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.
Property taxes must be deducted as an itemized expense on Schedule A.
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, filing jointly) 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.
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.
- 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.
- 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 law.
Second home sales also can provide some tax benefits, but not as much as they did in the past, thanks to a law that took effect in 2008. Previously, you could move into your vacation property, live in the home as your primary residence for two years and then sell and pocket up to $250,000 or $500,000 profit tax-free. Now, however, you'll owe tax on part of the sale money based on how long the house was used as a second residence.
Foreclosure tax troubles
Unfortunately, thousands of Americans over the past few years have seen their homeownership dream crumble.
Many lost homes to foreclosure.
Others disposed of their homes via a short sale to prevent more drastic lender action. In a short sale, the mortgage lender allows you to sell the property for less than the outstanding loan balance and cancels the remaining loan balance.
At best, struggling homeowners were able to restructure their mortgage terms so they could keep their homes under more favorable loan terms.
All of these cases, however, generally carry tax costs. The lender's forgiveness of the existing home's mortgage, in full or in part, is known as canceled debt and that amount is taxable income.
Because so many homeowners were facing cancellation of debt, or COD, tax bills, the Mortgage Debt Relief Act of 2007 was enacted to provide some relief. Under this law, homeowners who were foreclosed, completed a short sale or had their home debt reduced by mortgage restructuring do not have to count the canceled debt as taxable income.
Up to $2 million of forgiven debt, or $1 million for married taxpayers filing separately, qualified for the tax exclusion.
However, this law expired on Dec. 31, 2014. It is part of a larger group of tax breaks known as extenders that are expected to be reconsidered by Congress sometime in 2015, but there is no guarantee that the Mortgage Debt Relief Act will be renewed again.
What's not tax-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, or PMI, because you weren't able to come up with a large enough down payment, that's a cost you probably won't be able to deduct -- unless you meet the requirements of a special PMI law. Under this law, some homeowners can deduct on Schedule A their PMI payments on loans originated or refinanced between Jan. 1, 2007, and Dec. 31, 2014, and which meet certain loan amount limits.
Note the 2014 expiration date. The PMI-as-interest tax break, like the COD law, expired last year and may or may not be revived by Congress in 2015.
The other big home-related insurance cost, property hazard insurance premiums, still remains nondeductible for all, 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 homeowners association dues, any additional principal payments you make, depreciation of your home, and 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 on to the receipts. Some longtime homeowners may find their property has appreciated 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.