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529 College Savings Plans

A brief history

529 plans were created by Congress in 1996 and have been modified through the years by various pieces of legislation. Known officially as “qualified tuition programs” or QTPs, 529 plans are so named because they are governed by section 529 of the Internal Revenue Code.

Put your savings effort on autopilot

Consider linking your 529 savings plan to your bank account so you can easily make automatic monthly contributions.

 

529 College Savings Plans

529 savings plans are tax-advantaged education savings vehicles and one of the most popular ways to save for college today. They can also be used to save for K-12 tuition. Much like the way 401(k) plans changed the world of retirement savings a few decades ago, 529 savings plans have changed the world of education savings.

Tax advantages and more

529 savings plans offer a unique combination of features that no other education savings vehicle can match:

  • Federal tax advantages: Contributions to a 529 account accumulate tax deferred and earnings are tax free if the money is used to pay the beneficiary’s qualified education expenses. (The earnings portion of any withdrawal not used for qualified education expenses is taxed at the recipient’s rate and subject to a 10% penalty.)
  • State tax advantages: States are free to offer their own tax benefits to state residents, such as a tax deduction for contributions.
  • High contribution limits: Most plans have lifetime contribution limits of $350,000 and up (limits vary by state).
  • Unlimited participation: Anyone can open a 529 savings plan account, regardless of income level.
  • Wide use of funds: Money in a 529 savings plan can be used to pay the full cost (tuition, fees, room and board, books) at any college or graduate school in the United States or abroad that is accredited by the Department of Education, and for K-12 tuition expenses up to $10,000 per year.
  • Professional money management: 529 savings plans are offered by states, but they are managed by designated financial companies who are responsible for managing the plan’s underlying investment portfolios.
  • Flexibility: Under federal rules, you are entitled to change the beneficiary of your account to a qualified family member at any time as well as roll over (transfer) the money in your account to a different 529 plan once per calendar year without income tax or penalty implications.
  • Accelerated gifting: 529 savings plans offer an estate planning advantage in the form of accelerated gifting. This can be a favorable way for grandparents to contribute to their grandchildren’s education while paring down their own estate, or a way for parents to contribute a large lump sum. Under special rules unique to 529 plans, a lump-sum gift of up to five times the annual gift tax exclusion amount ($15,000 in 2019) is allowed in a single year, which means that individuals can make a lump-sum gift of up to $75,000 and married couples can gift up to $150,000. No gift tax will be owed, provided the gift is treated as having been made in equal installments over a five-year period and no other gifts are made to that beneficiary during the five years.
  • Transfer to ABLE account: 529 account owners can roll over (transfer) funds from a 529 account to an ABLE account without federal tax consequences. An ABLE account is a tax-advantaged account that can be used to save for disability-related expenses for individuals who become blind or disabled before age 26.

Choosing a 529 savings plan

Although 529 savings plans are a creature of federal law, their implementation is left to the states. Currently, there are over 50 different savings plans available because many states offer more than one plan.

You can join any state’s 529 savings plan, but this variety may create confusion when it comes time to select a plan. Each plan has its own rules and restrictions, which can change at any time. To make the process easier, it helps to consider a few key features:

  • Your state’s tax benefits: A majority of states offer some type of income tax break for 529 savings plan participants, such as a deduction for contributions or tax-free earnings on qualified withdrawals. However, some states limit their tax deduction to contributions made to the in-state 529 plan only. So make sure to understand your state’s rules.
  • Investment options: 529 savings plans vary in the investment options they offer. Ideally, you’ll want to find a plan with a wide variety of investment options that range from conservative to more growth-oriented to match your risk tolerance. To take the guesswork out of picking investments appropriate for your child’s age, most plans offer aged-based portfolios that automatically adjust to more conservative holdings as your child approaches college age. (Remember, though, that any investment involves risk, and past performance is no guarantee of how an investment will perform in the future. The investments you choose may lose money or not perform well enough to cover college costs as anticipated.)
  • Fees and expenses: Fees and expenses can vary widely among plans, and high fees can take a bigger bite out of your savings. Typical fees include annual maintenance fees, administration and management fees (usually called the “expense ratio”), and underlying fund expenses.
  • Reputation of financial institution: Make sure that the financial institution managing the plan is reputable and that you can reach customer service with any questions.
  • User experience: Is the plan’s website easy to use? Can you easily take care of routine tasks online, such as set up automatic monthly contributions, change your contribution amount, research plan investments, find your rate of return, or request a withdrawal?

With so many plans available, it may be helpful to consult an experienced financial professional who can help you select a plan and pick your plan investments. In fact, some 529 savings plans are advisor-sold only, meaning that you’re required to go through a designated financial advisor to open an account.

Account mechanics

Once you’ve selected a plan, opening an account is easy. You’ll need to fill out an application, where you’ll name a beneficiary and select one or more of the plan’s investment portfolios to which your contributions will be allocated. Also, you’ll typically be required to make an initial minimum contribution, which must be made in cash or a cash alternative.

Thereafter, most plans will allow you to contribute as often as you like. This gives you the flexibility to tailor the frequency of your contributions to your own needs and budget, as well as to systematically invest your contributions by setting up automatic monthly transfers from your bank account.

As for investment changes, beware that under federal law you are allowed to exchange your existing plan investments for new investments only twice per year. In other words, if your existing plan funds are currently invested in plan portfolios A & B but you want to change them to plan portfolios C & D, you can do this only twice per calendar year. However, you generally have unlimited say in how your future contributions will be invested.

You will also be able to change the beneficiary of your 529 savings account to a qualified family member with no income tax or penalty implications.

529 prepaid tuition plans — a distant cousin

There are actually two types of 529 plans — savings plans and prepaid tuition plans. The tax advantages of each are the same, but the account features are very different. A prepaid tuition plan lets you prepay tuition at participating colleges, typically in-state public colleges, at today’s prices for use by the beneficiary in the future. 529 prepaid tuition plans are generally limited to state residents, whereas 529 savings plans are open to residents of any state. Prepaid tuition plans are much less common than savings plans.

Note:  Investors should consider the investment objectives, risks, charges, and expenses associated with 529 plans before investing; specific plan information is available in each issuer’s official statement. There is the risk that investments may not perform well enough to cover college costs as anticipated. Also, before investing, consider whether your state offers any favorable state tax benefits for 529 plan participation, and whether these benefits are contingent on joining the in-state 529 plan. Other state benefits may include financial aid, scholarship funds, and protection from creditors.

Ballast Advisors – Woodbury Area
683 Bielenberg Dr., Suite 208
Woodbury, MN  55125-1705
Tel: 651.478.4644
Ballast Advisors – Arden Hills Area
3820 Cleveland Ave. N, Ste. 500
Arden Hills, MN  55112-3298
Tel: 651.200.3100
Ballast Advisors – Punta Gorda & Port Charlotte County Area
6210 Scott St., Suite 117
Punta Gorda, FL  33950-3901
Tel: 941.621.4015 

If you’re interested in receiving additional financial advice on saving for college or an analysis of your financial plan, contact Ballast Advisors for a complimentary consultation at a location near you:

 


IMPORTANT DISCLOSURES Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice. This communication is strictly intended for individuals residing in the state(s) of AZ, CA, CO, FL, GA, ID, IL, IN, IA, LA, MN, ND, OH, PA, TX, VA, WA and WI. No offers may be made or accepted from any resident outside the specific states referenced.
 

 

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2019.

Why Do I Need a Financial Planner?

Why do I need a Financial Planner? Financial planning is about more than just managing money. It’s about setting goals for your future and taking steps to achieve those goals. A trusted advisor can help set you on the right path and ensure you stay the course.

 

We know your life is about more than the size of your bank account. It’s about the journey. If you’re interested in receiving additional financial advice, contact Ballast Advisors for a complimentary consultation at a location near you:

Ballast Advisors – Woodbury Area
683 Bielenberg Dr., Suite 208
Woodbury, MN  55125-1705
Tel: 651.478.4644
Ballast Advisors – Arden Hills Area
3820 Cleveland Ave. N, Ste. 500
Arden Hills, MN  55112-3298
Tel: 651.200.3100
Ballast Advisors – Punta Gorda & Port Charlotte County Area
6210 Scott St., Suite 117
Punta Gorda, FL  33950-3901
Tel: 941.621.4015 

Ballast Blog: Your Home as a Source of Dollars in Retirement

 Your Home as a Source of Dollars in Retirement

If you own a home, you may be wealthier then you think. The equity in your home could be one of your largest assets, especially if your mortgage has been paid down over the years or paid off. This home equity can be a valuable source of extra income during your retirement years.

 

How do you tap your home equity?

There are two ways to tap your home equity if you’re approaching retirement (or already retired) and don’t want to make mortgage payments: You can trade down, or you can use a reverse mortgage. Trading down involves selling your present home and replacing it with a smaller, less expensive home. A reverse mortgage is a home mortgage in which the lender makes monthly payments to you, rather than you making monthly payments to the lender. Both of these strategies can give you substantial additional income during retirement.

Note: You could get money from your home by taking a home equity loan, where you place a regular mortgage on your home. But you must repay the home equity loan, with interest, like other regular home mortgages.

Trading down can give you increased income

If your home is larger than you need, trading down to a smaller place may be a good way to increase your retirement income. The difference between the price that you receive for your present home and the cost of a smaller new home can be added to your retirement funds to provide you with additional investment income. The amount of cash that you can get by trading down depends on the value of your present home, the cost of purchasing a new home, and the incidental costs involved in the trade (e.g., brokerage commissions, legal fees, closing costs, and moving expenses). You should estimate these amounts to get some idea of the net amount that you will receive. To check the present value of your home, you should get an estimate of its selling price from two or three real estate agents. You should also get an estimate of the cost of your replacement home by shopping around for the type of home that you think you’ll want.

Note: If you think that the tax consequences of trading down are a drawback, think again. You may be able to exclude from federal taxation up to $250,000 ($500,000 if you’re married and file a joint return) of any resulting capital gain, regardless of your age. To qualify for this exclusion, you generally must have owned and used the home as your principal residence for a total of two out of the five years before the sale. An individual, or either spouse in a married couple, can generally use this exemption only once every two years. However, even if you don’t meet these tests, a partial exemption may be available. (For sales and exchanges made after December 31, 2008, this homesale exclusion won’t apply to the extent the gain is allocated to periods (not including any period before January 1, 2009) during which the property was not used as your, or your spouse’s, principal residence.)

Trading down can reduce your housing costs

The other important financial benefit of trading down is that it reduces housing costs–often substantially. A smaller home usually means lower real estate taxes and smaller bills for heating, cooling, insurance, and maintenance costs. If your move is from a single-family house to a condominium, your costs will be reduced even more because outside painting, roof repair, landscaping, and similar costs disappear into lower monthly condo fees. You should carefully estimate the amount of the cost savings that you’ll get from trading down. Compare the annual cost of maintaining your present home with the expected annual cost of maintaining your new home. Be sure to prorate expenses that do not occur regularly, such as indoor and outdoor painting and roof repairs.

But trading down may have disadvantages

Consider the possible drawbacks of trading down. For instance, you may not want to reduce your living space by moving to a smaller home. Or, you may not be able to find a smaller home as attractive as your present home. Another common problem with trading down occurs if you are strongly attached to your present home. You may not want to be uprooted from your home and the social network around it. Still, you may also be troubled by worries that afflict many older homeowners, such as rising property taxes, the threat of escalating insurance, and the unexpected cost of major repairs. You may decide that trading down is warranted to lighten these worries as well as your financial burden.

Note: If you sell your home at a gain and aren’t eligible for the capital gain homesale exclusion, you’ll have to pay federal income taxes on the difference between the selling price and your adjusted basis (the initial cost of your home, plus amounts you’ve paid for capital improvements, less any depreciation and casualty losses claimed for tax purposes) in the home.

A reverse mortgage can also give you increased income

If you are older and have substantial equity in your home, a reverse mortgage can give you a valuable supplemental source of retirement income. You can receive this income based on the equity that you have built up over the years in your home–without having to repay the reverse mortgage during your life. The amount of the monthly payment you receive from a reverse mortgage depends on four factors:

  • Your age
  • The amount of equity in your home
  • The interest rate charged by the lender
  • Closing costs

The older you are and the more the equity in your home, the larger your monthly payments will be. Also, a lower interest rate and lower closing costs will increase your payments.

A reverse mortgage lets you keep your present home for life

As discussed, you may not want to trade down for a variety of reasons, including attachment to your present home. With a reverse mortgage, you can increase your income and continue to live in your present home for life. The mortgage typically becomes due when you no longer live in the home.

When reverse mortgage payments last as long as you live in your home, the mortgage is known as a tenure reverse mortgage. You can get other types of reverse mortgages, including an annuity advance reverse mortgage. With the annuity mortgage, payments last as long as you live, regardless of whether you continue to live in your home.

But a reverse mortgage is not without drawbacks

With a reverse mortgage, you must mortgage your home to the lender. Each payment that you receive from the lender increases the amount of principal and interest that you owe on the mortgage. Although the mortgage typically does not become due while you’re still living in the home, the equity value of your home is reduced by each payment that you receive. This reduction in the equity value of your home may have a negative effect on your children’s ultimate inheritance.

Note: If you face a retirement income shortage, this equity reduction may be preferable to a reduction in your standard of living. Also, in the rare case where the value of your home appreciates more rapidly than the mortgage loan increases, equity reduction does not occur.

A reverse mortgage may have other drawbacks, including:

  • High up-front costs: The closing costs for a reverse mortgage normally exceed the closing costs for a conventional mortgage. This means that a reverse mortgage may not be cost effective if you plan to remain in your home for only a few years.
  • No reduction in homeowner costs: Unlike trading down to a home with lower housing expenses, a reverse mortgage does not reduce your housing costs. Since you stay in your home, you still face real estate taxes, insurance, repairs, and other costs associated with the home.I

If you’re interested in receiving additional financial advice for your retirement, contact Ballast Advisors for a complimentary consultation at a location near you:

Ballast Advisors – Woodbury Area
683 Bielenberg Dr., Suite 208
Woodbury, MN  55125-1705
Tel: 651.478.4644
Ballast Advisors – Arden Hills Area
3820 Cleveland Ave. N, Ste. 500
Arden Hills, MN  55112-3298
Tel: 651.200.3100
Ballast Advisors – Punta Gorda & Port Charlotte County Area
6210 Scott St., Suite 117
Punta Gorda, FL  33950-3901
Tel: 941.621.4015 
Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2018.
IMPORTANT DISCLOSURES Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice. This communication is strictly intended for individuals residing in the state(s) of AZ, CA, CO, FL, GA, ID, IL, IN, IA, LA, MN, ND, OH, PA, TX, VA, WA and WI. No offers may be made or accepted from any resident outside the specific states referenced.

Ballast Blog: Housing Options for Older Individuals

Housing Options for Older Individuals 

As you grow older, your housing needs may change. Maybe you’ll get tired of doing yard work. You might want to retire in sunny Florida or live close to your grandchildren in Illinois. Perhaps you’ll need to live in a nursing home or an assisted-living facility. Or, after considering your options, you may even decide to stay where you are. When the time comes to evaluate your housing situation, you’ll have numerous options available to you.

 

There’s no place like home

Are you able to take care of your home by yourself? If your answer is no, that doesn’t necessarily mean it’s time to move. Maybe a family member can help you with chores and shopping. Or perhaps you can hire someone to clean your house, mow your lawn, and help you with personal care. You may want to stay in your home because you have memories of raising your family there. On the other hand, change may be just what you need to get a new perspective on life. To evaluate whether you can continue living in your home or if it’s time for you to move, consider the following questions:

  • How willing are you to let someone else help you?
  • Can you afford to hire help, or will you need to rely on friends, relatives, or volunteers?
  • How far do you live from family and/or friends?
  • How close do you live to public transportation?
  • How easily can you renovate your home to address your physical needs?
  • How easily do you adjust to change?
  • How easily do you make friends?
  • How does your family feel about you moving or about you staying in your own home?
  • How does your spouse feel about moving?

Hey kids, Mom and Dad are moving in!

If you are moving in with your child, will you have adequate privacy? Will you be able to move around in your child’s home easily? If not, you might ask him or her to install devices that will make your life easier, such as tub or shower grab bars and easy-to-open handles on doors.

You’ll also want to consider the emotional consequences of moving in with your child. If you move closer to your child, will you expect him or her to take you shopping or to include you in every social event? Will you feel in the way? Will your child expect you to help with cooking, cleaning, and baby-sitting? Or, will he or she expect you to do little or nothing? How will other members of the family feel? Get these questions out in the open before you consider moving in.

Talk about important financial issues with your child before you agree to move in. This may help avoid conflicts or hurt feelings later. Here are some suggestions to get the conversation flowing:

  • Will he or she expect you to contribute money toward household expenses?
  • Will you feel guilty if you don’t contribute money toward household expenses?
  • Will you feel the need to critique his or her spending habits, or are you afraid that he or she will critique yours?
  • Can your child afford to remodel his or her home to fit your needs?
  • Do you have enough money to support yourself during retirement?
  • How do you feel about your child supporting you financially?

Assisted-living options

Assisted-living facilities typically offer rental rooms or apartments, housekeeping services, meals, social activities, and transportation. The primary focus of an assisted-living facility is social, not medical, but some facilities do provide limited medical care. Assisted-living facilities can be state-licensed or unlicensed, and they primarily serve senior citizens who need more help than those who live in independent living communities.

Before entering an assisted-living facility, you should carefully read the contract and tour the facility. Some facilities are large, caring for over a thousand people. Others are small, caring for fewer than five people. Consider whether the facility meets your needs:

  • Do you have enough privacy?
  • How much personal care is provided?
  • What happens if you get sick?
  • Can you be asked to leave the facility if your physical or mental health deteriorates?
  • Is the facility licensed or unlicensed?
  • Who is in charge of health and safety?

Reading the fine print on the contract may save you a lot of time and money later if any conflict over services or care arises. If you find the terms of the contract confusing, ask a family member for help or consult an attorney. Check the financial strength of the company, especially if you’re making a long-term commitment.

As for the cost, a wide range of care is available at a wide range of prices. For example, continuing care retirement communities are significantly more expensive than other assisted-living options and usually require an entrance fee above $50,000, in addition to a monthly rental fee. Keep in mind that Medicare probably will not cover your expenses at these facilities, unless those expenses are health-care related and the facility is licensed to provide medical care.

Nursing homes

Nursing homes are licensed facilities that offer 24-hour access to medical care. They provide care at three levels: skilled nursing care, intermediate care, and custodial care. Individuals in nursing homes generally cannot live by themselves or without a great deal of assistance.

It is important to note that privacy in a nursing home may be very limited. Although private rooms may be available, rooms more commonly are shared. Depending on the facility selected, a nursing home may be similar to a hospital environment or may have a more residential feel. Some on-site services may include:

  • Physical therapy
  • Occupational therapy
  • Orthopedic rehabilitation
  • Speech therapy
  • Dialysis treatment
  • Respiratory therapy

When you choose a nursing home, pay close attention to the quality of the facility. Visit several facilities in your area, and talk to your family about your needs and wishes regarding nursing home care. In addition, remember that most people don’t remain in a nursing home indefinitely. If your physical or mental condition improves, you may be able to return home or move to a different type of facility. Contact your state department of elder services for guidelines on how to evaluate nursing homes.

Nursing homes are expensive. If you need nursing home care in the future, do you know how you will pay for it? Will you use private savings, or will you rely on Medicaid to pay for your care? If you have time to plan, consider purchasing long-term care insurance to pay for your nursing home care.

If you’re interested in receiving additional financial advice for your retirement or an analysis of your insurance protection, contact Ballast Advisors for a complimentary consultation at a location near you:

Ballast Advisors – Woodbury Area
683 Bielenberg Dr., Suite 208
Woodbury, MN  55125-1705
Tel: 651.478.4644
Ballast Advisors – Arden Hills Area
3820 Cleveland Ave. N, Ste. 500
Arden Hills, MN  55112-3298
Tel: 651.200.3100
Ballast Advisors – Punta Gorda & Port Charlotte County Area
6210 Scott St., Suite 117
Punta Gorda, FL  33950-3901
Tel: 941.621.4015 
Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2018.
IMPORTANT DISCLOSURES Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual’s personal circumstances. 

Ballast Blog: Qualifying for the Home Office Deduction

Qualifying for the Home Office Deduction 

Working from home can certainly provide you with personal benefits, such as a flexible schedule and more family time. But increasing numbers of people are discovering the tax advantages as well. It’s no secret that you generally can’t deduct certain personal expenses (e.g., homeowners insurance, utilities, and home repairs) on your federal income tax return. But if you’re using part of your home as a home office, you may be able to write off part of these expenses. To qualify for the home office deduction, you must first understand the IRS requirements.

The home office deduction is really a group of deductions

First of all, what is a home office? A home office is a room in your home, a portion of a room in your home, or a separate building next to your home (such as a converted garage or barn) that you use exclusively and regularly to conduct business activities.

This definition is important, because you may be able to deduct part of your housing expenses (such as rent, utilities, and insurance) on your federal income tax return if you have a home office. This deduction (or group of deductions) is known as a home office deduction. To take the deduction, you’ll need to file Form 8829 with the IRS. To even consider the home office deduction, though, your at-home business activities must involve a trade or business — a hobby won’t do.

Now let’s consider the IRS requirements. To qualify for a home office deduction, you must meet two threshold tests — the place of business test, and the regular and exclusive use test.

The place of business test is somewhat flexible

To pass this test, you must show that you use part of your home as:

  • The principal place of business for your trade or business, or
  • A place where you regularly meet with clients, customers, or patients

In some cases, you can also meet the principal place of business requirement if you conduct substantial administrative and management tasks for your outside business at home and have no other fixed location where you conduct these activities. These tasks might include billing customers, keeping books and records, ordering supplies, setting up appointments, or writing reports. For example, assume you’re a doctor at a local HMO who’s been given examination space but no office space. You use a room in your home regularly and exclusively to correspond with insurance companies, bill patients, and read medical journals. You have no other fixed location for conducting these types of activities. In such a case, your space would likely pass the place of business test for a home office deduction.

What if your home office is in a separate structure next to your home, like a shed or garage? In that case, it needn’t be your principal place of business. However, you must use that office regularly and exclusively in connection with your trade or business. Be sure you use this structure only for business purposes — you can’t store your car there.

You must also meet the regular and exclusive use test

In general, you must also pass the regular and exclusive use test before you can take a home office deduction (exceptions apply for taxpayers who run day-care facilities from home and for sellers who use part of their homes for storing inventory). As you might expect, this test requires you to show that you exclusively use a portion of your home for business purposes on a regular basis.

For example, assume you set aside one room in your home as your home office. You also use this room as a playroom for your children. Here, you wouldn’t meet the exclusive use test. Now assume that you use one room in your home exclusively for your side business of selling insurance. You engage in this business only occasionally. Because you don’t use the office on a regular basis, you still won’t qualify for the home office deduction.

Telecommuters might also qualify for the home office deduction

For 2018 to 2025, the deduction for miscellaneous itemized deductions subject to the 2 percent floor (including unreimbursed employee expenses) is suspended.

If you telecommute or are an employee who works at home, you may also qualify for the home office deduction. You’d have to meet the above requirements. In addition, though, your home office must be for the convenience of your employer. In plain English, this means that your employer must ask you to work out of your home. The arrangement must serve your employer’s business needs, not vice versa.

The home office deduction for an employee who works at home is taken as a miscellaneous itemized deduction on Schedule A of Federal Form 1040. This deduction is subject to the 2 percent limit for miscellaneous itemized deductions. However, as noted, this deduction is not currently available.

If you qualify for the deduction, you can deduct all direct expenses and part of your indirect expenses

You can deduct both your direct and indirect expenses regarding your home office. Direct expenses are costs that apply only to your home office. You can deduct these costs in full against your business income. Some examples include the cost of a business telephone line and the cost of painting your home office. However, no deduction is allowed for basic local telephone charges on the first line in your home, even if that line is used for the home office.

Indirect expenses are costs that benefit your entire home. You can deduct only the business portion of your indirect expenses. Some examples of indirect costs include rent, deductible mortgage interest, real estate taxes, and homeowners insurance. The business percentage of your home is determined by dividing the area exclusively used for business by the total area of the home. For example, assume your home is 2,000 square feet and your home office is 200 square feet. Your business percentage is 10 percent (200 divided by 2,000). In such a case, if you rent your home, you can deduct 10 percent of your rent as part of your home office deduction.

Even if you don’t qualify for the home office deduction and are unable to deduct home-related expenses (e.g., homeowners insurance), you can still take a deduction for your regular business expenses, such as the purchase of file cabinets, business equipment, and supplies.

Some of your home office expenses may be limited

If the gross income from your business (the one associated with the home office) equals or exceeds your regular business expenses (including depreciation), all expenses for the business use of your home can be deducted. But if your gross income is less than your total business expenses, certain expense deductions for the business use of your home are limited. The deduction isn’t lost forever, though. It’s simply carried forward to the next year.

Can you spell “audit”?

Historically, the IRS has closely scrutinized home office deductions. Here are some steps you can take to substantiate the existence of your home office:

  • Use your home address on your business cards, stationery, and advertisements
  • Install a separate telephone line for your business
  • Instruct clients or customers to visit your home office, and keep a log of those visits
  • Log the dates, hours spent, and type of work performed in your home office
  • Have business mail sent to your home

Having a home office can be a factor when you sell your home

Unless you’re careful, deductions today can cost you money when you sell your home. Homeowners who meet all requirements can generally exclude from federal income tax up to $250,000 of capital gain (up to $500,000 if you’re married and file a joint return) when a principal residence is sold. You may end up paying some taxes, though, if you have a home office. That’s because when you sell your principal residence, an amount of capital gain equal to certain depreciation deductions you were entitled to (as a result of having your home office) won’t qualify for the exclusion. Specifically, the exclusion won’t cover an amount equal to depreciation deductions attributable to the business use of your home after May 6, 1997.

Note: In addition, where the business portion of the home is separate from the dwelling unit (e.g., an office in a converted detached garage) any capital gain on the sale of the house has to be apportioned; only the part of the gain allocable to the residential portion is eligible for exclusion.

For example, assume a self-employed accountant bought a home in 1998 and sells the home several years later at a $20,000 gain. Although the house was always used as his principal residence, the accountant used one room within the house as his business office. Over the years, the accountant claimed $2,000 of depreciation deductions for his office. Under IRS regulations, $18,000 of the capital gain will be tax free. Only the $2,000 of the gain equal to the depreciation deductions will be taxable.

If the accountant’s office had been located in a converted detached garage on his property, he would have to treat the sale as two separate transactions and pay tax on any gain allocable to the converted garage.

Because this area is complex, you should consult a tax professional. Also, you might want to read IRS Publication 587, Business Use of Your Home.

Optional simplified method of calculation available

For tax years beginning on or after January 1, 2013, you’re able to use an optional simplified method of calculating your home office deduction. The simplified method doesn’t change the requirements for claiming the deduction, it simply changes the way the deduction is calculated. Instead of determining and allocating actual expenses, under the simplified method you calculate the home office deduction by multiplying the square footage of the home office (up to a maximum of 300 square feet) by $5. Since square footage is capped at 300, the maximum deduction available under the simplified method is $1,500. You cannot use the simplified method if you are an employee with a home office, and you receive advances, allowances, or reimbursements for expenses related to the business use of your home under an expense or reimbursement allowance with your employer.

Each year, you can choose whether to use the simplified method of calculating the deduction or to use actual expenses. There are two things to keep in mind, though:

  • If you use the simplified method in one year, and in a later year use actual expenses, special rules will apply in calculating depreciation
  • If you are carrying forward an unused deduction (because your business deduction exceeded your business income in a prior year), you will not be able to claim the deduction in any year in which you use the simplified method — you’ll have to wait for the next year you use actual expenses to claim the unused deduction

 

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2018.

 


If you’re interested in receiving additional financial advice as a business owner, contact Ballast Advisors for a complimentary consultation at a location near you:

Ballast Advisors – Woodbury Area
683 Bielenberg Dr., Suite 208
Woodbury, MN  55125-1705
Tel: 651.478.4644
Ballast Advisors – Arden Hills Area
3820 Cleveland Ave. N, Ste. 500
Arden Hills, MN  55112-3298
Tel: 651.200.3100
Ballast Advisors – Punta Gorda & Port Charlotte County Area
6210 Scott St., Suite 117
Punta Gorda, FL  33950-3901
Tel: 941.621.4015 

IMPORTANT DISCLOSURES Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice. This communication is strictly intended for individuals residing in the state(s) of AZ, CA, CO, FL, GA, ID, IL, IN, IA, LA, MN, ND, OH, PA, TX, VA, WA and WI. No offers may be made or accepted from any resident outside the specific states referenced.