[This is the eighth article in a series about tax tips for small businesses and individuals.]
We probably don’t have to tell you – and you don’t have to tell your clients – how difficult it is to claim a deduction for medical expenses under current law. Prior to 2013, the deduction was limited to excess of your qualified expenses above 7.5% of adjusted gross income (AGI), a daunting threshold for most. And now the floor for medical deductions has been raised to 10% of AGI (remaining at 7.5% for taxpayers age 65 or over, but only through 2016).
This means it will usually take at least one significantly large expense to push a taxpayer over the deduction threshold. But it’s still possible and it doesn’t have to be a calamity either. In fact, the family might even benefit from some summer recreation at the same time.
Here’s the background information: To qualify as a deductible medical expense, the cost must be incurred primarily for prevention or alleviation of a physical or mental defect or illness. On the other hand, if the expense is merely beneficial to your general health or well-being, you can’t deduct the cost. For example, if you install a swimming pool for your children to frolic in during the warm weather, no deduction is allowed, even though they’re getting some much-needed exercise away from their video games and computers.
However, there’s a silver tax lining if the pool is needed by a family member to alleviate arthritis or some other specific illness. For a medically-necessary improvement made by a homeowner, the deductible amount is equal to the cost above the corresponding increase in the home's value. In addition, the annual maintenance costs associated with the pool — chlorine, repairs, utilities, cleaning services, etc. -- also qualify for the deduction. Note that the entire cost of a qualified improvements, plus the maintenance costs, is deductible by tenants.
Suppose that your client has an AGI of $150,000 and $12,000 in unreimbursed medical expenses in 2014. His doctor has ordered him to start swimming laps in a pool to improve a heart condition. The client builds an in-ground pool in his backyard for $25,000, but a local realtor says it will increase the value of the home by only $15,000. Previously, the client could not claim any medical expense deduction because the $12,000 total is less than 10% of his AGI, or $15,000. But when he adds the $10,000 write-off for pool, the total increases to $22,000. Now he can deduct $7,000 in medical expenses ($22,000 - $15,0000) on Schedule A of Form 1040.
A few other common examples of home improvements that may be deductible as medical expenses are air conditioning installed to alleviate a child's asthma, an elevator constructed for an adult who can’t walk up stairs and special modifications for a disabled person. Again, no deduction is allowed for purely cosmetic changes.
Best approach: Obtain a written appraisal from an independent real estate professional establishing the increase in a home's value due to an improvement. Also, if a physician prescribes a home improvement to alleviate or treat a medical condition, get the recommendation in writing. Keep these documents on file in case the IRS ever challenges the deduction.