RETIREMENT TAX SUGGESTIONS

The tax laws contain many loopholes designed to help people live more comfortably in retirement.

Effective for sales after May 6, 1997, the 1997 Taxpayer Relief Act provides a new universal exclusion on home sale profits. Under this provision, exclusion for gain of up to $250,000 is available to individuals other than married couples filing a joint return. If a joint return is filed for the year of the sale, the exclusion applies to as much as $500,000 of gain.

To qualify for a full exclusion (up to the applicable dollar limit) a taxpayer must have owned and used the property sold or exchanged as his or her principal residence for periods of two years or more during the five-year period ending on the date of the sale or exchange. For a married couple filing a joint return, either spouse must meet the ownership requirement, or both spouses must meet the use requirement, with respect to the property, in order to qualify for the full $500,000 exclusion.

The exclusion generally may not be used if, during the two-year period ending on the date the home is sold or exchanged, there was any other sale or exchange for which the exclusion was used. However, taxpayers who claimed the exclusion within the previous two years or fail to meet the ownership and use requirements, may be eligible for a partial exclusion if the sale is due to a change in employment, health or unforeseen circumstances.

Think twice before selling appreciated assets, such as securities, to provide cash gifts for children and grandchildren. It may be better to give the assets directly to the kids and let them sell them. A gift of the property will save tax (and create a bigger gift) if the recipient is in a lower tax bracket than the giver. The recipient will pay less tax on the gain than he/she would at a high tax bracket.

The strategy changes if the recipient intends to retain the property. In this case, it’s better to give cash now and let the intended recipient inherit the appreciated property.

Reason: The recipient will inherit the property at its value at the date of your death. He or she won’t have to pay capital gains tax on the property’s increase in value.

A way to get Uncle Sam to subsidize the cost of supporting an elderly parent is for the children to buy a parent’s retirement condominium and rent it to the parent. At the very least, the children will get tax deductions for mortgage interest and property taxes. Plus, there may be appreciation.

These deductions produce a greater tax benefit to high-income children than they would to a low-bracket retired parent. If the children charge the parent fair market rent, they will also be able to take depreciation deductions on the condo. Tax rules allow deduction up to $25,000 of losses if adjusted gross income is less than $100,000. This loss allowance is phased out between $100,000 and $150,000 of adjusted gross income.

Before the government will pay a person’s nursing home bills, they are required to use up the money in their name. Strategy:

Put money into a trust that pays income but which doesn’t allow the donor or beneficiary to touch the principal. Only the income would be lost to nursing home care - not the principal. Caution:

In most states, a trust set up within two years of a person’s entering a nursing home won’t be effective, so it is essential to get competent legal advice and take action well in advance.

A married couple both ages 65 or over will pay more tax on a joint return than the combined tax they would pay if they were single. Another consideration: if income (including tax-exempt income) plus one-half Social Security benefits exceeds certain levels, half the Social Security benefits are also taxable. The levels are $25,000 for a single person, or $32,000 for a married couple. While this level will be indexed slightly, notice that the couple amount is not twice the single amount.

Combining incomes on a joint return may force taxation of Social Security benefits that would completely escape taxation if the couple did not marry.

Retirees must start taking money out of a traditional IRA by April 1 following the year in which they reach age 70 ½, unless still employed. However, it is possible to slow the distribution down (take less in early retirement years) by using actuarial tables. There is no minimum distribution on the Roth IRA.

All retirees should give a power of attorney over a bank account and other assets to a relative or other trusted person. If a person becomes incapacitated, that money will be available for medical and personal care.

Many elderly people fail to plan for the possibility that it may be wise to arrange for automatic deposit of checks and the automatic payment of bills. Securities dividends and interest may be automatically credited to a brokerage account if the securities are in that name. Social Security and many pension checks may be automatically deposited to an account. Utility bills can be drafted automatically against an account as well. This will reduce the amount of paper and money handling.

 

Consider setting up a trust that can take out life insurance to pay the estate taxes that will eventually go to the government. Premiums for people in their early sixties are lower than one might think. This can be a low cost way of paying estate taxes - in effect, at a discount. Some retirees use such life insurance liquidity for estate settlement and commence gifting non-income producing properties to their heirs - reducing taxes.

 

TECHNIQUES FOR RETIRED PARENTS AND THEIR CHILDREN

It is legal to deduct all losses on houses rented to relatives, provided the rents are reasonable by market standards. This opens up profitable retirement tax benefits. Parents could sell their old house and if one or both are over 55, pay no tax on any profit up to $125,000. They could even rent out their old house, take the deductions that the property generates and use the income for their retirement.

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