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How Tax Deductions Work

Many people know that the interest paid on a mortgage is deductible on their income taxes. But they don't understand how it really works.

tax deduction

Many people know that the interest paid on a mortgage is deductible on their income taxes. But they don't understand how it really works.

When you understand the way a tax deduction works, you should be able to estimate the amount of tax relief you would receive from owning your own home and paying a mortgage.

First, you need to know what is deductible. In many cases, homeowners are allowed to deduct the amount of mortgage interest paid from their income. They are also able to deduct the amount of real estate property taxes paid on the property.

For example, we have a homeowner and a renter who both make the same annual income of $60,000.

The renter pays $1,000 a month in rent and receives no tax benefits for renting a home.

The homeowner holds a $140,000 fixed rate mortgage with a 7% interest rate. His total mortgage payment is $1,100 a month. He pays $1,500 in real estate property taxes. His total mortgage interest paid for this tax year was $9,755.

Here's where the taxes make a difference. The owner is able to deduct $11,255 from his income before he calculates his tax liability. The renter has no deduction from his income and is taxed on $11,255 more than the owner.

Let's keep it simple and assume that both are in a 25% tax bracket. The renter will owe the IRS $15,000 in taxes on his income of $60,000. The owner's taxable income has been reduced to $48,745 after his deductions. He only owes $12,186 in income taxes. The owner saves $2,814 in taxes each year. That's a savings of $234 each month.

Basically, the homeowner's after-tax monthly payment is actually $866. The renter is still paying $1,000. The homeowner gets to keep his house in the end.

There are many variables that can affect the amount of mortgage interest you pay in any given year. But, you could often say that you can take 20% off of your mortgage payment to get a rough idea of the tax benefits of owning.

Ask your lender. A good loan officer should be able to give you a reasonable estimate of your mortgage interest and tax payments over a given period of time. Many lenders will give you a schedule when you close on your home.

When it comes to determining your tax bracket and deductions, ask your CPA or tax attorney for advice. Your loan officer can't really help you with tax details.

The bottom line is that owning your own home has many financial advantages. If you are tired of spending your paycheck on rent, but getting nowher, home ownership may prove to be a more affordable solution for you.

 

Vehicle Tax Deductions: Overview

Automotive trends are beginning to change. Gas guzzling SUVs are making way for smarter hybrid vehicles. Also called "clean fuel vehicles", these cars and trucks operate on either an electric motor, or a fuel engine and an electric motor. They are wise choices for anyone concerned with preserving our earth's precious resources, and the government is awarding these smart consumers with special tax deductions.

If you have purchased a vehicle that runs on both fuel and ele...

Automotive trends are beginning to change. Gas guzzling SUVs are making way for smarter hybrid vehicles. Also called "clean fuel vehicles", these cars and trucks operate on either an electric motor, or a fuel engine and an electric motor. They are wise choices for anyone concerned with preserving our earth's precious resources, and the government is awarding these smart consumers with special tax deductions.

If you have purchased a vehicle that runs on both fuel and electricity, you can claim a one-time deduction of up to $2,000. Owners of vehicles that operate on electricity only can claim up to $4,000.

For yours to qualify as clean fuel vehicle, it must run on natural gas, LNG, LPG, Hydrogen or any other fuel that is 85% alcohol or less. You should be cautioned that even though gasoline/electric hybrids use an electric motor, they are not eligible for electric vehicle tax credits.

If your vehicle operates on more than one type of fuel, the cost incurred in converting the car into a proper clean-fuel user may earn you a deduction, subject to the stated limits.

There are other additional requirements to consider. To get a tax credit on your car, you must buy it first-hand and drive it primarily within the USA. The vehicle should have four wheels and is not to be used for commercial purposes. If any of these conditions change within three years of purchasing the vehicle, some of the money you received as tax deduction will have to be reimbursed.

Vehicle donations can also earn healthy tax credits. You may have seen advertisements by charity organizations offering tax breaks for vehicle donations. Technically, this is a valid offer, but there are several things that you need to consider. You cannot state the value of the car you are donating to be a penny more than its current market price. In effect, the deduction will be based upon the same amount that a buyer would pay in the fair market.

The amount of the tax deduction will depend not only on the value of the car, but also how the charitable organization uses it. The organization you donate the vehicle to must also be recognized by tax agencies. As unusual as the situation might be, you will have no idea as to the amount of tax break your donation will fetch you.

If the charity you gave your vehicle to sold it off at a lower price than your stated value, you will receive a tax deduction on the lower amount. On the other hand, if the charity sells your car after using it over a period of time, you need not worry. In this case, the deduction will be based on the value of your car at the time of your donation.

If you're thinking about donating a car to charity, or purchasing a clean fuel vehicle, you will benefit in two ways. You will feel better knowing that you've helped a greater cause, and the government will reward you for making a smart choice.

Charitable Tax Deductions

People who give to charity do so freely, without a tinge of "what's in it for me". But even the most earnest philanthropists will agree that a tax break can make the good feeling you get from giving, even better.

When you donate to your favorite charity, make sure to let the tax agency know. Charitable tax deductions are readily and legitimately available to you. Your contributions to charitable organizations can add up to a sizeable deduction when you itemize them on IRS Form 1040, Schedule A.

Before you make any donations, be sure to carry out a few checks. Remember that only donations made to organizations that are recognized by tax agencies are eligible for tax deduction. Refer to the IRS Publication 78 for a complete list of all recognized charitable organizations. Check your public library or search online to view this list.

Tax benefits are not available on donations made to individuals, political leaders or political organizations. Further, you cannot claim a tax break for time spent raising money for organizations by holding raffles, bingo or any other games of chance.

Tax deductions are available on contributions made in the form of goods, services or merchandise. This deduction must be claimed on the fair market value of these goods or services. For example, you may choose to donate by gifting stocks of your company. In this case, the value of the donated stocks will be calculated as the average of highest and lowest traded prices on the date of valuation.

You may also receive a tax break by donating a vehicle. The amount of the deduction will be based on the vehicle's resale value at the time of donation. This is also true of planes and boats donated to charity. However, if the claimed value of the donated boat, plane or motor vehicle exceeds $500, and the item is sold by the charitable organization, the tax break is limited to the gross proceeds from the sale.

If you are donating a household or personal item, a deduction can be claimed on the amount that the item would have fetched at a garage sale or at a flea shop. To qualify for a tax deduction, a proper receipt is required for all charitable contributions over $250.

Only contributions made during the tax year will qualify for a deduction. If you have used a credit card or issued a check, it does not matter what date the transaction shows on your account. You can claim the deduction only in the tax year that you made the donation.

Even if you don't expect to get anything in return for your goodwill, go ahead and keep a list of your charitable donations. The tax department will appreciate and reward your generosity.

 

Valuable Tax Deductions for your Vehicle You Can't Afford to Miss

Is your business missing out on valuable tax deductions you can take for the use of your personal vehicle for business purposes? Even if you work at home most of the time, miles you've driven to purchase office supplies, buy stamps or mail packages, and other errands for your business can translate into big tax deductions. With fuel costs soaring, you are literally throwing money down the drain if you are not keeping track of this mileage and taking the deductions for it to which you're entitled as a business owner.

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Is your business missing out on valuable tax deductions you can take for the use of your personal vehicle for business purposes?If you haven't done so already, you should definitely beat a path to the door of your local office supply store and pick up a notebook for logging the mileage you drive to conduct business—and be sure to log the miles you drove to buy it!

Not taking the trouble to do this is like letting your pricey gasoline flow onto the pavement instead of into your tank.

Even if you work at home most of the time, miles you've driven to purchase office supplies, buy stamps or mail packages, and other errands for your business can translate into big tax deductions. With fuel costs soaring, you are literally throwing money down the drain if you are not keeping track of this mileage and taking the deductions for it to which you're entitled as a business owner. And the first entry you need to make is the beginning mileage on the odometer as of January. You'll also want to make sure that you keep track of all your automobile expenses associated with that personal vehicle that you're using for business.(See why in my article "Valuable Tax Deductions for your Vehicle You Can't Afford to Miss").

The dramatic surge in fuel costs has not been lost on the IRS. Of course, gasoline prices began to edge up shortly after the beginning of the war in Iraq; but the devastation wrought by Hurricane Katrina prompted the IRS to offer a valuable money-saving solution for business owners. (If you live outside the U.S.A. you should check your tax authority's website for similar provisions.)

Last year,for 2005, the IRS increased the standard mileage rate for the use of a vehicle (car, van, or truck) by 3 cents a mile, to 40.5 cents a mile for all business miles driven. However, in the wake of Katrina, that rate was increased further to 48.5 cents a mile for the business miles driven in the months of September, October, November, and December, 2005.

This increased mileage rate ended with the end of 2005. The new mileage rate for 2006, effective January 1, is now 44.5 cents per business mile driven. You can maximize this deduction if you're careful to consolidate business and personal errands. For example, I wait until I need to go to the post office to ship a package for my business to stop to at the drug store and supermarket right next door to pick up groceries. What would have been "dead" mileage becomes a deductible business trip, as long as you've logged your business purpose in your mileage logbook.

In addition, for both 2005 and 2006, the IRS also encouraged Katrina-related charitable relief activities by granting higher rates for miles deductible and miles reimbursable driven for such activities.

Of course, the use of these mileage allowances can be rather complicated. For example, you cannot take additional deductions for business use of an automobile to which you have already applied the Modified Accelerated Cost Recovery System (MACRS), after claiming a Section 179 deduction for that vehicle that your business purchased directly.

And if you're using a personal vehicle for your business, don't forget to calculate the percentage of total miles for the year that you travel for business purposes. At the end of 2006, you'll note the year-end odometer reading in your mileage logbook and subtract from it the odometer reading that you recorded this month. Then you'll add up all miles driven for your business that you have recorded and divide it by that total mileage to calculate the percentage of total miles you used for your business. If it turns out that 30% of your total mileage on that personal vehicle was for business purposes, you can deduct 30% of *all* your expenses for maintaining that vehicle: not only fuel, but all trips to the garage for routine maintenance or special repairs as part of your business expenses for the year.

The devil is in the details, as always, of course. You will want to consult your tax accountant on how best to apply the rules to your situation. If you prepare your tax returns yourself, you can get the details directly from the IRS website:
http://www.irs.gov/pub/irs-drop/rp-04-64.pdf. Examine the fine print closely: You'll find that there are limits on what percentage of business use can be claimed for a personal vehicle, no matter what your actual numbers might be; so if your actual business mileage is greater than 75 per cent of your total mileage, you might be better off purchasing a separate vehicle dedicated to business use. If you've taken the care to structure your business correctly--using a corporation, limited liability company, or other stand alone entity--you and your business will benefit from even greater deductions.

(C) Copyright 2006 Azur Pacific Associates. All formats and media, known and unknown. All Rights Reserved.

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