Tax for Buyer
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One of the biggest advantage of home ownership is the Tax Benefit. For many people, except 401k (Max $15500/yr), IRA etc, itemized house expense might be the most efficient way to save income tax.
What is Points?
When most people buy a home, they generally obtain a mortgage. Mortgages have costs and one of those costs is the “loan origination fee.” The loan origination fee is usually a percentage of the loan amount, generally expressed as “points.” For example, one “point” on a $150,000 loan would be 1% of the loan amount which is $1500.
On VA and FHA loans, points are often broken down into two categories: loan origination fee (which is usually one point) and discount points (which are also a percentage of the loan balance). Both are deductible. The loan origination fee must be expressed as points in order for it to be tax deductible.
Points Paid on a Purchase.
When buying a home, points are deductible in the year they are paid, providing they meet following criteria:
- The loan is secured by your primary residence and the loan was used to buy, improve or build the home.
- Paying points (and the amount of points paid) is not an irregular practice in the seller’s geographic area;
- The points are computed as a percentage of the loan principal;
- The points are clearly stated on the buyer’s settlement statement; and you must put more cash than the points you were charged.
- * Seller paid point for buyer is tax deductible by buyer not seller.
- Points paid to finance the purchase of a second home must be deducted over the life of the loan, not in the year in which they are paid.
- Your lender cannot inflate the points to include other items you would normally be charged. When buying a home, there are normally other charges such as appraisal fee, title insurance fee, property taxes, settlement fees, and so on. If by some miracle you are not charged these fees but your “points” are higher than normal then you can’t deduct the points.
Except pre-paid pro-rated interest and property taxes, all other closing cost is non-tax deductible.
Tax for Homeowner
Your Biggest Deduction: Interest
Mortgage interest on a primary residence & 2nd home is usually fully tax-deductible, unless your mortgage balance exceeds $1 million or you took out a mortgage for reasons other than buying, building or improving a home. (Schedule A, labeled “itemized deductions.”). Your lender should send you a “Form 1098” that tells you how much mortgage interest you paid for the year. You should record your interest deduction on tax return line 10.
Your home can be a house, co-op, condominium, mobile home, trailer, or even a houseboat. For trailers and houseboats, one requirement is that the home must have sleeping, cooking, and toilet facilities.
Even a rental can be considered a second home, provided you live in it either 14days out of the year or at least 10% of the number of days you rent it for, whichever is greater.
If you obtained the loan prior to October 13, 1987, the loan is considered “grandfathered.” All interest paid on grandfathered loans in a given year is fully tax deductible. After that, there are conditions, but most conditions won’t apply to most homeowners.
Home Acquisition Debt (an IRS Term)
An important IRS term is “home acquisition debt.” Any first or second mortgage used to buy, build, or improve your home is considered to be home acquisition debt.
Acquisition debt can be a first or second mortgage used to buy your home. If you get a second mortgage and use it all for home improvement, that is also considered acquisition debt. If you do a “rate and term” refinance and don’t get any “cash out” since you are just refinancing your acquisition debt that also can be considered acquisition debt.
For any of the above types of loans that aren’t “grandfathered” — you can still deduct all the interest — but only if your total mortgage debt does not exceed one million dollars. For married couples filing separately, the limit is $500,000 each.
Home Equity Debt (another IRS Term)
The IRS has another term called “home equity debt.” Basically, this is any loan amount in excess of what was spent to purchase, build, or improve your home.
If you get “cash out” when refinancing your home, the amount in excess of your original loan amount is considered “home equity debt” unless some of it was used for home improvement. Anything in excess of the home improvement cost is considered “home equity debt.”
For second mortgages, it works the same way. Anything not used to improve the home is considered “home equity debt.”
The interest on a home equity loan is usually tax-deductible. However,
- Home equity debt cannot exceed $100,000 and the total mortgage debt on the home must not exceed its value.
- If your home equity loan combined with your first mortgage amount > 100% of the house value, you can only deduct 100% of the house value instead. So for125% loan-to-value second mortgages to consolidate debt, the portion of the loan amount that exceeds the value of your home is not tax deductible(unless you used it for home improvement).
Late payment charge & mortgage prepayment penalty
- Tax deductible
- Late payment charges also may be deducted as home mortgage interest if not for a specific service received in connection with your home loan. The same is true for mortgage prepayment penalties you pay off your mortgage early and incur a prepayment penalty, you can deduct that penalty as home mortgage interest (subject to the same requirements for late payments).
Points Paid for Refinancing
Points paid during refinancing must be deducted over the life of the loan. For a thirty-year loan, you divide the points by thirty and get to deduct that amount each year.
However, if you did a “cash out” refinance and used some of the funds to improve your primary residence, a portion of the points are deductible in the year you paid them. That portion is related to how much of the loan was used for home improvement. If you obtained a $200,000 loan and $50,000 was used for home improvement, then one-fourth of the points are deductible in the year you obtained the loan. So you need to save your receipts.
If you refinanced more than once
For example, you refinanced in 2003 and paid points. You can deduct 1/30th of those points in that tax year. However, say you refinanced again in 2006, paying off that 2003 loan. The remaining points from the 2003 refinance-that is, those that hadn’t yet been deducted-can now be deducted in full since that loan has been paid off.
Deducting Property Taxes
- Owner Occupied home up to 1M
- Most homeowners pay property taxes to a local, state or foreign government. In most cases, property taxes are deductible. They must be charged uniformly against all property in the jurisdiction and must be based on the assessed value.Special property tax assessments imposed by states and counties for local improvements to property for streets, sidewalks, and sewer lines cannot be deducted. Local property taxes are deductible only if they are for maintenance or repair, or interest charges related to those benefits.
Impound Accounts (escrow account)
Don’t deduct what you pay into the impound account but what is paid directly from the account to the taxing authority.
Limits on Deductions
You may be subject to a limit on some of your itemized deductions. For 2000, this limit applies if your adjusted gross income is more than $128,950, or $64,475 if you are married filing separately.
Non-tax deductible Items
- Charges for services. An itemized charge for services to specific property or people is not a tax, even if the charge is paid to the taxing authority. You cannot deduct the charge as a real estate tax if it is:
- A unit fee for the delivery of a service (such as a $5 fee charged for every 1,000 gallons of water you use),
- A periodic charge for a residential service (such as a $20 per month or $240 annual fee charged for trash collection), or
- A flat fee charged for a single service provided by your local government (such as a $30 charge for mowing your lawn because it had grown higher than permitted under a local ordinance).
Tax for Sellers
As long as you lived in the home for at least two of the five years before you sell, each individual owner can have up to $250k capital gain tax free. The two years that you have lived in it do not need to be in sequential order. There is no maximum to the number of personal residences that you can sell and reap tax-free gain, those sales must always happen two years apart.
Tax for Investors
- Write-off all expense
- For professional realtor etc, all loss from rental property is tax deductible
- 1031 exchange
Investing in rental properties (both residential and commercial) can yield a variety of tax benefits. Your money can multiply, as you take advantage of all the tax breaks offered by the IRS. You do need some know-how, though, to help make your investment property pay off.
When you purchase property and rent it out, you’re essentially running a business. You take in revenue ?namely rent from your tenants ?and incur expenses from the property. You hope that, over time, your revenue exceeds your expenses so that your real estate investment produces a profit (cash flow, in real estate lingo) for all the money and time you’ve sunk into it. You also hope that the market value of your investment property appreciates over time. The IRS helps you make a buck or two through a number of tax benefits. The major benefits follow.
Operating expense write-offs
In addition to the deductions allowed for mortgage interest and property taxes, just as on a home in which you live, you can deduct on your tax return a variety of other expenses for rental property. Almost all these deductions come from money that you spend on the property, such as money for insurance, maintenance, repairs, and food for the Doberman you keep around to intimidate those tenants whose rent checks always are “in the mail.”
But one expense “depreciation” doesn’t involve your spending money. Depreciation is an accounting deduction that the IRS allows you to take for the overall wear and tear on your building. The idea behind this deduction is that, over time, your building will deteriorate and need upgrading, rebuilding, and so on. The IRS tables now say that for residential property, you can depreciate over 27-1/2 years, and for nonresidential property, 39 years. Only the portion of a property’s value that is attributable to the building(s)’s and not the land’s can be depreciated.
For example, suppose that you bought a residential rental property for $300,000 and the land is deemed to be worth $100,000. Thus the building is worth $200,000. If you can depreciate your $200,000 building over 27-1/2 years, that works out to a $7,272 annual depreciation deduction.
If your rental property shows a loss for the year (when you figure your property’s income and expenses), you may be able to deduct this loss on your tax return. If your adjusted gross income is less than $100,000 and you actively participate in managing the property, you’re allowed to deduct your losses on operating rental real estate up to $25,000 per year. Limited partnerships and properties in which you own less than 10 percent are excluded.
To deduct a loss on your tax return, you must actively participate in the management of the property. This rule doesn’t necessarily mean that you perform the day-to-day management of the property. In fact, you can hire a property manager and still actively participate by doing such simple things as approving the terms of the lease contracts, tenants, and expenditures for maintenance and improvements on the building.
If you make more than $100,000 per year, you start to lose these write-offs. At an income of $150,000 or more, you can’t deduct rental real estate losses from your other income. People in the real estate business (for example, agents and developers) who work more than 750 hours per year in the industry may not be subject to these rules.
You start to lose the destructibility of rental property losses above the $100,000 limit, whether you’re single or married filing jointly. You can carry the loss forward to future tax years and take the loss then, if eligible. This policy is a bit unfair to couples, because it’s easier for them to break $100,000 with two incomes than for a single person with one income. Sorry, this is yet another part of the marriage tax penalties!
Rollover of capital gains on rental or business real estate
Suppose that you purchase a rental property and nurture it over the years. You find good tenants and keep the building repaired and looking sharp. You may just find that all that work pays off, the property may someday be worth much more than you originally paid for it.
However, if you simply sell the property, you owe taxes on your gain or profit. Even worse is the way the government defines your gain. If you bought the property for $100,000 and sell it for $150,000, you not only owe tax on that difference, but you also owe tax on an additional amount, depending on the property’s depreciation. The amount of depreciation that you deducted on your tax returns reduces the original $100,000 purchase price, making the taxable difference that much larger. For example, if you deducted $25,000 for depreciation over the years that you owned the property, you owe tax on the difference between the sale price of $150,000 and $75,000 ($100,000 purchase price minus $25,000 depreciation).
All this tax may just motivate you to hold on to your property. But you can avoid paying tax on your profit when you sell a rental property by “exchanging” it for a similar or like-kind property, thereby rolling over your gain. The section of the tax code that allows rollovers is a 1031 exchange. (You may not receive the proceeds ?they must go into an escrow account.) The rules, however, are different for rolling over profits (called 1031 exchanges, for the section of the tax code that allows them) from the sale of rental property than the old rules for a primary residence.
Under current tax laws, the IRS continues to take a broad definition of what like-kind property is. For example, you can exchange undeveloped land for a multiunit rental building.
The rules for properly doing a 1031 exchange are complex. Third parties are usually involved. Make sure that you find an attorney and/or tax advisor who is expert at these transactions to ensure that you do it right.
Real estate corporations
When you invest in and manage real estate with at least one other partner, you can set up a company through which you own the property. The main reason you may want to consider this setup is liability protection. A corporation can reduce the chances of lenders or tenants suing you.
Tax for Low- to moderate-income homeowners & Old buildings
If your state considers you to be a low- to moderate-income homeowner, you may be eligible for mortgage interest tax credits for a portion of the interest that the state pays on your behalf. You must obtain a “mortgage credit certificate” from your state or local government prior to obtaining the mortgage. Contact your local government agency for this and other eligibility information and for more information about how the credits work.
The IRS grants you special tax credits when you invest in low-income housing or particularly old commercial buildings. The credits represent a direct reduction in your tax bill because you’re spending to rehabilitate and improve these properties. The IRS wants to encourage investors to invest in and fix up old or rundown buildings that likely would continue to deteriorate otherwise.
The amounts of the credits range from as little as 10 percent of the expenditures to as much as 90 percent, depending on the property type. The IRS has strict rules governing what types of properties qualify. Tax credits may be earned for rehabilitating nonresidential buildings built in 1935 or before. “Certified historic structures,” both residential and nonresidential, also qualify for tax credits. See IRS instructions for Form 3468 to find out more about these credits.