Home improvements

Oct. 1, 1998
Although the costs of improving one`s home are not tax-deductible, they can result in tax savings when the home is eventually sold. Improvement costs are added to the cost basis of one`s home, thus reducing the potential capital gains.

Hugh F. Doherty, DDS, CFP

Although the costs of improving one`s home are not tax-deductible, they can result in tax savings when the home is eventually sold. Improvement costs are added to the cost basis of one`s home, thus reducing the potential capital gains.

Advice: Set up a file on home-improvement costs and keep track of expenses from such capital improvements as landscaping and major plumbing projects. Over the long run, these costs can really add up and create eventual future tax savings.

Yield comparisons on bonds

If you want to add some bonds to your portfolio and you are a novice bond buyer, you might be confused by the various ways of figuring yields.

All bonds carry an interest rate pegged to their par (face) value. Called the "coupon rate," it`s simply a specified percentage of the bond`s par value. For example, a $1,000 bond with a 6 percent coupon will pay $60 interest annually.

But bond prices seldom stay at par for long, once trading in them begins. Assume a 6 percent bond is trading today at 92 ($920). The coupon still assures a $60 payout, so the "current yield" is 60/920, or 6.52 percent. But if the price were to rise above par - say, to 105 ($1,050) - the current yield would fall below 6 percent. In this case, it would be 5.71 percent (60/1050).

When comparing bonds, it`s important to distinguish between current yield and "yield to maturity" (YTM). In the previous example, when the bond matures, you would receive $1,000 - that is, $80 more than the $920 you would pay today. So your yield to maturity would be more than 6.52 percent. Calculating the YTM involves some math, but your broker can easily give you the figure. You`ll want to know the YTM, because it tells you whether a bond`s quoted price is in line with those of others having different coupons and maturity dates.

Finally, a bond you`re looking at may be subject to call - early redemption by the issuer, usually at a price above face value. If so, you`ll also need to know its "yield to call," which is the yield calculated as if the bond`s maturity date were its earliest call date. You can`t count on getting more than that.

Keep adequate investment records

Many people purchase investments and fail to keep a record of how much they paid for them. When they eventually sell the investments, they are unable to determine their gain or loss, because they do not know what their cost basis is. It is even more common for people who have received stock or other property by gift or inheritance to be unaware of their basis in the property.

A recommendation: To avoid reporting too much gain or too little loss, you should keep detailed records of your purchases. If you receive property by gift or inheritance, have the donor or executor provide you with information about the property`s basis and make sure you retain a record of that information.

IRS targets FLPs

If your financial adviser suggests setting up a Family Limited Partnership (FLP) to reduce your taxable estate, think twice. The IRS is challenging an increasing number of these partnerships.

Here`s how an FLP works: A husband or wife serves as general partner and transfers a large portfolio of assets, such as stocks or bonds, to the partnership. Then he or she parcels out pieces to the children, the limited partners, valuing the assets at a discount. A 20 percent share of a $1 million partnership, for example, might be valued at $100,000 instead of $200,000. The rationale for the discount is that limited partners cannot convert their shares to cash and have no control over the assets.

The present feeling of the IRS is that the provision has been abused. The IRS wants detailed explanations as to why a particular discount is used. They want to know how an asset that was worth $1 million in the morning can be valued at half a million in the afternoon. A suggestion is to consider whether an FLP is worth risking the IRS`s attention and the legal bills that might result. An alternate estate-planning strategy is: You can make a gift of $10,000 annually to each child tax-free without an FLP. If you do set up an FLP, make sure to get a qualified appraisal of the entire partnership and each of its parts.

Hugh F. Doherty, DDS, CFP, is a national lecturer, financial advisor to the health-care profession, and CEO of Doctor`s Financial Network. For personal financial consultations or to have Dr. Doherty speak to your study club or dental society, contact him at (800) 544-9653. E-mail: [email protected]. Web site: www.dr.hughdoherty.com.

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