Brad Keyes |
Tax Benefits of HomeownershipHome Sweet Home: Shelter from TaxesMore Americans than ever own homes because it's the ultimate tax shelter.By Broderick PerkinsYou save taxes when you buy it. You save taxes while you own it. You save taxes when you sell it. "The mortgage interest deduction and the deduction for property taxes are, to most Americans, sacred. These deductions have been around since time immemorial and the purpose was to encourage home ownership," said Leonard W. Williams, a certified public accountant in Sunnyvale, CA. Mortgage interest deductionAll but the very wealthy homeowners deduct all the mortgage interest they pay and consider that the primary tax benefit to home ownership. IRS Publication 936 "Home Mortgage Interest Deduction" says, in general, joint tax filers can deduct all the interest on a maximum of $1 million in mortgage debts secured by a first and second home, plus the interest paid on a maximum $100,000 in home equity loans. The maximums are halved for married tax payers filing separately. Watch out for those popular 125 percent equity-loans. Your equity tax deduction is limited to the lesser of the $100,000 maximum and the home's fair market value, determined by a complicated formula found in Publication 936. The mortgage interest deduction, along with other itemized deductions are included on "Schedule A, Itemized Deductions" to reduce your taxable income and ultimately your tax bill. "If that total exceeds the standard deduction ($3,550 for married couples filing separately, $4,250 for singles, $6,250 for heads of household and $7,100 for married couples filing joint returns) then you get it deducted from your adjusted gross income," said Peter Vernaci, a certified public accountant from San Jose. Mortgage tax creditThe Mortgage Credit Certificate (MCC) program allows some first time home buyers to benefit from a mortgage interest tax credit. An MCC, which you first must obtain from your local housing department before you get a mortgage, gives a qualified first-time home buyer a federal income tax credit of up to 20 percent each year the buyer keeps the same loan and lives in the same house. As explained in IRS Publication 530, "Tax Information for First-Time Homeowners," the credit is subtracted, dollar for dollar, from the income tax owed. For example, if you paid $10,000 in interest, your tax credit would be $2,000. The remaining 80 percent of the interest _ $8,000 is taken as a typical mortgage interest deduction. You can see the tax credit's benefit immediately in your paycheck by adjusting your W-4 exemption status to reflect the credit. In some cases, lenders will qualify you for a loan based on the monthly mortgage payment minus the tax credit, enabling you to qualify for a bigger loan. PointsHome buyers also get to fully deduct all points associated with a home purchase mortgage. Sometimes called "origination fees," "loan discounts" and "broker discounts," each point is one percent of the financed amount. In many cases, the buyer can also deduct points on the buyer's mortgage that are paid by the seller.
"If you refinance, you have to amortize the deduction for points over the life of the loan, but if you refinance again you get to write off the balance of the points from the old refinance," said Vernaci. Property Taxes “Real Estate Taxes”Property taxes, referred to as "real estate taxes" in Publication 530, are also deductible from your income. Be careful not to deduct escrow money held for property taxes, but not actually used to pay them, say until the next tax period. Local tax refunds reduce your deduction by a like amount. Home salesEven when you sell your home, it continues to be a tax shelter, for a few homeowners. "The broker's commission, title insurance, any of the legal fees, administrative costs, inspection fees. Those are selling costs, and as expenses of the sale, they are deductible from the gain," said Vernaci. Your gain is your home's selling price, minus deductible closing costs, minus your basis. Publication 530 also offers a worksheet to help you figure your basis - the original purchase price, plus capital improvements, minus any depreciation. Thanks to the 1997 Taxpayer Relief Act, however, many home sellers no longer suffer a taxable gain. That's because, under the act, sellers get to keep, tax free, up to $250,000 in capital gains ($500,000 for married sellers who file taxes jointly) on sales of homes used as a principal residence for two of the prior five years. "If the gain is less than the $250,000/$500,000 exclusion, then those sales expenses are a kiss-off. They aren't written off against taxable income, hence they don't save any taxes," Williams said. Tax Benefits of Home Ownership Are Almost Too Good to Be TrueUncle Sam helps you in three ways when you own your home.By John AdamsThey say there are only two things you can count on in this world: death and taxes. But when it comes to owning a home, it appears there may be a third. And that is the favorable treatment of home ownership by the Internal Revenue Service. 1. The PurchaseWhen buying your own home, most of the expenses are not tax deductible. But there is one exception that is worth finding. The IRS says you can deduct interest in the year that it is paid, and that is usually part of each monthly loan payment. In addition, if the day you purchase is on any day other than the first of the month, you will likely pay a charge for "daily interest" between the day of closing and the end of the month. Look on line 901 of your HUD settlement statement. 2. Mortgage interestIn general, you can deduct interest charged on a loan used to acquire or improve your principal residence in the year that it is paid. In the early years of a loan, most of your monthly payment is interest, so this can really add up. If you are in a 28% federal tax bracket, this can have the effect of lowering your borrowing costs by almost a third, depending on which state you live in. This is truly nothing more than a subsidy to home owners, and it's a very popular deduction. In addition, you can always deduct interest on an additional $100,000 of mortgage debt, which can be used for any purpose. This is called the "Home Equity Loan" exception, and it allows you to tap into your home equity for any purpose. This gives home owners the ability to do what is called "debt-shifting." For example, if you live in an apartment and have a credit card balance of $10,000 at 18% interest, none of that interest would be deductible. But if you bought a house, obtained a home equity loan for $10,000 and paid off the credit card, then ALL of the interest expense becomes automatically deductible. Furthermore, the rate on the home equity loan is likely to be around prime plus one or two, usually much lower than credit card rates. This same technique works with any and all personal debt, from car loans to consolidation loans - with only one hitch. In every home equity loan, you have pledged your house as collateral for the loan. If you fail to pay the payments as agreed, you could lose your house to foreclosure. So be careful in using this technique. 3. The saleThis is the best. In fact, I can hardly believe this myself. Here's how it works: If you have owned and occupied your principal residence for at least two of the past five years, you can earn up to $500,000 on the sale of that house and pay no federal income tax whatsoever. That's assuming you are married - singles get up to $250,000 tax free. And here comes the kicker: You can do this as often as every two years for the rest of your life. This is as good an excuse for getting married as I have ever heard. Buy a fixer-upper in an up and coming neighborhood, work on it nights and weekends for two years, then sell it at a nice profit and pocket the cash, totally free of federal taxes. And most states recognize the federal exclusion, so you put the cash away totally tax free. You don't have to re-invest, you don't have to be age 55, and you can do this every two years forever. No, I'm not kidding. |