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12 essential tax questions for homeowners

mortgage taxesAlbert Einstein once said, "The hardest thing in the world to understand is the income tax.” If you buy, sell, finance or own real estate, it gets even worse. Property and taxes go together like blood and leeches.

Yet there's no reason to pay more than the minimum, and the Internal Revenue Code actually gives property owners lots of tax breaks.

"For many homeowners, real estate taxes and mortgage interest are by far some of their biggest tax deductions," says Art Ford, a certified public accountant in Boston. "If I pay $1,500 a month in mortgage interest, that's an $18,000-a-year deduction."

So before you belly up to the nearest bar or start pulling your hair out, here are some commonly asked questions about taxes and homeownership. Knowing these answers will help keep your tax bill as low as possible.

No. 1: How much of my mortgage payment is tax deductible?

On a Schedule A, you can generally deduct the following:

  • For mortgages made before December 14, 2017, interest on debt used to buy, build or improve your primary or second home (called acquisition debt), as long as mortgages totaled $1 million or less ($500,000 if single or married filing separately). For mortgages made after this date, the limits are $750,000 / $375,000.
  • Mortgage insurance (or funding fees for government loans) for loans taken after 2006 as long as your adjusted gross income does not exceed $100,000 for a married couple (half that for singles and those married filing separately)
  • Property taxes on first and second homes (if you itemize your deductions). Starting in 2018, the amount of property tax you can deduct is capped at $10,000.

No. 2: I sold my home this year. Will I owe capital gains tax?

As long as the property was your principal residence for at least two of the last five years, you can exclude $250,000 of your profit ($500,000 for married couples) from your federal taxable income. If you profited less than the $250,000/$500,000 threshold, no extra form is required. You can do this as often as every two years.

If you made a higher profit or otherwise don't qualify for the exclusion (say, you sold after just one year), Ford says you'll generally owe up to 23.8 percent in federal taxes on your gains over and above the "excluded" amount. (Your actual rate will vary depending on your income.)

But when calculating your taxable gains, Ford suggests looking beyond what you originally paid for your home. You should also factor in anything that you spent on home improvements while you owned the property.

Say you and your spouse bought a place for $100,000 two decades ago, lived there as your primary residence and sold the home for $800,000. You'd ordinarily have to pay capital-gains taxes on $200,000 -- your $800,000 sale price minus your $100,000 purchase price minus the $500,000 exclusion for married couples.

However, if you spent $150,000 on upgrades, you can deduct that from your capital gain. In the example above, that would reduce your taxable profit from $200,000 to just $50,000.

That said, IRS Publication 523 notes that you generally can't deduct repairs or maintenance, only "improvements" that are designed to increase your home's value. Unfortunately, the rules for what's a "repair" versus an "improvement" are pretty vague.

For instance, the IRS says fixing a broken windowpane is a repair, but replacing it as part of a project to swap out all of your home's windows is an improvement. So, consult with a tax professional or read IRS Publication 523 for further guidance.

If you still have taxable profits on your home after factoring in all of the above, you'll report your gains on a Schedule D, Capital Gains and Losses. There are special rules for vacation homes. You may be able to exclude some or all of your gain.

Remember, different states have different rules. Always consult with a tax professional if you need personal advice.

No. 3: I lost money on the sale of my home. Do I get to deduct the loss?

Loss on the sale of a personal residence is treated like a loss on the sale of any personal property. It is not deductible. Losses on investment properties are deductible.

No. 4: Are my closing costs tax deductible?

You can claim a deduction for real estate taxes you paid as part of your mortgage closing costs. Starting with 2018, this amount will be capped at $10,000. The same goes for prepaid interest. It will be included on the 1098 form your lender sends you.

What about points?

The IRS has a flowchart that you can use to see if points are fully deductible. In general, you must have paid points to build, buy or improve your primary residence in order to deduct the entire amount in the year they were paid. Otherwise, they may still be deducted but on a prorated basis.

No. 5: What happens with points on a refinance?

This deduction is often overlooked, and it could be worth a lot. When you pay points on a refinance, they have to be prorated.

For example, if you paid $3,000 in points on a 30-year mortgage, you can deduct $100 a year for 30 years. But if you refinanced again this year and have prorated points that have not yet been deducted -- for example, you are 10 years into a 30-year loan and have only deducted $1,000 of $3,000 in points paid -- you can deduct the remaining $2,000 in the year you refinance.

No. 6: Does a mortgage modification affect my taxes?

If you modify your mortgage, one consequence might be that you pay so much less interest that you will save more by choosing the standard deduction rather than itemizing. Don't just assume that itemizing is always best because you did it in the past.

No. 7: Does a foreclosure, short sale or principal reduction affect my taxes?

Homeowners who lost their homes to either a foreclosure, short sale or had a bank "forgive" part of their mortgage principal (this could have occurred during a loan modification) used to have to pay income taxes on any money that their lender agreed to write off.

But the Mortgage Forgiveness Debt Relief Act of 2007 and subsequent extensions changed that for loans restructured between 2007 and 2017 for primary residences. For those tax years, you don't have to consider the discharge of mortgage debt as taxable income. It is not clear if Congress will allow this treatment for mortgage debt forgiven in 2018 or beyond, though.

However, the 2007 law doesn't cover investment properties and vacation homes, nor does it apply to forgiven home equity loans.

Lastly, some jurisdictions require filers to pay state income taxes on forgiven mortgage debt, so check with a tax professional about your personal situation.

No. 8: Can I deduct prepayment penalties?

Prepayment penalties paid on a mortgage are tax deductible in the year that they are paid.

No. 9: What expenses am I NOT allowed to deduct from my income?

Unless your property is a rental or investment, you don't get tax breaks for the following:

  • Hazard insurance
  • Homeowners association dues
  • Principal payments
  • General closing costs like appraisal fees or title insurance
  • Local assessments to improve your neighborhood

No. 10: Does the so-called "Obamacare" tax affect gains from property sales?

The 2010 "Obamacare" Affordable Care Act added an extra 3.8 percent tax on capital gains incurred by certain high-income taxpayers.

If you fall under the law's requirements, you'll have to pay 23.8 percent in federal income taxes on your home-sale profits over and above the $250,000/$500,000 exclusion rather than the 20 percent rate that you'd otherwise face.

However, this extra tax only applies to single or head-of-household filers who have a $200,000 adjusted gross income or married joint filers with a $250,000 adjusted gross income. And remember, the first $250,000 of a single taxpayer's profits ($500,000 for joint filers) is federally tax free.

No. 11: How does the U.S. Supreme Court's gay-marriage ruling affect same-sex couples?

The Supreme Court's June 2015 ruling legalizing gay marriage in all 50 states doesn't affect same-sex couples' federal income taxes because the IRS has recognized legal gay marriages for tax purposes since 2013.

An earlier Supreme Court ruling that partly invalidated 1996's Defense of Marriage Act prompted the tax agency to decide that same-sex couples married in any U.S. or foreign jurisdiction that recognized gay marriage could file tax returns jointly. The rule applied even if gay couples later moved to states that didn't allow gay marriage.

However, last summer's landmark high-court decision legalizing same-sex marriage nationwide means gay couples in states that previously banned the practice should have the right to file state or local income-tax returns jointly for 2015 for the first time.

No. 12: Does my income affect my tax deductions?

The IRS has increased the maximum adjusted gross income that filers can have for 2017 and still fully itemize deductions -- good news for wealthy homeowners who want to claim things like the mortgage-interest tax break.

For the 2017 tax year, married joint filers can have $313,800 AGIs and still itemize all deductions, up from $311,300 in 2016. Singles can make an adjusted $261,500 versus $294,400 previously, while married couples filing separately can have $156,900 AGIs, up from $155,650 in 2016. Above those limits, IRS rules begin to phase out what percentage of expenses you can deduct.

Conversely, the IRS has also boosted standard deductions for 2017. Married joint filers who don't itemize can claim a standard $12,700 versus $12,600 in 2016, while singles and married people filing separately can $6,350 instead of $6,300 a year earlier. (Heads of household can receive $9,350, up from $9,300 in 2016.)

Bonus: Can I deduct Private Mortgage Insurance (PMI) premiums?

Like the Debt Forgiveness Act, the ability to deduct PMI premiums from your taxes isn't a permanent part of the tax code, and so is subject to the whims of Congress from year-to-year. Fortunately for homeowners, the Congress did reauthorize the deductibility of premiums paid for the 2017 tax year, with premiums treated in a manner similar to any mortgage interest you paid during the year. Of course, you'll need to itemize to be able to deduct either. Also, according to the extension agreement, "this deduction phases out ratably for taxpayers with adjusted gross income of $100,000 to $110,000" so your circumstance will dictate how much you can deduct.

Smart homeowners will do the math to see which works out better for them -- itemizing or taking the standard deduction.

Lisa Greene-Lewis, an accountant with TurboTax, says many homeowners will do better by itemizing instead of simply claiming the standard deduction. "The mortgage-interest deduction is one of the biggest itemized deductions for many people for sure," she says. "That's usually the one that puts homeowners over the threshold to where itemizing makes sense."

Knowing what tax deductions are available to you can help minimize the tax man's bite come April 18. After all, the law says you have to pay taxes -- but there's no reason to leave Uncle Sam a tip.

Schedule A

IRS Publication 523

Schedule D Capital Gains and Losses

Form 1098

Gina Pogol was the original author of this article. (Image: ljdema/iStock)

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  1. Mike October 28, 2018 9:32 pm

    Hi We purchased a house in Apr 2014 and planing to sale in Dec 2018 - it is our primary house. Do we owe capital gain tax since we did not own the house for 5 year ?Thanks

  2. Vanessa Candle October 17, 2018 9:59 am

    Thank you for this useful article!

  3. Mary September 26, 2018 9:02 am

    I bought a house April 16th 2017 and did my homestead. When should I see my mortgage payment go down. The house was a rental now it is my primary home.Thank you

  4. EDcook Real Estate June 08, 2018 4:34 am

    Thank you for taking the time to provide such an informative and helpful post.

  5. Leola Rice January 26, 2017 3:08 am

    I only paid $484.00 interest on my mortgage in 2016 because I have almost paid off and no other interest to itemize. Do I file standard with a 40,000.yearly salary.

    1. Editorial Team February 07, 2017 8:06 pm

      The only reason to itemize your deductions is if your deductions for mortgage interest, property taxes, medical expenses, etc. total more than the standard deduction that is available for your filing class.

        Reply »  
  6. Ann October 05, 2016 10:37 pm

    Parent lived in home (I owned) for years. My primary residency is in another state. If I have lived in the home on and off for just under two of the last five years (to care for my parent), can I still deduct the "permanent" upgrades and improvements that I have made over the years to the home -- such as a water filtration system, full duct work and installed ac, water heater,electrical etc. even though I may not have have lived there myself for the full two years? Having sold the house after living there for half of the year, I also made other permanent upgrades that add to the structural value of the house. Do I qualify to take the permanent upgrades deductions? Thank you.

    1. Editorial Team October 25, 2016 3:50 pm

      Ann, Thanks for your comment. The rule is usually that you must have lived in the home as a principal residence for two of the last five years. You definitely want to consult with a tax professional to be sure of all the ins and outs. -Tim, HSH

        Reply »  
  7. Sandra porter September 03, 2016 10:02 pm

    My father passed in 2015 and he willed the house to me. I went thru probate and got my name on the deed. I couldn't sell it because I was so devastated by finding him dead on the side of the house working on the gate latch. I still am and I am still in his house since he died October 23rd. I refinanced it in my name because I had debt and the house was not paid off. I only owe $52k.It was appraised at 300k. I am just an Accounting Clerk and unemployed at this time. Tough time. If I sell it soon, how much capital gain taxes would I have to pay if I were to sell it for only $250k?

  8. liz September 01, 2016 10:39 pm

    Hello we closed on our home end of july and first payment was 1 st of September however first mortgage lender sold the loan to wells fargo bank and received a letter from the first mortgage lender that our 1 st payment will be due in October to wells fargo bank . however on the corner there is a stamp saying payment is still due to them on the 1 of September . I don't get how they are owed if some other bank has the loan now ? can someone help . thanks

  9. Ashley August 23, 2016 6:47 pm

    Hi! We bought a house a year ago. We may move to a new house (for a better school district). Can we sell our house before 2-years and not be taxed? We we're told that we may get dinged for selling before 2 years. Thank you in advance!

  10. Marci August 18, 2016 12:06 am

    We sold our house in MN in August 2016. We purchased the house for $174,900 in 2001 and sold for $215,000. We have $25,000 of improvements (documented). We have not lived in our house since 2011 because we moved to AZ; therefore we rented the house for the past 5 years. Since we are using a VA for our new house we are not required to put money down. After figuring out what we could be taxed on (capital gain), it came to around $15,500. Are we better off putting $15,500 down on our new house and avoiding any capital gain taxes, or will we still pay tax on that amount regardless if we keep it or put it down as a down payment? Hope that makes sense :)


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