Home

    In the early days of this country, our founding fathers, particularly influenced by Thomas Jefferson, believed that an individual's property ownership was core to his freedom and independence.  At that time a foundation was being laid for all citizens to be given the chance to become land owners.  To further this cause, our nation introduced thirty-year mortgages as an accepted way of purchasing property.  The United States was in fact the first country to put this practice into effect.

   It was in this spirit that modern day government implemented a number of  programs and tax incentives to encourage individuals to own and maintain their own homes.  Home buying encouragement has come from programs such as the GI bill, the FHA, Fannie Mae and Ginnie Mae programs as well as the implementation of the secondary mortgage market.   The IRS has done its part by offering the home buyer the ability to defer or exempt certain capital gains on home sales as well as deduct legitimate home buying expenses such as the mortgage interest on a home loan. 

 

The Mortgage Interest Deduction

    In the early years of a loan, most of the payment will be going to the payment of interest.  Refer to the example in Exhibit A.  Notice the entry for the first full year which is 2004. The year's mortgage payment  was "$17,610" for the entire payment with the interest amount of "$15,894."  In this case you would  be able to deduct  $15,894 off of the top of your taxable income for the year.

    This incentive can easily be justified against the cost of owning vs. renting.  In that case, you make a monthly payment, are not building equity and have no tax deduction at the end of the year.

 

Exhibit A

Amortization Schedule

           Loan Amount: $200,000                                                                     Amortization Period Years: 30

           Loan Life Years: 30                                                                           Monthly Payment:        $1,467

           Interest Rate: 8%                                                                             Compounding:             Monthly

 

                      Year                        Payment                Interest                 Principal               Balance

_______________________________________________________________________________

                  2004                          $17,610                  $15,894                  $1,715                   $199,457

                  2005                          $17,610                  $15,752                  $1,858                   $195,883

                  2006                          $17,610                  $15,597                  $2,012                   $193,871

                  2007                          $17,610                  $15,430                  $2,179                   $191,692

                  2008                          $17,610                  $15,250                  $2,360                   $189,331   

 

Real Estate Taxes

     As a home owner, you will have a yearly tax bill that must be paid to your town.  With political elections, propositions issues and general changes in local sentiments, these amounts can fluctuate and can often be substantial.  Because of this, it is helpful to know that you can deduct this amount from your income when you file your taxes. 

     Real estate taxes are primarily based on the assessed value of a home.  Assessments are not conducted by real estate agents or appraisers.  They are set by the town's assessors.   In most towns, properties are reassessed every three years.  Your assessment will be based upon a number of factors that have taken place in your community in the current assessment period.   Some of these include the sales of all homes and,  more specifically, sales of  houses of the same style, size and neighborhoods as yours.  Also taken into consideration are the number of baths, bedrooms, out buildings, such as sheds and any other factor that may detract from or enhance the value of your home.

     As you search for a new home, be sure to get all of the assessment and tax information from the seller or broker.  Your taxes are usually broken up into monthly amounts and are escrowed and paid with your mortgage payment.   When you file your federal tax return, you will be able to deduct the amount you have paid in property taxes for the year.

 

Home Office    

     If you own your own business, you may be able to take advantage of the home office deduction.   Although the potential is an attractive one, before actually taking this deduction, be very careful that you meet with all of the requirements. 

To qualify as a home office for the purpose of the IRS, you must comply with the following:

1.  Your use of the business part of your home must be:

     a) Exclusive 

     b) Regular,

     c) For your trade or business, and

2.  The business part of your home must be one of the following:

     a) Your principal place of business,

     b) A place where you meet or deal with patients, clients, or customers in the normal 

         course of your trade or business, or 

     c) A separate structure you use in connection with your trade or business.

 

     Figuring the deduction:

            1.  Divide the area (length multiplied by the width) used for business by the area 

                 of your home.                          

            2.  If the rooms in your home are all about the same size, you can divide the  

                 number of  rooms used for business by the total number of rooms in your home.

     Example:

                -  Your office is 240 square feet (12 feet x 20 feet).

                -  Your home is 1,200 square feet. 

     Divide your office square feet by the total square feet in your home:

                -  Your office is 20% of the total area of your home.

 

     Expenses you can deduct for business use of the home may include the business portion of real estate taxes, mortgage interest, utilities, insurance, depreciation, painting and repairs.  However, you may not deduct personal expenses, expenses for lawn care or those related to rooms not used for business.

                   

      For a more complete explanation of the home office deduction refer to Publication 587 of Department of the Treasury Internal Revenue Service, "Business Use of Your Home." available at www.irs.gov.

    

  Home Improvements

     If you take out an equity loan to make substantial improvements to your home, you can deduct the interest paid on the amount borrowed for the improvement.   The IRS defines improvements as those items that "add to the value of your home, prolong its useful life, or adapt it to new uses."  

The following are examples of home improvements that may qualify:

Additions:  bedrooms, bathrooms, a deck, a garage, a porch or patio.

Lawn & Grounds:  landscaping, walkway, fence, retaining wall, sprinkler, swimming pool.

Heating and Air Conditioning:  heating system, central air, a furnace, duct work a central humidifier, a filtration system.

Miscellaneous:  storm window, doors, a new roof, central vacuum, wiring updates, a security system.

Plumbing:  a septic system, water heater, water softening system.   

Interior Improvements: built-in appliances, kitchen modernization, flooring, wall-to-wall carpeting, insulation, attic, walls, floor, pipes, duct work.

 

Points 

    In your mortgage application, you will have the option of paying points to help you to get a lower interest rate. A point is 1% of the principal and is usually considered pre-paid interest. For example, one point on a $100,000 loan would be $1,000.

    To be treated as pre-paid interest the points have to be paid solely for your use of the money and not for services performed by the lender. Even if the lender calls this amount a "loan origination fee" as long as it is a charge for the use of the money, the fees are deductible on your income taxes.

     To qualify for deduction of points on your income tax, you must meet the following criteria:

1.  Your loan is secured by your main home. 

2.   Paying points is an established business practice in the area where the loan was made.

3.  The points paid were not more than the points generally charged in that area.

4.  You use the cash method of accounting.  Most people use this method.

5.  The points were not paid in place of normal settlement costs, such as appraisal fees, etc.

6.  The funds you provided at closing were at least as much as the points charged.

7.  You use your loan to buy or build your main home.

8.  The amount is clearly shown on the settlement statement (Form HUD-1).

 

 

The Capital Gains Exclusion     

   Prior to May 7, 1997, a home seller needed to use the proceeds from the sale of his home to buy a more expensive home in order to avoid paying taxes on capital gains.  The Taxpayer Relief Act of 1997 changed all that.   Now, rather than having to roll over into another residence, home owners only need to comply with the following:

 When you sell your home, provided you have occupied it for at least two out of five years, you have a $250,000 exclusion from capital gains taxes on this amount if you are single, and a $500,000 exclusion as a married couple.   The property you are selling must be your principal residence, not an investment property.  However; if you hold a property for five years, rent it out for the first three, then live in for the last two, you qualify for the tax exemption.  Also, your habitation of the home does not necessarily have to be sequential.  You could live in the home for a year, rent it out for three and live in it for the final year.  It is also not necessary that you are residing in the home at the time of sale.  So, you could live in the house for a year, rent it out for two, move back into it for another year and rent it out in the final year.  The rule is, you must live in the home two out of any five years of ownership. 

   We regard to the married couple exclusion, you must both pass the use test and that is that each of you must have lived in the residence for two years.  If you own a home for two years and your significant other marries you six months before the two year time period, you can qualify for the $500,000 tax exclusion, as long as you file jointly and your significant other has lived in the property with you for the last two years.  If he has not lived in the property for the two year time period, or, if he owned and sold his own property and claimed the exclusion within the two year period, then, you do not qualify for the married couple exclusion. 

   These capital gains rules are a vast improvement over the previous ones since you can now use the proceeds from your home to travel, buy clothes or embark on a completely new venture.  Also, there is no limit on the number of times you can use the home-sale exemption.  In fact, you can have a tax-free profit of $250,000 (or $500,000 if married) every time you sell a home provided that each sale is at least two years apart.

  

 

    These are brief descriptions of the some of the possible tax savings with home ownership.  Before taking any deductions on your taxes, check with your tax accountant, attorney or appropriate IRS publication which may be found at www.irs.gov.   

 

Home