Bunching can work with any expense that you can itemize, but you need to be able to control when you incur these expenses. That typically leads people to bunch expenses in three key areas:
- Property taxes. If your municipality allows it, wait until January to pay the previous year’s property tax bill. Then, pay the current year in December. Because you paid two bills in one year, you have upped the amount that you can itemize in that tax year. One potential issue: The amount of property tax you can deduct is capped at $10,000. Note, this $10,000 cap applies to state income taxes as well.
- Charitable contributions. Charitable contributions have long been a common expense that people itemize. If you want to bunch itemized deductions, you have two options. One is to simply double the amount that you give to charity in one year and then skip your donation the following. People who use this strategy will often donate on January 1st and then again on December 31st. For all intents and purposes, you’re donating on a yearly cadence. But for tax purposes, it’s a year on and a year off. Another option is to use a donor-advised fund (DAF). A DAF lets you make a large donation in one tax year (and take the tax deduction in that year). The fund will invest the money and eventually distribute it to a nonprofit, based on recommendations you make to the fund manager. Often people use a DAF when they’re looking to make multiple years’ worth of contributions in a single tax year, perhaps because they got a large bonus or sold a business. (Note: DAFs do have minimum contribution limits.)
- Health expenses. In order to itemize and deduct medical expenses, you must have unreimbursed costs that are above 7.5 percent of your adjusted gross income. But if you pay out of pocket or have a high-deductible plan and you know you’re going to have a big health care expense (and you can control the timing of it), you can incur that cost in the year that you bunch itemized deductions.
These are the most common items people bunch. But there may be others that apply in your situation. It’s a good idea to talk to your tax advisor if you think this strategy could work for you.
Who Does Bunching Itemized Deductions Work Best For?
Bunching itemized deductions works best when the amount you could itemize each year doesn’t quite get you to the standard deduction, but it’s close. Without this strategy, you would likely take the standard deduction every year. By bunching your itemized deductions every other year, you can get a higher deduction in the bunched years, reducing the amount of tax you owe in those years.
Here’s how it works. Let’s say you’re married, filing jointly. You itemize:
- $7,000 in mortgage interest
- $8,000 in property taxes
- $8,000 in yearly charitable contributions
Added together, this gets you to $23,000 worth of itemized deductions. You’re better off taking the $24,800 standard deduction (the standard deduction will grow to $25,100 for married couples for the 2021 tax year).
Now let’s bunch your itemized deductions.
- $7,000 in mortgage interest
- $10,000 in property taxes (even though you paid $16,000, you’re capped at $10,000)
- $16,000 in yearly charitable contributions
You can take a $33,000 deduction every other year when you bunch itemized deductions. Then, in off years, you will take the standard $24,800 deduction. If you’re in the 22 percent tax bracket, the additional deduction you can take every other year will save you $1,804 in federal tax.
As with any tax situation, it’s a good idea to speak with a tax advisor who can help you with your unique situation.
This article is not intended as legal or tax advice. Northwestern Mutual and its financial representatives do not give legal or tax advice. Taxpayers should seek advice regarding their particular circumstances from an independent legal, accounting or tax adviser.