Home
OwnershipYour
Best Tax Shelter
Homeowners
Receive Big Tax Breaks
Tax
Planning and Your Home
The
information outlined here is only a brief overview of the tax
rules
involving home ownership. Since the rules are complicated,
if
you’re thinking of buying or selling your home, or refinancing a
home
loan, it’s best to discuss the plans with your tax advisor
to
interpret closing documents and to make absolutely certain
the
transaction meets the necessary qualifications.
Home
ownership can provide you with several important
tax
benefits:
•
Deductions
for real estate taxes and home mortgage interest, and
•
Gain
exclusion if you meet certain occupancy and holding
period
requirements.
•
If
you meet certain qualifications and purchase a home in 2009
or
2010, you may qualify for the Homebuyers Tax Credit. Call this
office
for more information.
In
fact, tax breaks are probably one of the biggest reasons you
decided
to buy your home in the first place. Unfortunately,
some
homeowners lose getting the most from their home’s
tax
advantages because they aren’t aware that certain limits apply.
The
purpose of this brochure is to highlight how you as a
homeowner
can best keep your home’s favorable tax edge.
Your
Home’s Basis
The
amount of the gain exclusion permitted under current tax
law
tends to make most taxpayers forget about keeping track of their
home
improvements. Don’t forget, inflation will take its toll, and in
a
few years the exclusion limits may not be as significant as they
are
today, or the law may change again. In either case, it may
be
appropriate to keep a record of the improvements on your home.
Once
you buy a home, you need to begin keeping records related
to
your home’s “basis,” i.e., the amount you have spent on
the
property. If you acquired your home through purchase, your
basis
is what you paid for it originally,including purchase
expenses,
PLUS improvement costs you incur while you own
it.
Keeping track of basis is extremely important in order to
accurately
report gain or loss if you decide to sell.
Loan
Points:
A
question often comes up about the deduction for points on a
home
loan. Points are another name for prepaid interest – they may
be
called loan origination fees or some similar term. One point
equals
1% of the loan amount. When points are paid for services
a
lender provides to setup a loan, the points aren’t
deductible.
However, when the points are paid as a charge for the
use
of money, the following rules apply:
•
As
a general rule, points are only deductible over the life of a
loan.
Say, for example, you paid $3,000 in points on a
30-year
refinance loan. Your tax deduction would be limited to
$100
a year ($3,000/30 years). If you decided to pay your loan
off
early, say after 15 years, you could write off the balance of t
he
points ($1,500) in that year.
•
An
exception to the general rules lets you deduct,in full, points
you
pay in connection with obtaininga mortgage to
purchase,
construct, or improve your main home.
•
Seller-paid
points can even be deducted by a
home
buyer, but the amount deducted reduces the
home’s
basis.
Reporting
Gains/Losses
Exclusion
of Gain:
When
you sell your principal home at a gain, you can exclude all
(or
a portion) of the gain if you meet certain occupancy and
holding
period requirements. To qualify for this exclusion, you must have
owned and occupied the residence for two years out of the five year
period that ends on the date of the sale. If you meet those
qualifications
and are filing a joint return with your spouse,you may exclude up to
$500,000 ($250,000 for a single individual) of gain from the sale.
For
the purpose of computing basis, it’s important to distinguish
between “improvements” and repairs; only improvement costs add to
your basis. Minor repairs like replacing faucet washers, painting a
bedroom or patching a hole in the roof don’t need to be tracked. In
general, improvements are of a more permanent nature than repairs.
They enhance the value of your home and are likely to last more than
one year. If you make the same improvement more than once, only the
most recent improvement adds to your basis.
You
should log costs of items like the following in a home improvement
record (be sure you keep your backup receipts and canceled checks):
Room
additions Landscaping
New
driveway Walkways
Fence
Retaining wall
Sprinkler
system Swimming pool
Exterior
lighting Satellite dish
Intercom
Security system
Storm
windows/doors Roof
Central
vacuum Heating system
Central
air Furnace
Filtration
system Light fixtures
Wiring
upgrade Water heater
Soft
water system Insulation
Built-in
appliances Kitchen upgrade
Bathroom
upgrade Flooring
Wall-to-wall
carpet
Whenever
there’s doubt about whether an expenditure qualifies as an
improvement, make a note of it in your record anyway. That way, the
ultimate decision about qualification can be made later when (and if)
you decide to sell.
Deductions
Related to Your Home
Certainly
not all costs related to your home are deductible. For example,
unless you use your home for business (e.g., you have an office in
your home), costs for insurance,repairs, utility costs, condo fees,
etc., aren’t deductible.However, you generally will be able to
deduct:
•
REAL
ESTATE TAXES
•
HOME
MORTGAGE INTEREST
Keep
in mind, however, that home mortgage interest deductions can be
limited. Generally, you can deduct the interest from mortgages up to
$1 million dollars on a combination of your first and second homes,
provided they were the original loans. As the principal on these
loans is paid down, the reduced loan amount becomes the new
limitation. If you were to later refinance the home for more than the
remaining balance on the original loan, the excess would have to be
used for home improvements or qualify
under
the provisions that allow a taxpayer to borrow up to $100,000 in home
equity. If not, a portion of the interest would not be deductible.
The
additional $100,000 of home equity can be borrowed from
the
primary residence and a second home. When used wisely,
the
$100,000 equity loan can be used to finance other purchases
where
the interest expense would normally not be deductible.
An
example of this would be a
personal vehicle.
Equity
debt interest is not deductible for Alternative Minimum Tax
(AMT)
purposes, so taxpayers who are taxed by the Alternative
Minimum
Tax (AMT) should consider carefully whether or not to
incur
home equity debt. Because of the current strict home
mortgage
deduction limits and the complicated tax rules associated
with
thistax deduction, be sure to review any home financing plans
with
your tax advisor before finalizing loan deals.
A
partial exclusion may be allowed even if the two-of-five year
ownership
and occupancy tests aren’t met if the saleis due to a
job-related
move, health, or certain unforeseen circumstances.
If
you do not qualify for the full or partial exclusion, there is no
deferral
privilege and the gain not eligible for exclusion is fully taxable.
NOTE:
A second home, such as a mountain cabin or lake cottage,
doesn’t
qualify for the exclusion of gain.
Previously
Postponed Gain:
Under
prior tax law (generally pre-’98), gain from the sale of a
principal
residence could be deferred into your replacement
residence.
Those gains were accumulated from home to home as
long
as each replacement home cost more than the adjusted selling
price
(i.e., sales price less expenses of sale and pre-sale “fix-up”
costs)
of
the previous home. Although gain deferral from a principal
residence
is no longer permitted under current law, the gains
deferred
under prior law into a home currently being sold must
be
accounted for.
Sales
at a Loss:
Losses
from the sales of business or investment properties
are
normally tax-deductible. However, a loss from the sale of
your
main home is considered personal in nature, and therefore,
unless
the law changes, it is not allowed as a deduction. This rule
also
applies to second homes.
Reporting
the Sale:
You
no longer need to report the sale of your main home on your
tax
return unless you have a gain and at least part of it is taxable –
i.e.,
if the gain is greater than your allowed exclusion, the sale
is
reportable. Otherwise, if the gain is totally offset by the
exclusion,
the
sale should not be shown on your tax return. However, to be
certain
that no reporting is required, you should provide your tax advisor
with
the sales documents, cost basis information, etc., to evaluate
your
situation. You may receive Form 1099-S showing the gross
proceeds
from the sale, although settlement agents (escrow companies) are no
longer required to issue a Form 1099-S for most sales of main
homes.
If you do receive a Form 1099-S, let your tax advisor review it and
determine if it is necessary to report the sales.
Exclusion
Qualifications
Under
prior law. . . (generally pre-’98), individuals were entitled
to
a
once-in-a-lifetime exclusion of gain from the sale of their principal
residence. To qualify for that exclusion, the taxpayer or spouse must
have reached the age of 55 prior to the sale, and they must have
resided in the home for three of the prior five years. Having
exercised that exclusion does not bar a taxpayer from qualifying for
the current law exclusion.
Under
current law… there
is no age requirement associated with the exclusion. The period of
time the homemust be owned and occupied as a principal residence has
been reduced to two out of the past five years. In addition,the
exclusion amount has been raised to $500,000 for couples
filing
jointly and $250,000 for other individuals. The once-in-a-lifetime
limitation has been deleted, thus permitting taxpayers to exclude a
gain every two years if they meet all of the other conditions.
CAUTION:
Prior law included a provision for the deferral of gain allowing
taxpayers to avoid taxation on a gain that was not excludable if
their replacement residence met certain qualifications. The new law
contains no deferral provisions, thus any gain not excludable is
immediately taxable.
Five-Year
Holding Period:
If
you originally acquired the home you intend to sell by means of a
tax-deferred exchange (sometimes referred to as a 1031 exchange), the
required ownership period to qualify for the home sale exclusion
becomes five years as opposed to the normal two years
Special
Prior Rental Issues:
If
your home was previously your rental property and used as a rental
any time after December 31, 2008 and prior to converting it to your
home, a portion of the gain will not qualify for the home gain
exclusion. Also, depreciation taken on the home while it was a rental
will not qualify for
the
exclusion. Please call this office for additional details when a sale
relates to a home that was previously used as a rental.
Non-Qualified
Use:
If
the home was previously used as other than your main home
(non-qualified use), for example, as a second home or a rental, and
converted to your personal residence after December 31, 2008, the
portion of the prorated gain attributable to the non-qualified use
will not qualify for the
home
gain exclusion.
