The filing deadline for 2013 is quickly approaching, and if you became a homeowner or refinanced last year, your return may be a lot more complicated than it was in 2012. Many folks who take the standard deduction year after year find that once they become homeowners, itemizing deductions gets them a much lower tax bill. Here’s what you need to know.
Your lender should provide you with a 1098 form detailing the amount of mortgage interest you paid in 2013. If you didn’t receive one, request it now. The first years of paying your mortgage usually come with the highest interest expense, and thus the highest deduction amounts. You don’t want to miss out.
You can deduct the interest on up to $1.1 million of mortgage debt. This can be first or second mortgages, and first or second homes. You cannot, however, claim a mortgage interest deduction on home equity loans that haven't been used to buy or improve the property.
Mortgage Insurance (MI)
In addition to mortgage interest, mortgage insurance may also be deductible. Mortgage insurance is typically charged when you take out a mortgage with less than 20 percent down. The insurance covers the lender if you default. The insurance premiums are fully deductible if:
- You took out the mortgage on which you pay MI on or after Jan. 1, 2007. No MI premiums are deductible for home loans made before that date. If you refinanced your home after December 31, 2006, you also qualify for the MI deduction on that loan. Be careful as to how you structure your refi. The mortgage insurance deduction applies to refinances up to the original loan amount, but not to any extra cash you might get with the new home loan.
- You also might be able to deduct mortgage insurance payments on a second home loan. As with your primary residence, the loan on the second home must have been issued in 2007 or later to be deductible.
- The additional property also must be for your personal use as a second or vacation home.
- Your adjusted gross income (AGI) doesn’t exceed $100,000 if you’re single, head of household or married filing jointly. The limit is $50,000 if you’re married filing separately.
The deduction is reduced by 10 percent for each $1,000 a filer's income is over the AGI limit. This eliminates it completely when homeowners’ AGI is $109,000 or $54,500 for married filing separately taxpayers.
Prepaid Mortgage Insurance – FHA, VA and USDA Loans
Mortgage insurance for VA loans (called a funding fee), and insurance provided by the Rural Housing Service (called a guarantee fee) may either be included in the amount of the loan or paid in full at the time of closing. These fees can be deducted fully in 2013 if the mortgage insurance contract was issued in 2013. Contact the mortgage insurance issuer to determine the deductible amount if it is not reported in box 4 of Form 1098.
FHA charges an upfront premium plus a monthly premium. Monthly premiums are fully deductible in the year they were paid. For FHA upfront mortgage insurance premiums, you must allocate the premiums over the shorter of the stated term of the mortgage or 84 months, beginning with the month the insurance was obtained. No deduction is allowed for the unamortized balance if the mortgage is paid off early – so if you sell your home and pay off the mortgage in five years (60 months), the upfront premiums allocated to the remaining 24 months will not be deductible, even though you paid them upfront.
Property taxes are deductible for first and second homes, but only if you itemize. To be deductible, the tax must be owed and paid – you can't pay 2014 taxes in advance and deduct them on your 2013 return. If your mortgage lender impounds your taxes, adding an amount to your monthly payment and then paying the installments as they come due, you don't deduct the amounts impounded, only the amounts actually paid by the lender to your local assessor. The lender should provide these amounts to you in your year ending statement.
In addition, many states and counties also hit you with additional taxes for improvements like assessments for streets, sidewalks, and sewer lines. These taxes cannot be deducted.
Unless Congress extends existing tax credits for residential energy efficiency, 2013 is your last chance to claim up to $500 in green energy credits for upgrades like insulation, energy efficient windows and doors, high efficiency air conditioner and heaters.
The credits are capped at $500, and you don’t get it if you claimed it previously since the credit was passed in 2011.
A bigger and better is available for solar energy installations, so long as they are on your primary residence and not a rental property. It covers 30 percent of the cost, including installation.
Cancellation of Debt
Cancellation of mortgage debt – in the case of a foreclosure, deed-in-lieu of foreclosure, or short sale – must be reported on your tax return, or you risk a hefty addition to your tax bill.
The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. This provision applies to debt forgiven in calendar years 2007 through 2013. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately The Act applies only to forgiven or cancelled debt used to buy, build or substantially improve your principal residence, or to refinance debt incurred for those purposes. In addition, the debt must be secured by the home. This is known as qualified principal residence indebtedness. The maximum amount you can treat as qualified principal residence indebtedness is $2 million or $1 million if married filing separately. In addition, mortgage debt forgiven as part of a bankruptcy is not treated as taxable income.
Your lender should send a Form 1099-C, Cancellation of Debt. The amount of debt forgiven or cancelled will be shown in box 2. If this debt is all qualified principal residence indebtedness, the amount shown in box 2 will generally be the amount that you enter on lines 2 and 10b, if applicable, on Form 982.
Selling Your Home
Selling your home can create both tax breaks and taxable income.
If you sold a home in 2013, costs including title insurance, advertising and real estate broker fees can also be claimed on your return. You can also claim repairs to reduce your capital gains on the sale if they were made within 90 days of the sale and obviously for the intent of marketing the property.
In addition, if you had to find a new home because of a new job that is located more than 50 miles away from your old home, you may be able to deduct your reasonable moving expenses, too. Selling a home can also trigger tax consequences. That's why it's so important to keep track of anything spent on your home that affects its basis. Basis is the amount subtracted from the proceeds of the sale to calculate your gain. Your basis can be increased by things like home improvements or settlement costs that you pay for the buyer, and decreased by things like depreciation deductions – check with a tax pro.
- One of the great benefits of home ownership is the way your gains are treated when you sell the property. You can exclude up to $250,000 of the gain ($500,000 if married filing jointly) on the sale of your property if you owned it for at least two years of the last five years and lived in it for at least two of the last five years (they don't have to be the same two years).
- What if you lose money on the sale of your home? Unfortunately, a loss on the sale of a primary residence is treated like a loss on the sale of any personal property. It is not deductible. Losses on investment properties can be used to offset capital gains on other investments.
- What about a short sale or foreclosure sale? The Mortgage Forgiveness Debt Relief Act of 2007 allows you to exclude forgiven debt resulting from a mortgage modification, short sale, or foreclosure on your primary residence only. Normally, debt that you aren't required to repay is considered taxable income, so this law is a lifesaver for those unable to afford the roof over their heads, much less extra taxes.
What about damage from natural and other disasters? You may be able to claim a tax break for substantial losses, but you only get to deduct amounts that exceed ten percent of your adjusted gross income. If you earned $100,000 and incur $12,000 in out-of-pocket losses, only the $2,000 exceeding ten percent of your AGI are deductible.
Deductible Closing Costs
If you bought a home or refinanced a mortgage in 2013, you probably paid some closing costs, and some of them may be deductible. Here’s a quick run-down:
- Points come in two forms. They can be loan fees known as origination charges or they can be prepaid interest called discount points. When you buy a home, origination charges are fully-deductible in the year that you pay them, and discount points are pro-rated over the term of your loan. If you have a 30-year mortgage, every year you get to deduct 1/30th of your discount points.
- If you refinance a home, all points must be pro-rated; however, if there are un-deducted points for the old loan, you get to deduct them all in the year that you refinance. Here's an example: If you refinanced in 2010 and then again in 2013, the initial points cost $3,000 and you only got to deduct $300 worth ($100 per year). In 2013, you paid another $3,000 to refinance into a 15-year mortgage. Your 2013 deduction is $200 for the refinance points ($3,000 / 15 years) plus the remaining $2,700 from the 2010 loan. So your total deduction is $2,900.
- If you sold or refinanced a home in 2013 and were charged pre-payment penalties, you can deduct them on your Schedule A.
Health Care Tax on Real Estate Sales?
Contrary to internet-based rumors, you will not be assessed a 3.8 percent tax on the sale price of your home. Here are the facts:
- It only affects you if your taxable income exceeds $200,000 ($250,000 for married taxpayers filing jointly) and if your gain from the sale exceeds $250,000 ($500,000 if married filing jointly).
- The tax is 3.8 percent of the LESSER of the amount in which your income exceeds your limit OR the amount that the gain on the sale of the home exceeds your threshold. For example, if a married couple’s income is $300,000 and they gain $575,000 on the sale of their home, their thresholds are:
- $300,000 income - $250,000 = $50,000
- $575,000 gain - $500,000 = $75,000
The lesser number, $50,000, is used to calculate the tax, which is .038 * $50,000, or $1,900.
Considering the many tax, financial and lifestyle benefits of homeownership, this charge isn’t much.