Deductions: Itemized Deductions
Personal, living or family expenses are disallowed by the IRC; Section 262.
However, Congress specifically allows some deductions for expenses which are
essentially personal in nature. “Itemized Deductions” are deductible from AGI and
are reported on Schedule A, Form 1040. The discussion in this chapter does not
apply to trade and business deductions, which are usually deductible on other
schedules, without regard to limitations.
o Amounts paid for the diagnosis, cure, mitigation, treatment or for the
prevention of disease for the purpose of affecting any structure or
function of the body; for transportation primarily for and essential to
medical care, and for insurance for medical care for the taxpayer(s)
or dependent(s). The cost of cosmetic surgery directed solely at
improving appearance does not qualify.
o Capital expenditures are deductible only to the extent that the cost
exceeds any increase in the FMV of the property, e.g. elevator.
o Transportation and lodging expenses are deductible if primarily and
essential to medical care, NOT including the cost of meals while
away from home receiving medical care. The current deduction for
medical mileage is 16.5¢ per mile. Parking fees and tolls are
deductible. Lodging costs are limited to $50 per night per eligible
o Only medical expenses paid by the taxpayer and not reimbursed are
o Cost of in-patient hospital care, including cost of meals and lodging is
deductible, as are nursing home expenses for eligible patients.
o Cost of prescribed medicines and drugs are deductible; over-the-
counter medications are not deductible.
o Medical insurance premiums paid for medical care insurance is
deductible. Long-term care insurance is deductible based on the
policy and age of the taxpayer, as is the medical care portion of the
cost of qualified continuing-care facilities.
o Medical expenses are deductible only in the year paid. Subsequent
reimbursement is reported as income in the year received, to the
extent of the attributable deductions allowed in the prior year (Tax-
o Only qualified medical expenses over 7.5% of AGI are deductible.
This AGI “floor” usually precludes deducting medical expenses,
except in dire circumstances or more often in elderly medical care.
Medical expenses 4,300
Floor (.075 x $40,000) (3,000)
Net Medical Expense Deduction $1,300 !!
o Real property taxes paid to state, local, and foreign governments
- Deductible only by the person upon whom the tax is assessed.
- Assessments as opposed to a tax, are not deductible
- Real estate taxes must be allocated among between the buyer
and the seller of real property in the year of sale by using a
o Personal property (ad valorem - based on value) taxes paid to state &
o Income taxes (or general sales taxes for the years 2004 through
2009 – future? TBD) that are paid to state, local, and foreign
governments – again, subject to the Tax-Benefit Rule.
o Interest is the amount which one has contracted to pay for the use of
borrowed money. Only specified types of interest are deductible, and
the amount deductible is often limited. The uses of loan proceeds
must be traced to determine the deductibility of any interest on the
loan. Loans used for personal or consumer purposes result in
personal interest which is not deductible.
o Qualified education loan interest up to $2,500 per year is an above-
the-line deduction, is subject to phase-out rules, and was discussed
in Chapter 6.
o Qualified Residence Interest
o Mortgage interest secured by the taxpayer’s principal or
second home (a home that is not rented out for the greater of
14 days or 10% of the number of days it is rented [vacation
o Qualified residence interest is deductible up to $1 million of
acquisition indebtedness – the debt to purchase or improve
any qualified residence. These rules are complex and are very
often misunderstood by taxpayers.
o Home Equity Indebtedness is borrowing up to $100,000
against the equity of a qualified residence. Hence, qualified
residence interest is limited to a total indebtedness of $1.1
million. The proceeds of equity loans may be used for any
purpose, but deductibility is subject to Alternative Minimum
Tax rules, discussed in Chapter 9.
o Qualified mortgage insurance premiums, subject to AGI
limitations (maximum AGI: $100,000, MFS $50,000) is
deductible as mortgage interest ( supposed to end in 2010).
o Investment Interest
o Interest on debt incurred or continued to purchase or carry
property held for investment, for example: stocks, bonds and
raw land, but not for investments earning tax exempt interest.
o Investment interest is deductible only to the extent of net
investment income (investment income less investment
expenses) earned by the taxpayer.
o Prepaid Interest – Points
o Cash and accrual taxpayers must deduct prepaid interest over
the life of a loan.
o Points are considered additional interest charges usually
connected with the application/approval of a loan. They are
deducted over the life of the loan unless they are points paid in
connection with the purchase or improvement of a loan
secured by the taxpayer’s principal residence. Points for this
type of loan may be deducted currently if they are common to
the area and carry a “standard” interest rate.
o Points paid on refinanced home loans are deductible only over
the life of the loan. Any unamortized points are deductible
when the loan is paid off, e.g. another refinance or if the
property is sold.
o Points paid by the seller may be deducted by the buyer, but
the buyer must agree to reduce the basis of the new house by
the seller paid points.
o Contributions made to qualified domestic organizations in the year
o Qualified organizations are defined in Code Section 501, see
Paragraph 8301, page 8-13, and must meet specific requirements in
order to be exempt from taxation.
o Gifts made directly to an individual or earmarked for a specific
individual are generally not deductible.
o Contributions may be made in cash or property. Any contributed
property must be valued at the Fair Market Value of the property.
o Many restrictions exist on contributions. The amount of any
deductible contribution must not include a personal benefit to the
o The FMV of contributed services is not deductible.
o Unreimbursed expenses, including automobile expenses (at 14¢ per
mile – statutory amount) incurred in travel and transportation to
perform charitable services are deductible.
o Charitable contributions are limited to 50% of AGI for public charities
with disallowed amounts carried over for up to five years. Complex
rules exist for private charities and contributed capital gain property. It
is important to review the Charitable Contribution Percentage Limits
presentation and example at Paragraph 8325, pages 8-18 thru 8-20.
o Records must be maintained for all contributions. All monetary
contributions must be supported by a cancelled check, bank record,
or written communication from the charity; and if $250 or more, the
contribution must be acknowledged in writing by the charity.
Contributions of property, at FMV, must be listed separately if over
$500, and appraisals must be attached to the tax return if over $5,000
for one item, or a group of similar items, excepting traded
securities. The amount of motor vehicle, boat or airplane deductions
is limited to the amount the charity receives for the item when it is
sold by the charity, and if the charity keeps it for its own use, the FMV
is the deductible amount of the contribution.
Casualty and Theft Losses
o Uninsured losses arising from fire, storm, shipwreck, or other sudden
(not progressive deterioration) unexpected, identifiable and provable
events of an unusual nature are deductible subject to incident and
o Each personal casualty loss is subject to a $100 (it was $500 for
2009) reduction, per event, and 10% of AGI. The effect of these limits
for uninsured losses means that few taxpayers qualify to deduct a
o If the damaged property is insured, a claim must be filed before
deducting a casualty loss which is then still subject to the limitation
o Theft losses are treated as sustained in the year discovered, and are
subject to the same limitation rules.
Miscellaneous Itemized Deductions
o The following deductions are all limited to the aggregated amount
that is in excess of 2% of AGI. As a result of this limitation, few
taxpayers are eligible to take these deductions:
Reimbursed and unreimbursed employee business expenses
were discussed in Chapter 6.
Job-seeking expenses are deductible if the taxpayer is
seeking employment in the same trade or business.
Deductions include, travel and transportation, preparation of
resume, mailing expenses, employment agency fees, etc.
Education expenses are deductible if incurred by the taxpayer
to maintain or improve skills that are required in the current
job. If the education qualifies the taxpayer for a new trade or
business, the expenses are not deductible (including a CPA
review course). If the education expenses are incurred to meet
the employers minimum educational requirements, the
expenses are not deductible. Do not confuse itemized
deduction education expenses with above-the-line qualified
education expenses. See paragraph 8665.
Work clothes and uniforms are normally not deductible except
for special equipment or clothes which are required as a
condition of employment and not suitable for everyday use.
Other miscellaneous itemized deductions:
Dues to professional societies
Union dues and expenses
Subscriptions to professional journals
Small tools and supplies
o Investment Expenses
Investment expenses are deductible if incurred for the
production or collection of, or for the management,
conservation, or maintenance of property held for the
production of income.
An exception to the 2% of AGI rule is rental and royalty
income. These types of incomes are above-the-line
deductions and are used to reduce gross rents and gross
royalties, and are reported on Schedule E along with all other
expenses related to the rents or royalties.
Miscellaneous investment expenses are deductible under
Code Section 212, and are subject to the 2% of AGI limitation.
These expenses include:
Safe deposit box rental fees that is used solely to
safeguard investment documents and items; not
personal documents or other personal items.
Investment counseling fees.
Subscriptions to investment publications.
Legal and accounting fees related to investments.
Expenses related to attending investment conventions,
seminars, or similar meetings are not deductible.
Office-in-Home deductions may not be taken, and do
not qualify as an investment deduction for a taxpayer
who manages their investment portfolio from their
Depreciation on a computer used exclusively for
portfolio management and administration is deductible.
o Tax Counsel and Return Preparer Fees
Expenses paid or incurred by an individual in connection with
the determination, collection or refund of any tax are
Fees and expenses paid for tax counsel, tax preparation fees,
proceedings involved in the determination of, or contesting a
tax liability, are deductible subject to the 2% of AGI limitation.
Tax preparation fees for an individual taxpayer may be
allocated among several schedules, e.g. Schedule A, Itemized
Deductions; Schedule C, Sole Proprietorship; or Schedule E,
Rents and Royalties, depending on the type and scope of tax
preparation services. To insure some deductibility of the fees
paid by the taxpayer, the minimum fee a good CPA should
charge for tax preparation work should be not less than
o Items NOT subject to the 2% of AGI Limitation
Wagering Losses are allowed as a miscellaneous itemized
deduction, not subject to the 2% limitation, but only to the
extent of gambling winnings. Professional gamblers may
deduct their losses as a business expense, but only to the
extent of their winnings, e.g. a zero net profit; no deductible
loss off-setting other income.
Excess deductions in the final year of an estate are passed
through to the beneficiary(s) of an estate.
If a taxpayer dies before recovering all of the after-tax
contributions made to an annuity, the remaining
unrecovered cost of the annuity can be deducted as a
miscellaneous itemized deduction, not subject to the 2%
limitation on the deceased taxpayer’s final tax return.
The following is an example of the application of the 2% of AGI rule:
AGI = $50,000, therefore, 2% of AGI is : $1,000
Miscellaneous Itemized Deductions :
Unreimbursed business miles (1,000 miles x 50¢ /mile $ 500
Unreimbursed client entertainment expenses ($320 x 50%) 160
Tax preparation fees (EA Not CPA) 350
Union dues 200
Safe deposit box fees 70
Total miscellaneous deductions $1,280
Less: 2% of AGI ( 1,000)
Net deduction $ 280
This information is presented for your information only. This explanation and
example of the previous rules related to the reduction of itemized deductions is
NOT effective for 2010, but is likely to return in 2011:
The limit on total allowable itemized deductions – a reduction by 3% of the amount
of AGI over a specified amount (assume $200,000 MFJ) was introduced in Chapter
3. This limitation did not apply to medical expenses, casualty losses, investment
interest or wagering losses to the extent of wagering gains. The reduction could not
exceed 80% of the total amount of itemized deductions reported on Schedule A.
Itemized deductions: Deductible Taxes $10,000
Qualified Mortgage Interest 45,000
Total Itemized Deductions $55,000
Adjusted Gross Income $ 320,000
Less base (assumed) (200,000)
Excess $ 120,000
Times reduction of 3% x .03
Tentative reduction $ 3,600
Limit on reduction - lesser of:
80% of $55,000 $ 44,000
Tentative reduction $ 3,600
Actual Reduction (Disallowed) $ 3,600
Allowed Itemized deductions:
Itemized deductions $ 55,000
Reduction (Disallowed) ( 3,600)
Schedule A adjusted Itemized deduction $ 51,400
This decrease in otherwise qualified deductions naturally results in higher
taxable income, aimed at perceived high-income taxpayers. It is often called a
stealth tax increase, as is the same type of decrease which was applied to the total
exemption amount, because it is not readily apparent to, or understood by, normal