The Paper Trail That Leads To Bigger Deductions

Tedious as it may be, documenting every conceivable deduction is the key to any tax-saving strategy. Dollars you reinvested in mutual funds, hours you spent in your home office, miles you drove as a volunteer or on business, points you paid on a mortgage, days you rented out your vacation home--these things and more may qualify for write-offs if you can back them up.

A major reason for overpaying taxes, accountants say, is failing to keep track of dividends and capital gains that automatically get reinvested in mutual funds. "It's one way you can really do yourself a disservice," says Michael Kennedy of Coopers & Lybrand in Philadelphia. People tend to remember only the price they paid originally, he says, and use that as their cost basis when they sell.

But if they acquired other shares later at higher prices, they could reduce their taxable gain or write off a larger loss--if they have the numbers at hand. The mutual-fund company might give or sell you an account history. But by having a complete list before you sell, you can designate the shares that will let you come out best on taxes. Kennedy recommends updating your list when each statement arrives. "That's what I do," he says. "But that's because I'm an accountant."

MILEAGE AUDITS. You almost have to be an accountant now if you want to take a home-office deduction. On its new Form 8829, the IRS requires 42 lines of justification, ranging from size of the space and hours you use it to such gems as "carryover of excess casualty losses and depreciation."

Being a bookkeeper can be critical to nailing down deductions for using your car on business or as a volunteer for a charity. "Keep a daily log," advises Jim Velten of Coopers & Lybrand. "They like to audit use of cars."

Buying and selling a house isn't an everyday thing. But to back up potential big-ticket tax benefits, you need to keep settlement statements and receipts for improvements "forever, essentially," says Ernst & Young partner Bill Brennan in Washington. That doesn't dawn on a lot of people until they sell their last house.

Then, the IRS is apt to want evidence of past purchase prices and outlays that add to the cost basis. Without records, the IRS could extract more tax on the final gain. The improvements don't have to be to the house itself, Brennan adds. Major landscaping or a swimming pool add to your basis, too--and if the receipts are lost, he adds, "take a photo" of the improvement to show the IRS.

Before it's here, it's on the Bloomberg Terminal.