3 percent itemized deduction phase-out rule

Taxpayers with adjusted gross income (AGI) above a certain amount may lose part of their deduction for personal exemptions and itemized deductions. The provision began in the early 1990s and will be repealed in 2010. The itemized deduction reduction originally required reducing your deductions by 3% of the amount your AGI exceeds the limit amount.

Beginning in 2006, the overall limit on certain deductions was phased out. Under this phase-out rule, the cap was lowered by one-third in 2006 and will be lowered by one-third in 2007, so the 3% phase-out is reduced to 2%. In 2008 and 2009, the 3% elimination will be reduced to 1%. The reduction will be removed in 2010.

For 2007, the amount you can claim as a deduction for exemptions is reduced once your AGI exceeds a certain level for your filing status. The threshold is indexed annually for inflation.

These levels are the following:

Married filing separately – $117,300.

Single – $156,400.

Head of household -$195,500.

Married filing jointly – $234,600.

Qualifying widow(er) – $234,600

You must reduce the dollar amount of your exemptions by 2% for every $2,500, or part of $2,500 ($1,250 if married filing separately), that your AGI exceeds the amount shown above for your filing status. However, he cannot lose more than 2/3 of the dollar amount of his exceptions. In other words, each exemption cannot be reduced to less than $1,133.

You may ask, “Am I subject to this limit?” The IRS considers you subject to the limit on certain itemized deductions if your AGI is more than $156,400 ($78,200 if married filing separately). Your AGI is the amount on Form 1040, line 38.

The following deductions are subject to the overall limit on itemized deductions:

1) Taxes

2) Interest paid

3) Gifts to charity

4) Work expenses and certain miscellaneous deductions

5) Other miscellaneous deductions (excluding gambling and casualty or theft losses)

The following deductions are NOT subject to the overall limit:

1) Medical and dental expenses

2) Investment interest expense

3) Losses due to acts of God and theft of goods for personal use

4) Casualty losses and theft of income-producing property

5) Gambling losses

You can use the Itemized Deduction Worksheet in the instructions for Schedule A (Form 1040) to figure your limit. You will enter the result on Schedule A (Form 1040).

You must compare the amount of your standard deduction with the amount of your itemized deductions after applying the limit. Use the larger amount when completing Form 1040, line 40.

To determine how to calculate your limit and see examples, visit www.real-estate-owner.com/itemized-deduction-reduction.html.

Also, to see an example of a worksheet used to determine what you can deduct, visit www.real-estate-owner.com/itemized-deduction-reduction-worksheet.html.