It's Tax Time! Deductions, Exclusions and Credits for Homeowners
Renowned economist John Maynard Keynes once said, "The avoidance of taxes is the only intellectual pursuit that still carries any reward." Tax time can be rewarding for homeowners who take advantage of the deductions and credits that come with home ownership; however, home ownership can also make filing your 2012 tax return a bit more complicated. Here's what you need to know.
The 3 deductions in your monthly payment
Your monthly house payment offers several opportunities for income tax savings. These include mortgage interest, property taxes, and mortgage insurance.
- Mortgage interest is deductible only if you itemize on a Schedule A. To be deductible, a loan must be secured by your primary residence or a second home. (You can deduct interest and other items for rental property on a Schedule E.) The loan can be a first mortgage, a home improvement loan, a home equity loan or a home equity line of credit. Your deduction is generally limited to interest on the first $1 million ($500,000 for married-separate filers) of money borrowed to buy, build, or renovate your home. You can usually deduct interest on up to $100,000 of additional home equity debt ($50,000 if you file singly or separately).
- 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 2013 taxes in advance and deduct them on your 2012 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. 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.
- Mortgage insurance, whether it's called PMI (private mortgage insurance), MI (mortgage insurance), MIP (mortgage insurance premium), or a funding fee (for VA or USDA mortgages), is deductible; however, you must itemize your deductions and your adjusted gross income (AGI) can't exceed $100,000 (half that for married-filing-separately) to fully claim your deduction. At that point, the deduction is phased out until it disappears entirely once income exceeds $109,000 ($54,500 for separate filers). Prepaid mortgage insurance must be prorated over the term of the loan or 84 months, whichever is shorter.
Deductible closing costs
If you bought a home or refinanced a mortgage in 2012, 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 2009 and then again in 2012, the initial points cost $3,000 and you only got to deduct $300 worth ($100 per year). In 2012, you paid another $3,000 to refinance into a 15-year mortgage. Your 2012 deduction is $200 for the refinance points ($3,000 / 15 years) plus the remaining $2,700 from the 2009 loan. So your total deduction is $2,900.
- If you sold or refinanced a home in 2012 and were charged pre-payment penalties, you can deduct them on your Schedule A.
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, debtthat 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 the 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 doesn't go into effect until 2013.
- It only affects you if your taxable income exceeds $200,000 ($250,000 for married taxpayers filing jointly) and only if you receive certain types of investment income.
- The tax is only applied to gains of more than $250,000 ($500,000 if married filing jointly)
There are plenty of opportunities for homeowners to reduce their tax burdens and you should take them if you can. While the law requires us to pay our taxes, there's nothing that says we have to leave Uncle Sam a tip.
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