Tax Considerations

Homeowners benefit from several generous tax advantages. The most important benefit is the mortgage interest deduction. People may deduct interest paid on mortgage loans totaling up to $1 million used to buy, build or improve a principal residence plus a second home. The IRS calls such loans acquisition debt. Points paid by the buyer or seller on a new mortgage loan for the purchase or improvement of a principal residence are deductible for the year in which the home was purchased.

Any points paid on a refinance mortgage, a loan to purchase a second home or a mortgage on income property must be spread over the life of the loan.

Note that when obtaining a new mortgage, the borrower usually is asked to pay interest from the closing date until the first of the next month. Check whether that charge is included in the year-end report. Property taxes on all real estate, including those levied by state and local governments and school districts, are fully deductible against current income. A homeowner cannot deduct maintenance expenses, nor can he take depreciation deductions on his personal residence.

Some moving expenses are deductible for people who changed jobs and relocated as a result. The IRS requires that the new employment be located at least 50 miles away, among other considerations.

The IRS allows no deductions for losses on the sale of your own home. There's no way to use a loss to your advantage on your income tax return. It won't matter what type of misfortune you may have run into.

When children inherit a home, the Internal Revenue Service determines their basis in the property on the date of the person's death. The cost basis is not the amount the owner originally paid for the house. It is the property's fair market value on the date of the mother's death.

Cost basis is a tax term for the dollar amount assigned to a property at the time it is acquired, for the purpose of determining gain or loss when it is sold. Assume the property was divided up equally. If one of the three siblings sold her share, she must pay capital gains tax for whatever profit she made over one-third of the new basis.

Other tax consequences include estate taxes. However, the estate must total $600,000 or more before tax issues become a concern. The IRS allow residents to pass on property, cash and other assets worth up to a total of $600,000 before charging the heirs any taxes.

Regarding the transfer of ownership, quit claim deeds often are used between family members in situations such as this when an heir is buying out the other. All parties must be agreeable to dropping a name from the title.

Homeowners affected by the IRS's 1995 announcement allowing buyers to deduct points paid by the seller are instructed to file an amended tax return for the year in which the home was purchased. If they're entitled to a refund, they will get a refund based on the filing of an amended return. The amendment form, called 1040X, can be ordered by calling the IRS directly at 1-800-TAX-FORM. At the top of the form, write "seller paid points,". Form instructions tell people to attach a copy of their settlement statement, commonly called the HUD-1 form.

People who purchased homes after Dec. 31, 1990, can deduct points paid by the seller. This deduction previously was reserved only for points actually paid by the buyer. However, many deals between buyers and sellers were taking place outside of escrow. Some buyers were paying the points but could not take credit for it because the seller wanted to use the deduction to reduce capital gains.

In the year of the (original) return, the buyer would have paid tax on what could be a couple thousand dollars... The IRS made the change so it would be the same no matter how people were doing it - it would be the same for everybody.

Many city and county governments offer Mortgage Credit Certificate programs.

These certificates allow first-time home-buyers to take advantage of a special federal income tax write-off, which makes qualifying for a mortgage loan easier.

Requirements vary from program to program. People wanting to apply should contact their local housing or community development office. Here is a list of four general requirements to keep in mind:

  • Some credit may be claimed only on your owner-occupied principal residence.
  • There are maximum income limits, which vary by locality and family size.
  • You must be a first time home-buyer, defined as not having held an ownership interest in a principal residence during the past three years. This restriction may be waived, however, if you are buying property within certain target areas.
  • Allocation must be available. A local MCC program may have to decline new applications when it runs out of funds.

Mortgage interest is completely deductible for the year in which you pay it, with the following limitations:

  • You may deduct interest paid on mortgage loans totaling up to $1 million used to buy, build or improve your principal residence plus a second home. The IRS calls such loans acquisition debt.
  • Your home must be used as security for the loan, which might be called a first mortgage (or deed of trust), a second mortgage, home-equity loan or line of credit. Loans used to purchase shares in a cooperative also qualify.
  • You may deduct as acquisition debt any interest on a refinanced acquisition mortgage, up to the amount you currently owed on the old loan when you refinanced.

In considering capital gains tax from the sale of a primary residence, the critical time frame is two years. Taxes on the gain, generally the difference between the price someone paid for their home and the price for which they eventually sold it, are not immediately collected if the sellers use the gain to purchase another house within 24 months. The IRS does allow homeowners to add the price of improvements to the cost basis for their property (to arrive at the adjusted cost basis). Gains tax is not forgiven forever; it simply is postponed until the next home is sold, at that point, it often is postponed again in the same manner, piling up untaxed profit on a string of homes.

The Mortgage Credit Certificate program allows first-time home- buyers to take advantage of a special federal income tax credit.

This program allows buyers credit in qualifying for the tax advantage they'll receive after they purchase the home.

The amount of the credit is tied to a local formula that every city with an MCC program must follow. An MCC credit, which can total $2,000 or more, reduces the borrowerís federal tax liability by an amount tied to how much one pays in annual mortgage interest.

Both the borrower's income and the purchase price of the home must fall within established guidelines.

To see if your community has an MCC program, call your local housing or redevelopment agency. You also may inquire with your real estate broker or the local association of realtors.

Casualty losses from fires, floods, earthquakes and other disasters are deductible from both state and federal income taxes. A casualty is the damage, destruction or loss of property resulting from an identifiable event that is sudden, unexpected or unusual. Causes range from earthquakes, tornadoes, floods and storms to vandalism and fires. In contrast to fire insurance, which often covers extensive replacement cost, Lank goes on to write, IRS deductions for casualty losses never can exceed fair market value before the casualty. Your loss of personal property is figured separately.

A landmark property could potentially be certified as a historic property and that would include certain tax advantages. A "historic structure" is "a property listed in the National Register of Historic Places, located in a registered historic district and certified by the Secretary Of the Interior as being of historic significance to the district, or located in a historic district designated under an appropriate state or local government statute that has been certified by the U.S. Department of the Interior.

The Internal Revenue Code provides certain tax incentives and deterrents to encourage the preservation of historic buildings and structures. There is a 20 percent investment tax credit for qualified rehabilitation expenses in qualified rehabilitated buildings and certified historic structures. In addition, the tax code penalizes an individual who demolishes or substantially alters a historic structure. Demolition costs will not be permitted as a deduction, and substantial alterations or completely new improvements will not be eligible for any form of accelerated depreciation.

Mortgage interest payments on acquiring and improving principal residences and second or vacation homes are fully deductible from income for tax purposes so long as the debt does not exceed $1 million. In addition, expenditures for permanent improvements can be added into your home's cost basis, or amount of money invested in a home, which reduces capital gains when it comes time to sell. Home-owners should save all receipts so they can include money spent over the years for permanent improvements, repairs after afire, flood or storm and special property tax assessments for neighborhood improvements. Capital gains are determined by the difference in price from the time a home is purchased and the time it is sold, minus the cost of any permanent improvements.

Points paid by the buyer are deductible for that year.

The IRS also has ruled that even points paid by the seller are deductible. Not a lot of other fees are immediately tax -deductible, but some may be figured into the adjusted cost basis of your home, an Important figure when people ultimately calculate capital gains.

When you buy your home, you have closing expenses, many listed on your settlement statement, that are not deductible on your income tax return, but, instead, simply are added to your cost basis for the property. If you haven't yet purchased your home, a look at the following list could frighten you away from the project forever! Any of these expenses you may encounter cannot be used as income tax deductions; add them to your basis:

  • title insurance
  • loan-application fee
  • credit report
  • appraisalfee
  • service fee
  • settlement or closing fees
  • bank attorney's fee
  • attorneyís fee
  • document preparation fee
  • recording fees