Your home, your kids, your car — all can be costly, but they also can generate significant tax benefits.
Tax laws include reams of breaks designed to help people send their kids to college, purchase a home, buy health insurance and make many other ordinary tasks a little more affordable.
How big a tax benefit you get depends on your particular situation and the combination of credits and deductions that might apply. A deduction lowers the amount of your income subject to tax. Often a credit is the better benefit because it reduces the tax liability directly.
“Not every provision applies to every taxpayer under every circumstance,” said Jackie Perlman, a senior tax research coordinator for H&R Block.
Many of the benefits start to add up for homeowners, who find their mortgage interest deduction takes a big bite out of their tax bill.
“If you’re a homeowner, then you are more likely to be better off itemizing,” said Bob Scharin, editor of RIA’s Practical Tax Strategies journal for tax professionals.
Itemizing deductions lets homeowners take advantage of several tax incentives not available to those who use the standard deduction. They include deductions for real estate taxes, state and local income taxes, charitable donations and medical expenses, to name a few.
Immediate tax benefits for home expenses stop at the mortgage interest deduction, but they can be a benefit down the road.
Major improvements, like new windows or a remodeled kitchen, can be subtracted from any increase in your home’s value, potentially lowering taxes owed when it comes time to sell and move.
Tax laws give homeowners a generous exclusion — $250,000 for individuals or $500,000 for married couples — before capital gains taxes are levied on a home’s increased value as long as the sellers have lived there for two of the previous five years.
“Five hundred thousand dollars may sound like a really big number, but there are areas of the country where the market value of homes just went through the roof,” Perlman said, urging taxpayers to keep track of their improvements. “It’s very important.”
Whether or not you’re a homeowner, you might qualify for some of the many education tax breaks for college and other costs. It could take some studying to discover which combination works best, especially for families with more than one student hitting the books.
A Lifetime Learning Credit covers 20 percent of the first $10,000 in tuition paid. The Hope Credit pays for the first $1,000 spent and half of the second $1,000 spent — a total of $1,500 — for freshman and sophomore students.
Families who earn too much to qualify for those tax breaks can use an education deduction, increased this year to $4,000.
Take a close look at rules that spell out whether the credits and deductions can be used together, particularly in combination with education savings accounts. Run through several scenarios, or use tax software or consult a tax professional if you need help.
Money spent for child care can also be offset with a tax credit, or a savings plan offered by some employers. Your children’s mere existence can mean you qualify for a $1,000 tax credit in most circumstances, with a portion refundable to lower income families.
If you’re in the market for a new car or truck, tax incentives can help buyers who choose hybrid, clean-burning vehicles. A new sales tax deduction, in effect for 2004 and 2005, might make that new car more affordable for some taxpayers.
You won’t get a huge deduction for donating your old car to charity, though. New rules limit the deduction to $500 or the amount a charitable organization makes by selling the car to raise money. That rule went into effect this year.