Tracking Home Improvements

Posted On August 6, 2017 By Scott Stratton, CFP(R), CFA In Financial Planning /

When you eventually sell your home, it may be helpful to have a record of your home improvement expenses. Because people often own their homes for decades, this is an area where a lot of records and receipts are lost. Here is what you need to know about tracking home improvements.

Primary Residence Exclusion

At the time of a home sale, the difference between your purchase price and your sale price is a taxable capital gain. Luckily for most people, there is a significant capital gains exclusion from the IRS: $250,000 (single) or $500,000 (married), for your primary residence. If your gain falls below this amount, you will not owe any taxes. In order to qualify, the property must have been your primary residence for at least two of the previous five years, and you must not have taken this exclusion for another property for two years.

If you make a capital improvement (described below), that expense increases your cost basis in the home. But because of the large exclusion ($250,000 or $500,000), many people don’t even bother to keep track of their home improvement expenses. That may be a mistake. Here are a number of scenarios which could be a problem:

If you get divorced or your spouse passes away, your exclusion will decrease from $500,000 to $250,000.
Should you move and make another property your primary residence for four years, you will lose the tax exclusion on the previous property.
If you own your property for the next 30 years, it is possible your capital gain ends up being higher than the $250/$500k limits. These amounts are not indexed for inflation.
Congress could reduce this tax break, although it would be very unpopular to do so. They are not likely to change the definition of cost basis and capital gains.

Capital Improvements

What constitutes a Capital Improvement which would increase your cost basis? In general, the improvement must be permanent (lasting more than one year), attached to the property (not removable or decorative), and add to the value, use, or function of the property. Maintenance and repairs are generally not capital improvements unless they prolong your home’s useful life. The IRS provides the following specific examples of expenses that are Capital Improvements:

Additions, such as a new bathroom, bedroom, deck, garage, porch, or patio.
Permanent outdoor improvements, including paved driveways, fences, retaining walls, landscaping, or a swimming pool.
Exterior features, such as new windows, doors, siding, or a roof.
Insulation for your attic, walls, floors, or plumbing.
Home systems, including heat/central air, wiring, sprinkler, or alarm systems.
Plumbing upgrades such as septic systems, hot water heaters, filtration systems, etc.
Interior improvements, including built-in appliances, flooring, carpet, kitchen remodeling, or a new fireplace.

While there are many expenses which count as improvements, repairs and upkeep do not. Painting, replacing broken fixtures, patching a roof, or fixing plumbing leaks are not improvements. Also, if you install something and later remove it, that expense may not be counted. For example, if you install new carpet and then later replace the carpet with wood floors, you cannot include the carpet expense in your cost basis.

Gain or Loss?

For full information on calculating your gain or loss on a home, see IRS Publication 523. While most homeowners are focused on mitigating taxable gains, I should add that if your capital improvements are significant enough to make your home sale into a loss, that loss would be a valuable tax benefit as it could offset other income. Here’s an example:

Purchase Price: $240,000
Capital Improvements: $37,400
Cost Basis: $277,400

Sale Price: $279,000
Minus 6% Realtor Commission: -$16,740
Closing Costs: -$1,250
Net Proceeds: $261,010

LOSS = $16,390

If you just looked at your purchase price and sales price, you might think that you would have a small gain (under the exclusion amount), and there was no need to keep track of your improvements. However, in this example, you don’t have any gain at all.

Unlike other receipts, which you only need to keep for seven years, you do need to keep records of your capital improvements for as long as you own the home, and then seven years after you file your tax return after the sale. Even if you think you are going to be under the $500,000 tax exclusion, I’d highly recommend you keep track of these capital improvements which increase your cost basis.

Will Trump Lower Your Taxes?

Posted On November 27, 2016 By Scott Stratton, CFP(R), CFA In Tax Strategies /

Since the surprise victory of Donald Trump, the markets have rallied and the dollar has strengthened. This is in expectation of increased infrastructure spending, looser regulation of finance, healthcare, and other industries, and lower tax rates. What does this mean for your personal tax situation?

You can read Trump’s tax platform on his website here. He proposes to simplify individual taxes from seven brackets today to three: 12%, 25%, and 33%. For higher income taxpayers, this would be a reduction from 35% and 39.6%. He also proposes to eliminate the 3.8% Medicare Surtax on Investment Income (for taxpayers above $200,000 single and $250,000, married). And he wants to lower the corporate income tax rate from 35% to 15% to prevent companies from leaving the US and to encourage US corporations to repatriate profits from overseas subsidiaries.

Before we consider what planning strategies this suggests, I’d like to make two points.

1) What candidates propose during the campaign and what they can actually achieve are often very different. There’s no guarantee these plans will become law. In Trump’s favor, however, he has a Republican controlled House and Senate which should work with him. Under budget reconciliation rules, the Senate can pass tax changes with a simple majority, and need not have 60 votes.

2) Under Trump’s economic plan, the deficit will soar and the national debt will grow at an unprecedented rate. Not only is he kicking the can down the road by not addressing the deficit, he will massively increase our debt load. Eventually, the cost of our debt service will crowd out other spending and has the potential to become a significant problem for our children and grandchildren.

For individual taxpayers, Trump wants to increase the standard deduction to $15,000 single and $30,000 joint, but to cap itemized deductions to $100,000 single and $200,000 joint. While he would reduce taxes for many taxpayers, the largest savings will go to those in the top tax brackets who would pay 33% on income over $225,000 (joint), under the Trump plan.

If you are in the top tax bracket and believe that Trump’s plan will become a reality in 2017, you would see your marginal rate decrease from 43.4% (39.6% plus 3.8% Medicare) to 33% next year. In that scenario, you would want to defer receipt of income, as possible, from 2016 to 2017. And you would want to accelerate any tax deductions, business expenses, and short-term capital loss harvesting to take those reductions in 2016. For example, in December, you could pay your property taxes, make charitable gifts planned for 2017, and make purchases of office supplies or other business goods which can be expensed and not capitalized.

If you own a business, under Trump’s plan, it may become appealing to convert to a C-Corporation to take advantage of the 15% corporate tax rate, instead of remaining a sole proprietor or other pass-through tax structure. While a dollar of income would be taxed at the corporate level and again when passed through to the owner, the owner of a C-corporation has the opportunity to take a modest salary and receive the rest of the profits as a dividend, which would be taxed at 15-20%, and not require any payroll tax.

For current owners of a C-Corporation, you would want to reduce your 2016 income as much as possible if you anticipate a 20% tax reduction in 2017. This means deferring income until January (which involves different strategies depending whether you use the cash or accrual accounting method), and maximizing your 2016 deductions.

Last December, Congress made the Section 179 deduction permanent. As a business owner, you should know about Section 179, which allows you to immediately deduct qualifying business equipment purchases, rather than capitalizing the costs over the life of the equipment and taking an annual depreciation amount. The limit on Section 179 is $500,000 per year, and is phased out for businesses who have purchased more than $2 million in qualifying property.

Qualifying property eligible for the Section 179 deduction includes equipment/machines, computers, software, furniture, and business vehicles over 6,000 pounds GVWR (Gross Vehicle Weight Rating). The vehicle deduction is very popular with business owners, and may be applied for new or used vehicles. Please note that vehicles under 6,000 pounds GVWR do not qualify, and that for certain vehicles, the deduction may be capped to $25,000.

If you are expecting your corporate tax rate to fall in 2017, I’d look to maximize your Section 179 purchases in 2016 and make those purchases before the year’s end.

I’d prefer you keep your hard-earned money rather than give it to the government to spend, and I will suggest every legal opportunity to reduce the amount my clients pay to the IRS. Having said that, it seems unfair to ask future generations to pay for our profligate spending. Hopefully, our politicians will eventually think further out than just winning the next election, but I’m not going to hold my breath for that one.

Trump’s economic plan also means that inflation should start to pick up. We’ve already seen interest rates move up since the election, perhaps more than they should have, in expectation of Trump’s spending plans. Mortgage rates have started to rise, and I believe that real estate price increases will slow. Property reflation may be in the 8th or 9th inning in many parts of the country. Affordability is an issue in many cities, and higher mortgage rates will not support home prices continuing to increase by 5-7% or more per year.

No one knows what will unfold over the next four years under Trump but if tax rates decline, we will certainly welcome the savings. We will continue to look for ways to reduce taxes from your investment portfolio and be as tax efficient as possible.

How to Invest if Income Taxes Increase

Posted On September 26, 2016 By Scott Stratton, CFP(R), CFA In Portfolio Management /

Is there really any doubt that income taxes will be going up at some point in the future? Deficits are growing ($590 Billion for 2016 alone) and there is no interest in Washington in reducing expenditures. Given the magnitude of Federal spending, even if a balanced budget were possible, the reduction in cash flow would crush the economy and send unemployment through the roof. We’re addicted to our spending.

Politicians have realized that even the faintest hint of “raising taxes” would be career suicide. This means that increasing marginal tax rates (except on those making over $250,000) is impossible. But raising tax revenue by “closing loopholes for the rich” is considered a heroic undertaking. There are a lot of proposals out there right now to increase tax revenue, and you don’t have to be Bill Gates or Warren Buffet to be impacted.

Many of these “loopholes for the rich” benefit middle class professionals. Chances are that if you are reading this, you’re going to be paying higher taxes in the years ahead. Even if your marginal tax bracket remains the same, your effective tax rate – the total amount of taxes you pay – could rise with these proposals:

Eliminate the Stretch IRA for beneficiaries who inherit an IRA.
Close the Roth conversion process which allows the “back-door Roth IRA”.
Create Required Minimum Distributions for Roth IRAs.
Cut the estate tax exemption from $5.45 million to $3.5 million and increase the rate from 40% to a range of 45% to 65%.
Eliminate the step-up in cost basis on inherited assets.
Add a 4% surtax on income over $5 million.
Cap itemized deductions to 28% of your income.
Create a capital gains schedule that requires an asset be held for 6 years to qualify for the lowest long-term capital gains rate of 20%. Increase capital gains taxes on assets held less than 6 years.
Increase the Social Security payroll tax from 12.4% to 15.2%.
Increase the payroll tax ceiling from $118,500 (2016) to $250,000. Or eliminate the cap altogether.
Apply the payroll tax to passive income, so business owners are taxed the same on distributions and dividends as they would be on salary.
A proposal in July from Ohio congressman James Renacci would lower the corporate income tax and add a consumption tax, or European-style VAT.
Limit the mortgage interest deduction, which disproportionately benefits wealthier home owners because it requires itemized deductions. One proposal is to replace the deduction with a smaller tax credit.
Place a cap on tax-deferred accounts. For example a 62-year old with $3.2 million in tax-deferred accounts would be ineligible to make further contributions. Other proposals suggest caps as low as $500,000.

Although this is an election year, I do not view this as a political issue. Whoever is elected to the Presidency and to Congress will have to deal with reducing deficits. While some candidates propose to cut taxes, this would dramatically increase the debt, which already stands at $19 Trillion. When interest rates eventually rise, a significant portion of our annual tax revenue could be needed solely for paying interest on our debt. So, I view tax cuts as not only unrealistic, but dangerously inflating a problem our children will ultimately have to bear.

If effective tax rates are going higher, what can you do to keep more of your investment return?

1) Tax efficiency will be more valuable. Using low-turnover ETFs, asset location, and tax loss harvesting can lower your tax liability. Reduce tax drag and keep gross income under $250,000, if possible. See: 6 Steps to Save on Investment Taxes.
2) Tax-free may be more preferable than tax-deferred. If you think your tax rate in retirement will be the same or higher than today, there is less benefit to investing in a Traditional 401(k) or IRA. Preference goes to the Roth 401(k) or Roth IRA. See: To Roth or Not to Roth.
3) Tax-free municipal bonds will be even more attractive when compared to taxable bonds.
4) Rather than allowing capital gains to accumulate for years and become an enormous tax bill in the future, it may be wise to harvest gains in years when you are in a lower tax bracket, up to the threshold of your current tax rate.
5) Don’t negate reduced tax rates for qualified dividends and long-term capital gains by placing those investments into an IRA or Annuity where the distributions will be taxed as ordinary income.

Do You Receive Mutual Fund Capital Gains Distributions?

Posted On August 8, 2016 By Scott Stratton, CFP(R), CFA In Portfolio Management /

I always ask prospective clients to bring a copy of their most recent tax return and often learn a wealth of information reviewing their taxes. In doing such a review last week, I noticed that in the previous year, a prospective client had to pay taxes on $13,875 in taxable capital gains distributions from their mutual funds.

If your mutual fund is inside of a 401(k) or IRA, capital gains distributions don’t matter. However, when a mutual fund is held in a taxable account, you end up paying taxes on capital gains distributions even though you didn’t sell the position. Instead, you are paying taxes for trading the fund manager does inside the portfolio, or worse, to provide liquidity to other shareholders, who sold before December and left you holding the bag to pay for their capital gains.

Luckily, there is a better way. In my previous position working with high net worth families, the majority of assets were held in taxable portfolios. We had a number of families with $10 million to over $100 million in investments with our firm. Needless to day, I spent considerable time in looking at ways to reduce taxes, and became very effective at the process of Portfolio Tax Optimization. I offer this same approach and benefits to my clients today.

Vanguard studied the value advisors bring through planning skills like tax optimixation. They estimate that “Advisor’s Alpha” can add as much as 3% a year to your net returns.
Link: Quantifying Vanguard Advisor’s Alpha

If you have significant assets in taxable accounts, I can help you. Here are five ways we can lower your taxes and allow you to keep more of your hard earned principal:

1) Use ETFs. The prospective client with $13,875 in capital gains distributions, had approximately $600,000 in mutual funds. I created a spreadsheet that calculated capital gains if they had been invested $600,000 in my 60/40 portfolio instead. Most of my holdings are Exchange Traded Funds (ETFs), which due to their unique structure, are much more tax efficient than mutual funds. In fact, my nine ETF holdings had total distributions of zero in the same year .

In the 60/40 model, we also had five mutual funds in categories where there are not equivalent ETFs. My calculation of capital gains distributions: $2,167. So, if we had been investing for this client, their capital gains distributions could have been reduced from approximately $14,000 to $2,000. The investment vehicles we choose matter!

I should note that this is just looking at capital gains distributions. Both ETFs and mutual funds also pay interest and dividends, which are taxable. There is more to managing taxes than just picking ETFs.

2) Asset Location. We could have further reduced taxes by choosing where to place each holding. Some funds generate interest, which is taxed as ordinary income, where as other funds generate qualified dividends, which is taxed at a lower rate of 15-20%. We place the funds with the greatest tax liability into your IRA or other qualified account, to reduce your overall tax burden. Funds that have little or no distributions are ideal for taxable accounts.

3) Avoid short-term capital gains. If you sell an investment within a year, those short-term gains are taxed as ordinary income, your highest tax rate. After 12 months, sales are treated as long-term capital gains, at a lower rate of 15-20%. We do not sell or rebalance funds before one year to avoid short-term gains. Unfortunately, many mutual fund managers don’t have any such tax mandate, so oftentimes, a significant portion of fund’s capital gains distributions are short-term.

4) Tax Loss Harvesting. At the end of each year, we review taxable portfolios for positions which have declined. We harvest those losses and immediately replace each position with a different fund in the same category (large cap, international, etc.). This fund swap allows us to use those losses to offset other gains or income, while maintaining our target asset allocation. If realized losses exceed gains, you can use $3,000 of losses to reduce ordinary income. Remaining losses are carried forward to future years.

5) Municipal Bonds. For investors in a higher tax bracket, your after-tax return may be better on tax-free municipal bonds than on taxable bond funds. However, an advisor will not know this without looking at your tax return and determining your tax bracket. That’s why we make planning our first priority, before making any investment recommendations. (Would you really trust anyone making investment recommendations without knowing your full situation? Are those recommendations designed to profit them or you?)

We take a disciplined approach to managing portfolios to minimize taxes, and it is a valuable benefit to be able to customize our approach for each individual client.

On this same client’s tax return, I realized that they did not deduct their Investment Management fees, a $6,000 miscellaneous deduction.
Link: Are Investment Advisory Fees Tax Deductible?

If you have taxable investments, we may be able to save you thousands, too. Let’s schedule a call today. You deserve a more sophisticated and efficient approach to managing your wealth.

Is Your Car Eligible for a $7,500 Tax Credit?

Posted On July 18, 2016 By Scott Stratton, CFP(R), CFA In Financial Planning /

If you are in the market for a new vehicle, you may want to know about a tax credit available for the purchase an electric or plug-in hybrid vehicle. Worth up to $7,500, the credit is not a tax deduction from your income, but a dollar for dollar reduction in your federal income tax liability. In other words, if your tax bill was $19,000 and you have a $7,500 credit, you will pay only $11,500 and get the rest back.

This credit has been available since 2010, but in the last two years a significant number of new car models have become eligible for the tax credit. If you drive a lot of miles, these cars may be worth a look.

The credit includes 100% electric vehicles like the Tesla Model S or the Nissan Leaf, and it applies to the newer plug-in hybrid models, including the BMW i3, Chevrolet Volt, Ford C-Max Energi, Hyundai Sonata Plug-In Hybrid, and others. The credit does not apply to all hybrid vehicles, only those with plug-in technology. While the plug-in cars may be more expensive than regular hybrids, they are often less expensive once you factor in the tax credit.

The amount of the credit varies depending on the battery in the car, and may be less than $7,500. The credit is phased out for each manufacturer after they hit 200,000 eligible vehicles sold, with the credit falling to 50% and then to 25%. So, for those 400,000 people who put down a deposit on the Tesla Model 3, most will not be getting the full $7,500 tax credit. Only purchases of new vehicles – not used – are eligible for the credit.

The program is under Internal Revenue Code 30D; you can find full information on the IRS website here. An easier-to-read primer on the program is available at www.fueleconomy.gov.

Some states also offer tax credits or vouchers for the purchase of a plug-in hybrid or electric vehicle. Unfortunately, Texas is not one of those states! You can search for your state’s programs on the US Department of Energy website, the Alternative Fuels Data Center.

Do you have a plug-in hybrid or electric vehicle? Send me a note and tell me how you like it.

The Saver’s Tax Credit

Posted On May 30, 2016 By Admin In Retirement Planning, Uncategorized / 1 Comment

Since most employers today no longer provide defined benefit pension plans for their employees, the burden of retirement saving has shifted to the employee. Not surprisingly, saving for retirement is a pretty low priority for the many Americans who are focused on how they are going to pay this month’s bills.

Avoiding Capital Gains in Real Estate

Posted On May 16, 2016 By Admin In Uncategorized /

I’ve gotten a number of questions about Capital Gains and Real Estate recently, so I thought it was time for a post. While many home sellers do not have to pay any tax on the sale of their home, for others, capital gains taxes can be significant, even hundreds of thousands of dollars. Here are five ways to reduce capital gains when you sell real estate.

Are Investment Advisory Fees Tax Deductible?

Posted On April 25, 2016 By Admin In Financial Planning / 1 Comment

It surprises me how few questions I receive about the tax deductibility of Investment Advisory fees. I hope that your CPA asks this question as they prepare your tax return, but I fear that some people miss this potential tax deduction. As with many tax rules, this one has quite a number of caveats. Here are three things you need to know:

1. First, we need to distinguish between Investment Advisory Fees (also called Investment Management Fees), Financial Planning Fees, and Commissions. Only Investment Advisory Fees are tax deductible. If you are a client, note that the fees charged by Good Life Wealth Management are Investment Advisory Fees.

Five Ways To Invest Tax-Free

Posted On February 29, 2016 By Admin In Financial Planning /

“It doesn’t matter how much you make, but how much you keep.” Over time, taxes can be a significant drag on returns, especially for those who are in the higher tax brackets. Today, many families are also hit with the 3.8% Medicare surtax on investment income. If you are in the top tax bracket, you could be paying as much as 43.4% (39.6% plus the 3.8% Medicare surtax) for interest income or short-term capital gains.

Qualified Charitable Distributions (QCDs) From Your IRA – Updated for 2026

Posted On February 8, 2016 By Scott Stratton, CFP(R), CFA In Retirement Planning / 5 Comments

A Qualified Charitable Distribution (QCD) allows individuals age 70 ½ and older to transfer money directly from their traditional IRA (or eligible inherited IRA) to a qualified charity and exclude that amount from taxable income. This can reduce your reported income while supporting your preferred charities — without needing to itemize deductions.

How QCDs Work (2026 Rules)

Who qualifies?
To make a QCD in 2026, you must be at least 70 ½ years old on the day of the transfer. The age requirement remains tied to 70½ even though the age for Required Minimum Distributions (RMDs) has increased (73 under SECURE 2.0 and later to 75).

Where can the funds come from?
QCDs must come directly from a Traditional IRA or a qualifying Inherited IRA. Employer plans such as 401(k)s, 403(b)s, and 457 plans are not eligible unless first rolled to an IRA.

How much can you give?
For 2026, the maximum annual QCD limit is $111,000 per individual, indexed for inflation (up from the prior $100,000 cap). A married couple can each make a QCD from their own IRA up to the annual limit.

Does a QCD count toward my RMD?
Yes — if you are already required to take an RMD, a QCD can be used to satisfy all or part of that year’s RMD requirement without increasing taxable income. However, QCDs made before RMD age do not count toward future RMDs.

Where must the money go?
The distribution must go directly from your IRA to a qualified public charity — not to a donor-advised fund, private foundation, or supporting organization — to qualify for the tax treatment.

Why QCDs Matter for Retirees

QCDs are particularly useful if you want to:

Lower Adjusted Gross Income (AGI) without itemizing, which can help with thresholds for Medicare premiums, Social Security taxation, and certain credits;
Satisfy RMDs tax-efficiently once you’re subject to them;
Support a charity directly from pre-tax funds in a tax-efficient way.

For a deeper look at how distributions fit into a retirement income plan, see our Retirement Income Planning Hub.

How QCDs Interact With Other Retirement Rules

RMD age vs. QCD age
Even though the RMD age has risen to 73 (and will later increase to 75), the minimum age for QCDs remains 70 ½. That means you can make QCDs before you are required to take RMDs, though they only count toward RMDs once you are subject to them.

Standard deduction and tax planning
Because QCDs exclude income rather than providing an itemized deduction, they can be especially helpful for retirees who take the standard deduction but still want to reduce taxable income.

Charitable vehicles that don’t qualify
Gifts to donor-advised funds, private foundations, or supporting organizations generally do not qualify as QCDs, even if they are IRS-recognizable charities.

Frequently Asked Questions (Retiree-Focused)

Q: Can I make a QCD from a Roth IRA?
Technically, yes, but QCDs from Roth IRAs are uncommon because Roth IRA distributions are generally already tax-free. Most QCD planning focuses on traditional IRAs or inherited IRAs.

Q: If I make a QCD that is larger than my RMD for the year, does it count toward future RMDs?
No. A QCD larger than your RMD only applies to the current year’s RMD requirement. Future RMDs must be met separately.

Q: When is the deadline to make a QCD?
A QCD must be completed by December 31 of the tax year for it to count in that year. There are no extensions beyond year-end.

Q: Are QCDs deductible on Schedule A?
No. QCDs are excluded from income rather than taken as an itemized deduction, which means they reduce taxable income without needing to itemize.

Q: Can my spouse and I both make QCDs?
Yes — if both spouses are at least 70 ½, each can make a QCD up to the annual limit from their respective IRA.