1999 Tax Guide: Tax Strategies for Everyone

IRA distributions before age 59½ are not subject to a 10-percent penalty if funds are used for certain education and home expenses. If the amount you withdraw pays "qualified higher education expenses" incurred by you, your spouse, or any of your children or grandchildren, no penalty is owed. Qualified expenses include tuition, fees, books and supplies, and certain room and board expenses at postsecondary education institutions. Ten thousand dollars may be withdrawn penalty free if used within 120 days to buy or build a "first principal residence" for you, your spouse, or your child or grandchild. A first-time homebuyer is someone who has not had ownership interest in a principal home for two years before the new home is acquired. These withdrawn amounts continue to be subject to regular income tax, however.

Maximize the amount of interest you can deduct. There are significant restrictions on the types of interest expense that are tax deductible. Some examples of deductible interest expense are most home mortgage interest (subject to limitations), investment interest (also subject to limitations), and interest related to a trade or business. Personal interest, including interest on credit cards, car loans, and tax deficiencies, is not deductible. Analyze your borrowings and restructure debt where possible to gain a tax deduction.

Don’t sell appreciated assets to fund charitable gifts. Both you and a charity can benefit if you give appreciated assets to the charity instead of selling the assets and donating the after-tax proceeds. The amount of the savings (which can be significant) will depend on how much capital gains tax you would have paid on the sale. For example, suppose you are in the 39.6 percent bracket and plan to make a gift to a public charity of appreciated securities worth $100,000 with a cost basis of $40,000. You must choose between gifting the securities outright or selling the securities and gifting the cash proceeds. The gift of stock allows you permanently to avoid $12,000 of tax on the appreciation ($60,000 appreciation ´ 20 percent capital gains tax rate). Keep in mind, however, that the current year’s deduction for these gifts is limited to 30 percent of AGI. Any excess can be carried forward for five years (subject to the same percentage limitations in those years).

Look for the double-shelter opportunity in some passive gains. The rules essentially provide that you cannot use real estate and other tax shelter losses to offset wages, interest, dividends, and gains from stock market investments. Passive losses can be used only to offset passive income, in most situations. The result is that many taxpayers have "suspended passive losses" that they carry forward from year to year. These passive losses can be valuable if you have passive income or dispose of a passive activity, and their use should be maximized.

One common situation involving real estate is the sale of the property and the recognition of capital gains, which may or may not be accompanied by the receipt of cash. These capital gains can be offset by both capital losses and passive losses (including losses from other passive activities). In effect, one gain allows two losses.

For example, assume that you sell real estate, that the sale generates a capital gain of $10,000, and that you have carried forward passive losses from earlier years totaling $10,000. If you do nothing, your capital gain will be sheltered by the passive loss carryforward, and the transaction will have no net effect on your taxable income. If, however, your stock portfolio also has a $10,000 capital loss in it, the capital gain related to the disposition of the real estate presents an opportunity. You can dispose of the appropriate stock and realize the capital loss, which will offset the real estate capital gain, and then use the passive loss carryforward to shelter other ordinary income. The net result is a reduction in current taxable income of $10,000.

An added benefit is that a passive loss offsets ordinary income, which is taxed at rates as high as 39.6 percent, while the gain is taxed at the maximum applicable capital gains rate (generally, 20 percent).