Capitalize on your deductions to minimize your tax bill
Finding appropriate items to deduct each year can be challenging but rewarding if you know where to look. Our tax law has many hidden gems just waiting to be discovered. While many deductions are geared to taxpayers of moderate-income levels, even higher-income earners can find deductions that will save them a pretty penny. Here are some key deductions Hawaii taxpayers may be eligible for:
You may deduct expenses used to generate taxable investment income. Expenses related to tax-exempt income, however, are not deductible. If you have investments at the same investment firm generating both tax-exempt income and taxable income, and the firm's statement reflects one fee amount, the fee must be allocated. Investment expenses include investment firm expenses, research costs and security for your investments, such as a safe deposit box. These expenses are considered miscellaneous itemized deductions, deductible only to the extent that they exceed 2 percent of your adjusted gross income (AGI).
Investment interest expense is deductible only to the extent of net investment income. For this calculation, the investment interest expense is compared to all net investment income on your tax return, not just the income specifically traceable to the interest expense. But remember that long-term capital gains (from the sale of investment property held for more than one year) and qualified dividends that are taxed at the preferential 15 percent rate are not considered investment income for purposes of deducting investment interest expense.
You can elect to treat some of your qualified dividends and capital gains as investment income in order to deduct investment expenses. You should weigh this benefit against losing capital gains treatment.
Unused investment interest expense can be carried forward indefinitely and may be usable in later years. It may be beneficial to carry the unused investment interest until after 2010, when the preferential 15 percent rate on long-term capital gains and certain dividends is scheduled to end. When tax rates are higher, deductions save you more money. But keep in mind the time value of money when you compare the possibilities.
You also can deduct interest on up to a combined total of $1 million of mortgage debt incurred to purchase, build or improve your principal residence and a second residence. A "residence" can include a motor home, boat or airplane as long as it is self-contained, such as having a kitchen, a toilet and sleeping spaces. If you have more than two homes, you can choose the home to treat as your second residence.
You can deduct related points in addition to interest if the loan is for purchasing or improving your principal residence. Refinancing points must be amortized over the loan's term. Interest is deductible on home-equity loans up to $100,000 in addition to the $1 million.
One thing to keep in mind is that while mortgage interest is deductible for alternative minimum tax (AMT) purposes, home-equity loan interest is not and can subject you to AMT in certain circumstances.
By planning now, you can make the most of your potential deductions and significantly reduce your tax bill. Contact your tax adviser to ensure you take advantage of the tax-planning opportunities available to you.
Nicole Borgman is a senior tax manager for Grant Thornton LLP. She can be reached at Nicole.Borgman@gt.com