Rules for deducting casualty losses

SC&H Group experts also address reverse mortgages, tax-exempt interest

Tax Talk 2006 Q&A

February 26, 2006|By JIM WILHELM, STUART RUDO AND GREG HORNING | JIM WILHELM, STUART RUDO AND GREG HORNING,SPECIAL TO BALTIMORESUN.COM's tax-advice column features three experts from the Hunt Valley accounting firm SC&H Group answering questions about preparing your return every Monday until April 17. To be included in the following weeks, please use the form at the right side of this page to submit your questions.

Bernie Weill, Brooklyn, N.Y.: Can I deduct losses on my house destroyed by a fire during 2005, although I have not yet settled with the insurance company as of Dec. 31, 2005?

SC&H Group: Generally, you can deduct a casualty loss only in the tax year in which the casualty occurred. To determine your deduction for a casualty or theft loss, you must first figure your loss.

When calculating your loss on personal-use property, you must subtract the actual or expected insurance reimbursement. You must reduce your loss even if you do not receive payment until a later tax year. Furthermore, if you later receive more or less reimbursement than you expected, you may have to include that difference on your return for the year in which you can reasonably expect no more reimbursement.

Finally, after you have figured your casualty loss on personal-use property, your deduction will be subject to two limitation rules: the $100 rule and the 10 percent rule. The $100 rule, simply stated, says you must reduce each casualty loss by $100 when figuring your deduction. The 10 percent rule applies after you apply the $100 rule and states you must reduce your total casualty loss by 10 percent of your adjusted gross income. If you determine you have a loss, use both of the following forms to report the loss: Form 4684 and Schedule A (Form 1040). (See IRS Publication 547 for more information and examples.)

Charles Brough, Manchester: I have a reverse mortgage. I paid over $7,000 in interest on my reverse mortgage last year. Is it deductible?

SC&H Group: A reverse mortgage is an interest-only loan that capitalizes the interest expense along with the principal during the life of the loan. That means that there are no loan interest payments at all until the note comes due. Since this type of mortgage draws from the principal in the property, the amount received is tax free.

Generally, you can only deduct interest you actually pay on a loan secured by your home. However, in the case of a reverse mortgage, since the interest is added to the loan balance over the term of the loan, it is not deductible under the personal residence interest rules until the loan is actually repaid.

Sharon, Bel Air: My 80-year-old mother lives with my husband and me. Can we claim her as a dependent? She has Social Security income, as well as approximately $1,280 in pension yearly. She does not qualify to file taxes. We take care of her in the sense that we provide shelter, food, take her to appointments, etc.

SC&H Group: You are allowed to claim an individual as a dependent if they satisfy all of the following tests.

Citizenship test: The dependent must be a U.S. citizen, resident or national, or a resident of Canada or Mexico.

Joint return test: No exemption may be claimed for a dependent who files a joint return (except if only to claim a refund and no tax liability exists).

Relationship test: Is a qualifying relative (such as a mother, father, etc.)

Support test: You provide over 50 percent of total support, or two or more persons shared the support and together provide more than 50 percent of total support. Examples of items that qualify as support are food, lodging, clothing education, medical, dental, recreation, transportation and other necessities. Examples of items that do not qualify as support include life insurance premiums, taxes paid on their behalf, the value of personal services performed for the dependent and funeral expenses.

Gross Income test: Your mother has less than $3,200 of gross income in 2005. Gross income does not include tax-exempt income (certain Social Security benefits, municipal bond interest, etc.), but does include income from rental property or from a Schedule C business.

Your mother does not have to live with you, so long as the gross income and support test are met. Based on the facts you presented, your mother would be able to be claimed as a dependent in 2005.

Dean Scannell, Perry Hall: Can you still take a deduction on interest paid on student loans?

SC&H Group: You are allowed to deduct, in 2005, up to $2,500 of interest paid on qualified education loans for you, your spouse, and/or a dependent's college and vocational school expenses. The deduction is an adjustment to income on Line 33 of the Form 1040.

The deduction begins to be phased out when modified adjusted gross income is between $50,000 and $65,000 ($105,000 and $135,000 if married and filing joint). In order for the loans to be considered qualified education loans, the funds must be used for tuition, fees, room and board, books, equipment and transportation at an eligible institution and solely for that purpose.

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