Itemized Deductions: are you actually deducting anything?

By guest blogger and friend: Timothy Buys, CPA – Crowe Horwath LLP

After reading Dirk’s blog post below about the poor investment decision of buying a home, you may be thinking to yourself, “Dirk! You didn’t mention anything about the HUGE tax breaks for homeowners! You left out one of the most financially responsible aspects of buying a home. I save all my receipts, turn them into my tax accountant and Uncle Sam gives me thousands of dollars in return!”

Wrong.

The truth is you are likely not saving anything. It may be quite the opposite. You are spending thousands and thousands of dollars on a poor investment!

As a CPA and former tax accountant, I hear about these ‘huge’ tax savings all the time. I hear it from the media, clients, friends, co-workers, the news and believe it or not, real estate salesmen. I find that most people are completely oblivious to their own tax returns, the tax code and especially, itemized deductions.

Let’s start off with some simple facts. When filing your taxes, you have the option between a standard deduction and itemizing your deductions. A standard deduction allows you to take a simple deduction of a predetermined amount from your adjusted gross income (AGI). On the other hand, itemizing your deductions allows you to deduct several amounts from purchases you actually made during the year – these purchases typically consist of mortgage interest, mortgage taxes, fees paid to tax preparers, medical expenses, etc.

You have the choice of one or the other.

For a 20-something, married couple in 2010, the standard deduction was $11,400. This means that to even BEGIN to benefit from the itemized deductions you would have to spend more than $11,400.

With that in mind, let’s run some numbers.

In 2010, let’s pretend Joe (plumber) and Mary (teacher) bought a house for $150,000 and have $70,000 adjusted gross income (AGI). They spent $2,000 in real estate taxes, $5,000 in mortgage interest, $300 to the CPA for preparing last year’s return, $5,000 on a car, $2,000 in medical expenses (they are some sick 20-somethings!), $2,000 in mileage to work and gave $2,000 to Encounter Church! Now let’s add up those HUGE tax deductions:
$2,000 real estate taxes
+ $5,000 mortgage interest
+ $300 CPA
+ $2,000 Encounter Church
+ $0 Car is not eligible
+ $0 Mileage to work is not a deduction
+ $0 Medical expenses are not eligible because they do not exceed 7.5% of AGI (limitation)
= $9,300 TOTAL ITEMIZED DEDUCTIONS

Remember taking the standard deduction without spending a dime during the year = $11,400.

You have the choice of one or the other.

So, Joe and Mary’s “savings” by itemizing their deductions = $0!!!! (Written out that says ‘zero dollars’)

“Wait!! But we spent thousands and thousands on this house!”.................................yep.

Even if Joe and Mary’s itemized deductions actually exceeded the standard deduction by $500, they would still only “save” $100-200 assuming they are in the 25% Federal tax bracket. For every dollar they spend above and beyond the standard deduction, they receive roughly 25 cents.

While this example may be simplified and may not take other factors into consideration, the key points are simple: 1. don’t assume you are deducting anything on your tax return – crunch the numbers for yourself, ask your tax accountant for an explanation. 2. The tax code is complex and stacked against you (in others words, Uncle Sam is #WINNING) – research www.IRS.gov to ensure you are in compliance with the law and understanding all the limitations and exceptions. 3. buying a house is wise if you call it a home not an investment. And 4. You could take those ‘thousands and thousands of dollars’ and invest them in a 401k, 403b, Roth IRA, rental property (good blog topic), etc.