Young professionals might want to invest in a first home, growing families may need more living space, and empty nesters could be ready to downsize. Whatever the motivation, spring is often the time when households start preparing for such a move.
Although home prices nationwide are still recovering from the housing crisis, the number of homeowners with underwater mortgages has declined.1 Federal mortgage regulators have also taken steps to ease the tight credit standards that have stymied some potential borrowers in recent years.2 A healthier housing market and an improving employment situation suggest that many Americans may be in a better position to buy or sell homes in 2015.
The ability to write off mortgage interest and other home-related expenses can be a significant financial incentive. To take advantage of the tax savings, homeowners must itemize their deductions on Schedule A of their federal tax returns instead of claiming the standard deduction.
Deductions Add Up
Interest. The mortgage interest deduction generally applies to a primary residence and a second home such as a vacation condo, mobile home, boat, house trailer, or any structure with sleeping, cooking, and toilet facilities. However, special rules may apply to a second home if it is rented for part of the year.
The deduction for mortgage interest applies on up to $1 million for first mortgages (secured by the home) plus up to $100,000 for home-equity loans. The interest deduction is especially valuable for homeowners with a jumbo mortgage or two home loans. For a married couple filing jointly who are subject to a 30% tax rate, deducting $24,000 in mortgage interest could result in a tax savings of up to $7,200.3
Property taxes. The legal property owner can also deduct real estate taxes in the year that they’re actually paid to the taxing authority, whether paid directly by the owner or by the lender through an escrow account.
Points. Paying points (or loan origination fees) up-front may help borrowers lower the interest rate for the life of the loan. When a mortgage loan is used to purchase or build a primary residence, the IRS allows the borrower to deduct mortgage points in the year they are paid — even if the seller pays them for the buyer. With a refinanced loan, deductions for points must typically be prorated over the life of the loan.
When It’s Time to Sell
A capital gain (or loss) on the sale of property is equal to the sale price minus the adjusted basis. The adjusted basis is the initial cost, plus money spent on capital improvements, less any depreciation and casualty losses claimed for tax purposes.
When a principal residence is sold, losses are not tax deductible. On the other hand, a profit of up to $250,000 ($500,000 for married joint filers) may be excluded from the federal capital gain tax.
To qualify for the exclusion, the home must have been owned and used as a principal residence for two out of the five years before the sale. Owners who cannot pass this test may be eligible for a reduced exclusion, but only if the home sale was due to a change in place of employment, health reasons, or certain other unforeseen circumstances.
Keep in mind that if you are subject to the alternative minimum tax or the Pease provision (which reduces the value of deductions for high-income taxpayers), your ability to deduct mortgage interest and other home-related expenses may be limited. Before you take any specific action, be sure to consult with your tax professional.
1) RealtyTrac, October 23, 2014
2) The New York Times, October 27, 2014
3) The Wall Street Journal, October 29, 2014
The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. Copyright 2015 Emerald Connect, LLC.
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