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Tax incentives and issues for homeowners

Think Tank
Eric Zinn,
J.D., LL.M., M.B.A.
Director of the Graduate Tax Program at the University of Colorado Denver Business School
Bonnie Villarreal,
Director of Graduate Accounting Programs at
Utah State University Jon M. Huntsman School of Business 

If you’re currently in the market for a home, there are a lot more advantages to purchasing real estate than the low mortgage rates we have enjoyed for the past several years. As Eric Zinn, director of the University of Colorado Denver Business School’s Graduate Tax Program, and Bonnie Villarreal, director of Utah State University’s Accounting Graduate Programs explain, a multitude of those advantages come into play during tax season. Furthermore, once you become a homeowner, a simple change in your circumstance can have a huge impact on the taxes you pay and the tax breaks you receive.

Q: What are some tax incentives for homeowners?
Eric Zinn, J.D., LL.M., M.B.A.
University of Colorado Denver Business School

A: No. 1: Mortgage interest deduction

As a general rule, you can deduct interest paid on mortgages used to finance up to two residential properties. Nevertheless, your mortgage interest deduction may not be fully deductible if the total outstanding balance exceeds $1 million for properties owned before December 15, 2017, and not more than $750,000 for properties purchased thereafter, or if you use the borrowed money for something other than the purchase, construction or improvement of your residences.

No. 2: Home equity loan interest deduction

Homeowners can deduct the interest paid on a home equity loan or line of credit, but only through tax year 2017, as the deduction has been rescinded. Up until 2017, your home equity loan interest deduction was fully deductible for amounts of up to $100,000. Homeowners often use money from a home equity loan to pay off other personal debts and credit cards and then generate tax deductible interest payments on the home equity loan, but this will no longer be the case starting in 2018.

No. 3: Mortgage insurance premiums

You may be able to deduct mortgage insurance payments on a principal residence or second home. Mortgage insurance is provided by the VA, FHA, USDA, or private insurers.

No. 4: Points and other settlement payments

Recent homebuyers may be able to deduct “points” reflected on your settlement statement. Points are generally charges paid by the homeowner to obtain a home loan. Points include loan origination fees, maximum loan charges, loan discounts, or discount points.

No. 5: Real estate taxes

You generally can deduct real estate taxes if you pay taxes either at the closing of the purchase or to a taxing authority (either directly or through an escrow account with your mortgage lender) during the year. However, for homes purchased after December 14, 2017, the amount of property tax you can deduct is capped at $10,000.

No. 6: Home office expenses

If your home is your principal place of business, you may be able to deduct expenses associated with your home office. Generally, you calculate your deductions based off of the percentage of the home devoted to the office. Deductible home office expenses include a percentage of mortgage interest, real estate taxes, insurance, utilities, repairs and depreciation. IRS Revenue Procedure 2013-13 provides a simplified method that homeowners can use to calculate their deductible home office expenses.

No. 7: Vacation homes

A homeowner that rents his or her vacation residence for 15 or more days per year generally can deduct some of the expenses associated with that rental. You allocate vacation home expenses -- mortgage interest, taxes, insurance, utilities, repairs, and depreciation -- between nondeductible expenses associated with your personal use of the home and the deductible expenses associated with the rental. In any given year, if your allocated rental expenses exceed the rental income earned, you generally may only deduct allocated expenses up to the amount of rent earned. Any excess expenses may be carried forward and deducted in subsequent years.

No. 8: Moving expenses

If you relocate for a job, you may be able to deduct moving expenses. Deductible moving expenses include the costs of moving and traveling, excluding meals. IRS Publication 521, Moving Expenses, provides information about this tax incentive. To claim deductible moving expenses, you must file IRS Form 3903.

No. 9: Casualty and theft losses

If your home is destroyed or damaged by a flood, fire, earthquake or theft, you may generate a deductible loss to the extent of any economic loss suffered by the homeowner not covered by insurance. Use IRS Form 4684 to report casualty or theft loss.

No. 10: Mortgage debt forgiveness

Certain homeowners can exclude from their taxable gross income discharged amounts of their mortgage balance made after 2006 and before the end of 2017.

No. 11: Residential energy credits

You may be able to claim tax credits for certain energy-saving improvements. To claim these residential energy credits, the homeowner must file IRS Form 5695.

No. 12: Mortgage credit certificate

If you received a Mortgage Credit Certificate, you can claim mortgage interest credits for your home mortgage interest payments. Low-income homeowners are eligible to claim the credit if he or she receives a “MCC” from a state or local government in connection with the purchase of a principal residence. To claim the mortgage interest credit, you must file IRS Form 8396.

No. 13: Exclusion of gain on sale of a principal residence

You may exclude up to $250,000 of gain ($500,000 for married selling homeowners that file jointly) on the sale of a principal residence. To qualify for the exclusion, you must satisfy both an ownership test and a use test. As a general rule, to satisfy the ownership test, you must own the home for at least 24 months during the 5 years preceding the date of the home’s sale. To satisfy the use test, you generally must use the home as a principal residence for at least 24 months during the period of time that you owned the home for the 5 years preceding the date of the home’s sale. IRS Publication 523, Selling Your Home, offers more guidance on this gain exclusion. Gain that you earn on the sale of your home in excess of the exclusion amount just described generally is taxed at preferential long-term capital gain rates if you owned the home for more than 1 year prior to its sale.

No. 14: Home improvements

Although not generally deductible, improvements that you make to his or her home do provide you with a tax benefit. You add the costs of any improvements to your home’s tax basis for purposes of calculating your future gain on the sale of the home. Consequently, to the extent that you increase the tax basis in your home for the costs of improvements, you will recognize a lower gain on the future sale of that home. 

Nondeductible home expenses

Except as otherwise noted previously, homeowners generally cannot claim deductible expenses for homeowner’s insurance, depreciation, or utility costs.

Q: How do circumstantial changes affect a homeowner’s taxes?
Bonnie Villarreal, MAcc
Utah State University Huntsman School of Business

A: Benjamin Franklin is often quoted, “In this world nothing can be said to be certain, except death and taxes.” Unfortunately, there seems to be a third certainty, and that is the fact that tax rules and provisions will change from year to year, making it difficult to make sure you are getting your tax return right and even more difficult to arrange your affairs in a way that considers tax costs and benefits. The best advice to any homeowner is to make sure you have a trusted financial advisor who stays abreast of the latest developments, can answer your questions and help you make savvy plans. Lately, tax return preparation software has become extremely affordable, and in many cases, free. Many homeowners can file their own tax returns electronically and feel secure in doing so. However, changes in a homeowner’s circumstances and changes in tax law may mean changes in the information you need to gather during the year and at tax time.

Here are several home-owning changes and how they impact your taxes:

  • Buying a home. Even though the First-time homebuyer tax credit has gone away, buying a home is still a major event that affects your tax return. Your settlement papers will provide most of the information about expenses that may be deductible and will establish your basis (investment amount) in your home. These need to go into your permanent file along with receipts for major improvements to an existing home. With mortgage rates low and an increased standard deduction amount, many first-time homebuyers are surprised to find out that they are still better off not “itemizing” their tax return deductions. It is always best to check, especially after a major change.
  • Changes in financing. When you refinance a home or take out any new credit that is secured by your home, there are often tax consequences. If you benefitted from programs like the Home Affordable Modification Program (HAMP), Hardest Hit Fund or the Emergency Homeowner’s Loan Programs, you may have tax consequences on your tax returns. Your tax professional can help you determine income that may be excludable, payments you can deduct and adjustments that you may need to make to the basis of your home that will be important when you later sell it.
  • Energy saving improvements. Some Residential Energy credits have been extended for 2014, including 30 percent of the costs for improvements such as solar panels and water heaters, residential wind turbines, and geothermal heat pump and fuel cells. For tax year 2014, a 10 percent credit is available for more conventional energy improvements such as exterior doors and windows, insulation, electric heat pumps and more.
  • Using your home as a place of business. Telecommuting has become much more common and tax laws have been modified to reflect the fact that doing business from home is no longer unusual or limited to day-care providers. Nor is it always a red flag signaling that the taxpayer is being aggressive in tax avoidance. Simplified rules for figuring deductions when you use all or part of your home to make a profit are now available.
  • Selling or renting all or part of your home. Changes in the housing market, changes in lifestyle and family situations mean that many homeowners may choose to change where they live. The main residence is often the largest investment a family will ever make. Sometimes, waiting to sell your main home and renting it out while waiting for a change in market conditions may make sense even though you need to relocate. If you are anticipating a move or thinking about renting out the property you own, consult with your tax professional about the tax impact and related rules and provisions. If you rent out your home for more than 14 days within the calendar year, you must report the rental income but may deduct rental expenses. Depreciation may need to be calculated and other expenses divided between personal and rental uses. These computations require some knowledge of the appropriate tax law. When your main home is sold, any loss is usually not deductible and gains on the sale need to be reported even though they may not be taxed, but the rules are somewhat complex. For instance, if your move is work related, the distance of your new residence from your old home or old place of work can determine whether you will pay tax on any gain on the sale.

This is an especially trying year for taxpayers preparing their 2014 returns and trying to sort out how new laws such as the Affordable Care Act and Net Investment Income Tax may affect them. Savvy homeowners should keep organized records, stay informed by reading publications that summarize issues to be aware of, and keep a good relationship with professionals who can look out for the details when rules change. A good professional advisor can help a homeowner know when it is smart to do the work themselves and when they can actually save time and money by investing in professional help.

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