What Retirees Miss on Their Tax Return Every Year

It’s common for those who are nearing retirement to assume their taxes get simpler in retirement. They often get more complex – and more expensive – because of what gets overlooked.

Before we get started, I am a flat-fee financial advisor who helps people retire in Alabama, Georgia, and across the country. Check out my blog for more financial insights for retirees and near retirees.

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Here are three of the most common (and costly) misses I see:

1.      Real Estate Depreciation Carryforwards

2.      Medicare IRMAA Traps

3.      State-specific nuances

Real Estate Depreciation Carryforwards

Often considered the “lost” deduction, unused rental losses can be forgotten. What happens is that losses on a rental property often get limited by passive activity rules. Those are IRS rules that determine when you’re allowed to use losses from certain activities (like rental real estate) to offset other income.

Those unused losses don’t disappear – they carry forward indefinitely. Many retirees (and even some tax preparers) lose track of them.  They may still be sitting there – waiting to offset rental income, capital gains, or property sale profits.

Keeping good records on Form 8582 and ensuring this history is maintained and transferred in the event there’s a change in tax preparers is good discipline. Doing so, can help to ensure this information may not only be used each year, but that it can be integrated into long-term planning decisions when considering how to exit a property via a 1031 exchange, a traditional sale, or deciding to continue holding the property.

Medicare IRMAA Traps

Income-Related Monthly Adjustment aka IRMMA is often referred to as the “stealth” tax retirees don’t see coming. Many don’t realize that their tax return directly impacts their Medicare premiums two years later.

Here’s a list of sources of income that can trigger IRMMA:

• Roth Conversions

• Capital Gains (especially property sales)

• Required Minimum Distributions

• Large one-time income events

One single decision can push income over a threshold that can increase Medicare premiums by thousands per year (for BOTH spouses). For example, assume a married couple’s income increases from $194,000 to $218,001.  They cross a threshold and pay significantly higher Medicare premiums for Part B and Part D for a full year.

Where people typically go wrong is doing Roth conversions up to a certain marginal income tax bracket but ignoring IRMAA, selling a rental property without coordinating tax timing, and not taking a forward-looking approach to their income planning. Coordinating income across multiple years, managing Roth conversions strategically, and avoiding accidental premium increases is a retiree’s best approach to avoiding or at least not being surprised by IRMMA. Ultimately, it’s important to remember that tax planning doesn’t end on April 15 as it shows up in your Medicare bill two years later.

State Specific Nuances

The best state for retirement isn’t necessarily the one with the lowest tax rate – it’s the one that taxes your specific income the least. What may matter more for retirees than the rate are the rules. Your tax outcome in retirement is driven less by the tax rate – and more by how your income is classified.

Each state tends to treat these buckets of income differently:

• Social Security

• Pension Income

• IRA/401(k) Withdrawals

• Investment Income (Capital Gains/Dividends)

• Real Estate Income & Sales

  
  

It’s the mix of these sources of income that determines your real tax rate. As I mostly work with clients in Alabama and Georgia I’ll compare those two bordering states.

Social Security, for instance, is not taxed at the state level in Georgia or Alabama. The nuance for more affluent retirees is that Social Security is often a small portion of total income. So even though it’s not taxed it often doesn’t drive the planning decision.

When it comes to pension income, Alabama generally treats Defined benefit pensions as tax free. This is a strong advantage for government retirees or corporate pension holders. Georgia, on the other hand, has a retirement exclusion up to $65,000 per person for those age 65 or older. The nuance here is that for a retiree with a large pension, Alabama can be extremely attractive although fewer retirees today rely heavily on pensions.

IRA and 401(k) withdrawals are generally taxable as part of your state income tax as there is no broad, universal exemption in Alabama. In Georgia, the $65,000 exclusion per person 65 and older applies again.  A married couple in Georgia over age 65 can exclude up to $130,000 per year which is a tremendous planning advantage. The nuance here is that there can be opportunities for tax-efficient withdrawal strategies and large Roth conversion windows at low state tax cost.

Another bucket of retirement income comes from capital gains and investment income. In Alabama, capital gains are taxed as ordinary income with no special exclusions. In Georgia, the retirement exclusion previously mentioned is available to offset this type of income as well which can reduce or even eliminate tax on gains in some circumstances. The nuance for retirees with brokerage accounts, real estate sales, and business exits may find Georgia to be materially more favorable.

Arguably the most overlooked factor is real estate income, and this is where state differences can really show up. In Alabama rental income, property sales, and depreciation recapture are all taxable. Georgia has the same baseline rules, but the retirement exclusion can offset this income which may offer better planning flexibility.

The timing of a property sale relative to retirement, state residency, and other income is a nuance that most miss and it can change the tax outcome significantly.

A somewhat advanced planning approach for a retiree or soon to be retiree may be to consider the timing of residency in one state versus the other. Let’s assume you live in Alabama and you own appreciated rental property but plan to move to Georgia.

One outcome is you sell before moving and you pay the full Alabama tax on the gain. Or, you could sell after establishing residency in Georgia and have the potential to offset the gain with the retirement exclusion.

You may see now that the bigger issue with taxes in retirement isn’t just making individual mistakes, it’s that the mistakes are largely the result of gaps in coordination. Good tax preparation looks backward. Good planning looks forward. And the biggest tax opportunities in retirement aren’t on your return – they’re in the decisions you make before it’s filed.

If you’re retired – or within 5-10 years of retiring - and have investment accounts, real estate, or multiple sources of income, it’s worth reviewing what may be getting overlooked. The goal isn’t just to file accurately. It’s to plan intentionally.

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