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Picking specific deductions to avoid the AMT

George SaenzDear Tax Talk,
My wife and I pay significant state (Ohio) income tax and local real estate tax (around $30,000 total in 2004), which we do not benefit from anymore because when we itemize on Schedule A they are added back to our income when figuring the AMT tax (Ugh!).

Would I be better off keeping track of sales tax in 2005 and using that as our deduction instead of income and property tax? My TurboTax calculation for 2004 automatically defaulted to the higher tax deduction. Any advice? Thanks. -- Michael

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Dear Michael,
Not only do you have to deal with regular income tax, but some folks such as yourselves have to deal with an alternate tax system known as the alternative minimum tax (AMT). The AMT is designed to take away some of the deductions you get for regular tax and force you to pay at least an alternative minimum amount of tax.

AMT is computed on Form 6251. Your starting point on this form is your adjusted gross income less your itemized deductions. Then the form goes on to add back your itemized deductions for all taxes and miscellaneous itemized deductions such as employee business expenses. Since you claim a large deduction for taxes, the AMT becomes greater than your regular tax so that you have to pay AMT.

Since all taxes are added back for AMT, it would not make a difference whether you claim state income taxes or sales taxes. The property taxes are deducted for regular tax, in addition to the larger of the sales tax or income tax, but also form part of the add back for AMT.

The only good advice I can offer besides moving from Ohio is to look at your property tax deduction. (You can read more about Ohio taxes in Bankrate's state tax roundup.) If you pay property taxes on investment properties then the law allows you to capitalize these taxes to the cost of the property instead of claiming the deduction. By capitalizing the taxes you add the taxes to the cost of the property which later reduces your taxes when you sell. Since the property taxes do not reduce your overall tax liability, you don't lose currently by deferring the deduction until you sell the property.

In order to capitalize property taxes you need to attach the following statement to your return:

"Taxpayer elects pursuant to IRS Sec. 266 and Regs. Sec. 1.226-1(c)(3) to capitalize the following items which would otherwise be deductible with respect the taxpayer's 2004 taxable year:"

Followed by an itemization of the taxes to which the election applies.

 
-- Posted: Feb. 22, 2005
     

More filers are paying the parallel alternative tax

 

 

Tax Talk: Skipping deductions to avoid the AMT

 

Some local taxes can reduce your IRS bill

 

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