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Tax Planning and Home
By cpa | March 20, 2008
Should I rent or buy a place to live? How much money do you have to pay for housing? Should I buy it now or should I wait? Many people have asked these questions.
Buying a house is a big dream for most of people. However, it is very complicated and it requires a tremendous commitment.
There are many issues need to be taking into consideration while you are buying a house.
- A substantial down payment is needed.
- There are a lot of costs associated with owning a house, such as insurance, property taxes, maintenance and repairs.
- Unexpected loss of income due to job termination or unemployment may limit money available for the mortgage.
However, there are many advantages to owning your own home as well:
In recent years, Congress and the Internal Revenue Service have made your home potentially the greatest tax shelter. You can deduct mortgage interest and property taxes. Also, you can usually keep all of the gains when you sell your home. It’s even better if you use your home for your business.
Since these tax breaks took place, home prices have shot up in real estate markets. Many people’s gain from the sale of a home exceeds their lifetime savings. People have more reasons and incentives than ever to own their homes.
How long these breaks stay in place is a question mark. President Bush’s Advisory Panel on Tax Reform thinks we should limit the exclusions on some of the gains. But these changes would take at least a few years to become law. So enjoy it now.
Property Taxes
You can deduct all the real property taxes you pay. If your bank escrows the taxes, you get the deduction when your bank makes the payment. You should receive Form 1098 at the end of the year from your bank.
Even if you’re a shareholder in a co-op apartment building, you get to deduct your share of any property taxes paid under Internal Revenue code section 216. A letter is provided to you by the co-op explaining how much is deductible per share owned.
Deductible taxes include all state or local taxes for the general welfare of the state or locality. However, it doesn’t count any trash or garbage collection fees or homeowner association charges.Owned More than One Residency? There’s no limit on the number of properties for which you can deduct taxes paid. If you have 10 homes, you can deduct the taxes on all 10. However, if your deductions are too great, you could be subject to the alternative minimum tax.
Interest
Interest paid on the purchase of your principal residence is deductible. You can deduct the interest you pay to buy a second residence or vacation home as well. The residence interest deduction is limited to the first $1 million of debt.
If you have a mortgage of $400,000 at an interest rate of 6%. You get to deduct $24,000 interest from your income.
If you’re in the 25% tax bracket, $24,000 in interest paid only takes $18,000 out of your pocket. Uncle Sam subsidizes the other $6,000.Gain exclusion
The 2–out-of-5 Rule: To qualify for the $250,000 ($500,000 on a joint return) exclusion, you must have owned and occupied a home as your principal residence for at least two years during the five-year period ending on the date of sale.
One-Time Exclusion? This is not a one-time exclusion. You can get another full exclusion every two years. You don’t have to buy a new house from the money you receive from the sale of your home. You can even rent after you sale your home.Partial Exclusion? You can even get a partial exclusion based on the time of use and ownership. But you need to be able to justify the sale of your residence based on the following reasons:
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Change of employment: “Change in employment” covers anyone who lives in the household. The person doesn’t even have to be an owner of the property. The “change in employment” must be the primary reason for the move. There’s a “safe harbor” that assumes that it was the primary reason if your new job is at least 50 miles farther from the residence sold than where you used to work.
- Health reasons: Health reasons include advanced-age-related infirmities, the need to move to care for a family member, or to obtain or provide medical or personal care for a qualified individual suffering from a disease, illness or injury.
- Unforeseen circumstances: Unforeseen circumstances include divorce, death, multiple births from the same pregnancy and even a change in employment or self-employment status that results in your inability to pay the costs and living expenses of your household. So, if your income goes down, or even if your spouse or other co-owner’s income goes down, you can qualify for a partial or even a full exclusion.
If you don’t meet the “safe harbor” test all is not lost. You may want to talk to your CPA. He or she might be able to help you to prove that it was the primary reason for the move based on the facts and circumstances of your case.
The partial exclusion is based on the maximum exclusion, not on the basis of your actual realized profit.
If you (single) bought a residence for $250,000 and sold it for $350,000, because of a job change, after only one year.
You are qualifying for a partial exclusion. It was your principal residence for one year out of two.
$250,000 Maximum Exclusion x 1 year / 2 Years = $125,000 – Maximum Exclusion
$350,000 Sold Price - $250,000 Purchased Price = $100,000
You can exclude the whole $100,000 gain.
Home offices
In the past, it’s a red flag to use home offices. IRS is getting friendlier with home office taxpayers. Let’s say you use 20% of your house as a home office. You can deduct depreciation and expenses (utilities, repair, etc.) for working in that part of the house.In the past, when you sold your house, 20% of the gain wouldn’t qualify for the exclusion because that 20% wasn’t used as a “residence.” Now, the IRS doesn’t care even if you used your home 90% for business as a home office. You can now exclude as much as 100% of your gain, up to the $250,000/$500,000 limit.
You only need to recapture the gain to the extent of depreciation taken on the building. That’s taxed at 25%.
Many people who work out of their homes and don’t claim home offices may begin to consider taking the advantage of home offices. If you are not sure how to maximize your tax benefits, please consult your CPA.
Topics: REAL ESTATE |