On the home front

Oct. 1, 2002
I recently received my home mortgage year-end statement. Where do I deduct the mortgage insurance that I paid?

Charles Blair, DDS
John McGill, MBA, CPA, JD

I recently received my home mortgage year-end statement. Where do I deduct the mortgage insurance that I paid? My CPA says it's nondeductible, but I disagree. Who is correct?

She is. In general, amounts charged for the use of money (e.g., interest) are fully deductible for federal and state income tax purposes. However, private mortgage insurance (PMI) is a separate charge levied because the loan balance exceeds a threshold percentage (usually 80 percent) of your home's value. Since this is a charge designed to compensate the lender for the increased risk of the loan — not for the use of the money itself — it is not deductible.

We recommend that you take whatever steps possible to eliminate this costly, nondeductible insurance. First, contact your lender to determine if the outstanding mortgage balance has been reduced to a level where the PMI can be cancelled. If not, consider paying down the mortgage to reach this point as quickly as possible or borrow funds from another source to pay down the loan to the required value, thereby eliminating this unnecessary, monthly premium.

My wife and I divorced two years ago, after building our new home and living in it less than two years. Under the divorce settlement, she is allowed to continue to occupy the house. However, it has recently become too large for her needs, and she is interested in selling it. Under the terms of the divorce decree, we are to split the $200,000 profit equally. Will I owe tax on my $100,000 share of profit from the sale?

No. The time in which your ex-wife lived in your personal residence under the terms of the divorce decree counts as part of your period of ownership. As long as she has lived in the home for at least two years, both of you will satisfy the two-year requirement, and the entire $200,000 gain will be tax-free.

Last year was my best ever in practice, but my federal and state income taxes soared. I did not have any type of retirement plan set up last year, but now I wish I had. Is it too late to set up a plan and contribute to it for last year if I have not yet filed my tax return?

Maybe not. As a general rule, contributions to any type of qualified retirement plan will not be deductible for a prior year, unless the plan was set up (legal documents were signed) on or before Dec. 31.

However, there is one exception. Contributions to a Simplified Employee Pension plan (SEP) are deductible for the prior year, provided that the SEP is established on or before the due date (including extensions) for your prior year's tax return. Even if you wish to set up some other type of retirement plan for the current year, it will be in your best interest to utilize a SEP for last year in order to generate a substantial tax deduction.

I will turn 70 this year and would like to defer taking IRA distributions until April of next year. Is this the best move?

No. If you defer IRA distributions until next year, you may end up with substantially higher federal and state income taxes. That's because you will not only have to report as income the amount of IRA distributions deferred from this year, but you also will have to pay taxes on next year's regular distribution, which must be taken on or before Dec. 31.

Bunching these two IRA distributions in a single tax year can throw you into substantially higher federal and state income tax brackets. As a result, we usually do not recommend deferring distributions unless your current year's income is higher than what you expect next year.

The information provided in this column is based upon the current Internal Revenue Code, regulations, IRS rulings, and court cases as of the date of publication.

This column is not to be construed as legal or tax advice with respect to any particular situation. Contact your tax attorney or other adviser before undertaking any tax-related transaction.

Dr. Blair is a nationally known consultant and lecturer, and is a member of the American Academy of Dental Practice Administration.

McGill is a tax attorney, CPA, and MBA, and is the editor of the Blair/McGill Advisory, a monthly newsletter helping dentists to maximize profitability, slash taxes, and protect assets. The newsletter ($184 a year) and consulting information are available from Blair/McGill and Company, 2810 Coliseum Centre Drive, Suite 360, Charlotte, NC 28217, or call (704) 424-9780.

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