The 6 Most Important Tax Deductions You Need to Claim
As Americans fire up their laptops and desktops to get another e-filing tax season underway, they might overlook something as old as tax time itself: savvy tax deductions. COVID-19 pandemic relief has temporarily changed the rules for some deductions, so it’s especially important brush up before you start work on your 2020 tax returns.
Take a look at the six most important tax deductions you should claim this tax season as you get ready to crunch the numbers. You’ll be surprised by how much you can save on your tax bill.
1. Mortgage Interest Deduction
Unless you bought your home with cash or have paid off the mortgage, this tax deduction is probably a big one for you. It was extended through 2020 for filers who itemize deductions, and it can potentially save you thousands of dollars in tax payments.
The mortgage interest deduction applies to your primary home and a secondary home. A second home you rent to tenants doesn’t qualify unless you live there for at least 15 days a year or more than 10% of the days you rent it to tenants, whichever is greater, according to TurboTax.
How much you can deduct depends on when you took out your mortgage because the rules changed in tax year 2018. For mortgage loans you took out in 2018 or later, you can deduct the mortgage interest you paid on a cumulative principal amount of up to $750,000 — or $850,000, in some cases.
For loans you took out in 2017 or earlier, or that you used to purchase a home that was under contract by Dec. 15, 2017 to close by Jan. 1, 2018, and which did close by March 31, 2018, you can deduct mortgage interest paid on up to a total of $1 million in principal. In other words, the IRS won’t penalize you for having closed slightly after the deadline as long as you signed your contract by Dec. 15, 2017 and stated on the contract that closing would occur by Jan. 1, 2018.
Married couples filing separate returns may each take half the deduction.
According to the IRS, taxpayers can deduct home mortgage interest if they meet two conditions:
- First, they must file a form 1040 and itemize deductions on Schedule A
- Second, the mortgage must be secured debt on a qualified home that an individual owns.
“Secured debt means you have put your home up as collateral to protect the interests of the lender,” said Mark Jaeger, director of tax development for TaxAct, a tax preparation software company. “Should a taxpayer not be able to pay the debt, the home can then serve as payment to the lender to pay back the debt.”
Learn More: Tax Year Deadline Dates You Need To Know
2. Student Loan Interest Deduction
The student loan interest deduction typically offers a life raft to students drowning in debt. For 2020, students with federal loans — and some with private loans — have had their payments in forbearance since March as part of CARES Act and private pandemic relief. But even though your deduction is likely to be smaller this year, it’s still worth taking. You don’t have to itemize in order to claim it.
“The amount is claimed as an adjustment to income, and the amount available to deduct is the lesser of $2,500 or the amount of interest actually paid,” Jaeger said.
The amount of the deduction gradually decreases for a single filer with a modified adjusted gross income of $70,000, or $140,000 if you’re married and filing a joint return, according to Money. The deduction phases out entirely for single filers who earn $85,000 and married joint filers earning $170,000.
To claim the deduction for 2020, you need to meet the following conditions:
- You have paid interest on a qualified student loan in tax year 2020.
- You are legally obligated to pay interest on a qualified student loan.
- Your filing status is not married filing separately.
- If filing jointly, the taxpayer or his spouse cannot be claimed as dependents on someone else’s return.
- The loan was taken solely to pay qualified higher education expenses.
3. Real Estate Taxes Deduction
Homeowners can use one form of tax to offset another. “Remember to deduct real estate taxes paid on real property you own — including state, local or foreign taxes,” said Melinda Kibler, a certified financial planner and client services manager with Palisades Hudson Financial Group‘s office in Fort Lauderdale, Fla.
To claim the deduction, make sure the taxes are based on the assessed value of the property and you itemize the payments on Schedule A of IRS Form 1040.
“If your real estate taxes are paid through your mortgage provider, be sure to check your Form 1098 for the real estate taxes portion,” Kibler said. “If you pull your real estate taxes from your county records, you may note there are portions broken out for ad valorem and non-ad valorem amounts.” For tax purposes, use the ad valorem number, which is the assessed value of real estate or personal property.
The maximum deduction you can claim for all state and local taxes, including real estate and personal property tax, income tax and sales tax, is $10,000 — $5,000 if you’re married and filing separately. It’s also important to note that you can’t deduct taxes levied because of improvements that increased the value of the property. The IRS gives assessments for sidewalks as an example.
4. Tax-Loss-Harvesting Deduction
Simply put, tax-loss harvesting is selling securities at a loss to offset a capital gains tax liability. That might sound a bit odd, but consider that the loss incurred is only temporary once you know how loss harvesting works — think of it as akin to harvesting apples but not cutting down the tree.
Mike Piershale, president of Piershale Financial Group in the greater Chicago area, cited a real-life example of loss harvesting in action. A retired client had triggered approximately $20,000 of long-term capital gains.
“I then looked at her investment statements and saw where she had approximately $30,000 in unrealized losses from a group of stock mutual funds that were down in value,” Piershale said. He noted that she could have moved her money out of the mutual funds, waited 31 days to abide by the IRS’ “wash sale rule” and then moved her money back into the same mutual funds.
“She then would have been able to declare a $30,000 capital loss, which she could have used to offset the $20,000 in capital gain,” Piershale said.
You can use losses of up to $3,000 a year to offset your ordinary income, and then carry the rest over for future years, according to Fidelity.
5. Flexible Spending Account Deduction
A flexible spending account, or FSA, is a pre-tax benefit used to pay for eligible medical, dental and vision care expenses that are not covered by your insurance plan or elsewhere. This includes deductibles and co-payments connected to your health insurance expenses.
This is one of the best tax-saving perks that employers offer, as it allows you to sock away up to $2,750 per year and not pay a cent of taxes on it. Some employers will even contribute to your plan.
FSAs do carry certain conditions. The most important is that you must spend all the money in the account by the end of the calendar year, or you will lose whatever you do not use. However, some employers will allow you to carry over up to $500 in the following year or credit funds to the prior year that you spend by March 15. For plan years 2020 and 2021, that deadline is extended to Dec. 31 as part of the COVID-19 relief package passed in December 2020, The National Law Review reported.
6. Charitable Contribution Deduction
Some people leave a sack of shoes at the Salvation Army and walk away feeling good. Others track everything they give and make the most of it on their tax returns.
“Whether you dropped off a bag of clothing at a local charity or donated $5 at the cash register of your grocery store, you should be tracking all of these contributions to ensure you get the highest tax benefit possible,” Kibler said.
Kibler added that if you own appreciated securities in a taxable investment account, you should consider contributing those as opposed to cash because this allows you to sidestep paying capital gains taxes on the amount you give. Deductions for contributions of long-term appreciated securities to public charities are typically limited to 30% of the taxpayer’s adjusted gross income.
You can even deduct money donated straight from your retirement savings, provided you are older than 70 ½. And for tax year 2020, CARES Act pandemic relief has increased the limit on the amount of qualified 2020 cash donations you can deduct, regardless of the source. For this year only, as of this writing, you may deduct up to 100% of your adjusted gross income. As an additional bonus, the deduction for cash donations is available to you even if you don’t itemize your deductions.
As you continue to work on filing, be sure to make the rounds and ask deduction-related questions of your trusted friends, business associates and accountant.
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Daria Uhlig contributed to the reporting for this article.
Last updated: Jan. 26, 2021