An Overlooked Deduction for Families Caring for Those with Special Needs

According to the Center for Disease Control and Disease Prevention (CDC), the numbers have gone from one in 10,000 to one in 54. In addition to the psychological and financial implications of having a child diagnosed with an autism spectrum disorder or any disability, parents of children with special needs are often unaware of the substantial tax benefits available to them and frequently forego many potential tax deductions and credits in determining their tax liability. 

Medical care expenditures alone for a child with special needs can prove astronomical. As a result, parents and their financial services professionals need to become familiar with some unusual Internal Revenue Code provisions in assisting their clients in the planning process. There is a medical expenditure available that often goes ignored by special needs families: medically necessary capital improvements. 

Overview of the Medical Expense Deduction 

According to the IRS, only individuals itemizing their deductions on their federal individual income tax returns can claim a medical expense deduction. Unreimbursed medical expenses are deductible only to the extent they exceed 7.5% of a taxpayer’s adjusted gross income (AGI) through 2020. The 7.5% AGI threshold for the medical expense deduction was reinstated with the Tax Cuts and Jobs Act of 2017 (from prior law’s 10% of AGI) for 2017 and 2018 and was retroactively extended thru 2020 by The Taxpayer Certainty and Disaster Relief Act of 2019. Alternatively, parents who are eligible to participate in tax-advantaged plans through work for funding medical expenses, such as flexible spending accounts or health savings accounts, can set aside limited amounts of money to finance medical care expenses on a pre-tax basis while bypassing the AGI limitation. Flexible spending account pre-tax contributions are limited to $2,750 for 2020. 

The Overlooked Deduction: Capital Expenditures as a Medical Expense 

Under most circumstances, capital expenditures aren’t permitted as a medical expense deduction. As a rule, assets used in a trade or business or held for the production of income are depreciated or amortized over time. Capital expenditures incurred for personal medical expenses are not depreciable nor amortizable. However, a medical expense deduction is available when the capital expenditure is made primarily for the medical care of the taxpayer, the taxpayer’s spouse, and/or the taxpayer’s dependents. To secure a current medical expense deduction for a capital expenditure, the cost must be reasonable in amount and incurred out of medical necessity for primary use by the individual requiring medical care. 

Qualifying capital expenditures for medical expense deductions fall into two categories. First, expenditures improving the taxpayer’s residence while also providing medical care (e.g., a central air conditioning system for an individual suffering from a chronic respiratory illness). Second, expenditures removing structural barriers in the home of an individual with physical limitations (e.g., construction costs incurred for an entrance ramp, widening doorways and halls, customizing bathing facilities, lowering kitchen cabinets, and adding railings). 

Capital expenditures in the first category are deductible only to the extent that the cost exceeds the increase in the property’s fair market value as a result of the capital expenditure. However, expenditures incurred in the second category are fully deductible under the presumption that there is no increase in the property’s value as a result of removing a physical barrier. Further, the entire cost of special equipment acquired to assist an individual with physical limitations is deductible. The following examples illustrate expenditures in both categories: 

Example One 

This past year, Thomas was injured in a severe skiing accident. Thomas sustained a disabling leg injury, which requires him to spend most of his time in a wheelchair. His physician recommends that he install an elevator in his home to alleviate the pressure on his knees from walking up and down stairs. During the year, Thomas made the following expenditures: wheelchair: $3,500, elevator: $19,000, operational and maintenance costs incurred with the elevator: $2,800, and entrance ramp and door modifications: $8,500. According to appraisers, the home increased in value as a result of the elevator by $5,000. As a result, Thomas has a $28,800 medical expense deduction before considering AGI limitations for 2020. 

Example Two

In 2020, Jane, a single mother with AGI of $100,000, fully supported her 20-year-old daughter living with her. Her daughter has no income for the year and was properly claimed as Jane’s dependent. During the year, Jane installed a central air conditioner at a cost of $17,000, which her physician said was required in caring for the daughter’s asthma. After installation, Jane’s home increased in value by $7,000, allowing for a deduction of $10,000 for the central air conditioner. In addition, Jane incurred the following medical expenses in 2020: prescribed drugs: $500, physician expenses: $1,000, and unreimbursed health insurance premiums: $3,000. As a result, Jane has a medical expense deduction of $14,500 before considering AGI limitations for 2020 and $7,000 after subtracting 7.5% of her AGI ($100,000). In addition, if Jane’s utility bills increased $150 monthly after installing the central air conditioner system, her medical expense deduction would increase to $8,800 after the AGI limitation. 

Under either category, costs incurred to operate or maintain the capital expenditure (such as increased utility expenses and maintenance costs to operate the elevator as illustrated in both examples) are deductible currently as medical expenses as long as the medical reason for the expenditures continues to exist. 

Conclusion 

Although many of families caring for those with special needs are aware of the medical expense deduction for special schools and education, the deduction for a capital expenditure for medical care is often overlooked. As illustrated, this deduction alone can result in saving thousands of tax dollars.