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Beyond the garden-variety deductions for mortgage interest and real estate taxes, J.K. Lasser’s™ Homeowner’s Tax Breaks reveals a treasure chest of tax breaks that any ...
Beyond the garden-variety deductions for mortgage interest and real estate taxes, J.K. Lasser’s™ Homeowner’s Tax Breaks reveals a treasure chest of tax breaks that any homeowner can use. These include such little-known breaks as getting tax-free rent from a short-term home rental, using the generous $250,000/$500,000 home sale exclusion to shelter gain from the sale of other real estate, and pocketing tax-free mortgage proceeds when trading up to a more expensive home.
J.K. Lasser’s™ Homeowner’s Tax Breaks provides a lively, concise, and plain-English explanation of tax rules for homeowners and a discussion of how these rules can be turned to your tax advantage and financial benefit.
Critical coverage will show you how to:
J.K. LasserPractical Guides for All Your Financial Needs
Next to being shot at and missed, nothing is so satisfying as avoiding a tax. Anonymous
It's often said the only thing you get from renting an apartment is rent receipts. It's an overstatement, of course, but it highlights the great preference Americans have for owning their own homes. The preference is understandable: In addition to being your own landlord and owning an asset that historically has been a stellar investment, home ownership provides you with unique tax benefits.
Home Ownership vs. Apartment Rental. As a homeowner, you enjoy a collection of tax breaks not afforded to rental apartment dwellers. For example, as a homeowner you can deduct your payments of real estate taxes and mortgage interest. If you rent an apartment, however, the rent you pay is a wholly nondeductible "personal" expense, even though part of your rent is used by the landlord to pay taxes on the building and mortgage interest. Similarly, home ownership is rewarded with a unique tax break when you sell your home at a gain. Tax on the gain may be completely avoided under exclusion provisions that exempt gain on the sale of your home. As explained in Chapter 4, you can exclude up to $250,000 of gain if you are single or up to$500,000 if you are married. No other asset is favored with exemption from taxation when it is sold at a gain.
The good tax news extends even to costs you pay in the year you purchase your home.
Deduction for real estate taxes. In the year you purchase your home, the deduction for real estate taxes for the year is split between you and the seller. You should take steps to make sure you get your proper share.
Deduction for mortgage points. Mortgage costs referred to as "points" may be treated as deductible interest in the year you purchase your home. But you have to meet IRS requirement to get the deduction.
Deduction for moving expenses. If you are purchasing your home as a result of a job-related move, part of your moving expenses may be deductible. Again, you have to meet IRS requirements.
This chapter shows you how to nail down your share of the real estate tax deduction for the year of your purchase and how to meet the IRS requirements for the deduction of mortgage points and moving expenses.
Co-Ops and Condos
While each of the tax factors noted should be considered by purchasers of single-family houses, they are equally relevant for purchasers of cooperative or condominium units.
Of course, when you purchase your home you ordinarily don't focus on factors that may affect your tax liability in the distant future. You have other things on your mind.
But there are other tax matters you should consider. How you take title is important. You should be aware of both the practical implications and the income and estate tax consequences if you take title to your home jointly with your spouse. (See Sections 1.5 and 10.2.) You also should be aware of the importance of keeping permanent records showing the "tax cost" of your home, including not just the purchase price but also brokerage commissions, legal fees, and other closing costs. These records can be critical if you sell your home later at a gain in excess of the home sale exclusion. (See Section 1.6.)
First we discuss real estate taxes in the year you buy.
1.2 Real Estate Taxes in the Year You Buy: Get Your Proper Share
When purchasing a home, buyers usually don't think much about the real estate taxes they're paying in the year of purchase. But buyers are entitled to deduct their share of real estate taxes on the home for the year in which the purchase occurs. As a purchaser, you should make sure you get your proper share of this valuable deduction.
Just as important, you should make sure the seller gets charged for the seller's proper share of the year's real estate taxes. Otherwise, you could be paying part of the seller's real estate tax even though you can't deduct the payment.
Seller's and Your Share. The contract of sale for the property controls how real estate taxes for the year of sale are apportioned between the seller and the purchaser. In the part of the contract dealing with closing adjustments, it should be clearly stated how the real estate taxes for the year are to be prorated between you and the seller. The seller should be charged with the amount of tax from the beginning of the real property tax year to the date of closing, and you should be charged with the balance of the tax to the end of the real property tax year. That way, each of you is responsible for the taxes for the portion of the real property tax year during which you own the property.
If real estate taxes for the real property tax year have not yet been paid on the date you close the purchase of your home and the contract doesn't provide for prorating at the closing, then, since you will own the property when the taxes become due, you will have a problem. You will have to pay the real estate taxes in full, even though part of the taxes are attributable to the part of the year the seller owned the property. To add insult to injury, the seller will be able to deduct the share you pay. In other words, if the seller doesn't get charged at the closing for the seller's share of the taxes and you pay all the taxes sometime after the closing, you lose twice: The seller gets a free ride for the seller's share of the taxes and, as illustrated below, you can deduct only your share, not the entire amount you paid.
Pro Rata Sharing Required. The tax rules are specific as to how the seller and the purchaser are to deduct real estate taxes for the real property tax year the home is purchased. The rules require that, for deduction purposes, the real estate taxes are to be split between the seller and purchaser based on the number of days each of them owns the property. The real estate tax for the part of the year that ends on the day before the sale is treated as a tax imposed on the seller, and the tax for the part of the year that begins on the date of the sale is treated as a tax imposed on the purchaser. This rule applies whether or not the seller and purchaser actually make an allocation of the real estate tax in the contract of sale, and regardless of who pays the tax.
Check the Contract. If real estate taxes on the property you are purchasing have not been paid before your closing, you will pay the tax bill sometime after the closing. Accordingly, you should make sure the seller gets charged in the contract of sale or in the closing statement with the seller's portion of the tax, and that the adjustments at the closing reflect the charge to the seller.
The following example, in which Mr. Sharp sells you his house, shows how the seller should be charged for the tax for the portion of the real property tax year during which the seller owns the property.
The real property tax year is April 1 to March 31. Mr. Sharp, who owns the property on April 1, 2003, sells it to you on June 30, 2003. You own the property from June 30, 2003, through March 31, 2004. The real property tax for the real property tax year April 1, 2003, to March 31, 2004, is $3,650, and you pay the entire tax when it becomes due in 2004. Under these facts, $900 (90/365 × $3,650, April 1, 2003, to June 29, 2003) of the real property tax is treated as imposed on Mr. Sharp. Similarly, $2,750 (275/365 × $3,650, June 30, 2003, to March 31, 2004) of the real property tax is treated as imposed on you.
Since Mr. Sharp owned the property for part of the tax year for which you have paid the entire tax, he should have been charged for his share of the tax at the closing. If not, you paid part of Mr. Sharp's tax. To add insult to injury, while your payment of $3,650 in taxes included part of his tax, $900, you can deduct only the part treated as imposed on you, $2,750.
An ounce of prevention can prevent this problem. Simply be sure the purchase contract or closing statement is reviewed by your lawyer to verify that the seller is charged with the proper portion of the year's real property tax.
1.3 Mortgage Points: How to Assure Deduction
Mortgage points are like cholesterol: There are good points and bad points. Only the good points are deductible.
Here's the story.
Charges you pay your lender for getting your home mortgage loan are expressed as a percentage of the loan and are called "points," each point being equal to 1 percent of the loan. For example, if you are obtaining a $150,000 mortgage, one point is $1,500. Can you deduct points you pay for your mortgage loan in the year you pay the points?
Service Charges vs. Interest. When making a loan, the lender may perform various services for you as a borrower, such as securing appraisals, preparing documents, and processing applications. Points that you pay for such services by the lender in a personal residential transaction are nondeductible "personal expenses." On the other hand, if the points are additional interest charged by the lender on your home mortgage, they are currently deductible as home mortgage interest if they meet IRS guidelines. So it is important to determine whether the points are a charge for services or additional interest. You should try to make sure any points you pay are for interest, not services of the lender.
Get Your Lender's Help. Sometimes the purpose for which points are charged by the lender is not clearly stated, so that it is difficult to tell whether the points are being charged for services or as additional interest. However, the IRS says that an allocation of points between service charges and additional interest in your loan contract normally will be respected if the allocation is based on an honest agreement between you and the lender. If it's unclear that the points charged by your lender are for interest, ask your lender to clarify their purpose in your loan contract.
How Do You Qualify to Deduct Points as Interest? Assuming the points are for interest and not service charges, are they deductible? Again, it depends. According to IRS guidelines, the points you pay your lender can be deducted in the year you buy your home if the following five requirements are met. While the guidelines are needlessly complex and annoying, the cautious home purchaser will make sure they are complied with.
Cash Basis Taxpayers. The guidelines apply to "cash basis" taxpayers. These are individuals who report income when received and expenses when paid. Individual homeowners are cash basis taxpayers.
1. Designation on Uniform Settlement Statement. The Uniform Settlement Statement you get at the closing must clearly designate the amounts involved as points payable in connection with the loan. For example, the amount should be shown as "loan origination fees," "loan discount," "discount points," or "points."
2. Figured as a percentage of the amount borrowed. The amount paid must be computed as a percentage of the principal amount of your mortgage loan.
3. Charged under established business practice. The amount you pay must conform to an established business practice of charging points for loans for home purchases in your local area, and the amount of points you pay must not exceed the amount generally charged in your area. When you were shopping for your loan, you probably found that the amount of points your lender was charging was more or less standard in your area.
4. Paid for acquisition or improvement of principal residence. You must pay the points in connection with the purchase of your principal residence, and the loan must be secured by the residence. The guidelines don't cover points paid on a loan used to purchase or improve a second residence or other property that is not your principal residence.
5. Paid directly by you. The points generally must be "paid directly" by you to your lender from your separate funds, not from the mortgage money. Your check to the lender on preexisting funds in your checking account is one way to handle this requirement.
Disguises Not Permitted. If amounts labeled points are paid in lieu of amounts that usually are stated separately on the settlement statement, such as appraisal fees, inspection fees, title fees, attorney fees, and property taxes, such amounts are not interest and, accordingly, are not deductible as points.
There's another way to meet this niggling "paid directly" requirement. Under the IRS guidelines, you will be treated as paying directly from your separate funds if you pay at the closing, from funds not borrowed, an amount at least equal to the points. Such payment from you would include your down payment, the application of earnest money at the closing, and other funds paid directly by you at the closing.
Example You purchase a principal residence for $150,000, paying $7,500 in closing costs, including $3,000 in points. You provide $4,500 in unborrowed funds to pay closing costs other than points and finance the payment of the $3,000 in points by increasing the mortgage loan by $3,000. You will be deemed to have met the "paid directly" requirement because you have provided unborrowed funds ($4,500) at least equal to the amount of points.
A cap is placed on the amount of points deductible under the IRS guidelines. Points allocable to a home mortgage loan in excess of $1 million are not protected by the guidelines. Moreover, the guidelines do not apply to points paid on a refinancing loan, a home equity loan, or a line of credit.
Nondeductible Points. There is only a small tax consolation prize if the points are not currently deductible. Nondeductible points on a home mortgage must be "amortized" on a straight-line basis over the life of the mortgage loan. This means that only a ratable portion of the total points paid is deducted each year. For example, if you pay $1,500 in points to obtain a 15-year mortgage, you can deduct only $100 yearly for 15 years ( $1,500/15 = $100).]
Excerpted from .K. Lasser's Homeowner's Tax Breaks by Gerald J. Robinson Excerpted by permission.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.
Part I: Sheltering Your Income with Home Deductions.
1. Deductions in Year You Buy Your Home.
1.2 Real Estate Taxes in the Year You Buy: Get Your Proper Share.
1.3 Mortgage Points: How to Assure Deduction.
1.4 Moving Expenses: Does Your Move Qualify for Deduction?
1.5 How Should Married Couples Take Title to Their Home?
1.6 Purchase Expenses: The Importance of Records.
1.7 Purchaser’s Tax-Planning Checklist.
2. Recurring Deductions Every Year You Own Your Home.
2.2 Planning to Maximize Deductions.
2.3 Deduct All Your Real Estate Taxes.
2.4 Tax Magic of Home Mortgages: Your Interest Deductions.
2.5 Refinanced Home Mortgage—Watch Out for Interest Deduction and Points.
2.6 Home Damaged? Let the IRS Help Pay!
2.7 How to Boost Your Damage Loss Deduction.
2.8 When Your Damage Is from a Presidentially Declared Disaster.
2.9 How to Deduct Your Home Office Expenses.
2.10 Eligibility of Employees.
2.11 Eligibility of Business Owners.
2.12 Figuring the Deduction.
2.13 If You Work outside Your Home: How to Get Home Office Deductions.
2.14 How Home Office Makes Commuting Costs Deductible.
2.15 Deduct Your Home Office Equipment Cost—Up Front.
3. Special-Situation Deductions for Homeowners.
3.2 How to Get Tax-Free Income from Short-Term Rental.
3.3 How to Make Your Credit Card and Car Loan Interest Deductible.
3.4 How to Deduct Cost of Medical Home Improvements.
3.5 Deductible Home Improvements for the Disabled.
3.6 How an Employee Gets a Tax Break for a “Sideline” Business.
3.7 Deduction of Fees for Home Tax Advice.
3.8 Tax-Wise Borrowing against Your Home for Business.
3.9 Renting a Part of Your Home.
3.10 Your Home as a Retirement Nest Egg.
Part II: Tax Shelter When You Sell Your Home.
4. How to Sell Your Home with No Tax on Gain.
4.2 How to Plan for the Sale.
4.3 Exclusion of Up to $250,000 or More of Gain.
4.4 How to Qualify for the Exclusion.
4.5 Exceptions to the Two-Year Rule: Job Change, Health Problems, or Unforeseen Circumstances.
4.6 Married Couples: How to Get the $500,000 Exclusion.
4.7 Is Your Home Your “Principal Residence”?
4.8 Your Home Office: Does It Qualify?
4.9 Vacant Land Can Qualify.
4.10 Snowbirds: How to Deal with the Southern Home Trap.
4.11 Gain in Excess of the Exclusion.
4.12 How to Cope with a Depressed Market by Rental before Sale.
4.13 How to Avoid Reporting to the IRS.
4.14 Seller’s Tax-Planning Checklist.
5. The High-Priced Home: How to Avoid Tax When Gain Will Exceed the $250,000 or $500,000 Ceiling.
5.2 Upper-Middle-Class Victims.
5.3 Tax Time Bomb.
5.4 Tax Idea 1: Deferred Sale Approach.
5.5 Tax Idea 2: The Leasehold Carve-Out.
5.6 Tax Idea 3: The Installment Sale.
5.7 Tax Idea 4: Conversion to Rental and Exchange.
5.8 Summing Up.
6. When Spouses Split.
6.2 Don’t Lose the Exclusion on Principal Residence Sale!
6.3 Transfer of Home to Spouse.
6.4 Is It Smart to Sell Prior to Divorce?
6.5 How to Avoid Gain on a Vacation Home.
6.6 Splitting Up Marital Property: Beware the Tax Trap.
Part III: Tax Shelter from Homeowner Loopholes and Vacation Homes.
7. Little-Known Loopholes Can Provide Big Savings.
7.2 The Super Loophole: How to Use Home Sale Exclusion to Shield Gain on Other Real Estate from Tax.
7.3 How to Buy Vacation Home with Tax-Free Dollars from Sale of Rental Property.
7.4 Avoiding Tax When Your Land Includes Both House and Investment Property.
7.5 Your Appreciated Residence Is a Tax Treasure: How to Trade Up and Get Tax-Free Cash.
7.6 Home Improvements: Handyman’s Special Tax Shelter.
7.7 Home Improvement Business: Tax-Free Income for Renovators.
7.8 When a House Is Not a Home: How to Deduct Loss on Sale of Home.
7.9 How to Get a Charitable Deduction for Your Home—And Still Live in It.
7.10 Every Home Owner’s Hidden Loophole: Nontaxable “Imputed” Income.
8. Your Vacation Home Is a Tax Shelter.
8.2 Scenario 1: Use of Vacation Home Exclusively as Vacation Home.
8.3 Scenario 2: Use for Vacation and Rent for 14 Days or Less.
8.4 Scenario 3: Use for Vacation and Rent for More Than 14 Days.
8.5 Tax Loss from Rental Not Allowed.
8.6 Figuring the Amount Deductible.
8.7 Scenario 4: Rent to Others for the Entire Year.
8.8 Need for Profit Motive.
8.9 Figuring Amount of Tax Shelter.
8.10 Hidden Nugget: A Little Personal Use.
8.11 Depreciation: The Deduction without Cash Outlay.
8.12 Tax Shelter Rules.
Part IV: Retirement Benefits and Estate Planning.
9. How to Get Tax-Free Dollars in Retirement from Your Home.
9.2 Tax-Free Trading Down.
9.3 How Trading Down Increases Cash Flow.
9.4 How Much Cash from Trading Down?
9.5 The Tax Benefit.
9.6 Tax-Free Reverse Mortgages.
9.7 What Is a Reverse Mortgage, Anyway?
9.8 The Tax Benefit.
9.9 How Much Cash Flow Can You Get?
9.10 What Type of Reverse Mortgage Is Best for You?
10. Reducing Estate Tax on Home.
10.2 Should Spouses Own Home Jointly?
10.3 Do You Need Estate Tax Planning?
10.4 Larger Estates: How Not to Lose the Second Exemption.
10.5 How Parent Can Cut Taxes on Vacation Home.
10.6 Estate Planning for a Parent’s Home: Using Sale–Leaseback to Shift Appreciation in Value.
10.7 How Parents Can Escape Estate Tax on Their Homes: The Qualified Personal Residence Trust.
Appendix A: Instructions for Form 8829.
Appendix B: IRS Publication 521: Moving Expenses.
Appendix C: IRS Publication 530: Tax Information for First-Time Homeowners.