Medical Expenses
You can take a deduction for medical expenses for you, your spouse, and your dependents. Medical expenses include amounts paid for the diagnosis, cure, mitigation, treatment, or prevention of disease. Examples include expenses for: regular checkups, dental expenses (including braces), health insurance paid with after tax dollars, prescription medication, cosmetic surgery (but only if it is done to correct a congenital defect or correct a deforming disease). If you spend money on property improvements to help a disabled or sick household member, the deductible amount is the cost of the improvement over the increase in market value of the house. For example, if you spend $20K to install an elevator, but it only adds $8K to the market of the home, the $12K excess is the deduction. Some improvements are fully deductible such as railways and ramps, modifying doorways, etc.
Now, deducting medical expenses can be difficult because you can only deduct the medical expenses in excess of 7.5% of your adjusted gross income (that’s the bottom line on the first page of your tax return). So, to use easy numbers, if you make $100K, only expenses in excess of $7.5K are deductible. Basically, medical expenses are a hardship deduction because they have to be very high compared to your income.
Taxes
You can deduct either state income taxes (that’s the MI withholding you see on your check stubs) or state sales tax. The sales tax deduction is for states that have no income tax. The sales tax deduction can be based on the actual sales tax you paid during the year, or based on a percentage of your income. Even if you use the percentage of income method to deduct sales taxes, sales taxes for large purchases (such as cars) can be added on top of the estimate.
You can deduct real estate taxes in the year you pay them. So if you pay your winter real estate taxes by December 31, you can take a current deduction for the taxes. One note here. If there is a special assessment on your property tax bill, that cannot be deducted. It is added to the cost of your home, and will reduce your gain (if any) when you sell the home. This isn’t very helpful because you can exclude up to $500K of gain when you sell your home as long as you’ve lived in and owned the home for more than 2 years.
There is a new deduction for sales taxes paid on vehicles with a cost up to $49,500. In the past few years, you could always take a sales tax deduction for vehicle purchases, but now you can claim state income taxes as a deduction, and take an additional deduction for sales taxes on new vehicles. This only applies to NEW vehicles. If you don’t itemize, the sales tax deduction is added to your standard deduction.
Other taxes include personal property taxes. These are the property taxes you pay on your cars, boats, motor cycles, and any other personal property. Other taxes also include any foreign tax you pay (for example if you worked in another country, or you have foreign investments).
Interest
There are two types of deductible mortgage interest. Acquisition mortgage interest, which is interest used to purchase or substantially improve a home. An example of a substantial improvements is adding an extension. You can deduct acquisition interest on a mortgage of up to $1M. The second type of mortgage interest is home equity interest. Home equity interest is for mortgages that are secured by your home, but the interest is still deductible regardless of how the money is spent. You can deduct home equity interest on mortgages up to $100K; however, if the sum of home acquisition debt and home equity debt exceed the market value of your home, a portion of the home equity interest will not be deductible.
Example: Jimmy buys a $200,000 home with a $200,000 home acquisition mortgage (with interest only payments). Five years later when Jimmy’s home is worth $220,000, Jimmy takes out a home equity loan of $30,000. Since the sum of the acquisition debt and home equity debt exceed the market value of the home by $10,000, interest on the $10,000 excess is not deductible (i.e., only 2/3 of the interest on the home equity loan is deductible).
Points are basically prepaid interest. If you pay points on the purchase of a new home, they are fully deductible in the year of purchase. If you pay points on a refinance or home equity loan, the points are deducted over the term of the new loan.
Charity
I want to focus on recordkeeping—there have been some changes in the past few years. If you make a cash donation under $250, you need either a bank acknowledgement or a receipt from the charity. So if you make weekly donations at church, you can no longer take a deduction unless you get a receipt from the church or you write a check each week. For cash contributions over $250, you MUST have a receipt from the charity before you file your return (or when it is due whichever is earlier). There was a court case where a couple actually donated several thousands of dollars to a church but did not get a receipt. Their deduction was challenged. They later got a church receipt and presented it to the tax court, but it was ignored because they did not have the receipt at the time they filed their return. So it is very important to have a receipt for cash donations over $250.
Fine Print: This posting contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.