Today, I want to show an example of an unusual even that had a very large tax impact. While this specific example is very rare, the principles behind the story apply to most of our clients. Every few decades there is always something really big that comes around that you never forget. Everyone has a few of those years in their lifetime. I bet you never thought about the tax implications of those high impact years.
At Molen & Associates (est. 1980) we’ve prepared over 25,000 tax returns in just the last ten years. I personally have prepared thousands of tax returns in that span of time and I’ve seen some very unusual things. In this post I’d like to share with you one particular case that required in depth research of not just the law, but also court cases and other precedent.
The Case
One day I received a call from a long-time client – we’ll call them the Smith family. They had a daughter with severe cerebral palsy and had just met with her doctor for a routine check-up. The doctor noticed that she had begun to increase her motor skills in some small, but surprising ways. He advised the Smiths that they should provide their daughter with a handicap accessible pool to help further stimulate these motor skills.
Medically Necessary
Mr. Smith then made one of the best financial decisions he would make that year, he called me. He asked if there could be any tax deduction for building a handicap accessible pool in his backyard. I gave him some general advice but also told him that I would need to spend some time researching the specifics. In the meantime, per my advice, he contacted the doctor and had him write what was essentially a prescription for the handicap accessible pool. This was a crucial piece of this case; we needed the doctor to determine that this pool activity was medically necessary.
Research
While Mr. Smith was working with the doctor, I was researching court cases to find precedent for the deduction. What I found was very unique and a little unusual. I called Mr. Smith to get the specific details and to explain what we could use and how. What we needed to do was have the home professionally appraised before the construction of the pool began, and then have it appraised again immediately after it was finished. The increase in Fair Market Value (FMV) of the home would have to be taken out of the deduction, as it was considered permanent value added to the home itself. That being said, any Realtor or person who has paid to have a pool built can tell you, what you pay for a pool is not typically recovered when selling your home. A portion of it maybe, but not the full investment. For the Smith’s case, we’d need to remove the portion of the pool that did increase the FMV from their tax deduction.
The Numbers
Let’s take a look at the specifics.
- Expected cost of the pool: $30,000 (shallow entry, handicap bars, etc.)
- Home FMV Appraisal before construction: $150,000
- Home FMV Appraisal after construction: $160,000
The increase in FMV of the home due to the building of the pool is removed from the deduction. The deduction started at $30,000 but then we removed the $10,000 increase in FMV, allowing a deductible portion of $20,000.
One important piece to understanding this specific case study is knowing how medical deductions work. Please click the hyperlink for another post illustrating how and when medical deductions are applicable, as I won’t go in depth here. Suffice it to say, you must exceed 7.5% of your Adjusted Gross Income (AGI) in medical deductions before even a penny of it is ultimately deductible. In this specific case, the Smiths had regular monthly medical expenses due to their daughter’s condition. Those expenses alone exceeded the 7.5% threshold, which meant the full $20,000 was applicable.
Now, to determine how much the pool deduction actually saved them let’s do some math. They have a $20,000 medical deduction and are in a 25% tax bracket. By deducting the $20,000 they remove $20,000 of income from being taxed at that 25% rate. $20,000 x .25 = $5,000. That one single phone call from Mr. Smith saved him $5,000.
Case Closed
The catalyst to all of this was Mr. Smith picking up the phone to talk with his tax professional about a major financial event. I couldn’t possibly have known that this was happening without that call. What could have happened if Mr. Smith didn’t call before he moved forward with the pool? Had he waited to talk with me when he came in to do his taxes for that year, he would not have known that he needed a professional appraisal prior to the building of the pool, which would then mean that he would have lost some or all of the viability of the deduction.
Did you have any major financial events this past year? Will you in the coming years? At Molen & Associates we pride ourselves on our accessibility outside of tax season. Our phones ring constantly as our clients have important, sometimes life-changing, financial events and need real answers to real questions. If you’re looking for a tax professional team to advise you more often than your yearly tax appointment, give us a call at (281) 440-6279 today.
Kevin Molen
Tax Manager
