Our tax code contains plenty of opportunities to cut your taxes. There are also plenty of places in the tax code that could create a surprising tax bill. Here are some of the more common traps.
- Home office tax surprise. If you deduct home office expenses on your tax return, you could end up with a tax bill when you sell your home in the future. When you sell a home you’ve been living in for at least two of the past five years, you may qualify to exclude from your taxable income up to $250,000 of profit from the sale of your home if you’re single or $500,000 if you’re married. But if you have a home office, you may be required to pay taxes on a proportionate share of the gain.
For example, let’s say you have a 100-square-foot home office in a garage, cottage, or guest house on your property. Your main house is 2,000 square feet, making the size of your office 5% of your house’s overall area. You may have to pay taxes on 5% of the gain when you sell your home. (TIP: If you move your office out of the detached structure and into your home the year you sell your home, you may not have to pay taxes on the gain associated with the home office.)
Even worse, claiming depreciation on your home office could add even more to your tax surprise. This depreciation surprise could happen to either a home office located in a separate structure on your property or a home office located within your primary home. This added tax hit courtesy of depreciation surprises many unwary users of home offices.
- Kids getting older tax surprise. Your children are an excellent tax deduction if they meet specific qualifications. As they age, many child-related deductions fall off and create an unexpected tax bill. And it does not happen all at once.
For example, one of the most significant tax deductions your children can provide you is via the child tax credit. If they are under age 17 on December 31st and meet several other qualifications, you could get up to $2,000 for that child on the following year’s tax return. But you’ll lose this deduction the year they turn 17. If their 17th birthday occurs in 2022, you can’t claim them for the child tax credit when you file your 2022 tax return in 2023, resulting in $2,000 more in taxes you’ll need to pay.
- Limited losses tax surprise. If you sell stock, cryptocurrency, or any other asset at a loss of $5,000, for example, you can match this up with another asset you sell at a $5,000 gain and – presto! You won’t have to pay taxes on that $5,000 gain because the $5,000 loss cancels it out. But what if you don’t have another asset you sold at a profit? In this example, the most you can deduct on your tax return is $3,000 (the remaining loss can be carried forward to subsequent years).
Herein lies the tax trap. If you have more than $3,000 in losses from selling assets and don’t have a corresponding amount of gains from selling assets, you’re limited to the $3,000 loss.
So if you have a significant loss from selling an asset in 2022 and no large gains from selling other assets to use as an offset, you can only deduct $3,000 of your loss on your 2022 tax return.
- Planning next year’s tax obligation tax surprise. It’s always wise to start your tax planning for next year by looking at your prior-year tax return. But you should then consider any changes that have occurred in the current. Solely relying on last year’s tax return to plan next year’s tax obligation could lead to a tax surprise.
Please call to schedule a tax planning session so we can help prepare you to navigate around any potential tax surprises you may encounter on your 2022 tax return.