QUESTION: An accountant told my husband and I that permanent improvements made to a house are deductible only if they are made within the last year of owning it. But friends have told me that all permanent improvements are deductible, no matter when they are made. Who is correct?--N. D.
ANSWER: No one. Confusion abounds. So let’s start over.
To begin with, permanent improvements--no matter when they are made--are not tax-deductible, per se. The cost of these improvements is simply added to the owner’s cost basis in the house. The higher the owner’s cost basis in a house, the lower the potential taxable gain when it is sold. It’s a kind of “tax deduction,” because it offsets taxable gains, but it certainly doesn’t meet the classic definition.
Also, you must be careful about what you call permanent improvements. They are carefully defined by the Internal Revenue Service and are limited to additions that enhance the value of the house. Repairs and other routine maintenance do not qualify, because they merely maintain the condition of the house and do not add to its value.
But just to make things more complicated, the IRS hands us one major exception: repairs made just before selling a house. However, the cost of repairs and other maintenance undertaken within 90 days of putting a home up for sale can be used to offset taxable gains only if the price of the replacement house is less than the original house’s sales price after commissions. If the new house costs more than the old one, these repair costs do not figure into the computations regarding deferred gains.
Form 2119, the report that taxpayers must complete and file with their income tax returns the year after selling a home, helps the home seller make the computations necessary to determining how any last minute repair costs can be deducted.
Q: I am leaving my job. How can I transfer the money in my 401(k) plan to another tax-deferred savings account without paying any penalties? I would be interested in an individual retirement account. I was told I could “store” this money in an IRA until I had a special need, such as buying my first home. Then, I was told, I could withdraw the money without paying any penalties. Is this true?--E. L.
A: Not entirely. You may roll over the funds in your 401(k) tax-deferred savings plan to an individual retirement account without being assessed any taxes or penalties. The only qualification is that the transaction must be completed within 60 days of receiving your 401(k) account proceeds. Once the funds are in an IRA, you may--if you want--switch them again into a qualified pension plan offered by your new employer. Or you may just leave them in the IRA until you are eligible to withdraw them.
The minute you withdraw any funds from your IRA for your personal use, you are subject both to taxes on the withdrawal as well as a possible penalty of 10% of the principal. The penalty is assessed if the withdrawal is made before you turn age 59 1/2. The only way a person under age 59 1/2 can avoid the 10% penalty is to withdraw the funds in annual increments according to the Internal Revenue Service’s disbursement schedule, which is based on estimates of life expectancy.
There have been several proposals in Congress to allow “younger” IRA account holders to use their funds for a down payment on their first house. The theory is that account holders, particularly young people frozen out of the home market for lack of a down payment, should be given access to their retirement savings without having to pay a penalty. So far, however, the proposals have not moved beyond the discussion phase.
Still, some experts argue that it may be worth your while to withdraw your IRA account funds--and pay the penalty and taxes--to make the down payment on your house. According to this theory, you basically use the interest that your IRA has accumulated on a tax-deferred basis to pay the penalty, leaving you--more or less--with the principal you contributed to the account. Although you’ve wiped out the interest, you still have the principal, which may be just what you need to buy that house.
Q: I am a college professor and must pay a monthly fee of $27 to park on campus. I am also charged $12 per month to belong to our Faculty Club dining room. Are these expenses deductible on my income taxes? Also, are annual management fees assessed to my individual retirement account deductible? I am billed $30 per year, and this fee is automatically deducted from the funds in my account.--C. L. C.
A: According to the Internal Revenue Service, your monthly parking fee and your faculty club dues are considered personal expenses and are not deductible on your income taxes. And unless your IRA management fee is separately billed and paid, it is not deductible. Your fee, because it is billed directly to and paid from your IRA account, would not be considered deductible. If you paid your IRA management fee separately, it would be considered a miscellaneous expense and would be deductible only to the extent that all of your miscellaneous expenses exceed 2% of your adjusted gross income during a given year.
Q: My sister lives on a permanent disability pension. Her annual income last year was $7,200, and if I didn’t supplement it, she would starve to death. Yet the Internal Revenue Service claims that she will owe $400 in income taxes. I can’t believe it!--W. E. K.
A: According to an IRA spokesman, it is entirely possible that your sister will owe the government income taxes for 1988. It depends on whether her income is taxable; some disability payments are. If she is single and under age 65 and she claims no deductions, the total federal tax bill on the $7,200 would come to $336, the IRA spokesman says.
Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Please do not telephone. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, Calif. 90053.