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The Concept of Itemized Deductions
Oct 16, 2022 By Triston Martin

To itemize your deductions, you must first compile a list of your deduction-eligible expenditures, add up all of those expenditures, and then submit that sum on your tax return. To determine the final amount of taxable income, the entire amount of itemized deductions are deducted from the AGI.

If you want to itemize your deductions on your tax return, you should maintain careful records of the eligible expenditures you incurred during the year. Save all your receipts and other documentation if the Internal Revenue Service requests evidence that these costs were appropriate. Bank statements, check stubs, real estate tax statements, insurance bills, medical bills, and appreciation letters for charity gifts are all documents that may be used as documentation. In general, you are permitted to make claims for itemized deductions in the following categories:

  • Medical and dental expenditures
  • Taxes imposed at the state and municipal levels
  • Taxes on real estate as well as personal property
  • Interest on home mortgages that are less than $750,000
  • Donations to good causes
  • Losses incurred due to accidents or theft

Medical and Dental

Insurance premiums are considered part of both medical and dental expenditures as long as the cost of those premiums is not covered by your health insurance plan. If they are considered eligible expenditures, fees for other medical treatment and dental care might be subtracted. For your taxes in 2021, you may deduct the amount that is more than 7.5% of your adjusted gross income. For example, if your adjusted gross income was $55,000 and you incurred $7,000 in qualified medical costs, you would only be able to deduct $3,375 of those expenses since this is the amount that is more than $4,125, which is 7.5% of your AGI.

Local, State, and Real Estate Taxes

TCJA limits the amount deducted for the state, local, and property taxes to $10,000 or $5,000 if the taxpayer is married but filing a separate tax return. This is $10,000 overall, not $10,000 for each sort of tax.

Mortgage Interest Deduction

The maximum amount of debt that may qualify for the mortgage interest deduction is $750,000. The limit is $375,000 if you are married yet file your taxes separately. If you incurred the debt on which you are now paying interest before December 16, 2017, the restrictions would rise to $1 million and $500,000, respectively.

This deduction can only be claimed for acquisition debt, not equity debt, as was the case historically. The only exception to this rule is if the funds from the equity loan are used to "buy, build, or substantially improve" a home, as stated by the IRS. This restriction was imposed by the Tax Cuts and Jobs Act (TCJA).

Charitable Gifts

Although certain kinds of donations remain subject to 20%, 30%, and 50% restrictions, most taxpayers can deduct charitable contributions of up to 60% of their adjusted gross income (AGI).

How Does an Itemized Deduction Work?

You can either take the standard deduction or itemize your yearly expenditures when you file your taxes. You may choose either one. You can calculate the entire amount of your eligible costs if you itemize them.

You may minimize the income required to pay federal income tax by taking advantage of both the standard deduction and the sum of your itemized deductions. You have the option of claiming the standard deduction or itemizing the specific deductions that you are eligible to claim — line by line — but you cannot claim both simultaneously. It only makes sense to go with the option that minimizes the amount of your income subject to taxation.

The easier approach is the standard deduction, a predetermined amount depending on your filing status. When the Tax Cuts and Jobs Act became law in 2018, it more or less quadrupled the number of deductions considered standard.

The standard deduction for single or married taxpayers but filing separate returns will be $12,550 beginning with the tax year 2021 (which will be the return filed in 2022). If you are married and filing jointly with your spouse or if you are an eligible widow or widower with a dependent child, this amount increases to $25,100. If you are eligible to file as a head of household, the amount is $18,800.

Most taxpayers took the standard deduction even before the Tax Cuts and Jobs Act (TCJA). The TCJA made various changes to several itemized deductions, including restricting them to particular amounts that had been unlimited before. Other itemized deductions were completely removed from the equation. As a direct consequence, the percentage of taxpayers who itemized their deductions in 2019 fell from 31.1% to 13.7% due to the legislation being implemented.