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If you’re used to claiming itemized deductions on your federal tax return, tax reform may have a surprise in store for you in 2019.
More than 45 million taxpayers itemized deductions in 2016, according to the IRS . If you were one of those people, that might change for the 2018 tax year.
The Tax Cuts and Jobs Act of 2017, or TCJA, affected many areas of the tax code, and itemized deductions are no exception. To avoid surprises at tax time, now is a good time to review some of the significant changes and get an idea of what will work best for your 2018 tax return.
Standard deduction vs. itemized deductions
Many taxpayers who itemized in the past will face a big question this year: Is it still worth itemizing given the new higher standard deductions?
The question of whether to itemize deductions or claim the standard deduction usually comes down to one issue: Which method is the most effective at reducing your taxable income?
When you prepare your tax return, you typically add up all your itemized deductions, including deductible medical expenses, taxes, interest and charitable contributions. If your total itemized deductions are higher than the standard deduction you’re eligible for, you would save more by itemizing. Otherwise, you’ll want to claim the standard deduction.
Tax reform made some changes that could impact that calculation starting in the 2018 tax year. Here are a few.
1. Nearly doubling the standard deduction
In 2017, the standard deduction was $6,350 for single taxpayers and those married filing separately, $9,350 for those filing as head of household, and $12,700 for a married couple filing jointly and qualified widow(er)s. Those figures nearly doubled for 2018 returns: $12,000 for single filers and married filing separately, $18,000 for heads of household, and $24,000 for married couples filing jointly and qualified widow(er)s.
So let’s say Tom is a single taxpayer who had itemized deductions of $8,500 in 2017 — that was $2,150 more than the standard deduction for his filing status that tax year. Assuming his tax situation stays roughly the same in 2018, Tom’s total itemized deductions probably won’t exceed the new higher standard deduction threshold.
You may be thinking, “Good for Tom. Instead of $8,500 in itemized deductions, he’ll get a $12,000 standard deduction in 2018!” But not so fast …Standard deduction vs. itemizing: Which should you choose for 2018?
While the doubling of the standard deduction is beneficial, it comes at a cost. The TCJA also suspended the personal exemption for 2018 through 2025. In 2017, that was worth $4,050 per person. So in 2017, Tom benefited from $8,500 in itemized deductions plus a $4,050 personal exemption for a total of $12,550. Tax reform means Tom just lost $550 in tax benefits.
Still, many tax experts predict that the higher standard deduction amounts will entice more people to choose the standard deduction over itemized deductions. In fact, the White House Council of Economic Advisers forecasts that the percentage of itemizers will plunge from 26% of filers to about 8% in 2018.
2. Limiting the deduction for state and local taxes
The TCJA limits the deductibility of state and local tax payments to $10,000 per tax year. Previously, those deductions were unlimited. For Tom in the example above, that’s not an issue, because his total state and local taxes are well under the limit. But for many taxpayers living in high-tax states, including New York, California and Illinois, that’s a significant change.
Let’s consider Anaya, a single taxpayer who owns a home in the high-cost San Francisco Bay Area. Anaya pays approximately $9,500 per year in state property taxes and $7,500 per year in state income taxes. For 2017, she was able to claim a deduction for the full $17,000 in state and local taxes. For 2018, she’ll lose $7,000 of that deduction.
3. Limiting the deduction for home mortgage interest
The TCJA also placed new limits on home mortgage interest deductions. Before the TCJA, a taxpayer who was married filing jointly could deduct interest on up to $1 million of home acquisition debt and $100,000 of home equity debt, for a combined limit of $1.1 million. And there was no limitation on what you used the home equity loan proceeds for.
For 2018 through 2025, the TCJA limits the deduction for couples married filing jointly to the interest paid on up to $750,000 of new home acquisition debt used to buy, build or improve a first or second residence. It also suspends the deduction for home equity interest — unless the proceeds are used to buy, build or improve a home.
For couples married filing jointly, the changes would not affect home acquisition debt of up to $1 million if the mortgage was taken out before Dec. 15, 2017 (and the purchase was finalized before April 1, 2018). So for those taxpayers, the $1 million limit still applies for couples married filing jointly, but the additional unrestricted interest on $100,000 of home equity debt is not grandfathered in.
To illustrate, consider Reo and Akari, a married couple filing jointly with a $900,000 first mortgage they took out to buy their home in 2016. On Sept. 28, 2017, they also took out a $50,000 home equity loan to remodel the house. For the 2017 tax year, they could deduct 100% of the interest paid on both the mortgage and home equity loan.
Now let’s imagine they took out both loans in 2018. Under the TCJA, the $50,000 home equity loan would still be deductible but only because the proceeds of the loan were used to buy, build or substantially improve the home. And because their total home acquisition debt ($900,000 mortgage + $50,000 home equity loan) is above the $750,000 cap, they’ve lost the deduction for interest paid on $200,000 of their total home-related debt.
4. Eliminating certain miscellaneous itemized deductions
Before the TCJA, taxpayers could deduct certain miscellaneous itemized deductions to the extent that they exceeded 2% of the taxpayer’s adjusted gross income, or AGI. That included items like unreimbursed employee expenses, tax preparation fees, investment expenses, job search expenses, hobby expenses and safe deposit box fees.
The TCJA suspended most miscellaneous deductions. So while many taxpayers with simple returns may not have had enough combined deductions to exceed the 2%-of-AGI floor anyway, it’s a major blow to those who pay big fees to their financial advisers — at least until the deduction returns in 2026.
What is adjusted gross income?
Adjusted gross income is your gross income (all the income you receive in a year) minus certain adjustments. AGI helps you determine tax credits and itemized tax deductions you may be eligible for. Learn more about adjusted gross income.
5. Limiting casualty loss deductions
Prior to tax reform, if you experienced a property loss from fire, storm, theft or other form of casualty — and those losses weren’t reimbursed by insurance or other compensation — you could potentially deduct the portion of your losses that exceeded 10% of your AGI. Tax reform tweaked the deduction slightly but significantly.
Now in order to deduct casualty losses on your 2018 return, the affected property must be located in a presidentially declared disaster area. The loss must be due to the events that prompted the area to be designated as a disaster, must still exceed $100 per claim and is still limited by your AGI.
So if a severe storm caused damage to your home in 2017, you could take a deduction . The same circumstances in 2018 wouldn’t yield a deduction, however, unless you’re claiming a loss that occurred in presidentially declared disaster area.
If you’re used to itemizing deductions, you might want to review the deductions you claimed on your 2017 return and think about how they might change in 2018. Potential tax benefits drive a lot of financial decisions for many taxpayers. They can influence whether you buy a home, when you pay your state income taxes or property taxes, how much you donate to charity and how much tax you have withheld from your paycheck.
Tax returns have many moving parts, and itemized deductions are only one of the many items affected by the 2017 Tax Cuts and Jobs Act. It’s important to understand how the new law will shape your tax situation in 2018 and beyond.