Is rental property a tax-wise investment?

Tax law changes so frequently that you must be concerned with tax planning year-round or you'll miss opportunities to lower your tax bill.

Here are just a few steps you should consider to take advantage of some of the newer tax breaks.

1. Familiarize yourself with the income levels at which various tax breaks phase out. While it doesn't make sense to make less income just to qualify for a tax break, shifting income from one year to another may sometimes be a smart thing to do.

   Learn about the tax credits and deductions for which you might qualify. Then estimate your income, and if it will be just beyond qualification range, look for opportunities to defer income to a later year. Investment income can often be shifted, or you might delay the exercise of stock options or the receipt of a bonus.

2. Don't pay tax on a home sale. The law lets you sell your home tax-free if you meet certain requirements.

   The home must have been owned and used as your principal residence for at least two of the five years prior to sale. Couples can enjoy $500,000 of tax-free profits in a home sale, while singles qualify for up to $250,000 of tax-free gain.

   To the extent possible, time home sales to meet the requirements in order to enjoy tax-free profits.

3. Factor education tax breaks into your college planning. First, there's the Hope credit for a percentage of qualified expenses paid during each of the first two years of higher education. Second, the lifetime learning credit allows a deduction for a percentage of qualified expenses paid for any year the Hope credit isn't claimed, and it even applies to job-related classes. Third, you may qualify for a deduction for interest paid on student loans. Fourth, education IRAs allow annual nondeductible contributions for every child under 18, with tax-free withdrawals for higher education expenses.

   Check the income phase-out levels for these breaks, and be aware that the breaks tend to be mutually exclusive. You will have to decide what's best in your situation and plan carefully to take advantage of the best options for you.

4. Invest to take advantage of lower long-term capital gains tax rates - 10 percent if you are in the 15 percent bracket for ordinary income and 20 percent if you are in other tax brackets. The holding period to qualify for these lower tax rates is more than 12 months.

5. Do an investment review to be sure you have the right investments in your tax-deferred accounts. To take best advantage of the lower capital gains tax rates, investments that produce divided and interest income should be held in tax-deferred accounts, while those that produce capital gains should be in taxable accounts. Putting capital gains investments in tax-deferred retirement accounts could turn income that would be taxed at lower rates into ordinary income taxed at much higher rates.

6. There's never been a better time to contribute to an IRA. Nonworking spouses can make annual contributions of up to $2,000. Individuals covered by a retirement plan at work can still have a deductible IRA at higher income levels than ever before. If you are not in a plan at work but your spouse is, you can make fully deductible IRA contributions as long as joint income doesn't exceed $150,000 annually.

7. Your IRA options may include the Roth IRA. With a Roth IRA, your contribution won't be tax-deductible, but the account will grow tax-free, and you won't pay federal income tax on distributions from the account once it's been in existence for five years and after you've reached age 59 1/2.

8. Consider rolling your IRA into a Roth. If you have a conventional IRA and you meet the income qualifications, you should give consideration to rolling your existing IRA into a Roth IRA. You'll have to pay income tax on the rollover, but the account can escape federal income taxation thereafter.

9. Keep your estate planning current with the frequent changes in the tax law. Be sure your estate planning documents (wills, trusts, etc.) are worded properly, or you may pay more estate tax than necessary simply through oversight.

10. If you work at home, get details on the home office deduction. More people can now qualify to take a deduction for home office expenses.

    Your home office may qualify as your "principal place of business" if you use it regularly and exclusively for administrative and management activities but perform the income-producing activities at another location.

11. Realize that in tax planning, the earlier you start, the more effective your tax-cutting efforts will be. Also realize that not every strategy is appropriate for everyone. You have to sort through the options to find what is best for you. Today's tax law is more complicated than ever, but you will find that awareness and planning can lower your taxes.