Tax breaks for homeowners
you've just taken another step up the American-dream ladder and are a homeowner.
Along with the joy of painting, plumbing and yard work, you now have some new
The good news is that you can deduct many home-related expenses.
These tax breaks are available for any abode -- mobile home, single-family residence,
townhouse, condominium or cooperative apartment.
The bad news is that to take full tax advantage of your home,
your taxes will get more complicated. You're not living on "EZ" Street
anymore; you've moved to the 1040 long form and Schedule A, where you'll have
Here's a look at homeowner expenses you can deduct, ones you can't
and some tips to get the most tax advantages out of your new property owning
Your biggest tax break is reflected in the house payment you make each month
since, for most homeowners, the bulk of that check goes toward interest. And
all that interest is deductible, unless your loan is more than $1 million. If
you're the proud owner of a multimillion-dollar mortgaged mansion, the Internal
Revenue Service will limit your deductible interest.
Interest tax breaks don't end with your home's first mortgage.
Did you take advantage of low rates and your real estate's growing value to
out extra cash through refinancing? Or did you decide instead to get a home
equity loan or line of credit? Either way, that interest also is deductible,
again within IRS guidelines.
Generally, equity debts of $100,000 or less are fully deductible.
But even then, the remaining amount of your first mortgage could restrict your
tax break. The IRS says you can deduct the smaller of interest on a $100,000
loan or your home's value less the amount of your existing mortgage. This could
be a concern if you excessively leverage your rapidly appreciating house.
For example, you bought your home three years ago with a minimal
down payment. Your mortgage balance is $95,000 and the house is now worth
$110,000. Your bank says you qualify for a 125 percent loan-to-value equity
line, or $42,500 ($110,000 x 125 percent = $137,000 - $95,000 left on your first
mortgage). To pay for your daughter's college tuition and buy her a car to get
to school, you take the bank up on the offer, thinking the interest deduction
on the loan would be icing on the tax-break cake.
However, you're not going to get to deduct all that interest.
Instead, your deduction is limited to interest on just $15,000 of the loan;
that's the amount your home's value exceeds your first mortgage. Interest payments
on the other $27,500 are not deductible, even though the equity line is secured
by your home. So don't automatically assume you can deduct all interest on home
What if your real estate circumstances are a bit brighter? Say,
for instance, you're able to swing a vacation
home on the lake. You're in tax luck. Mortgage interest on second homes
is fully deductible. In fact, your additional property doesn't have to strictly
be a house. It could be a boat or RV, as long as it has cooking, sleeping and
bathroom facilities. You can even rent out your second property for part of
the year and still take full advantage of the mortgage interest deduction as
long as you also spend some time there.
But be careful. If you don't vacation at least 14 days at your
second property, or more than 10 percent of the number of days that you do rent
it out (whichever is longer), the IRS could consider the place a residential
rental property and axe your interest deduction.
Did you pay points to get a better rate on any of your various home loans? They
offer a tax break, too. The only issue is exactly when you get to claim it.
The IRS lets you deduct points in the year you paid them if, among
other things, the loan is to purchase or build your main home, payment of points
is an established business practice in your area and the points were within
the usual range. This Bankrate
tax tip lists the complete qualification list your loan must meet to deduct
points all at once.
A homeowner who pays points on a refinanced loan also is eligible
for this tax break, but in most cases the points must be deducted over the life
of the loan. So if you paid $2,000 in points to refinance your mortgage for
30 years, you can deduct $5.56 per monthly payment, or a total of $66.72 if
you made 12 payments in one year on the new loan.
But if the refinancing frees up cash you then use to improve your
house, you can fully deduct points on that money in the year you paid the points.
The same rule applies to home equity loans or lines of credit. When the loan
money is used for work on the house securing the loan, the points are deductible
in the year the loan is taken out. If you use the extra cash for something else,
such as buying a car, you still can deduct the points but not completely on
one tax return. The points deductions must be parceled out over the equity loan's
And points paid on a loan secured by a second home or vacation
residence, regardless of how the cash is used, must be amortized over the life
of the loan.
The other major deduction in connection with your home is property taxes.
A big part of most monthly loan payments is taxes, which go into
an escrow account for payment once a year. This amount should be included on
the annual statement you get from your mortgager, along with your loan interest
information. These taxes will be an annual deduction as long as you own your
But if this is your first tax year in your house, dig out the
settlement sheet you got at closing to find additional tax payment data. When
the property was transferred from the seller to you, the year's tax payments
were divided so that each of you paid the taxes for that portion of the tax
year during which you owned the home. Your share of these taxes is fully deductible.
A word of caution: If your settlement statement shows any money
you paid into an escrow account for future taxes, this amount is not deductible.
You can only deduct the taxes in the year your lender actually pays them to
the property tax collector.
For example, you bought your house on July 1. Your property taxes
are due each Jan. 1. When you closed, the seller had already paid the year's
taxes of $1,000 in full so you reimburse the seller half of his annual tax payment
to cover your ownership of the property for the last six months of the year.
Your $500 reimbursement to the seller is shown on your settlement documents.
The closing document also shows you pre-paid another $500 to the
lender as escrow for the coming year's taxes due next Jan. 1. The $500 you reimbursed
the seller at closing is deductible on this year's tax return, but the $500
held in escrow is not deductible until it is paid the next year.
When you sell
When you decide to move up to a bigger home, you'll be able to avoid some taxes
on the profit you make.
Years ago, to avoid paying tax on the sale of a residence a homeowner
had to use the sale proceeds to buy another house. In 1997, the law was changed
so that up to $250,000 in sales gain ($500,000 for married joint filers) is
tax free as long as the homeowner owned the property for two years and lived
in it for two of the five years before the sale.
If you sell before meeting the ownership and residency requirements,
you owe tax on any profit. The IRS provides some tax relief if the sale is because
of a change in the owner's health, employment or unforeseen circumstances. In
these cases, the tax-free gain amount is prorated.
And a ruling by the IRS in late 2002 could put more dollars in
homeowners' pockets when they must sell before they qualify for the full tax
break. The Treasury has defined the unforeseen circumstances that often force
homeowners to sell and under which they now can get some tax relief. They include:
- Divorce or legal separation,
- Job loss that qualifies for unemployment compensation,
- Employment changes that make it difficult for the homeowner
to meet mortgage and basic living expenses, and
- Multiple births from the same pregnancy.
A partial exclusion can be claimed if the sale was prompted by
residential damage from a natural or man-made disaster or the property was "involuntarily
converted," for example, taken by a local government under eminent domain
What's not deductible
While many tax breaks are available to a homeowner, don't get too carried away.
There are still a few things for which you have to bear the full cost.
One such expense is insurance. If you pay private mortgage insurance
because you weren't able to come up with a large enough down payment, that's
a cost you can't write off at tax time. Neither can you deduct your property
insurance premiums, even though the coverage generally is required as part of
the home loan and is included as a portion of your monthly payment.
Other nondeductible residential expenses include homeowner association
dues, any additional principal payments you make, depreciation of your home,
general closing costs and local assessments to increase the value of your neighborhood,
such as construction of new sidewalks or utility connections.
What about all those repairs that seem to crop up the day after
you move in? Surely they're tax deductible. Sorry. While they'll make your house
much more comfortable, you're on your own here, too.
But hold onto the receipts. In today's hot real estate market,
some homeowners may find their property will appreciate beyond the $250,000
($500,000 for married couples) amount the IRS will let you keep tax free when
you sell. If that happens, the records
of property improvements could help you establish a higher basis
for your house and reduce your taxable profit.
-- Posted: July 1, 2003