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How the OBBBA’s New Rules Can Slash Your Capital Gains Tax in 2027

Posted on by UMMC

The One Big Beautiful Bill Act (OBBBA) has fundamentally reshaped the tax-advantaged investment landscape by making the Qualified Opportunity Zone (QOZ) program permanent. For taxpayers sitting on significant capital gains in 2026, the strategy for when to sell and reinvest has shifted dramatically. Under the new OBBBA rules, waiting until 2027 to reinvest can unlock far superior benefits compared to the original framework.

The 2026 “Dead Zone” vs. the OBBBA Era – For several years, the tax benefits of the original Opportunity Zone program have been phasing out. While the core benefit of tax-free growth after 10 years remains, other incentives like gain deferral are nearing a “cliff.”

Under the original rules, any capital gain reinvested into a Qualified Opportunity Fund (QOF) must be recognized for tax purposes no later than December 31, 2026. This means that if you invest a gain today in a QOF, your tax deferral lasts less than a year. Furthermore, the 10% and 15% basis step-up benefits, which reduce the amount of deferred gain you eventually pay tax on, are currently unavailable for new 2026 investments because the required holding periods cannot be met by the fixed 2026 deadline.

Why Waiting Until 2027 Matters – The OBBBA introduces a rolling five-year deferral period for investments made on or after January 1, 2027. Instead of a fixed deadline, your deferred gain is recognized on the fifth anniversary of your investment date. Additionally, these new rules restore the 10% basis step-up for everyone who holds their investment for five years.

Taxpayers realizing gains in 2026 should consider structuring sales so that the 180-day reinvestment window falls in 2027, allowing them to bypass the “dead zone” of 2026 and qualify for the vastly superior OZ 2.0 incentives.

Unpacking the OBBBA Tax Benefits – The One Big Beautiful Bill Act (OBBBA) that became law on July 4, 2025, offers a powerful three-tiered tax incentive for investors who reinvest eligible gains into QOFs starting in 2027.

  • Rolling Gain Deferral: For investments made after December 31, 2026, the OBBBA replaces the fixed 2026 recognition date with a rolling timeline. You can defer paying federal tax on your original gain until the earlier of:
    o The date you sell or exchange your QOF investment.
    o The fifth anniversary of the date you made the investment.
  • The 10% (or 30%) Basis Step-Up: If you hold your QOF investment for at least five years, you receive a permanent 10% increase in your basis. This effectively functions as a 10% discount on your original tax bill—you only pay tax on 90% of the deferred gain.
    For those who invest in the newly created Qualified Rural Opportunity Funds (QROFs), this benefit is even more significant. Rural investments receive a 30% basis step-up after five years, meaning 30% of your originally deferred capital gain becomes completely tax-free.
  • Tax-Free Appreciation (The 10-Year Rule) – The most potent benefit of the program remains: if you hold your QOF investment for at least 10 years, any appreciation on that new investment is 100% free from federal capital gains tax. This includes the elimination of depreciation recapture.

What Gains Qualify and How Much to Invest? One of the most common misconceptions about QOFs is that you must reinvest the entire sale proceeds. This is not the case.

  • Only the Gain is Required: To receive the full tax benefit, you only need to invest the taxable gain portion of your sale, not the principal (your original basis).
  • Eligible Gains: You can defer both standard capital gains and qualified Section 1231 gains (gains from the sale of depreciable property used in a trade or business). Unlike a Section 1031 exchange, which is limited to real estate, QOFs allow you to reinvest gains from the sale of stocks, bonds, businesses, art, or any other appreciated asset.
  • Section 121 gains: Even Section 121 gains (gains from the sale of a primary residence) are fully eligible for reinvestment into a Qualified Opportunity Fund, to the extent the gain exceeds the amount excluded from taxation. Thus, any gain remaining after applying the $250,000 ($500,000 for married filing joint) home gain exclusion is a qualifying gain. To qualify for the full Sec 121 gain exclusion, you must have owned and used the home as your primary residence for 2 of the 5 years counting back from the sale date.

Both short-term and long-term capital gains are eligible for reinvestment into a Qualified Opportunity Fund (QOF). The program does not distinguish between the two; essentially any gain that would be treated as a capital gain for federal income tax purposes qualifies for deferral.

Timing and the 180-Day Rule – Timing is the most critical component of QOF compliance. Generally, you have 180 days from the date of the sale that generated the gain to reinvest that gain into a QOF.

  • Pass-through Entities – For taxpayers with gains from pass-through entities (like partnerships or S corps), there is additional flexibility. These taxpayers can often choose to start their 180-day clock on:
    • The date the entity recognized the gain.
    • The last day of the entity’s tax year (typically December 31).
    • The un-extended due date of the entity’s tax return (typically March 15 of the next year for calendar year entities).

This flexibility is vital for 2026 planning. A gain realized by a partnership in early 2026 might still be eligible for QOZ investment in 2027 under the new OBBBA rules, provided the taxpayer uses the March 15 starting point for their 180-day window.

Where Are the Funds Invested? QOFs must invest at least 90% of their assets in Qualified Opportunity Zone Property, which includes:

  • QOZ Business Property: Tangible property (like real estate or equipment) used in a trade or business within a zone.
  • QOZ Stock or Partnership Interests: Equity in a business that operates primarily within a zone.

How Do Taxpayers Invest in QOFs?

  • Syndicated Funds: Invest in existing funds managed by institutional players who handle compliance, asset selection, and the “90% asset test”. Generally, this is the method used by individual taxpayers.
  • Self-Certified Funds: Create your own corporation or partnership to invest in your own project. You must file Form 8996 annually to self-certify that the entity meets the 90% asset requirement. Generally, this method would be employed by real estate developers, high-net-worth utilizing personal capital gains and similar circumstances.

Estate Planning and Other Considerations – The QOZ program is an exceptional tool for both tax and estate planning.

  • Estate Planning: While the QOZ investment does not receive a traditional “step-up in basis” at the owner’s death, the deferred gain is treated as Income in Respect of a Decedent (IRD). This means the heirs will eventually owe the tax on the original deferred gain, but they also inherit the potential for tax-free appreciation on the QOF investment itself.
  • The 30-Year Frozen Step-Up: The OBBBA caps the tax-free appreciation benefit at 30 years. For investments held longer than 30 years, the basis is “frozen” at the fair market value on the 30th anniversary of when the taxpayer made the investment. Any growth after that 30-year mark may be subject to tax.

If you are anticipating a major capital gain in 2026, the difference between an “end-of-year” sale and a “new-year” reinvestment could be worth 10% to 30% of your total tax liability. Please contact the Leesburg or Warrenton office if you have questions or would like to discuss your particular situation with a tax professional.

Do you Qualify for Sports Expenses and Deductions for Your Child?

Posted on by UMMC

A child’s and their parent’s sports expenses, from registration fees and travel to equipment and volunteer time, sit at the intersection of personal, medical, charitable and business tax rules. For tax minded parents the key is sorting each cost into the correct box, documenting it carefully, and understanding the limited circumstances when a deduction or credit is available. This article walks through the major categories: possible child care treatment, charitable contributions and volunteer out of pocket expenses, medical expense exceptions, and when a child’s sport activity can be treated as a business.

As a Child Care Expense:

The child and dependent care credit (and associated employer provided dependent care benefits) is aimed at expenses that enable a parent (or parents) to work or look for work. Eligible care is generally custodial care for a qualifying individual, most commonly a child under age 13.

  • What Counts: Fees for day camps and similar custodial programs generally do qualify as dependent care expenses if the care is primarily custodial and not mainly educational. Day camps that provide supervision during work hours often meet the test. Overnight camps are not eligible.
  • What Does Not Count: Tuition for lessons, private coaching, sports camps that are primarily instructional (i.e., teaching athletic skill rather than providing care), summer school and tutoring are treated as educational and therefore do not qualify. Likewise, kindergarten or private school tuition is not eligible.

If a program combines athletic instruction and custodial care, only the portion of the cost allocable to custodial care is eligible. This requires reasonable allocation and substantiation in the event of a tax audit.

Charitable Contributions:

Donations to youth sports nonprofits and quid pro quo payments:

  • Cash donations: parents who make true gifts of money to a qualified 501(c)(3) youth sports organization can claim an itemized charitable deduction for the donated amount (subject to the usual AGI limits and substantiation rules). If the taxpayer receives a benefit in return — e.g., a ticket to a fundraiser or a uniform — only the amount that exceeds the fair market value of the benefit is deductible (a quid pro quo contribution).
  • Payments to Participate: Fees paid to register a child for a nonprofit’s program are usually payments for services (considered program fees) rather than pure charitable gifts. If the registration is essentially a payment for admission or participation, it is not a deductible charitable contribution. Where a program has a subsidized “scholarship” option or a voluntary donation component, only bona fide voluntary gifts to the nonprofit qualify.
  • Substantiation: Get the organization’s name, EIN, the amount, and contemporaneous written acknowledgement for any single donation of $250 or more. Document any benefits received and the fair market value estimate for non-cash donations.

Volunteering Parents: Unreimbursed Out of Pocket Expenses:

  • Deductible Volunteer Expenses: While the value of donated time or services is not deductible, many out of pocket costs incurred while volunteering for a qualified charity are deductible as charitable contributions. Examples include:
    • Supplies and equipment purchased for the nonprofit (e.g., marking cones, field maintenance supplies) that you donate.
    • Uniforms required by the organization that are not suitable for everyday wear.
    • Travel costs incurred while performing volunteer duties (e.g., transporting equipment or players or traveling between sites). For automobile use, volunteers generally may deduct either actual out of pocket costs or charitable mileage rate set by Congress, which has been 14 cents per mile for many years. A mileage deduction isn’t allowed if the volunteer’s own child was among those being driven
    • Lodging and meals when the travel is away from home overnight for the charity (subject to the usual business vs personal tests and substantiation).
  • What is Not Deductible: The fair rental value of allowing a charity to use your property (see next section), and the value of your time. The costs of items purchased specifically for use by your child participating in the activity (e.g., a baseball glove or uniform) aren’t deductible.
  • Substantiation: Keep receipts, mileage logs showing date, purpose, miles driven and the charity’s name, and written acknowledgements for donated items.

Use of an Asset by a Charity: No deduction is allowed for mere use. Core rule: allowing a charity to use an asset you own (lending your field, permitting a nonprofit to use your boat, computer or home for activities) is not the same as donating the asset. The IRS generally disallows a charitable deduction for the value of the use of property.

  • Donation vs. Use:
    • Deductible: If you transfer ownership of tangible property (e.g., you donate sports equipment, you convey the field or transfer title to an asset), the value of that contributed property may be deductible (subject to normal rules about basis, fair market value, and limits), provided you itemize your deductions rather than claiming the standard deduction.
    • Not deductible: If you simply let the nonprofit use your private tennis court for tournaments for a season but retain ownership and the right to reclaim use, you cannot deduct an imputed rental value or the “use” of the court.

Practical nuance: If you rent your property to a nonprofit at a below market rate, the difference between fair market rent and the amount charged could be considered a charitable contribution only in narrow circumstances and requires careful valuation and documentation; consult counsel.

Medical Expense Exception:

Prescribed activities for children with special needs may meet the definition of medical expenses that are primarily for the prevention or alleviation of a physical or mental disability or illness and may be deductible to the extent they exceed the floor (7.5% of adjusted gross income). The expense must be primarily medical in nature.

  • Sports and therapy: In very specific cases a doctor’s prescription that a child undertake a particular physical activity (for example, therapeutic horseback riding, specialized swimming therapy, or adaptive sports training) may make related costs deductible as medical expenses. To meet the IRS standard:
    • There must be a written recommendation or prescription from a licensed medical professional stating the medical necessity.
    • The activity must be primarily for medical care or treatment, not merely general health or recreation.
    • Costs must be reasonable, ordinary for the treatment, and not reimbursed.
  • High bar and examples: A physician prescribing therapeutic horseback riding for a child with cerebral palsy could support deductibility of fees and certain related costs (lessons, specialized equipment) if well documented; by contrast, ordinary travel to recreational soccer practice for a child with asthma would not meet the medical necessity threshold.
  • Documentation: Keep the physician’s prescription, notes showing the medical condition and treatment plan, invoices, receipts and any program descriptions demonstrating the therapeutic nature of the activity.

When a Child’s Sport Becomes a Business:

Profit motive matters. If a child participates in a sport with a bona fide profit objective (e.g., competing for significant prize money, endorsement deals, or providing paid coaching services), the activity could be a trade or business. In which case:

Income (prize money, sponsorships, appearance fees, Name, Image, and Likeness (NIL) deals for college athletes) is taxable.

Related ordinary and necessary business expenses are deductible against that income if the activity is carried on for profit. If the activity is classified as a hobby, expenses are not deductible.

  • Self Employment (SE) Tax: Net earnings from a child’s self employment (including independent contracting for sports appearances or coaching) are subject to self employment tax if above thresholds — remember this can create both income tax and SE tax obligations.
  • Kiddie Tax and Earned Income: Wages and business income earned by a child are considered earned income and generally are not subject to the “Kiddie Tax” rules that apply to unearned investment income.
  • NIL Income for College Athletes: Payments for name, image and likeness are taxable. Whether the compensation is treated as wages received as an employee or independent contractor income depends on the arrangement. College athletes receiving NIL payments should report them and keep records; some NIL arrangements generate self employment tax and the need to issue/receive 1099 forms.

Please contact the Leesburg or Warrenton office you if need assistance or would like to discuss your particular situation with a tax professional. Leesburg office 703-771-1818 or the Warrenton office 540-347-5681.

Important Tax Information And Strategies To Help Understand The Kiddie Tax Code

Posted on by UMMC

“Kiddie Tax” is a term that refers to the tax imposed on the unearned income of children. It was Introduced as part of the Tax Reform Act of 1986.

The Reason Behind Kiddie Tax – Its primary purpose is to prevent families from exploiting a lower tax rate by shifting income to their children to take advantage of lower tax brackets. Before the introduction of this tax, children could receive significant interest and dividend income while paying minimal taxes due to their low-income tax threshold. This situation encouraged high-income families to shift assets to their children solely to reduce their tax liabilities.

By taxing a child’s unearned income above a certain threshold at the parent’s tax rate, the government aimed to eliminate this method of income shifting, thus ensuring fairness in the tax system.

Here’s a comprehensive exploration of the Kiddie Tax, its implications for filing, and various strategies to consider.

Please Note: The various numbers used in this material are for the 2026 tax year and they are annually adjusted for inflation and may be different for other years.

The Difference Between Earned and Unearned Income

  • Earned Income (Work): Money received as pay for work performed is termed earned income. Examples include wages, salaries, tips, and self-employment (like babysitting or lawn mowing).
  • Unearned Income (Assets): Generally, unearned income consists of all income that is not earned from work. Examples include taxable interest, dividends, capital gains, rents, royalties, and taxable scholarships not reported on a W-2.

To Which Children Does the Kiddie Tax Apply? – A child is generally subject to the kiddie tax if they meet ALL the following conditions:

  • Age Requirements:
    Under age 18 at the end of the year,
    Age 18 at the end of the year, if their earned income (wages/tips) did not provide more than half of their own support, OR
    Between ages 19 and 23 and a full-time student, if their earned income did not provide more than half of their own support.
  • Income Threshold: Unearned income exceeds $2,700. Unearned income generally refers to investment type income as opposed to earned income from employment (W-2) or being compensated for personal services.
  • Parental Requirement: At least one of the child’s parents was alive at the end of the tax year. This is because the parent’s income tax rate is used to compute the kiddie tax. Where the parents are divorced the living parent is the custodial parent.
  • Filing Status: The child is required to file a tax return and does NOT file a joint return for the year.

Who Is a Living Parent? – Besides a biological parent here is a discussion related to other possibilities:

  • Adoptive Parents – For tax purposes, an adoptive parent is treated the same as a biological parent. If a child is legally adopted, the kiddie tax applies as long as at least one adoptive parent is alive at the end of the year.
  • Step-Parents – A step-parent is generally considered a “parent” for these rules if they are married to the child’s biological or adoptive parent. If the child lives with a step-parent and a biological/adoptive parent, the tax applies based on their joint income.
  • Foster Parents – While foster parents can claim a child as a dependent for other credits (like the Child Tax Credit), they are not considered “parents” for the kiddie tax requirement. If a child’s only “living parents” are foster parents, the kiddie tax generally does not apply.
  • Guardians – Legal guardians (such as grandparents or other relatives) are not considered “parents” under these specific IRS rules unless they have legally adopted the child. If a child’s biological and adoptive parents are deceased, the kiddie tax does not apply, even if they have a living legal guardian.

Specific Exemptions and Exceptions – The kiddie tax does NOT apply if ANY of the following is true:

  • Self-Support: The child (aged 18-23) has earned income that covers more than half of their own financial support (includes food, shelter, clothing, medical care, and tuition), or
  • Marital Status: The child is married and files a joint tax return, or
  • Living Parents: Neither of the child’s parents was alive at the end of the tax year, or
  • Income Type Exception: The tax only applies to unearned income. All “earned income” (salaries, wages, tips) is taxed at the child’s own individual rate, regardless of the amount.
  • 529 College Savings Plan Exception: Earnings from Sec 529 college savings plans are generally exempt from the kiddie tax if used for qualified education expenses.

Overview of Filing Options – When it comes to filing taxes for children with unearned income, families have two main options:

  1. Filing a Child’s Own Tax Return:
    Child’s Only Income is Unearned Income: If their unearned income exceeds $2,700 and their parents do not elect to include the child’s unearned income on their return. The unearned income is taxed in three distinct layers:
    First $1,350: Not taxed (covered by the child’s standard deduction).
    Next $1,350: Taxed at the child’s own tax rate (usually 10%).
    Above $2,700: Taxed at the parents’ marginal tax rate, which can be as high as 37%.
    Both Unearned and Earned Income: The child must file their own tax return.
    Earned Income – Is taxed entirely at the child’s individual tax rate, but subject to a standard deduction which is the greater of $1,350 or the child’s earned income plus $450, not to exceed the regular standard deduction of $15,750.
    Unearned Income – Only unearned income is subject to the “kiddie tax”. It is taxed in three tiers
    First $1,350: Generally tax-free as it is covered by the child’s standard deduction.
    Next $1,350: Taxed at the child’s marginal tax rate (typically 10%).
    Amount over $2,700: Taxed at the parents’ marginal tax rate.
  2. Including Child’s Income on Parent’s Return:
    Parents can opt to include their child’s income on their tax return by using Form 8814. This option is available provided the child’s only income is from dividends, interest, and capital gain distributions, the child’s gross income is less than $13,500, no income tax was withheld from the child’s income, and no estimated tax payments were made for the child.
    This method can simplify the filing process but may lead to higher tax liabilities due to the consolidation of income.
    The child’s unearned income is taxed as follows:
    First $1,350: Not taxed (covered by the child’s standard deduction).
    Next $1,350: Taxed at the child’s own tax rate (usually 10%).
    Above $2,700: Taxed at the parents’ marginal tax rate, which can be as high as 37%.
    This may seem to be the same way it is taxed on the child’s return. However, this is where consolidating the parent’s and a child’s income may cause an increase in the tax on the parent’s income.

Note: In all three possible filing scenarios, the unearned income itself is taxed in the same manner.

Strategies for Minimizing Kiddie Tax

  1. Invest in Growth-Oriented Assets: Consider investing in securities that offer capital appreciation rather than current income, such as growth stocks. These do not produce immediate taxable income but may yield benefits long term.
  2. Defer Income: Utilize investments like U.S. savings bonds where interest can be deferred until redemption, thus postponing tax liabilities.
  3. Use Tax-Advantaged Accounts: Contribute to accounts like 529 plans, where earnings are tax-free if used for education, therefore avoiding the Kiddie Tax.
  4. Leverage Qualified Trusts: Income from a qualified disability trust may be considered earned income for Kiddie Tax purposes, potentially lowering the tax burden.

Conclusion
Navigating the complexities of the Kiddie Tax requires a clear understanding of the rules and thoughtful analysis of each family’s financial situation. By considering filing options and understanding the implications of both, parents in conjunction with their tax professional can make informed decisions that minimize or eliminate the kiddie tax. Please contact us in our Leesburg (703-771-1818) or Warrenton (540-347-5681) offices if you need further information or assistance.

If You Are Thinking About Selling Your Life Insurance Policy, Consider These Potential Tax Issues Before You Do

Posted on by UMMC

When watching television, you’ve probably seen those advertisements promising quick cash for unneeded life insurance policies. These commercials often target those who might not see the need for policies anymore, offering substantial financial returns. While these transactions can indeed serve as a financial option, especially for those in need of immediate liquidity, the process of selling a life insurance policy—known as a life settlement—comes with a labyrinth of financial implications, particularly around taxes. Let’s explore the various facets involved with life settlements, from potential settlement amounts, tax issues related to policy disposition, and end with a look at viatical settlements for individuals with health concerns.

Life Settlements: What to Expect – A life settlement involves the sale of a life insurance policy to a third party for more than its cash surrender value but less than its net death benefit. The proceeds from a life settlement can offer policyholders much-needed liquidity for retirement, debt repayment, or other financial obligations.

Reasons for Considering a Life Settlement – include:

  • Funds are needed to pay medical or long-term care expenses,
  • The insured can no longer afford the premiums,
  • The primary beneficiary has died, and the policy is no longer needed,
  • The insured got divorced,
  • Business circumstances have changed, and the coverage is no longer needed to fund a buy-sell agreement, and
  • Expected death tax costs have been reduced or eliminated and the coverage is no longer needed to pay death taxes.

Potential Settlement Amounts – The amount you receive from a life settlement will depend on various factors, including your age, health condition, and the type and size of the policy. Some reports say that the average payout is 10%-35% of the face amount of the policy but they can vary widely. Generally, the older the policyholder or the poorer their health, the higher the settlement offer tends to be, as the buyer of the policy will receive the payout from the death benefit sooner. However, these transactions typically yield a payout that is significantly less than the death benefit of the policy but more than the surrender value.

Disposition of a Policy: Surrender or Sale – When it comes to disposing of a life insurance policy, policyholders have two primary options: surrendering the policy or selling it.

  • Policy Surrender – Surrendering a policy means you’ll cancel the insurance and in exchange the insurance company will pay you the policy’s cash value, net of any redemption fees specified in the contract. If there is no cash value, there is no payment to the policyholder. This option can be straightforward, especially with term policies that typically do not accumulate cash value. However, surrendering a policy could result in tax implications, particularly if your cash surrender value exceeds the total premiums paid.
  • Sale of a Policy – If you opt to sell your policy, particularly if there’s substantial cash value involved, this could prove more financially beneficial than surrendering. When a policy with or without cash value is sold, the policyholder can receive a better return. However, the financial upshot includes intricate tax consequences that aren’t immediately evident.

Tax Implications for Policyholders – IRS taxes life settlement proceeds using a three-tier system.

  • Premiums Paid: Returns up to the amount of the premiums paid generally aren’t taxed.
  • Taxable Gain Ordinary Income: Proceeds up to the policy’s cash surrender value over the amount of premiums paid are taxed as ordinary income.
  • Capital Gains Tax: Amounts that exceed the cash surrender value are subject to capital gains tax.

Example 1 – Surrender of Policy – John held a life insurance policy that accumulated cash value over time. After eight years, he decided to surrender the policy, receiving its cash value of $78,000. This amount included a deduction of $10,000 for the “cost of insurance.” Over the life of the policy, John had paid a total of $64,000 in premiums. Consequently, John realized a gain of $14,000, calculated by subtracting the premiums paid ($64,000) from the cash surrender value ($78,000). Because surrendering a life insurance policy does not yield a capital gain, this $14,000 is considered ordinary income for tax purposes.

Example 2 – Sale of Policy with Cash Value – Consider the same initial scenario, but instead of surrendering the policy, John sells it to George, an unrelated party who has no personal financial stake in John’s death. John receives $80,000 from the sale. This results in a gain of $16,000, calculated by subtracting the premiums he paid ($64,000) from the sale price ($80,000). Of this gain, $14,000—the amount by which the cash value exceeds the premiums paid—is considered ordinary income. The remaining $2,000 is classified as a capital gain.

Viatical Settlements: A Specific Scenario – Any amounts received under a life insurance contract on the life of a terminally ill individual are excluded from tax gross income. Excludable amounts received under a life insurance contract by chronically ill individuals are limited to the cost of qualified long-term care services.

Definitions:
Terminally Ill Individual – the term “terminally ill individual” means a person who has been certified by a physician as having an illness or physical condition that reasonably can be expected to result in death within 24 months of the date of certification.
Chronically Ill Individual – a “chronically ill” individual is one who has been certified within the previous 12 months by a licensed health care practitioner as:

  • (A) being unable to perform, without “substantial assistance” from another individual, at least two activities of daily living for at least 90 days due to a loss of functional capacity,
  • (B) having a similar level of disability as determined under IRS regulations prescribed in consultation with the Dept of Health and Human Services, or
  • (C) requiring “substantial supervision” to protect the individual from threats to health and safety due to “severe cognitive impairment,” even if the individual is physically able.

Information Reporting – All parties involved in life settlement deals must adhere to IRS requirements for information reporting. This includes Form 1099-LS for life settlement transactions and Form 1099-SB for surrendering a policy or being part of a life settlement.

Final Thoughts – Life settlements, viatical settlements, and the broader financial implications they involve are complex. With overlapping rules and potential financial advantages, navigating these waters requires a thorough understanding of not only the transactions themselves but the ever-evolving tax implications they incur. Don’t hesitate to reach out for tailored advice or to discuss your specific situation. Please contact us in our Leesburg (703-771-1818) or Warrenton (540-347-5681) offices if you need further information or assistance.

Potential Tax Benefits From Medically Related Home Improvements

Posted on by UMMC

The year 2025 marked a significant milestone in the United States. Why? Because a record number of people reached the age of 65. On average about 11,400 Americans turned 65 every day of the year 2025. This demographic shift, largely driven by the baby boomer generation, has implications for retirement planning, healthcare, and the economy at large.

The U.S. Centers for Disease Control and Prevention (CDC) has stated that falls are the leading cause of injuries among people age 65 and older, and nearly 30% of older adults reported falling at least once in the preceding 12 months. To help minimize falls, and to accommodate age-related infirmities, many people are adding grab bars in showers, modifying stairways, widening hallways to accommodate a wheelchair, and other projects to make the home safer and more accessible for older occupants. If you are planning to make such home improvements, you may be eligible to include the costs as a medical expense for income tax purposes.

Generally, the costs of home improvements are not deductible except to offset home gain when the home is sold. But a medical expense deduction may be claimed when the primary purpose of the home modification is for a medical reason. The tax law says that deductible medical expenses are those paid for the “diagnosis, cure, mitigation, treatment, or prevention of disease, and the costs for treatments affecting any part or function of the body.”

So, if you are making the modifications because you, your spouse, or a dependent has a medical need for doing so, then the modification expense may be deductible as a medical expense, but only to the extent that it exceeds any resulting increase in the home’s value.

Even though a prescription from a doctor for most medically related home modifications isn’t required, the taxpayer, if questioned by the IRS, needs to be able to demonstrate how the expenditure relates to his or her medical care or that of a spouse or dependent. And having a letter from the individual’s doctor that explains the type of modifications that would be medically beneficial would help to prove a medical need.

Not all improvements result in an increased home value. In fact, some, such as lowering cabinets for an occupant confined to a wheelchair, could decrease the home’s resale value.

The IRS has identified certain improvements that don’t usually increase a home’s value but for which the full cost can be included as a medical expense. These improvements include, but are not limited to, the following items:
• Constructing entrance or exit ramps for the home,
• Widening doorways at entrances or exits to the home to create space for walkers and wheelchairs.
• Widening or otherwise modifying hallways and interior doorways,
• Installing railings, support bars, or other modifications,
• Lowering or modifying kitchen cabinets and equipment,
• Moving or modifying electrical outlets and fixtures,
• Installing porch lifts, stairs lifts and other forms of lifts.
• Modifying fire alarms, smoke detectors, and other warning systems,
• Modifying stairways,
• Bathroom modifications including grab bars, lower sinks, and roll-in showers,
• Adding handrails or grab bars anywhere,
• Modifying hardware on doors,
• Modifying areas in front of entrance and exit doorways,
• Grading the ground to provide access to the residence, and
• Flooring modifications, including non-slip surfaces or leveling floors to prevent falls
Only reasonable costs to accommodate a home to a disabled condition or to an elderly individual are considered medical care costs. Additional costs for personal preferences, such as for architectural or aesthetic reasons, are not medical expenses (but could be additions to the home’s tax basis).

Unfortunately, the total of all medical expenses can be deducted only to the extent that they exceed 7.5% of the taxpayer’s adjusted gross income (AGI) and only if the taxpayer itemizes deductions. With the current high value of the standard deductions, fewer than 15% of taxpayers are expected to currently itemize their deductions. So even if a medically needed home improvement is made and qualifies to be deducted, only a small percentage of taxpayers will end up with a tax benefit because of the expenditure.

All is not lost, though. To the extent that the taxpayer doesn’t claim the expense as an itemized deduction, the improvement costs, including those that might not meet the medically necessary standard, can be added to the home’s purchase cost to determine the home’s tax basis. Thus, when the home is sold, the capital gain from the sale will be lower. Either to substantiate the currently deductible improvements or with a future home sale in mind, taxpayers should be sure to keep records of the home improvements they make, including the receipts for the costs. Maintaining “before and after” photos is also recommended.

Hot Tub Deduction Issues: When exploring the realm of medically deductible home improvements, it’s nearly impossible to avoid the intriguing discussions around the attempts to classify home hot tubs as medical expenses. Taxpayers frequently explore innovative strategies to lower their tax obligations, and one common tactic involves claiming a hot tub as a medical expense.

These efforts often sit at the intersection of necessity and luxury, challenging both tax laws and personal morality in the quest to alleviate the burdens of medical costs. Understanding what qualifies as a legitimate medical home modification means delving into the creative strategies employed by taxpayers to include items like hot tubs in their deductible expenses, bringing to light broader questions about health-related tax benefits and individual needs.

While it is indeed feasible to claim a hot tub as a deductible medical expense, the process is intricate and must adhere to stringent IRS guidelines. The primary use of the hot tub must be for medical treatment rather than for general wellness or leisure activities. This presents considerable tax challenges and requires clear documentation to satisfy IRS conditions, emphasizing that the primary function is health-related rather than for enjoyment or relaxation purposes. Here are the critical tax considerations and guidelines

• Primary Use: The fundamental requirement is demonstrating that the hot tub’s main function is for the “diagnosis, cure, mitigation, treatment, or prevention of disease.” Expenses that simply enhance general well-being do not qualify for a deduction.
• Medical Confirmation: A detailed prescription or recommendation from a licensed physician, specifying the medical condition (such as arthritis, chronic back pain, or fibromyalgia) and explaining how hydrotherapy will aid treatment, is crucial for IRS verification. Notes from chiropractors or non-MD practitioners are generally insufficient.
• Capital Expense vs. Property Value Enhancement: The IRS regards a hot tub as a capital expense, akin to a home improvement.
If its installation leads to an increase in property value, only the portion of the cost that surpasses this enhancement is deductible. An appraisal might be necessary to determine the exact increase.
If the hot tub does not elevate the home’s value (for example, a portable unit), the entire expense might be deductible.

Example: A doctor recommends that his patient with severe arthritis have daily hydrotherapy, and so the individual has a hot tub installed at a cost of $21,000. The individual then hires a certified home appraiser to determine how much the hot tub addition increased the home’s value. The appraiser concludes the increase is $20,000. The individual’s medical deduction for the year the hot tub is installed will be limited to $1,000 ($21,000 – $20,000). The other $20,000 of expenses will increase the home’s basis, meaning that it will add to the home’s cost and will offset the sales price when the home is sold.

• Threshold for Deductible Amounts: Medical expenses, including the hot tub, are deductible only if they exceed 7.5% of your Adjusted Gross Income (AGI). Many taxpayers may not surpass this threshold, effectively negating the deduction.
• Apportioning for Personal versus Medical Use: If the hot tub is utilized by other family members or enjoyed for reasons unrelated to the medical condition, only the portion of costs that corresponds to its medical use are deductible.
• Reasonable Cost: The IRS may closely examine the size and expense of the hot tub. A modest, functional spa is easier to justify than a large, luxurious built-in model with a costly customized deck, which might imply a recreational intent.
• Record Keeping and Audits: Thorough documentation is essential. Keep all receipts related to the purchase, installation, and maintenance (such as electricity, chemicals, repairs). In a potential audit, a taxpayer will need to provide medical evidence, the doctor’s prescription, and possibly a usage log to demonstrate its primary medical purpose.


It is also noteworthy to mention these same issues would apply to swimming pools, saunas, elevators and the like.

If you have questions related to this deduction and whether you will benefit, tax-wise, from any medically related home modifications, please contact our Leesburg (703-771-1818) or Warrenton (540-347-5681) offices for further assistance.

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