Money Management Q&As

April 22, 2005

Inheritance tax; Roth withdrawals; blended policies; deductible IRAs

Deducting the cost of continuing care Q. My parents are renting an apartment in a continuing care retirement community that offers assisted living and nursing services to residents when necessary. Although my folks fortunately don't need to use those facilities now, can they treat part of their rent as a medical expense?

A. Yes. In a recent case, the IRS insisted that the deductible portion must be calculated using very complicated actuarial projections of longevity and healthcare utilization. But the Tax Court ruled in favor of a simplified method based on the percentage of the retirement community's total expenditures attributable to medical service costs. Your parents should be able to obtain this information from the community's project manager.

Inherited income with a tax bill Q. When I sold my practice last year, the buyer agreed to pay me $100,000 in equal installments over 10 years for a covenant not to compete. If I die sooner, the contract calls for the remaining payments to go to my wife. Will they be tax-free?

Why Roth withdrawals aren't always tax-free Q. I'm buying a home and want to close a three-year-old Roth IRA with $8,500 in it, so that I can use the money for part of the down payment. Will the withdrawal be tax-free?

A. No. If you don't maintain a Roth IRA for at least five years (counting from Jan. 1 of the year in which you made your first contribution), any earnings you withdraw are treated as taxable income. This doesn't apply to the contributed funds, though, because you've already paid tax on them. Normally, persons under age 59½ owe a 10 percent penalty on the earnings in addition to the regular tax, but the penalty is waived for withdrawals of not more than $10,000 by first-time homebuyers. You'll qualify for the exception if you haven't owned a home during the two years before buying this one.

Is special education a medical expense? Q. My wife and I have a severely dyslexic child, and his pediatrician recommended a special school for him. But an accountant told us we can't deduct the tuition as a medical expense, because the school has no staff physician. Is this true?