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How To Plan Your Itemized Deductions

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By grouping two years of itemized deductions into one year, it may be possible to get the benefits of both itemized deductions and the standard deduction. If you can time when you pay deductible expenses, you can take advantage of that flexibility to bunch your deductions in one year and then claim the standard deduction in the next.

Since the increased standard deduction, it can be difficult for many taxpayers to have enough itemized deductions to make it worth itemizing. For many taxpayers, it will be best to simply take the standard deduction. But for taxpayers whose itemized deductions are close to the new standard deduction, there may be more planning needed to take better advantage of their deductible expenses.

I will dig into these different deductions separately below, explaining how each deduction works and how to use timing to your advantage.

Mortgage Payments

Mortgage payments have a minimum of two components: the interest and the principal. For some homeowners, property taxes and insurance are included via escrow. If you have escrow, do yourself a favor and call your mortgage company about removing it. You don’t need to be providing them an interest-free loan. If you have the self-control to save up for your annual property tax and insurance bills and actually pay them on time, you should do it without escrow.

The way to bunch deductions on your mortgage would be to make one mortgage payment early every other year.

Confirm with your mortgage company or servicer that you can indeed make early payments before the due date. Also, make sure that they would be applied as a mortgage payment rather than an extra principal payment. In late December, you can make a payment to satisfy your January payment. By paying it in the current year, you pull forward a portion of interest into this year. Essentially, you’re getting 13 interest payments in one year and the next year you’ll get 11.

Property Taxes

Following the same principle above, if you pull forward a property tax payment into the current year, you can get two times your annual property taxes as a current year deduction.

Once again, you’ll need to confirm this with your local tax assessor. Some jurisdictions are not set up to accept these early payments. In my county, next year’s tax assessment doesn’t occur until May. I base my prepayment on my prior-year tax bill and will pay any deficiency when the actual bill comes out.

Note: You can’t do this if you are paying escrow with your mortgage payment. This is because the mortgage company is aggregating your property tax payments and making those payments on your behalf.

The IRS recently came out with guidance saying that prepaying property taxes before you even receive an assessment or bill wouldn’t be deductible, so I would make sure your property is assessed already before you make the payment. The assessment could differ from when you receive the bill. Do some research to see whether there may be a mismatch in timing that proves beneficial for deductions.

Income Taxes

If you’re self-employed and/or pay estimated tax payments, you can time these so you double up on deductions too. Paying your 4th quarter estimated taxes in December will pull forward the deduction into the current year. If you double it up with paying a year in January, you can get five payments in one year.

Note: With the new tax bill, property and income tax deductions are limited to $10,000. Have a high income or high property tax bill? Doubling up on deductions for income or property taxes may not be possible given this limitation. The alternative minimum tax used to be an issue here but it is no longer. The AMT thresholds are so high that you’re likely to be over the $10,000 limitation and therefore losing deductions already.

Charitable Giving

There are two ways to plan your charitable giving to bunch your deductions. Either actually give every two years or use a Donor Advised Fund (DAF). With a DAF, you can give a large amount in one year and distribute the funds in the future. Therefore, this may be a more appealing option. Especially if you would like to keep your contributions to charities steady instead of lumpy.

For example, you can give $10,000 this year and distribute $2,000 per year out to your normal charities going forward. This way, you can pull forward five years’ worth of donations into the current year. Fortunately, the charities continue to receive their annual receipts. If you’re just trying to bunch your deductions every other year to coincide with your taxes and mortgage payments above, doing a DAF contribution every two years may be the best option.

Opening A Donor Advised Fund

The mechanics of opening a Donor Advised Fund (DAF) vary based on the organization you use, but with Schwab Charitable, who I’m most familiar with, it’s just like a new brokerage account. You fund the DAF with a minimum of $5,000 and pick an investment option. I would strongly recommend going more conservative than your normal investment mix. You’re no longer investing your money, rather the charity’s money. Often, we will just invest the funds in a money market account!

Note: There are fees associated with these accounts (0.6% in Schwab’s case–$30 per year on a $5,000 account). You should compare the fees with your expected tax savings.

Once the funds are in the account and you’d like to make the distribution, you just instruct the charitable fund (in this case Schwab Charitable) to distribute on your behalf. They’ll write a check out to the organization–as long as it is a recognized 501(c)3.

DAF Contributions

It’s important to note that DAF distributions cannot be used to meet any pledge obligations. Keep that in mind if you’ve already got a pledge established or plan to. Make a pledge and hope to use this method to satisfy it.

Finally, one of the other great benefits of a DAF is to make contributions of appreciated stock. Use appreciated stock and get a charitable deduction for the fair market value (limited to 30% of AGI) without having to incur the gain on the sale. Afterward, you can use the cash you would have otherwise given to the charity to repurchase the shares that you gifted, at a higher cost basis!

Practical Application–The End Result

In my case, our itemized deductions were just above the new standard deduction amount. With these timing techniques, I’m pulling forward roughly $8,000 worth of deductions into the current year. In the end, I’ll have about $35,000 of itemized deductions this year. Next year when my deductions decrease to roughly $19,000, I’ll take the standard deduction of $24,000 instead. All told, I’ll be paying the same amount out of pocket at $54,000 over two years, but will get credit for deductions of $59,000!

The new standard deduction for 2019 is $24,400 and 2020 is projected to be $24,800. The exact number doesn’t come out from the IRS until December so that ups those numbers a little bit.

If you’d like further reading on this subject, I recommend Michael Kitces’ article on all the changes in the tax bill. He discusses this strategy of bunching deductions near the bottom of the article. But, I’m sure you’ll want to read the whole thing for the pleasure!

How To Plan Your Itemized Deductions

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Choose FI has partnered with CardRatings for our coverage of credit card products. Choose FI and CardRatings may receive a commission from card issuers. Opinions, reviews, analyses & recommendations are the author’s alone, and have not been reviewed, endorsed or approved by any of these entities. Disclosures.
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