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Converting home to rental property
Dear Tax Talk:
I have lived in my home for 16 years, and am thinking of renting
it for a year or two. How do I avoid a loss in capital gains taxes?
Thanks,
Pat
Dear Pat:
You'll be glad to know that you can rent out your home prior to
its sale and still qualify for the home-gain exclusion of $250,000
($500,000 in the case of a married couple filing jointly). A lot
of people choose to keep their home for a period after moving out
because they may want to return or the real estate market might
not be appropriate. The law states that as long as you have owned
and used your former home as your main home for two of the last
five years when it is sold you qualify for the exclusion.
When your home is offered for rent and you have moved
out, you can begin claiming depreciation deductions for the original
cost of the property (or if lower, its market value). These depreciation
deductions are claimed on Schedule E where the property's income
and deductions are reported. The depreciation deductions lower the
cost of the property for determining gain later on at its sale.
Additionally, the amount of depreciation claimed is income at the
time of the sale that does not qualify for the exclusion. In effect,
you are claiming deductions during the rental that later you will
have to report as income. However, this is beneficial in most cases,
since you get current deductions at your current tax rate and later
will claim the amount as income subject to a maximum tax rate of
25 percent.
Limiting taxes on lottery
winnings
Dear Tax Talk:
I won $558,000 in the Maryland Lottery last month. Twenty-eight
percent of that ($156,240) was withheld for federal taxes and another
$41,850 (7.5 percent) for state taxes. I'm married, and our combined
annual income will be about $123,000. We're both 48 years old and
are contributing the maximum to our thrift savings plans at work.
We have three children, ages 15, 16 and 19. The oldest
is a college sophomore. The other two will be entering college in
the next few years. We have a 15-year mortgage with a balance of
$112,000 at 5.75 percent. I paid all of our other bills (car loan,
credit card, etc.).
Can you suggest ways to shelter some of this income
from taxes? I realize only 28 percent was withheld and I am now
in the 39.6 percent tax bracket. Thank you in advance for considering
my question.
Paul
Dear Paul:
It must feel good to be so lucky, and certainly the government will
appreciate you more now as it reaches into your pockets to share
in your good fortune. One thing you may luck out on is a tax rate
cut down to 33 percent, which we will know about in the
next few weeks.
As you may be aware, when your income exceeds certain
thresholds you lose the benefit of some itemized deductions, dependency
exemptions and tuition credits. There is not much you can do about
the latter two; your income will be too high this year to receive
any tax benefits from your dependents or paying additional tuition.
With respect to your itemized deductions, you can
still receive some tax benefit by making certain that you have satisfied
and paid your state income tax obligation prior to year-end, since
this is deductible in the year paid. In addition, gather up all
your losses from gambling, since this is deductible as a miscellaneous
itemized deduction not subject to reduction.
In addition, I would suggest consulting with a financial
planner with a tax background that may be able to help you structure
a tax-deductible retirement savings if you can generate some self-employment
income prior to year-end.
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