Add More Money Your Roth IRA - Undo and Redo Contributions After Losses?

So you listened to the financial experts and dutifully contributed $5,000 to your Roth IRA in early 2008. Unfortunately, stuff hit the fan and now you’re left with a lot less. Wouldn’t it be nice to be able to find some silver lining and shield another ~$1,000 plus earnings from taxes forever?

Well, here’s a slightly controversial idea that I ran across in this Boglehead Forum thread that might help you do just that. I think the easiest way to explain it is to continue with an imaginary scenario. Note that this leaves some variables in exchange for simplicity.

Example Scenario
Sometime in early 2008 you contributed $5,000 to your Roth IRA for the 2008 tax year. At the time, your IRA was worth $20,000 in total after the contribution. Now, in January 2009, the entire IRA is now worth $15,000.

You first “undo” your 2008 $5,000 contribution by following the same steps as someone who ended up being ineligible for a Roth IRA due to too much income*. Because your entire IRA account dropped by 25%, your $5,000 contribution is considered to have dropped by the same amount. You end up receiving a check for $3,750. You have received a return of your contribution, and have now technically contributed nothing to your 2008 Roth IRA.

Soon afterward, you simply open up a new IRA either at a new broker, or at your current broker if they are on the ball and have your 2008 total contributions as zero. (Otherwise they might throw a fit…) You can now throw in another $1,250 and contribute $5,000 again to your Roth IRA for the 2008 tax year before April 15th, 2009. Even if you just reinvest the $3,750 the same way as you did before, by using this strategy you have allowed another $1,250 to grow shielded from taxes, forever.

Is This Legal?
This is somewhat similar to the Traditional-to-Roth IRA reconversion method to save taxes. I read some skeptical posts in the BH thread as to the legitimacy of this action, but none were really backed by any evidence. I don’t see why both methods aren’t equally legal.

As another example, you might have made two separate $5,000 contributions by accident, and need to undo one of them. If everything is accounted for correctly by your IRA custodian, the IRS shouldn’t blink an eye. Here is another educated discussion in support of this idea. Other tax pros please add your thoughts in the comments below.

We ended up not being eligible for a Roth IRA this year, but if I was a candidate I think I would take advantage of this idea. In the long run, even stuffing another $1,000 in a Roth could save a lot of money in taxes.

* More information on correcting excess contributions in this Investopedia article. It must be done by the owner’s tax-filing deadline, which usually April 15, 2009 unless you file for an extension. Note that this is not the same as taking a distribution.

Posted in Retirement, Taxes | 31 Comments »

Free Equifax FICO Score Redux

Looks like Equifax and FICO are giving out another 10,000 free FICO scores (expired!). Again… no credit card or trial required. This is an official FICO score based on your Equifax credit file. Score only, no credit report. This time you don’t have to sign up for an extra forum account.

If you already got one of these free scores recently, you are out of luck. There is a limit of one every 12 months. The site URL is FreeFICOScore.com, which really sounds spammy, but it is verified by Verisign to be run by Fair Isaac Corporation.

Posted in Deals & Offers, Taxes | 16 Comments »

Historical Federal Tax Rates by Income Group

In my last post on 2009 marginal tax rates, reader Alexandria (aka MonkeyMama) made a very good point that planning our retirements around future tax brackets is very difficult as they change all the time. But isn’t that what we are forced to do every time we contribute to a IRA and/or 401k? We can either pay tax now (Roth), or pay tax later (Traditional). In any case, I figured I should look into this more.

I previously explored this area in my post about historical marginal tax rates vs. median income. There, I concluded that at my current high income level, my personal tax rates would probably go up in the future. Now why might I change my mind?

Total Federal Tax Rate vs. Income Group
More recently, the NY Times published the following graph that plots the total federal tax rate vs. income starting from the 1960s. Total federal tax rate includes income taxes and also things like payroll taxes and capital-gains taxes.

As you can see, tax rates as a whole have been dropping recently and are relatively low compared to the past. I would also note that the total tax rate at the median income group (middle 20% line) has varied very little over the last few decades, hovering around 18-20%.

Federal Income Taxes For Median Family
Next, here is a 2006 chart from the Center on Budget & Policy Priorities, which is based on Treasury Dept. data. The Center estimates that the median-income family of four will pay only 5.6 percent of its income in federal income taxes in 2006, the lowest since 1955.

As you can see, the range for this median family has stayed between 6 and 12%.

My short take. Tax rates right now are historically low. Given this and all our future governmental obligations, they will most likely go higher. However, future tax hikes will probably be more heavily placed on high income earners as opposed to those earning at the median or below. The tax rate paid by the “middle class” tends to stay in a relatively low and narrow range.

Everyone’s situation is different. Right now, we are earning in the top 5% or so. But in retirement, I think we can easily fit into this median group, especially if the mortgage is paid off. So even though the future is unknown, my bet is that our tax burden will decrease upon retirement.

Posted in Retirement, Taxes | 11 Comments »

2009 Marginal Rate Brackets For Federal Income Tax

For personal reference, there are the new 2009 federal income tax brackets, which have been adjusted for inflation. This is taxable income, so it is after any exemptions and either standard or itemized deductions have taken place, as well as pre-tax contributions to Traditional 401ks and IRAs. (And all that other stuff that makes the tax manual so thick.)

The value of each personal exemption also increased to $3,650, up $150 from 2008. The standard deduction is now $11,400 for married couples filing a joint return (up $500), $5,700 for singles and married individuals filing separately (up $250) and $8,350 for heads of household (up $350). Source: IRS.gov

If you are like many others and didn’t get a raise that matched inflation last year, at least you might pay a little less in taxes.

Since we’re married, I always pay attention to the point where you jump from 15% to 25%, which this year is $67,900. (With the two personal exemptions and a standard deduction, this would be a gross income of $86,600.) My fuzzy goal is to be able to live on less than this amount in (early?) retirement, so that all my IRA and 401(k) withdrawals will be taxed at a maximum of 15%.

Posted in Taxes | 25 Comments »

Undo/Redo Traditional to Roth IRA Conversion After Market Losses

If you did a Traditional IRA to Roth IRA conversion in 2008, and have since suffered some significant losses, you may want to consider undoing the conversion now that it is 2009. Then, as long as you wait 30 days after that and still qualify, you can redo the conversion again. This way, you only owe income taxes on the lower amount.

This Roth IRA conversion “do-over” is discussed in this CNN Money article, which included a helpful example scenario:

One of the main considerations are that you want to make sure your losses are enough that they likely won’t be recouped in the 30 days you are “out” of the market. One option is to re-invest the money in a taxable account during that period, but you’d be subject to more potential losses, as well as taxes on gains.

Another consideration is that you are essentially doing a entirely new 2009 conversion. You’ll have to again meet the income limits, and make sure your new tax bracket is acceptable to you. I did a Traditional to Roth IRA conversion in 2007 and shared my decision process, including the eligibility requirements and how to pay for it. There are more details on reconversions in this Fairmark article.

Next up: Controversial ways to deal with other Roth IRA losses.

Posted in Retirement, Taxes | 4 Comments »

Tax-Loss Harvesting For Buy & Hold Mutual Funds and ETFs

Always the procrastinator, I finally sold some shares of my punished mutual funds and ETFs in order to do some tax-loss harvesting. There are only two days left in 2008!

What is Tax-Loss Harvesting?
The main idea of this tactic is to legally pay less taxes by taking advantage of the fact that losses are taxed at potentially different percentages than gains are.

The IRS lets you claim a deduction for investment losses against your ordinary income, up to $3,000 each year. (If your net capital loss is more than this limit, you can carry the loss forward to later years.) For example, if you lose $3,000 on an investment, and you realize that capital loss by selling the stock or fund that incurred the loss without realizing any capital gains in the same year, you can claim a $3,000 deduction on your income tax return. This means you won’t have to pay income tax of up to 35% on $3,000 of your income that you would’ve had to pay otherwise.

On the other hand, a realized capital gain of $3,000 which you held for at least a year would only be taxed at a maximum of 15%. Therefore, although losses are still undesirable, if we plan on holding the investment for at least another year, we should “harvest” all the losses we can get.

Expanded Example

Taken and edited slightly from a older post:

Scenario #1: You are in the 28% tax bracket. Say this year you bought $10,000 of IVV, an ETF that tracks the S&P 500. In 2006 it drops to $9,000, and in 2007 it rebounds to $11,000 and you sell. You’d have a long-term gain of $1,000 from your original $10k, so you pay 15% in taxes ($150), and end up with $10,850 in your pocket. Net gain of $850.

Scenario #2: Same 28% tax bracket, same start period. You buy $10,000 of IVV, and in a year (2006) you sell at $9,000, and the very same day you buy IWB, an ETF that tracks the Russell 1000 Index, but is very similar (but not identical) to the S&P 500. Since it tracks very closely, your $9,000 of IWB in 2006 will also rise back to $11,000 in 2007. After a year and a day, you sell your IWB for $11,000.

Now in 2006, you had a capital loss of $1,000 from your IVV. So you deduct $1,000 from your ordinary income taxed at 28% and save $280 in taxes. That’s $280 in your pocket. Then, in 2007 you realized a long term capital gain of $2,000. You pay your 15% tax ($300) and you end up with $11,000 - $300 = $10,700. Add in your $280 from the last year, and you end up with $10,980.

This time, even though you had basically the same level of market risk, you obtained a net gain of $980.

Substantially Identical?
Note that you must do this with similar, but not “substantially identical” investments. For example, you can’t buy IVV back again right after selling it and try this. That would be called a ‘wash sale‘ by the IRS.

Posted in Investing, Taxes | 10 Comments »

Last-Minute Flexible Spending Account Ideas

Time to pay the price for being healthy, and try to use up the rest of the balance in my Flexible Spending Account. First up, here is my list of usual suspects:

Starter Checklist of FSA-Elgible Items

• Advance refill of prescriptions
• Eye exams
• Contact lenses and lens solution
• Pain killers
• Cold and flu medicines
• First aid supplies for emergency kits
• Condoms and other birth control items
• Ear plugs
• Acne medication

Big Lists, More Ideas
The most authoritative resource is probably this list of eligible medical deductions from the IRS. Then there are some nicely organized lists from health insurers like Aetna or third-party FSA administrators like Conexis.

You can also search for inspiration at the special FSA-eligible sections of Drugstore.com, CVS, and Walgreens.

Finally, check the final date allowed on your specific plan. If yours is like mine and ends on 12/31, make sure that you have a receipt dated in 2008. Certain plans may allow you to spend your money up until March of next year. This may give you more time to line up a doctor’s appointment and get some care you’ve been putting off.

When will they fix this broken system? For one, if you are desperate you can always buy some junk, fax in the receipts, and then return the items. Unethical and illegal? You bet. But why are we forced to estimate our unpredictable expenses in a use-it or lose-it format?

Posted in Frugal Living, Taxes | 34 Comments »

Your Own Financial Rescue Plan, Part 1: Adequate Cash Reserves

Well, the big boys are getting their rescue/bailout plan, but I guess ours got lost in the mail… So what should we do? I think that everyone should take a second look at their cash reserves. Do you have enough?

What Job Security?
These days, I don’t see any job as safe. My company went from interviewing people to hiring… nobody. Even local and state governments are facing major budget deficits. At a minimum, I would want a few months of living expenses to tide me over until I find another job. I still remember the dot-com bust days when former tech workers ended up living in their cars.

A Reason Not To Invest In Stocks
Hey, if you’re looking for an excuse not to buy any more stocks for a while, beefing up your emergency fund is not a bad one. Any money you may need within 5 years should be in cash or short-term investments anyway.

A Reason *To* Invest In Stocks
Ironically, after you build up a nice cushion, it may actually make you feel better about investing in the stock market. I definitely helps me to keep short-term money separate from long-term money. As such, I’m still applying my upcoming income towards maxing out my 401(k) for 2008. But after that, I will probably start to save another three months of living expenses, for a total of 9 months in cash.

Less Credit Available
A lot of people used to simply assume that their home equity line of credit (HELoC) could serve as their emergency fund. But these days, it just takes one letter in the mail that says your HELOC is frozen or greatly reduced. You don’t want to be forced into taking an early withdrawal from your 401(k) or IRA, or paying exorbitant credit card interest.

If anything, apply for a credit card with a low fixed interest rate now while it is still offered. Here is a list of no fee 0% APR balance transfer credit cards. Just buy goods as you regularly would, and pay the minimum while saving the difference in an interest-bearing account. (Don’t go buying more stuff, obviously!)

Looking Ahead
For me, an alternative reason for increasing my cash reserves is that I can also use it later for investing in real estate. I still don’t see many opportunities with good cashflow right now, and may not see them for another couple of years. But I want to be ready, as the no-money-down days may never come back.

Where do you keep it?
As long as it is safe and liquid, I just go by rate. Use the new FDIC insurance estimator if you have lots of money. Both Vanguard and Fidelity are participating the money market fund insurance program, so they are super-duper safe now. . Well, your old money is safe. Still, I consider money market funds with Fidelity and Vanguard as safe as FDIC-insured, although this is only my opinion. However, my cash is currently split between:

1. Series I US Savings Bonds - Bought in April with 1.2% fixed rate, now only 0% fixed rate available. Note that they are illiquid for the first 12 months. Rates adjust semi-annually. I earn 4.38% for 1st six months, 6.06% for 2nd six months. With recent inflation, my 3rd six months should also be pretty good. Exempt from state income tax as well.
2. 12-Month 5% APY CD at WaMu/Chase - Sadly, no longer available.
3. Low or no-minimum banks with high liquidity - A big chunk currently in transit to Everbank at 4.65% for first 3 months.

Posted in Banking, Career, Frugal Living, Goals, Taxes | 26 Comments »

Recommended Book On Tax Deductions For Home Businesses and Freelancers

I got a lot of positive responses from my self-employed tax-related post yesterday. I’ll be happy to continue sharing more of my experiences, but given the complexity of tax issues I wanted to throw out a book recommendation - Home Business Tax Deductions: Keep What You Earn by Fishman.

This is my hands-down favorite book on tax deductions for those with home-based businesses. It has saved me many times the $20 cover cost. I checked this book out from the library first as well, but ordered it online within a few days. I’ve read several other tax books and they are either (1) too light on the details, or (2) too aggressive and bordering on both the unethical and illegal. This book provides a good summary of the IRS code, and practical ways to substantiate deductions that you qualify for.

The primary benefit of a good tax book is that it gives you the confidence to take the deductions that you deserve and qualify for. Many times people simply don’t try because they are afraid of the Big Bad Audit. Instead, I am now confident that I followed the rules and can pass an IRS inspection. Remember the difference between tax avoidance and tax evasion:

Tax Avoidance is perfectly legal. The courts have stated clearly that you have no duty to pay more taxes that what is minimally required by law. You have every right to take all legitimate deductions and also to structure your business to minimize taxes.

Tax Evasion is a crime. This involves fraud, misreporting income, or taking deductions that you do not qualify for.

(Is it tacky to quote yourself?) Even if you have an accountant, I think it is good to understand a bit of what is going on.

Posted in Self-Employment, Taxes | 10 Comments »

Self-Employed or Freelance? Maximize Your Business Mileage Tax Deduction

An important part of maximizing the profit from your own business - no matter how small - is to be smart with taxes. If you are running a side business on top of your day job, you may be paying around 50 cents of every dollar made towards taxes. This means, that for every $1 in tax deductions you find, you are keeping an extra 50 cents in your pocket.

One of the more tedious tax deductions for self-employed folks is deducting transportation expenses. The simplest way to claim this deduction for those without vehicles used solely for business is to track the number of miles driven for business use. (You can also record actual automobile expenses like gas and maintenance, and pro-rate.) The IRS just announced yesterday that the standard mileage deduction will be 58.5 cents/mile for all business miles driven for the last half of 2008, up from 50.5 cents/mile.

From above, this means that for every single business mile you deduct, you might save around 29 cents. Deducting just 100 miles per month would save you around $350 over a year. Put another way, not tracking 100 miles a month will lose you $350 a year. There are many complex rules for what constitutes eligible business travel, but it can be worth asking your accountant or reading up. Here are some examples:

• Driving to the office supply store to make business purchases.
• Driving from your home office to an external location meet a client.
• Driving to the bank to deposit checks or make other business transactions.
• Driving to pick up mail from your UPS Store or P.O. Box.
• Driving to the post office to send business-related mail or buy stamps.

Many times, you might do this stuff without a second thought. But with gas costs so high, I would argue that we need to recoup whatever we can get. Trust me, these miles can add up quickly!

How do I properly track such mileage? At most office supply stores you can buy a mileage logbook. Or, simply start up a spreadsheet program and create these columns: date, purpose (bank, etc.), odometer start value, odometer stop value. Print it out, slap it on a clipboard, and stick it permanently in your car like I do. Record everything immediately, it should take seconds; you can add up the miles later. (Added: mileage log template for Excel)

What about driving from my self-employed home office to my day job with another employer? Nope, although it would be sweet to deduct such commuting costs, this is not qualified business travel. However, if you have a second site for your own business like a storefront, travel to/from your home office to/from that site can be deductible.

What if my UPS mailbox is next to my day job? Here’s where things get a bit fuzzy. You definitely aren’t allowed to deduct personal trips. But let’s say the supermarket is right next to your business bank. Since you’re already there, isn’t doing some grocery shopping the the eco-friendly thing to do? From my non-official understanding, you would need to prove that your trip to the bank is necessary and the primary reason for the trip, and not just an excuse to go to the supermarket. Making an actual deposit transaction would seem to be sufficient in that regard.

But if you are trying to say that your “business bank” is 30 miles away from your home office and just happens to be the one next door to your 9-5 job, then that may be much harder to justify. It is truly necessary to use that branch?

There’s more… You may also be able deduct mileage driven for charity, medical treatment, job searches, and moving.

References: IRS Publications 535, 463, and 529

Posted in Self-Employment, Taxes | 27 Comments »

IRS Economic Stimulus Check Promotions: 10% Bonus at Albertson’s, Kroger, K-Mart, Sears, and More

The economic stimulus checks are coming! Before depositing your tax rebate at the bank, it might be a good idea to see what retailers will offer you for it. While I don’t necessarily like the idea of treating this extra money as different from any other money (a dollar is a dollar), you might as well take advantage of the promotions if it doesn’t change your intended spending patterns. Although some of these require an economic stimulus check, others work with any tax refund check.

Even if the big names like Kroger and Albertson’s don’t ring a bell, read the lists below carefully for a store that is near you. For example, in Portland, Oregon there is the popular Fred Meyer chain, which I didn’t know was part of the Kroger family.

Supervalue Inc. Supermarkets - 10% Bonus
Including Acme, Albertsons, bigg’s, Cub Foods, Farm Fresh, Hornbacher’s, Jewel-Osco, Lucky, Shaw’s/Star Market, Shop ‘n Save and Shoppers Food & Pharmacy. From their press release:

Customers who are interested in growing their refunds should bring their government-issued economic stimulus or tax refund checks, along with government-issued identification, to customer service counters at their local stores between May 2 and July 31, 2008, to purchase store gift cards in $300 increments, not to exceed $1,200 per household. Each gift card will be loaded with an additional $30, to bring each gift card total to $330.

Kroger Co. Supermarkets - 10% Bonus
Including Kroger, Baker’s, City Market, Dillons, Fred Meyer, Food 4 Less, Fry’s, Gerbes, Hilander, Jay C, King Soopers, Owen’s, Pay Less, Ralphs, Smith’s and QFC stores. From their press release:

Kroger customers who are interested in exchanging their refunds or economic stimulus checks should present their check and customer loyalty card at their local store’s Customer Service center from May 2, 2008 through July 31, 2008. The program is limited to one offer per household with a limit of $1,200.00.

Sears, K-Mart, and Land’s End - 10% Bonus
I was going to buy a Martha Stewart futon from K-mart just last week… From their press release:

When customers bring their stimulus checks to a Sears or Kmart cash register, they can convert the amount of the check into gift cards, plus receive a bonus gift card worth an additional 10 percent. To be eligible, the amount of gift cards purchased must be equal to the full value of the stimulus check. The gift cards can be redeemed at any Sears, Kmart or Lands’ End retail stores or online at sears.com or landsend.com. The promotion is scheduled to last from May 14 to July 19, 2008.

Radio Shack - 10% off $50+ Purchase
Targeted at the “underbanked”, but if by chance you want something from there… Personally, I’ve only bought a headphone splitter from there in the last 5 years. Their press release.

Customers who use their checks to pay for purchases above $50 between May 4 and July 12, 2008, will receive a 10 percent discount on their purchases. Any amount left over from the purchase will be placed on a Vision Silver Prepaid MasterCard, which can be used at any place that accepts MasterCard.

Via Reuters, Fatwallet, and Consumerist. Oh, Staples has a page of special offers like $50 off $500 spent on computers, but nothing specifically tied to a stimulus check. Anyone else?

Don’t lose those $660 gift cards!!

Posted in Deals & Offers, Taxes | 38 Comments »

Does The Government Underestimate Inflation Through The Consumer Price Index (CPI)?

Many people, including myself, are worried about inflation. Is it just because of the current housing and stock market conditions, or are our bills really a lot higher than before? The inflation numbers that we usually hear about are based on the Consumer Price Index (CPI). Variations of the CPI are published monthly by the government’s Bureau of Labor Statistics, and they supposedly track the prices consumer pay for a basket of goods and services. For example, a greatly simplified basket may include a month’s rent, 10 pounds of steak, a tank of gas, and a laptop. As the price of this basket goes up, that’s inflation.

Why Does CPI Matter?

1. Payouts on inflation-protected investments like TIPS and Series I bonds are indexed directly to the CPI.
2. Social security payments, pensions, and inflation-indexed annuities all rely on CPI data to determine their annual adjustments.
3. The size of individual income tax brackets, personal exemptions, and the standard deduction are tied to movements in the CPI.
4. Low inflation numbers (especially when they are much less than GDP growth) make the economy seem healthy.

However, there is some controversy over whether the CPI is an accurate measure of inflation. As you can see above, there are many reasons why the government and large pension groups would like to see a lower inflation number. Lower inflation numbers mean lower payouts, a smaller budget deficit, and a happy stock market.

In 1995, the Boskin Commission study suggested that the CPI overestimated inflation by around 1.1% every year, and in 1996 changes were made to counteract these alleged errors. But critics say these changes were completely unnecessary, and now the CPI underestimates inflation by around 1.1% per year. Here are some of the arguments:

Substitution Adjustments
It was suggested that if steak becomes too expensive and people buy hamburger instead, then the CPI should just start using hamburger prices instead. After all, that is what people are buying right? Not only does this reduce inflation, critics wonder where this is headed. Hamburger gets too expensive, so then we eat hot dogs. Hot dogs turn into… dog food?

In addition, let’s say we go from using steak to hamburger due to price, and then back to steak again once it gets cheaper. Roundtrip, this substitution system would say that there was zero or even negative inflation during this time. But obviously prices actually rose. Just doesn’t sound right.

Quality, or Hedonic, Adjustments
A second major factor is that the CPI tries to adjust for increases in quality as well as increases in price. If a car costs 10% more, but it is 10% higher in quality, then there was no inflation. Okay, I can see this in certain examples. But critics point out that many times the consumer has no choice but to pay the higher price, so why aren’t we taking this into account?!

Example: If the government mandates an additive to your gasoline that costs an extra 20 cents per gallon, there is no affect on the CPI because this 20 cents was an improvement in “quality”. But we still get stuck with higher bills!

I wonder… if we follow all these quality adjustment ideas, isn’t shifting from steak to hamburger losing quality and shouldn’t that be adjusted for as well?

What If We Remove These Adjustments?
Here are two estimates of what the CPI number would look like without these adjustments. From Shadows Stats² (Clinton era means 1996, when the changes were made):

From Bill Gross and PIMCO³:

Personally, I think the government has a vested interest in getting the inflation numbers at least somewhat correct (considering the scrutiny they are under), but at the same time they want to err on the low side rather than the high side. Some of the methods they use definitely seem to support this goal, and I wouldn’t be shocked if the CPI-based inflation numbers lagged what consumers actually experience by up to 1% per year at times. This may be something to consider when buying anything indexed to the CPI.

Sources and More Information

1. The great inflation cover-up by Elizabeht Speirs, for Fortune Magazine.
2. Consumer Price Index by ShadowStats / John Williams - Slightly more aggressive and controversial.
3. Haute Con Job by Bill Gross - He runs PIMCO and the largest bond mutual fund in the world, so not quite a kook. Also see Con Job Redux.
4. US CPI Inflation Statistics Manipulation and Deception? by Ronald Cooke.

Posted in Investing, Taxes | 29 Comments »

Find Out How To Lower Your Property Taxes

While I tend to be straight-laced when it comes to taxes, I also think it is our right - heck, even our duty - to pay as little taxes as legally required. I take every deduction that I can substantiate. While learning about property taxes, I read that somewhere between 30-60% of homes in many areas are over-assessed. If the estimated assessment value is too high, then those homeowners are paying too much in taxes! In areas of dropping home values, you may be able to get your assessment lowered.

But don’t expect anybody to tell you this. From this 2000 and 2004 articles about property taxes, both from CNN Money:

“It’s an unfair system,” Lewis said. “You can go to one particular block in Long Island, for example, where 11 houses got a tax reduction last year because they filed grievances. The remaining 4 homeowners who didn’t file a grievance are still overpaying. In most municipalities, if you don’t file it means you accept the assessment value of your home.”

“The bottom line is that if homeowners aren’t focused on what has happened in their marketplace, they are paying too much in property tax,” says John Brusniak, a Dallas property tax lawyer.

My sister-in-law recently contested her assessment and successfully got a reduction in her property taxes. The way to do it seems to be for (1) each homeowner to do a little research as to how their local government does their property taxes, (2) figure out if they are over-assessed, and then (3) file an appropriate appeal if necessary.

How Are Assessments Calculated?
This varies between states and even counties, but it could be based on:

1. the sales of comparable homes in your neighborhood,
2. the replacement value of your home, or how much it would cost to build your home from scratch at current material and labor costs,
3. a multiplier of how much rental income your property would produce,
4. or the most recent purchase price, plus an inflation adjustment.

You can usually find an assessment report at the tax collector’s office showing you how they got their number. Now you have to reverse engineer things to figure out how you can argue it back down. For example, you might have comparables with lower prices, or they might have marked down your square footage or other details wrong. Use sites like Zillow or Domania as well, since they can be based on tax records. Ideally, you’ll find a house just like yours, but with a lower assessment value.

The Appeals Process
Check out your local state website. If you live in California, there is this Guide to Residential Property Assessment Appeals. In New York, they have a Guide to Fair Assessments For Property Owners.

After looking at a few examples, some places seem to have a written from you can fill out first (an informal review). From this SF Chronicle article:

If your home is worth less than you paid, chances are you also can get a temporary reduction in your property taxes - without a battery of lawyers or dubious arguments about functional obsolescence. Just ask your county assessor for an informal review of your assessed value. It’s free and easy to do yourself. [...] In most counties, you can simply call or write your assessor’s office or download a form from its Web site and mail it in.

If that fails, then you might have to perform a formal appeal which involves meeting with officials and assessors face-to-face. It doesn’t seem all that complicated, besides building up your evidence the most important thing to have is persistence. Hurray for bureaucracy!

p.s. If you’re selling your home, consider that a lower assessment (and thus a lower tax bill for the new owner) can help you sell your home faster or even for a higher price.

Posted in Real Estate, Taxes | 16 Comments »

Renting A Room To A Relative: Setting A Price, Tax Issues

We are considering renting a room to one of our siblings temporarily. She’s moving out here for a new job, and since we live in an pricey area living with us will offer her a way to save up some money. On our side, we are two people with four bedrooms, so we have plenty of room right now.

Of course, horror stories abound when renting to family members. I don’t know what to say about that. I don’t foresee it being a problem as we are pretty close, and we are all responsible professional adults, but I’m sure everybody else says that as well. Being that we recently rented a unit from a another family member successfully, I also feel good being able to “pay it forward”.

The Plan
We would collect “rent”. The idea is that she would pay 1/3rd of all utilities (gas, electric, water, garbage, cable, internet) plus some buffer for other miscellaneous household maintenance items. This obviously will be much less that what it would cost to share an apartment on the open market, let alone a studio. So she’s paying her way, but we aren’t making much profit if any, ideally preventing any guilt or resentment on either side.

The Problem: Fair Rental Price
But then I did some research about the potential tax implications. Is rent always taxable income, even if from a relative sharing a home? From what I can tell, the IRS says yes. (Someone please correct me if I’m wrong.)

However, if I am reading the IRS “Renting to Relatives” regulations right, the good news is that if I rent out the room at “fair rental price”, I can start deducting a portion of my expenses - including interest, taxes, repairs, maintenance, utilities, insurance, and depreciation. This has the potential to offset the rental income completely (resulting in no net tax owed), although I can’t create a loss since it’s my personal home.

The bad news is that if I don’t charge fair market rent, then I can’t deduct anything. 100% of the rental income is now fully taxable as passive income. Having to pay taxes on money that is basically covering the utilities just doesn’t sound right.

Solution?
From anecdotal evidence, I’m sure compliance is spotty at best in this area. What if a son pays $200/month to live with Mom and Dad? But to fall in line with the rules, it seems like I should either (1) charge something close to “market” rent and maybe buy her a nice gift later or (2) not charge anything at all. My idea was simply have her pay some of the utilities directly. This way I don’t actually accept any money. Any suggestions?

Posted in Family, Real Estate, Taxes | 49 Comments »

Save More vs. Earn More: A Dollar Saved Is Two Dollars Earned

Earn more. Save more. Those are the two ways to get out of debt or build wealth. I’m a big proponent of doing both, but I think for many people it is easier to cut back on some luxuries rather than look for a raise or more work. It’s also more effective, and here’s why: Let’s say you are single and your (taxable) gross income is $50,000 a year. If you were to go out and earn another additional $1 at as an employee, here’s how that $1 would get broken down:

You’d only keep 58 cents. On top of that, a lot of extra or freelance work is done as an independent contractor. That means you’re self-employed and get the happy task of paying another 7.65% of payroll taxes (the employer share), which brings your total tax hit to 49.6%! So in order to keep $1 in your pocket, you’d have to get someone to pay you $1.99. Then your choice becomes:

This fact helps me visualize the balance between spending and saving in my head. Now when you save $1, you can feel good knowing that you’d have to have earned $2 of income to equal that. But on the flip side, when I get a check from a project for $500, I know I’ll only keep $250.

The Small Print

• This is a specific example, your tax situation may vary. Also note that this isn’t the average tax rate on all your income, but for the next $1 you might earn.
• You might get a portion of your Social Security or Medicare taxes back in the future, even though your taxes aren’t being saved or invested anywhere; it’s being paid out immediately to current retirees. In any case, the return on investment certainly won’t be that great.
• Some states don’t have an income tax, but may have higher sales tax or property tax rates. But remember, a sales tax is basically a tax on income that you spend!
• You’re allowed to deduct half of your self-employment tax from your adjusted gross income, which saves you a bit in taxes.

Posted in Frugal Living, Taxes | 60 Comments »