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Monday, November 28, 2005

Worried About My Potential Tax Liability

This has been a big year for me. I started a new stage in my IBM career with a position that may force me to relocate a couple times in the near future. I took on an improvement project to my home, and then later rented it out for a positive cash flow. I began renting a room from a friend of mine to minimize rent expenditures. All these events add up when it comes to my tax bill.

With only about 1 month to go in the tax year I finally started thinking about what I need to do to make sure I don't have a potentially large tax liability. At the end of the year I estimate my work income will be about $10,000 more than last year, and I have lost about $4,500 of deductions from the property taxes and mortgage interest on the conversion of my home to a rental property.

In a perfect world my goal would be to find an additional ~$14,500 in deductions over last year to avoid paying any additional federal income taxes (I already feel like I pay too much). I had been planning on buying a new house which would have helped reduce this exposure, but after months of searching I haven't found a home that has met my criteria yet.

So far I can add the following to my list of additional items to minimize my tax increase:
-$1,000 for the 401k limit increase this year
-$500 - a rough estimate of the additional charitable contributions I have made above and beyond last year
-$1,000 - loss from rental activity, there is still a LOT of number crunching I need to do here, but I am currently estimating that my loss from the 6mos of renting my house will be about $1,000 when I factor in maintenance costs, mortgage interest, taxes and depreciation. I did a rough estimate a couple months ago when I hoped it would be a larger loss, but it turned out that the positive cash flow would minimize the deductions the and net loss looks to be only about $1,000. I definitely need to do a better analysis of the rental activity.

So this still leaves me with potentially $12,000 more in tax exposure over last year. That means I could roughly owe about $3000 more in income tax above last year.

So what else can I do?
-MM set up an individual 401k that sounds like it has possibilities. However I don't really have any self-employment income. I think a good goal for 2006 would be to start creating some additional sideline income and then this option may be a good strategy to defer taxes on some of this income.
-I have already made Roth IRA contributions this year, but I was thinking maybe I could also take advantage of a Traditional IRA to shield another $4,000, but a quick search reminded me that I can only contribute a total of $4,000 to a Roth or Traditional IRA. Long term I think a Roth IRA is a better bet so I will stick to sending my contributions to my Roth IRA.
-Jonathan over at mymoneyblog had a great post about a sure way to beat the market that I would love to try especially with the large loss I am holding in Pfizer stock. Unfortunately I have already nearly maxed out my $3k tax loss from capital gains this year so it won't help me with this year's taxes.
-I recently discussed increasing my charitable giving, this may be a good time to get this started.
-I could accelerate some expenses for my rental property - I need to think about what items/services I need for my rental property (since I will buy them anyway) to increase my rental activity loss.

Unfortunately this doesn't look good. Other than increasing my charitable giving and rental expenses I don't see any easy ways to avoid paying additional income taxes. I guess I also need to start setting up a reserve to pay this potential tax bill.


  • You should also check to make sure you have enough paid in (withheld) to avoid underpayment penalties.

    By Anonymous Anonymous, at 10:47 PM  

  • A few of the standard moves:
    Make January house payments in December, so the interest and/or rental property expense is deductible this year, and sell any stock losers you'd like to get rid of.

    Later this week I'm going to research the new energy-conservation bill that was passed recently. Starting January 1, 2006 you can get credits for energy-efficiency improvements (up to a certain dollar limit). I don't know if this applies to rental property owners or not, but I don't see why it shouldn't. So before doing anything this year to your rental property that may fall in that category of improvement, you may want to find out more about the bill. Like I said, I'll be posting on it later this week.

    By Blogger Dwight, at 11:57 AM  

  • I found a good site that spells out what qualifies and what the benefit will be for the new tax credits. I posted about it at New tax credits.

    By Blogger Dwight, at 4:44 PM  

  • pre-pay the taxes on the rental income properties on dec 31st. that might help a bit.

    By Blogger Adventures In Money Making, at 7:28 PM  

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