| Tax breaks designed to help you get ahead |
| By Steve Santiago • Bankrate.com |
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In 1758, Benjamin Franklin said, "It would be a hard government that should tax its people one-tenth part of their income."
Imagine what Citizen Ben would think if he were transported to the 20th century, during which the top marginal rate exceeded 50 percent much of the time, peaking at 94 percent in 1944-45 for taxpayers with incomes of more than $200,000. Today, income tax rates range from a relatively benign 10 percent to 35 percent -- still more than Ben would have liked.
The tax code is not only designed to generate revenues for government programs. Uncle Sam provides some pretty nice tax breaks that provide Americans incentives to get a college education, buy a home and save for retirement.
These breaks typically come in the form of tax deductions or tax credits. A tax credit is usually a dollar-for-dollar sum that can be directly deducted from taxes owed. A tax deduction is a sum that reduces your taxable income.
Identifying the breaks that you qualify for is the first step toward lowering your overall tax burden, which helps build your bottom line.
Tax breaks that advance your best interests
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Tax deductions for homeownership
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Mortgage points |
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Mortgage interest |
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Mortgage insurance premiums |
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According to the Office of the Comptroller of the Currency, there are more than 34.7 million mortgage loans worth more than $6.1 trillion as of June 2008.
That means a lot of people are eligible to reduce their overall tax bill if they know where to look.
The Internal Revenue Service generally allows mortgage points, also known as discount points, to be deducted from your tax return. Mortgage points are upfront fees paid to a lender for the loan.
One mortgage point equals 1 percent of the loan amount. Points are usually paid at closing and generally result in a lower interest rate on the loan.
IRS rules allow homeowners to deduct points over the term of the loan or all at once in the year they were paid. To deduct points all at once, you must meet certain IRS eligibility tests. In general, the home must be your main residence. In addition, the points you paid must not be considered exorbitant, must be computed as a percentage of the mortgage and must be clearly identified as points on your settlement sheet.
"The key thing to remember about this is all of these things need to be itemized," says Kay Bell, a tax expert who writes Bankrate's "Eye on the IRS" tax blog. "You can't use Form 1040-A or 1040-EZ."
Points that don't meet IRS eligibility tests or points paid on loans secured by a second home can be deducted only over the life of the loan. In general, the loan period must not be longer than 30 years and the number of points must be six or less.
Generally, the IRS will allow a deduction for interest paid on a home loan. That includes loans for the mortgage on your primary residence and a vacation property and, under certain conditions, interest on a second mortgage, a home equity line of credit or a home equity loan.
The IRS requires that you claim the deduction on a Form 1040 and that you -- not someone else -- are legally liable to repay the loan.
The IRS also places restrictions on whether the interest is fully deductible. In general, the combined mortgage total (including both first and second mortgages) cannot exceed $1 million.
As you pay down your loan, you'll probably pay less in interest and more in principal. In some cases, taking the mortgage interest deduction may not pay off.
"If the mortgage interest is less than the standard deduction, which is around $10,700 for a married couple, it might not be worth it to deduct the mortgage interest depending on the taxpayer's other itemized deductions," says George Saenz, a certified public accountant and Bankrate's "Tax Talk" columnist.
Tax blogger Kay Bell, a member of the Taxpayer Advocacy Panel, agrees that in some cases, the standard deduction may be a better deal.
"The standard deduction amounts have been going up, so you need to pay close attention to what those are," she says. "Some people might not have enough (interest to deduct), so it makes no sense itemizing."
Lenders generally require you to pay mortgage insurance if you put less than 20 percent down on your home.
Mortgage insurance sometimes appears on your settlement sheet under different names. For example, if it's provided by the Department of Veterans Affairs, it's called a funding fee. If it's provided by the Rural Housing Service, it's called a guarantee fee.
Fortunately, homeowners who bought a residence in 2007 or afterward can deduct all or a portion of the mortgage insurance premium, thanks to the Tax Relief and Health Care Act of 2006.
Originally, this legislation applied only to mortgages closed in 2007. However, passage of the Mortgage Forgiveness Debt Relief Act of 2007 has extended this tax break through 2010.
Some restrictions apply. For example, your adjusted gross income can't be more than $109,000 ($54,500 if married filing separately), and you must file an itemized tax return.
For more information, read the Bankrate feature "Deducting private mortgage insurance payments."
Joe Clark, a Certified Financial Planner and managing partner at Financial Enhancement Group in Anderson, Ind., says some of his clients with FHA loans lose out on the insurance premium deduction because they don't file an itemized tax return.
"What I've seen is some people thought they had mortgage insurance they could deduct, but they filed using the short form," he says.
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