Tax Tips for Homeowners

Homeownership is one of the behaviors that the tax code is intentionally designed to encourage, which means that homeowners should pay close attention to the code and take advantage of all the deductions that they can.  Whether you recently bought your first house or are reviewing your situation in preparation for tax time, here are some tips for homeowners.

Purchase.  There are several major tax implications for purchasing a home.  The first is the purchase price.  In most cases, this becomes the basis for the home.  The basis is the term that the tax code uses to determine something’s value when you bought it for capital gains purposes.  As for more immediate tax issues, interest points that you pay at closing are deductible in the year that you buy the home.  This can amount to quite a deduction, so keep very careful track of your closing costs (HUD-1) and your end of year tax forms from your lender (1098).  Make sure that you include your points as a deductible interest expense on your itemized deductions.  Recently, the purchase of a home also qualified for first time home buyers’ tax credits.  If you purchase or purchased a home in a year when the government was offering those credits, make sure that you claim the credit.

Ongoing costs.  During years that you own a home, there are two major sources of tax deductions for a homeowner: interest and taxes.  In both cases, you must itemize your deductions to take advantage of the deduction.  A bank will normally send you a form 1098 at the end of the year to total the interest that you paid.  If you pay your property taxes out of an escrow account, the bank will also likely include that amount on a separate line on the 1098.  If you pay your property taxes yourself, remember to include those as a deductible expense on your return.  The situation is a bit more complicated if you also pay interest to somebody other than a bank.  Many people who arrange for seller financing are in that situation, and your seller might not send you a form to total your interest for the year.  Your loan contract with the seller likely spells out how your payments are being allocated, or if normal amortization is being used, an of a number of online mortgage calculators can tell you how much of each payment was interest and how much was principal.

Repairs and improvements.  As a general rule, repairs are not tax deductible and have no impact on taxes.  However, improvements to the home will eventually be added to the basis to come up with an adjusted basis.  You should carefully track any expenses that you have for improvements to the home.  The IRS looks very carefully at claimed improvements, and if you have a question about whether an expense is a repair or improvement you should contact an accountant or the IRS for guidance.  There is one category of home repairs and improvements that is deductible in the year that it occurs: costs of making the home more energy efficient.  Not all projects qualify, but if you install extremely energy efficient windows and doors, or high efficiency heating and cooling systems, you might be able to claim a credit of up to 30% of the costs of those improvements, up to certain limits.

Selling a house.  When it comes time to sell the house, there are certain tax consequences.  Normally, a sale of property like a house triggers a tax on the capital gains.  But if you have lived in the home as your primary residence for two of the previous five years, your home sale will be exempt from capital gains taxes on the first $250,000 in gains on the sale (double that if married filing jointly.)  This gain no longer has to be rolled over into a new house as it used to.  Remember also to tally up all those costs of home improvement (not home repair) that you have made over the years and add that to the basis before calculating the gain.  Some people are selling homes without the luxury of a gain in value at all.  If you are conducting a short sale, the normal rule is that any amount of the loan that the bank is agreeing to write off is income to the borrower.  That rule was temporarily lifted in the heat of the mortgage crisis, so double check your specific situation if you sell short – you might owe a huge tax bill on the short part of the sale.

If you are not sure about any of the tax implications of home ownership, an accountant or tax preparer can give you up to the minute guidance about improvements, capital gains, and short sales.  The tax code is designed around homeownership and many of the provisions are meant to encourage people to own and upgrade homes.  Regardless of whether you are buying, maintaining, or selling a home, make sure you double check how the tax code will impact you.