Tax time: Saving money at home

@FortuneMagazine July 7, 2011: 11:02 AM ET
Best tax deductions will be found in the home.

FORTUNE -- Anybody who has raised children, supported elderly parents, or even just owned a house knows how costly (albeit rewarding) they can be. But this year the home front is where easy-to-overlook tax breaks can be found.

Let's start with the grim side. In Greenwich, Conn., an 11,500-square-foot mansion recently sold in foreclosure for $4.6 million, $2.6 million below the asking price. It was a reminder of how hard even the affluent have been hit by tough times. In fact, houses worth more than $1 million had a higher rate of foreclosure in 2010 than those under, according to CoreLogic.

But that former owner faces a potential double whammy. Short sales and foreclosures both involve debt forgiveness. That vaporized debt -- the difference between what was owed on the mortgage and what the bank received in the sale -- can be viewed as income. It's not a problem for most people who sold their principal residence at a loss in 2010. They should qualify for up to $2 million in mortgage debt forgiveness with no tax, according to CCH, which creates tax software.

The trouble comes if you weren't living in the house or you rented it out. Then it might not be considered your personal residence. "If you mess that one up, it's real bad," says Bill Smith, managing director of the national tax office at CBIZ MHM. "You think, 'I lost my home, and it can't get worse,' and then you get a 1099 saying you owe another $15,000 for cancellation of debt income." While it could be too late if you lost your home last year, people who are considering short sales or strategic defaults this year should weigh the tax consequences if the home is not their main residence.

Another domestic deduction: a credit for 30% of the cost of newly installed energy-efficient heating systems, including labor and materials for solar panels, wind energy, geothermal heating systems, and the like, all of which are quite expensive.

Then there's a tax break for the so-called sandwich generation, those paying for children and parents. It's generous but hard to qualify for. "If you're paying more than half of the support for your parents or adult children and they don't make more than $3,650 a year [not counting Social Security]," says Kathy Pickering, executive director of the Tax Institute at H&R Block, "then they can be claimed under the qualifying relative exemption." If their income falls under that line, a portion of their support -- including food, lodging, and medical care -- can be deducted.

For those who turned 70½ in 2010, there's a reminder. After a one-year hiatus, the required minimum distribution for traditional retirement accounts has returned: Withdraw that amount before April 1 or face a penalty equal to 50% of the shortfall. Lyle Benson, president of L.K. Benson & Co., a CPA and financial-planning firm, notes that people who don't need that income but don't want to pay taxes on the distributions can donate $100,000 per person from their IRA to charity, which could satisfy their minimum distribution.

With a presidential election next year and tax policy ever more in play, the landscape will probably change again in two years. So take the breaks while you can because, as Smith says, "long-term planning is currently a thing of the past."  To top of page