Tax deductions are valuable tools that reduce the amount of your income that's subject to taxation. They can save you money—but sometimes, you might not be able to fully utilize all your deductions within a single tax year. This article will explain what happens to those unused deductions and provide strategies to help you make the most of them.
Why You Might Not Be Able to Use a Full Deduction in the Current Year
Imagine you've been diligently collecting receipts for charitable donations throughout the year, eager to reduce your tax bill. But come tax season, you realize you haven't earned quite enough income to fully benefit from all those deductions. What happens to those unused deductions?
This is a surprisingly common scenario. Tax deductions are a fantastic way to lower your tax liability, but there are situations where you might not be able to use the full amount in a single year. Let's explore why this might happen.
One reason is deduction limits. The government sets specific caps on how much you can deduct for certain expenses. For instance, there are limits on itemized deductions, like those for mortgage interest or state and local taxes (SALT).
Another reason is simply not having enough taxable income. Deductions can only reduce your taxable income, not create a tax refund that's bigger than the taxes you've already paid. So, if your deductions are higher than your income, you won’t be able to fully utilize the deductions.
What Happens to Unused Deductions?
Carryovers
Some deductions are eligible for “carryover.” This means that if you couldn't use the full deduction amount this year, you may be able to carry the remaining portion over to future tax years. Some examples include:
- Capital losses
- Charitable donations that exceed a certain percentage of your adjusted gross income
- Net operating losses for businesses
- Home office deductions that exceed your business income (for self-employed individuals)
- Excess contributions to some retirement plans
- Depreciation deductions on rental property or commercial buildings
- Bonus depreciation generated from cost segregation
Lost Deductions
Unfortunately, many deductions follow a “use it or lose it” principle. If you cannot utilize them in the current tax year, they disappear. The most common examples include:
- The standard deduction
- Most itemized deductions (e.g., mortgage interest, medical expenses exceeding a threshold, state and local taxes, casualty losses)
Strategies to Make the Most of Unused Deductions
Bunching Deductions
Bunching deductions is especially helpful if you itemize. Instead of spreading deductible expenses evenly across years, you concentrate them into a single tax year. This could allow you to surpass the standard deduction threshold and get a bigger tax break.
Bunching works best for expenses you have control over, like charitable donations or non-urgent medical procedures. For example, let's say you typically donate $5,000 to charity each year. Instead of donating $5,000 annually, you could donate $10,000 every other year. In the “bunching” year, your itemized deductions would be greater, potentially saving you money.
Another example of bunching is a grouping election for multiple rental properties. This allows you to combine your properties as a single activity for tax purposes, allowing deductions from one property to offset income from the others. This strategy can maximize your deductions, especially if some properties are profitable while others operate at a loss.
Timing Income and Expenses
Another strategy is strategically timing income and expenses, when possible, for optimized tax benefits. If you have some flexibility over when you receive income (bonuses, freelance payments, etc.), you might be able to shift it into a year where it will offset more deductions. Similarly, you might time certain deductible expenses advantageously.
Tax Planning
While discovering that you have unused deductions can be disappointing, it doesn't mean your opportunities for tax savings are gone. One effective way to ensure you maximize these potential deductions is by working with a specialized tax firm like Engineered Tax Services (ETS). Whether it's navigating the latest tax law changes or optimizing carryover deductions, our team of experts provides tailored solutions that make a real financial difference.
Conclusion
Discovering you have unused tax deductions might seem frustrating, but remember that all is not lost. Understanding how deductions work and whether they can be carried over is crucial for maximizing your tax savings. Strategies like bunching deductions, timing income and expenses, and especially consulting with tax experts can help you make the most of every tax advantage available.
At ETS, we specialize in helping individuals and businesses navigate the complexities of tax law and specialty tax incentives. If you're unsure of how to handle unused deductions or want to optimize your tax plan, we're here to help!
Don’t let unused deductions go to waste—contact us today for expert advice.
