Tax Planning

Grad pupil’s inventory switch sensible tax planning

Q: I am 28 years old and single. I worked full-time through the end of 2020 and then went back to school to finish a master’s degree. My job wasn’t challenging and I felt it exposed me to COVID risk. My father was very supportive of my decision and told me he wanted to pay for my degree. He transferred $60,000 of stock to my name so I could pay tuition and living expenses. He paid $22,000 for this stock. His accountant says that with no other income in 2021, I can pay zero capital gains tax on the gain I had from the sale. Because I did not need all of the money in 2021, I bought back half of the shares after sale. The idea was that I could get an adjustment to the cost of the repurchased shares by buying them back and pay no tax on the sale. I have been told by another accountant that buying the shares back will mean that half of the capital gains will not be reported in 2021 and I will keep my father’s cost in those shares. I bought back on the same day and the other guy tells me I had to wait 31 days. Thoughts?

A: I like your plan. It works exactly as your father’s accountant told you. You will have no capital gains tax if your total taxable income is $40,400 or less.

The repurchase will reset the tax base, used to measure a future gain or loss, to the amount you paid to repurchase the shares.

Your family was able to use your 2021 tax situation to avoid tax on the appreciation on the shares that your father gifted to you. That is great tax planning.

The other accountant is referring to something called the “wash sale” rule. That rule applies only when a sale produces a loss. The loss is denied if the shares are repurchased within 30 days.

The wash sale rule does not apply when the sale produces a gain. This is why your strategy works even with the repurchase.

Q: I refinanced the loan on my personal residence last year and paid $4800 in points. IRS Schedule A refers to home mortgage interest and points paid. This appears to allow points to be deducted. But I read online that this is not the case when the points are paid for a refinanced loan. I will itemize my deductions this year but may not next year so this might be a big difference for me.

A: Unless you used proceeds of the refinance loan to improve the home you will not be able to deduct the points paid.

Interest can only be deducted in the time period to which it relates. If interest is prepaid the deduction must be spread across the time periods covered by the loan.

This is a general principle of tax law. Rules may have exceptions when Congress wants to benefit a certain activity or sector of the economy.

Owning a principal residence (your “main” home) allows for a few special tax breaks. One is the ability to deduct prepaid interest (“points”) when paid.

This special rule applies only to the loan used to purchase the home. However, it also includes building or improving a home.

When you first bought the home you probably paid points on the acquisition loan. Those points were deducted when paid.

Your refinance loan is not treated the same. The “theory” is that the new loan was done for personal reasons rather than as a condition of buying the home.

If you used any of the proceeds to improve the home it is treated similar to purchasing or building a home. Points on that share of the loan are immediately deducted.

If you did not make any improvements, the prepaid interest must be spread over the term of the new loan.

If your refinance loan is itself refinanced, you can write off any points on the first refinance that were not already deducted.

This is not a special break. If the loan goes away so do the points. Points on the second refinance must be spread over the term of that loan.

James R. Hamill is the director of tax practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at jimhamill@rhcocpa.com.

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