As the time to file income taxes approaches, we need to take
a new look at the changing tax landscape for homeowners. The dynamic atmosphere
in Washington, D.C. has a different effect each year on which tax breaks are
proposed, rescinded, changed, and extended for taxpayers who own a home.
Thanks to the efforts of many real estate
industry groups including the National Association of Realtors, many of
the tax benefits that homeowners
enjoy–which were on the chopping block over the past few months–have been
protected and extended through the 2013 tax season.
1. Mortgage Interest Deduction
The mortgage interest deduction has always been the
most-beloved tax benefit of home buyers in the U.S. New homeowners’ monthly mortgage payments are
made up almost entirely by interest for the first few years. Their ability to
deduct that interest can result in a healthy reduction in tax liability.
Affordability for first-time home buyers is directly linked to their ability to
deduct the interest on their mortgage.
Homeowners who itemize their deductions can deduct the
interest paid on a mortgage with a balance of up to $1 million. While there is
some movement to limit the total itemized deductions for taxpayers with higher
incomes (over $400,000), the current deductions holds for all tax brackets.
Americans save around $100 million every year by deducting mortgage interest on
their tax returns.
2. Home Improvement Loan Interest Deduction
The interest on home equity loans used for “capital
improvements” to a home can also be a tax deduction. On loans with balances of
up to $100,000, the interest is tax-deductible for a homeowner who uses the
loan to make improvements to the home such as adding square footage, upgrading
the components of the home, or repairing damage from a natural disaster.
Maintenance items like changing the carpet and painting a home are usually not
included as capital improvement projects.
3. Private Mortgage Insurance (PMI) Deduction
Homeowners who make a down payment of less than 20% are
usually paying some sort of Private Mortgage Insurance. PMI (sometimes
abbreviated MIP or just MI), can be a few dollars to hundreds of dollars per
month, and it is a large portion of many homeowners’ mortgage payments.
If your mortgage was originated after Jan 1, 2007, and you
have PMI, it can be a tax deduction. The deduction is phased out, 10% per
$1,000, for taxpayers who have an adjusted gross income between
$100,000-$109,000 and those above that level do not qualify. The extension of
this tax deduction in 2013 was one of many last-second saves by real estate
industry advocates.
4. Mortgage
Points/Origination Deduction
Homeowners who paid points on their home purchase or
refinance can often deduct those points on their tax returns. Points, often
called origination fees, are usually percentage-based fees which a lender
charges to originate a loan. A one percent fee on a $100,000 loan would be one
point, or $1,000.
On a home purchase loan, taxpayers can deduct the entirety of
the points that they paid in the same year. On a refinance loan, the points
must be deducted as an amortization over the life of the loan. Many taxpayers
forget about this amortized benefit over time, so it’s important to keep good
records on the deduction of points on a refinance.
5. Energy Efficiency
Upgrades/Repairs Deduction
Homeowners can deduct the cost of the building materials used
for energy efficiency upgrades to their home. This is actually a tax credit,
one which is applied as a direct reduction of how much tax you owe, not just a
reduction in your taxable income.
10 percent of the total bill for energy-efficient materials
can be used as a tax credit, up to a maximum $500 credit. Insulation, doors,
new roofs, and many other items qualify for the energy efficiency credit. There
are also individual limits for certain items, such as $150 for furnaces, $200
for windows, and $300 for air conditioners and heat pumps.
6. Profit on Sale of
Real Estate Deduction
If you’ve sold a home in the past year, you’re likely aware
that individuals can claim up to $250,000 of profit from the sale tax-free, and
married couples can claim up to $500,000 tax-free. Of course, there are some
requirements to escaping the capital gains tax on this profit.
The home must be a primary residence. This means that you
must have lived in the home, as your primary residence, for two of the past
five years. You could rent it out for years one, three, and five, while living
in it for years two and four. In this way, a homeowner could potentially claim
this tax break on multiple homes within a fairly short time frame, but each
tax-free sale must occur at least two years apart from the previous tax-free
transaction.
7. Real Estate Selling
Cost Deduction
For those lucky folks whose profits on the sale of their home
might exceed the $250k/$500k limits, there are still some ways to reduce the
tax burden. The costs of selling the
home can be significant, and those in themselves can be claimed as tax
deductions.
By adding up all of the fees paid at closing, capital
improvements made to the home while you owned it, money spent to make repairs
to damaged property, and marketing costs
necessary to sell the home, you can add a significant figure to the cost basis
of your home. This basically raises the
original price you paid for the home.
Your cost basis begins with the original price of the home, and then
adds in the improvement and selling costs.
When the new cost basis price is compared to your selling price, it
reduces your potentially-taxable profit on the home significantly.
8. Home Office
Deduction
The home office tax deduction is often cited as a deduction
that increases your likelihood of being audited. While the raw numbers might add some
credibility to that perception, it’s really the way a home office is deducted
that gets some taxpayers into audit purgatory.
This deduction, when used correctly, is just as safe as any
other. Homeowners deduct a percentage of
their mortgage, utilities, and repair bills in direct proportion to the amount
of their home that is dedicated office space.
There are a few hard and fast rules to live by when deducting
the costs of your home office. The home office must be your principal place of
business (the primary office location where you get the majority of your work
done). It needs to be exclusively used
for business (it can’t be your kitchen by day and office by night). You need to be realistic with its size and
use (unless you enjoy audits).
9. Property Tax
Deduction
New homeowners often don’t know that their property taxes are
deductible. While it may sound strange
to have a tax-deductible tax, the overall effect is that you don’t pay income
tax on money that was spent on property taxes.
Homeowners should be careful to only deduct the amount of
property tax actually paid to their local municipality for the year. This is
not necessarily the amount you paid to your escrow account, and should not
include any other city/county fees that might potentially be on the same bill
as your property taxes.
10. Loan Forgiveness
Deduction
The Mortgage Debt Forgiveness Relief Act of 2007 was created
when short sales were becoming a new and growing part of the real
estate market. An underwater homeowner might convince their lender to
agree to a short sale of their home at $100,000, even though they owe $150,000
on their mortgage. While the lender forgives the extra $50,000 owed after the
short sale, the government views it as $50,000 in taxable income (a gift from
the lender to the borrower).
The Debt Forgiveness Act temporarily relieved the taxpayer of
that burden, but was set to expire this year. Through much effort, it was
extended along with many other homeowner tax relief measures this year and
homeowners can continue to claim this tax relief in 2013.
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