Homeowners Rejoice: Tax Breaks Are Here....
Lets be honest: April 15th is a day of reckoning, the moment when we find out what we really owe for taxes. In households nationwide wallets are drained and many who were rich on the 14th are greatly impoverished by the 16th.
But for those with real estate the load is made lighter by tax rules which encourage the ownership of homes and investment property. Such rules are not only good for homeowners, they're also good for the country: About 20 percent of all economic activity nationwide is related to real estate, so policies which encourage real estate activity help everyone.
It seems that almost every year changes to the tax code require the production of new forms and a re-education process. That said, the real estate basics remain in place and they're good news for buyers, sellers, borrowers and owners.
Mortgage interest is generally deductible.
The IRS says there are three categories of deductible home mortgage interest:
1. Mortgages you took out on or before October 13, 1987 (called grandfathered debt).
2. Mortgages you took out after October 13, 1987, to buy, build, or improve your home (called home acquisition debt), but only if throughout 2005 these mortgages plus any grandfathered debt totaled 1 million or less (500,000 or less if married filing separately).
3. Mortgages you took out after October 13, 1987, other than to buy, build, or improve your home (called home equity debt), but only if throughout 2005 these mortgages totaled 100,000 or less (50,000 or less if married filing separately) and totaled no more than the fair market value of your home reduced by (1) and (2).
Substantial profits can be sheltered when a prime residence is sold.
When a prime residence is sold, up to 500,000 in profits can be sheltered from federal taxes if married, 250,000 if single, providing the home has been used as a prime residence for two of the past five years. Generally this deduction cannot be used more than once every two years, according to the IRS.
There are also provisions which may be helpful to individuals who must sell a prime residence in less than two years. Under the 2004 safe harbor rules, individuals may be able to get some capital gains relief under certain circumstances, such as being forced to move because a job has been relocated at least 50 miles or a home that must be sold because of multiple births resulting from the same pregnancy.
Also, individuals in the Armed Forces and the Foreign Service may be entitled to special consideration under the Military Family Tax Relief Act of 2003 (MFTRA). For instance, you may have longer to take a capital gains deduction or to amend a tax return. There are other provisions under MFTRA that also may be helpful, so check with a tax professional for specifics.
Points may be deducible by both buyers and sellers.
Picture a situation where a home is sold for 500,000 and the owner -- to help close the sale -- offers to pay 1 point for the buyer. If the property was financed with a 350,000 mortgage, a point would be worth 3,500. According to the IRS, "the seller cannot deduct these fees as interest. But they are a selling expense that reduces the amount realized by the seller."
Interestingly, in this situation the buyer can also deduct the points when the home is sold.
"The buyer," says the IRS, "reduces the basis of the home by the amount of the seller-paid points and treats the points as if he or she had paid them."
In effect, the seller gets to write-off the 3,500 cost by reducing any profit from the sale. The buyer essentially lowers the purchase price of the property when the home is sold at some point in the future -- thus increasing the size of any profit. However, since up to 500,000 in sale profits may be untaxed, most buyers will effectively never pay a tax on the seller's contribution for points.
If a prime residence is refinanced then the deal with points is different: The expense of a point must deducted over the life of the loan. If the home is sold before the loan term ends, then any undeducted cost for points can be used to reduce owner's profit from the sale.
Home offices may be deductible.
If a portion of your home is used regularly and exclusively as your principal place of business or for the convenience of your employer it may be possible to write off a portion of such costs as mortgage interest, property taxes and utilities. There are a number of tests which must be met to take this deduction, see IRS Publication 587, Business Use of Your Home for details.
In some cases there may be tax advantages associated with not deducting your home office in the year or two before you move. Speak with a tax professional for specifics.
Investment real estate can generate substantial write-offs.
If you own rental property you must seek a fair market rental for your property. You may generally deduct mortgage interest, property taxes, repair costs, management by an outside party, depreciation, advertising, insurance, utilities, legal services and other expenses.
It's possible with rental properties to have both a positive cashflow and a loss for tax purposes. However, the ability to use real estate losses to reduce overall taxes may be phased out as income rises above 100,000.
If a rental involves relatives special rules and restrictions may apply. Check with a tax pro for details.