Pacific Beach Real Estate, Mission Beach Real Estate, San Diego County Real Estate
Income tax planning for homeowners should start well in advance of the April 15th filing deadline each year. If you delay until the last minute, it might be too late to maximize your credits and deductions. In fact, my suggestion is that you take an hour or two to formulate a tax plan for the current year before the end of this month to determine if you need to take any action by December 31st. In order to give you a head-start, below is a brief list of some of the top homeowner tax benefits available.
You should also visit the Internal Revenue Service's website for more details on each item.
Mortgage Loan Interest
The "Mother of all Tax Breaks", this is the number one tax benefit because interest payments comprise a large portion of your mortgage payment in the early years of the loan's term. Mortgage interest on a maximum of $1 million in mortgage debt secured by a first and second home is deductible. Deductions reduce your taxable income against which your taxes due are calculated. The $1M level applies to joint tax filers. You get half the deduction if you file single or separately. Likewise, home equity loan interest is deductible, but is limited to the smaller of $100,000 (half as much for each member of a married couple if they file separately) or the total of your home's fair market value as determined by a complicated formula (consult your tax professional for details if this applies to you).
Home Improvement Loan Interest
The interest on a home improvement loan is deductible, but calculated differently. You can deduct all the interest on a home improvement loan provided the work is a "capital improvement" rather than repairs, maintenance or cosmetic upgrades. Capital improvements typically increase your home's value (room addition), prolong its life (new roof) or adapt it to new uses (improvements to assist the elderly or those with disabilities). You get tax benefits from repair work only when you sell your home but you can use a home equity loan to make repairs and deduct the interest -- up to the limits.
Points, each equal to 1 percent of the loan principal, are charged by lenders as part of the cost of a loan. You can fully deduct points associated with a home purchase mortgage, but not a mortgage broker's commission. Refinanced mortgage points are also deductible, but they must be amortized over the life of the loan. Once you refinance a second time, the balance of the old points from a refinanced loan offer is an immediate write off as you begin to amortize the new points.
Property taxes are fully deductible. Any local city or state property tax refund reduces your federal property tax deduction by the same amount. Also, don’t forget that if you bought property last year, escrow would have prorated the portion of property taxes to be paid by each party. Check your closing statements. A purchase also typically results in yet another dreaded tax... this one is the "supplemental" tax bill which can be an often over-looked deductible item. Last, many taxpayers pre-paid the second half of their California property taxes in December which are not due until February 1st... late on April 10th. These are deductible in the year they are paid.
Capital Gains Exclusion
A homeowner’s very best tax shelter comes from provisions in the Taxpayer Relief Act of 1997 which allows married taxpayers who file jointly to keep, tax free, up to $500,000 in profit on the sale of a home used as a principal residence for two of the prior five years. Some of the details:
• The IRC 121 exemption permits you to shelter up to $250,000 in profit if you're a single owner, twice that if you're married, and not owe any capital gains taxes upon the sale of your principal residence. You don't have to buy another home with your sale proceeds & you can use the money to travel to Europe in style, buy an RV, etc.
• There's no limit to the number of times you can use the home sale exemption. In most cases, you can make tax-free profits every time you sell a home.
• The property you are selling must be your principal residence. That means you live or lived in it. This tax break doesn't apply to a house or other property that you have held for investment purposes. You can turn a rental house into your primary residence, making the sale of it eligible for the exclusion. This is accomplished when you meet the IRS use and ownership tests meaning that you own and live in the home for two out of the five years before the sale. A bit more about this strategy later.
• Your actual habitation of the home doesn't have to be sequential. The IRS lets you aggregate the time you live in the house in order to meet the two year residency requirement. Generally, if you owned and used the home as your main home for periods totaling at least two years within five years ending on the date of the sale, you will be eligible for the exclusion.
• You do not have to be living in the house on the date of sale. The flexibility of the use test means you could live in your house for a year, rent it for two, move back in for another year and rent it again the year before you sell. Since during those five years, you owned and lived in the property for two years, you meet the use and ownership tests.
• While technically there's no limit on the number of homes you can sell and reap tax free gains, each sale must be at least two years apart.
• Partial Exclusion. Even if you do not meet all of the home sale exclusion tests, your tax break might not be totally lost. Selling a home because of "special conditions" (e.g., a change in health, employment or “unforeseen circumstances”), earns a prorated tax free gain.
• Members of the military also get "special home-sale" consideration. Because of deployments, military personnel often find it hard to meet the residency rule and end up owing taxes when they sell. But a law change in 2003 now exempts military personnel from the two year use requirement (for up to 10 years), letting them qualify for the full exclusion whenever they must move to fulfill service commitments.
• Until recently, when a spouse died, the surviving spouse had to sell his or her home in the same tax year as the spouse’s death in order to take advantage of the full capital gains exclusion noted just above. Thus, if a spouse died in December, unless the surviving spouse could sell the home by the end of the month, he or she would only be able to deduct $250,000 instead of $500,000 and wind up with a horrendous tax bill upon the sale of the home. If the deceased spouse had just waited until January, the survivor would not have that problem! Recent legislation now permits the surviving spouse to claim the full $500,000 exemption if the home is sold within two years after the date of the spouse’s death.
Home-Based Business Deduction
Homeowners who use a portion of the home exclusively for business may deduct a percentage of costs related to that portion. Included are a percentage of your insurance and repair costs, utility bills, garbage service, water, repairs/maintenance, gardener, pool service, telephone, etc. Under clarified provisions of the Taxpayer Relief Act of 1997, if your home office qualifies, you don't have to allocate a home sale's capital gains between the home and the business.
Selling Costs and Capital Improvements
When you sell your home, you can reduce your taxable capital gain by the amount of your closing and selling costs. Closing costs include real estate commissions, title insurance, legal fees, advertising and inspection fees whereas selling costs are those associated with getting your home ready for sale. These may include decorating or repairs -- painting, wallpapering, planting flowers, maintenance, and the like. These costs are deductible if you complete them within 90 days of your sale and with the intention of making the home more saleable. The way to figure your gain upon sale: Gain is your home's selling price minus deductible closing & selling costs minus your tax basis in the property. Your basis is the original purchase price plus closing expenses at purchase plus the cost of capital improvements you have made to the property.
A move triggered by a new job comes with some deductible moving costs. To qualify, you must meet certain requirements which include: moving within one year of starting your new job, moving 50 miles farther from your old home than your old job was, and working full-time at the new job for 39 of 52 weeks following the move. Deductions include travel or transportation costs and expenses for lodging and storing your household goods.
Mortgage Tax Credits
Mortgage Credit Certificates (MCCs) allow qualifying low income, first time buyers to take a mortgage interest tax credit of up to 20% of the mortgage interest payments made on a home. This credit is available every year you have the loan and live in the home. Unlike a deduction which reduces your income, a credit is subtracted, dollar for dollar, from the tax owed.
Ground Rent Payments
This often overlooked deduction does not impact all that many homeowners but if your residence is located on leased land you might be entitled to deduct your ground rent payments. The lease needs to be for at least 15 years, can be freely assignable to a potential buyer of your home, the landowner’s interest is primarily a security interest, and you have an option to purchase the land.
Mortgage Debt Forgiveness
Prior to enactment of the Mortgage Debt Forgiveness Relief Act of 2007, when a lender forgave repayment of a portion of principal and/or interest the borrower owed, the discharged debt was considered to be ordinary income. This new law now allows taxpayers to exclude this amount and thus escape the tax liability.
Mortgage Insurance…commonly referred to as "PMI"
PMI is paid by the borrower but protects the lender when the buyer’s equity is less than 20% and the amount of your monthly insurance premiums will depend on the amount you have borrowed to purchase your home. The mortgage insurance tax deduction for private mortgage insurance has been extended for another year to help generate more homebuyers. The previous deduction was set to expire but has now been extended. The full deduction is available for taxpayers whose adjusted gross is less than $100,000; a prorated amount may be available for those whose AGI is above $100K.
Energy Tax Credits
Tax credits that were 30% up to $1,500 expired on December 31, 2010. New tax credits were passed, but at lower levels and for existing homes and not for new construction. The levels revert back to those in effect in 2006 and 2007 which were 10% of the cost of the improvement, up to $500 with a $200 max for windows, and several other set maximums.
• Tax credits may be available, up to $500 total and for principal residences only: windows and doors including sliding glass doors, insulation, roofs (metal and asphalt), HVAC (central air conditioners, heat pumps, furnaces and boilers), water heaters ( gas, oil, & propane).
• Tax credits may also be available at 30% of the cost with no upper limit through 2016 (does not have to be your "principal residence; vacation homes are eligible): geothermal heat pumps, solar panels, solar water heaters, small wind energy systems.
Some states may also offer tax credits or rebate deals that could reduce the federal credit.
The "What's New" section of IRS Publication 17 (http://www.irs.gov/publications/p17/index.html
) offers a sneak peek at all tax changes from the previous year which might affect homeowners.