An Overview of Itemized Deductions: Definition, How to Claim & Limitations

An Overview of Itemized Deductions: Definition, How to Claim & Limitations
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If you're looking for a way to cut down your tax bill, claiming itemized deductions could be a suitable alternative to taking the standard deduction for your filing status. Rather than getting a certain guaranteed amount, you'd need to claim qualified expenses, meet the Internal Revenue Service rules for each and provide the total amount on your tax return form. As a result, you can get the benefit of having a lower taxable income.

Learning all about itemized deductions helps you know when, how and why to itemize.

Understanding Itemized Deductions

To understand how itemized deductions work and why they can help certain taxpayers, it's helpful to understand tax deductions in general. When determining your taxable income, the IRS adds up all your income sources and then accounts for above-the-line deductions first to get you a lower adjusted gross income. These include things like education expenses and certain retirement contributions.

After that, you have below-the-line deductions that are subtracted from the adjusted gross income to get you a lower taxable income subject to federal income tax, but your Medicare and Social Security taxes don't change.

Itemized deductions are included in the below-the-line deduction category and help you get tax savings for expenses such as out-of-pocket medical care, mortgage interest, property taxes, certain miscellaneous expenses, charity gifts, various state and local taxes and various other types of interest.

The amount you can deduct is personalized to your tax situation and the expenses you can show for the year. The IRS sets rules for when and how you can deduct such costs, so not everybody qualifies, and many choose to take the standard deduction.

Figuring all your itemized deductions can be difficult, but the IRS has provided a tax form called Schedule A that lists many common deductible expenses and walks you through calculations for each. Claiming itemized deductions often requires consulting other tax forms you receive and may even require additional IRS forms to figure the total amounts. It also means keeping close track of receipts, bank statements, credit card statements and other documents to back up your claims.

Itemized deductions are included in the below-the-line deduction category and help you get tax savings for expenses such as out-of-pocket medical care, mortgage interest, property taxes, certain miscellaneous expenses, charity gifts, various state and local taxes and various other types of interest.

Comparing to the Standard Deduction

The standard deduction serves as the very popular alternative to itemizing, as you can get a large deduction with far less work than itemizing and without the need to have incurred any special expenses. This option is usually available to you unless your spouse itemizes, you're filing for a partial year, you're a special entity like a partnership or trust, or you have an alien status.

You get the same effect as itemizing in that the deduction leads to a lower taxable income, and you don't need to fill out Schedule A. However, keep in mind you can't claim your itemized expenses if you go with this option.

When it comes to amounts, single taxpayers can get a ​$12,400​ standard deduction in 2020 along with those married and filing separately. The amount doubles to ​$24,800​ for married couples who file jointly and goes up to ​$18,650​ for a head of household. However, special rules apply to dependents, the elderly and the blind. For example, dependents can get as little as ​$1,100​, while the other groups can get between ​$1,300​ and ​$1,650​ extra.

Popular Types of Itemized Deductions

When itemizing, you can only deduct qualifying expenses, and this means also knowing the limits and calculations required.

Here are some popular itemized deductions to know about:

  • Charity contributions​: The IRS encourages giving to charities by letting you deduct up to a portion of your AGI for cash and non-cash donations. To qualify, you need to make sure the charity is registered with the IRS and keep all documentation; certain donations need an appraisal to help determine value. Usually, deduction limits range from ​30 to 60 percent​ of your AGI, but the Coronavirus Aid, Relief and Economic Security Act has included some temporary changes. For example, the deduction limit goes up to ​100 percent​ for cash donations this year, and people not itemizing can even deduct ​$300​ through an above-the-line deduction.
  • Dental and medical expenses​: Whether you've had medical and dental expenses for you or others on your tax return, the IRS allows you to itemize them as long as they're not reimbursed by insurance and you can meet a threshold based on your adjusted gross income. The total expenses need to be more than ​7.5 percent​ of your 2020 AGI, and at that point, you can deduct whatever exceeds that number. As an example, let's say you had a ​$20,000​ bill for surgery, and ​7.5 percent​ of your AGI was ​$10,000​. This would mean you can claim ​$10,000​ of the medical expense as an itemized deduction. IRS Publication 502 can guide you as you decide what you can and cannot deduct.
  • Mortgage interest​: When you get Form 1098 from your lender, you can find the home mortgage interest expense you incurred and deduct it as long as you're the owner and you follow the IRS limits based on mortgage debt and filing status. For example, people who bought homes before December 15, 2017, can qualify to deduct the interest they paid on the first ​$1,000,000​ in mortgage debt, but if they're married filing separately, that limit goes down to ​$500,000​. People who bought their home later can get the deduction with ​$750,000​ in mortgage debt unless they're married and filing separately, which would cut that to ​$375,000​. You may also be able to deduct your property taxes. Other forms of interest expense may also be deductible.
  • Casualty and theft losses​: If a federal disaster the President has declared led to a personal property loss, this deduction could help you. If your event qualifies, then you need to meet a ​10 percent AGI​ threshold for the loss as well as subtract ​$100​ from the loss amount. Otherwise, you can't claim it. Note: This category covered undeclared events like floods, fires, vandalism and tornadoes in general prior to the 2017 tax changes.
  • Various taxes​: The IRS places a ​$10,000​ limit (​$5,000​ for taxpayers who are married filing separately) on deductions for various types of state and local taxes. So, you can easily deduct up to that amount in property taxes, sales tax and local and state income taxes.
  • Private mortgage insurance​: Besides your mortgage interest, the IRS lets you deduct private mortgage insurance for mortgages started on January 1, 2007 and beyond. This deduction temporarily expired but has returned. Income limits do apply before this PMI deduction gets phased out or eliminated. For example, those filing as single, heads of household and married filing jointly usually see a phaseout at a ​$100,000​ AGI and elimination at ​$109,000​. The limits are half these amounts for married taxpayers filing separately.
  • Gambling losses​: Whether you've lost money playing the lottery, poker or casino games, you can deduct losses and even carry them forward if necessary. However, keep in mind you also need to report what you win gambling, and the IRS doesn't let you deduct more than you won. This means you may only win $1,000 and lose $10,000, but you can just deduct $1,000. This can make the gambling deduction less appealing.

Knowing Whether to Itemize

Depending on your tax situation, deciding to itemize can be a simple or difficult process. For example, you have no other option if you're married filing separately and your spouse itemized, or if you fall into one of the other categories of people excluded from taking the standard deduction. It can also be an easy decision if you checked your standard deduction amount and knew right away you've incurred expenses far beyond that figure.

When the answer is less clear, the IRS recommends going ahead and filling out Schedule A to see what number you end up with. Particularly, it recommends considering itemizing when you've had large individual expenses like a big property tax or medical bill or donated a significant amount to charities.

Since itemized deductions can be complex, it's helpful to consult a tax professional as they can go through the form and provide a suggestion more quickly. However, online tax services can show you the better deduction option if you answer the questions presented; this is often an automated process where the software or website chooses which option gives a bigger number.

Claiming Itemized Deductions

When itemizing on your tax return, reporting the deduction is as simple as putting the amount on line 9 of your Form 1040. However, you need to go through and complete Schedule A to get that number, and the IRS provides instructions that can walk you through each section and deduction category you need to know about. This guide also includes worksheets that help you figure out the amounts for individual deductions.

Here's a basic walkthrough of what you see on Schedule A:

  • Form header​: You need to put your legal name and Social Security number here.
  • Medical and Dental Expenses​: This section has you enter your total unreimbursed dental and medical expenses, transfer over your adjusted gross income, use the ​7.5 percent multiplier​ and subtract to get the amount that qualifies based on your income.
  • Taxes You Paid​: There are several lines where you enter state and local income taxes, real estate taxes, property taxes and sales taxes. Since these are subject to either ​$5,000 or $10,000 limits​ based on filing status, you can do the math to determine the smaller amount. You can then add additional qualified taxes to get the total you can deduct.
  • Interest You Paid​: This section covers mortgage interest and points for which you may or may not have received a Form 1098. It also addresses investment interest and mortgage insurance premiums; these may require using a worksheet or completing an extra form to figure. You get to total all of these.
  • Gifts to Charity​: Following the IRS guidance on which contributions qualify, how much you can deduct and which need additional documentation, you enter the amounts for cash and noncash gifts along with any carryover you have from a past tax year to get a total charitable contribution deduction.
  • Casualty and Theft Losses​: You first need to fill out the first page of Form 4684 with information about your property and the federally declared disaster that led to a loss. You get your final number on ​line 18​ and can transfer that over to this section on Schedule A.
  • Other Itemized Deductions​: You get a few lines to declare the amounts for other types of deductions, such as unrecovered investments, gambling losses and certain federal estate taxes.
  • Total Itemized Deductions​: After you add up the totals for each category, you get the financial itemized deduction amount for ​line 17​. Lastly, you need to check the box for ​line 18​ if the standard deduction amount exceeds your itemized deductions but you're still itemizing anyway.

With Schedule A complete, the number from line 17 goes on Form 1040 ​line 9​ to help bring you to a lower table income on ​line 11b​. But before you transfer the number, consider the standard deduction amount to ensure you get the most tax savings.