referred to as loan origination fees or loan discounts). These are typically reported on page two of the settlement sheet under a section entitled "Items Payable in Connection with Loan." These points are fully deductible on Schedule A, Line 12 in the year they were paid on a principal residence. Seller paid points are deductible by the home buyer as well as points they paid directly.
Unfortunately, the other fees paid at settlement are not deductible expenses. However, be sure to keep a copy of your settlement sheet because some of these items will increase your tax basis in the property when it is sold.
Also note that IRS publication 530 "Tax Information for First-Time Homeowners" may be a helpful resource. This publication can be found on the IRS Web site.
Bob, Lutherville: Is a settlement from an insurance company because of an accident taxable?
SC&H Group: Auto insurance proceeds may or may not be taxable, depending upon the circumstances.
If the settlement is simply reimbursement for the expenses you incurred in repairing the vehicle, the proceeds would not be taxable. However, if the proceeds received are greater than the costs incurred, the excess would generally be taxable.
On the other hand, if the vehicle was destroyed, you may be eligible for a casualty loss deduction. This loss is calculated as the lesser of the adjusted basis of the property destroyed or the decrease in the Fair Market Value (FMV) due to the casualty loss. This loss amount must then be reduced by any insurance proceeds expected. This loss will be deductible on your tax return if the loss is greater than $100 and the total loss exceeds 10% of the adjusted gross income reported on your tax return. The IRS website can offer additional guidance on this calculation.
J.D., Perry Hall: I've owned mutual funds for a number of years. I plan on selling some and applying the proceeds from the sale toward an IRA. I was wondering what the tax burden will be on the sale? I've received Form 1099-DIV each year and paid taxes accordingly. How would the taxes be calculated based on the sale price?
SC&H Group: Taxes on the sale of mutual funds will create a capital gain or loss, which will be taxed at a rate that is determined by the holding period of the fund as well as your tax bracket. To determine the capital gain, the proceeds you receive from the sale will be reduced by the tax basis of the shares of the mutual fund you sold.
Tax basis of a mutual fund investment includes cash investments, plus reinvested dividends and capital gain dividends, minus returns of capital paid out to the owner. Shares in mutual funds are acquired at different times and at different prices. The IRS allows the basis to be computed by using either the cost basis or the average basis.
The cost basis method involves identifying and calculating the actual cost of the mutual fund shares, and shares are considered to be sold on a first-in-first-out basis (FIFO). This means that when you sell a portion of the mutual funds you consider that you have sold the oldest shares first.
The average basis method is computed by taking the total cost of all shares owned and dividing by the number of shares owned. If you choose this method, you must use it for any future sales of the same mutual fund.
Linda, Glen Burnie: My son is a paid assistant coach for a non-profit children's hockey league. He and the coach purchased prizes and food for the kids. Is this purchase tax deductible?
SC&H Group: Linda, generally contributions to only the following types of organizations are tax deductible: religious, charitable, educational, scientific and literary, as well as organizations for the prevention of cruelty to children or animals and certain organizations that foster amateur sports competitions. It sounds like your son gives the prizes and food directly to the kids. If this is the case, the purchases are not deductible. If your son donates items to the league and the league qualifies as a non-profit organization, the purchase may qualify as a non-cash charitable deduction. If this is the case, you should inquire with the league about whether they are a qualified organization. If they are not sure, you can check IRS Publication 78 on the IRS Web site.
Dan, Forest Hill: We exercise Incentive Stock Options (ISO's) each year and pay a large tax on the difference between the market price and the exercise price, which are unrealized gains, because we are buying, not selling. Plus, when we someday sell the shares for a gain, we'll pay tax on the gain, too. Is there any reform in sight for this tax of unrealized gains?
SC&H Group: Dan, I assume you are talking about the alternative minimum tax. The tax you pay on the difference between the market price and the exercise price (unrealized gains) generates alternative minimum tax carryovers (minimum tax credits). New law allows individuals with minimum tax credit carryforwards to use a portion of them -- regardless of whether they would otherwise be subject to AMT -- during the six-year period starting in 2007. Usage of the minimum tax credit is subject to a phase-out formula. The extra minimum credit allowed under this provision is "refundable". Also, there is current legislation in Congress that would repeal the alternative minimum tax for individual taxpayers.
Answers to selected questions are published on Mondays.