As we get into the heart of tax preparation season, we thought it would be useful if we highlight some of the tax return mistakes that we have seen at Logbook Financial Planning, LLC when working with Foreign Service employees, federal government employees and military members. Our goal is for you to avoid these common errors on your own return this year. Please note, this article is not tax advice but a guide to facilitate a discussion between you and your Certified Public Accountant (CPA) or Enrolled Agent (EA) about your own tax situation.
Do not forget to claim depreciation when you put your primary residence into service as a rental property or if you own rental real estate. Depreciation is a non-cash charge that is claimed over the life of an asset. For rental property in the United States, claim depreciation over 27.5 years. For rental property outside the U.S., claim depreciation over 40 years. When you sell the property, the IRS will recapture the depreciation at 25%, whether or not you took the depreciation–so don’t forget this every year on your tax return. If you have forgotten to claim depreciation in the past, hire a tax preparer to complete the Application for Change in Accounting Method form 3115.
For DC rental property owners, if your gross receipts are over $12,000, you must file a D-30 every year. The D-30 is the form for unincorporated business franchise taxes. The minimum fee is $250 per year for gross receipts under $1M and 8.25% of your profits. In the District you also need a business license. Penalties and interest will apply so don’t forget these requirements.
Normally, in order to claim the capital gains exclusion on your primary residence when you sell, you must have owned and lived in the property for two of the last five years. However, Foreign Service, military, Peace Corps, and intelligence personnel are allowed to extend the normal time limit for 10 additional years. Many tax preparers are unfamiliar with this exception so ask your tax preparer to dig into the details outlined in IRS Publication 523.
Finally, we suggest you keep excellent records for all of your real estate. To minimize taxes when you sell, keep track of all of your capital improvements with receipts to support your claim to the IRS. Get in the habit of tracking your adjusted basis right after you close on your home and each year thereafter.
Contributions to a Roth IRA are limited by your modified adjusted gross income (MAGI). In 2018, the phaseout limit for singles begins at $120,000 and for married couples at $189,000. Your adjusted gross income (AGI) includes capital gains, interest and your spouse’s earnings if married. To calculate your MAGI you need to add back the foreign earned income exclusion, student loan interest deduction, IRA deduction and other items outlined in IRS Publication 590-A. Remember the limit is not based on your W-2 income. If you think you will be close to the income phaseout limit and do not have a traditional IRA already, it would be easier to go ahead and do a “backdoor” Roth IRA to avoid having to recharacterize your contribution at the end of the year.
Coverdell Education Savings Accounts (ESA)
Just like the Roth IRA above, ESA’s have strict income contribution limits. If you have funded these accounts in previous years in which your income was too high, you will need to pay a 6% excess contribution penalty. Let your tax preparer know if you made or have made ESA contributions in the past year.
We have seen two errors recently. Make sure your tax preparer is claiming a state income tax deduction for your 529 contribution if your state offers one. Over 30 states, including the District of Columbia, Virginia and Maryland offer tax deductions. Also, if your child earns a college scholarship and you have overfunded the 529 account, brush up the rules on how to withdrawal the money without paying a 10% penalty.
Required Minimum Distributions (RMDs)
If you inherit a beneficiary IRA, you are required to take RMDs that are calculated based on your status as a spouse or non-spouse. There is a 50% penalty if you do not take a required distribution each year. Check with your beneficiary IRA custodian (Fidelity, Vanguard, TD Ameritrade, etc.) or your tax preparer to make sure you have calculated the RMD correctly. This is easy to overlook in your busy life so set up a calendar reminder.
We hope highlighting these common pitfalls will help you with your own tax return this year. Take a good look at this year and your past three years of returns to catch any errors that need amending. We wish you the best of luck with your tax return!
As a former Foreign Service Officer and Air Force pilot, I’m passionate about continuing to serve those in government and the military. Our services and publications are designed for individuals and families in these communities. Follow me – Chris Cortese - on LinkedIn so you can continue to benefit from our expertise.
Financial Planner & Founder
Logbook Financial Planning, LLC
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