Albert Einstein once said, "The hardest thing in the world to understand is the income tax." If you buy, sell, finance or own real estate, it gets even worse. Before you belly up to the nearest bar or start pulling your hair out, check out this list of FAQs for tax-paying, home-owning citizens.
Yep, property and taxes go together like blood and leeches. Yet there is no reason to pay more than the minimum. Here are some commonly asked questions about taxes and homeownership. Knowing the answers will help keep your tax bill as low as possible.
1. How much of my mortgage payment is tax deductible?
On a Schedule A, you can deduct the following:
* Interest on debt used to buy, build or improve your primary or second home (called acquisition debt), as long as mortgages totaled $1 million or less ($500,000 if single or married filing separately).
* Mortgage insurance (or funding fees for government loans) for loans taken after 2006 as long as your adjusted gross income does not exceed $109,000 for a married couple (half that for singles and those married filing separately).
* Property taxes on first and second homes. Starting in 2010, however, you must itemize your deductions to get this tax break.
2. I sold my home this year. Will I owe capital gains tax?
As long as the property was your principal residence for at least two of the last five years, you can exclude $250,000 of your profit ($500,000 for married couples) from your taxable income. If you profited less than the $250,000/$500,000 threshold, no extra form is required. You can do this as often as every two years.
For those with profits that cannot be excluded, you'll report your gain on a Schedule D, Capital Gains and Losses. There are special rules for vacation homes. You may be able to exclude some or all of your gain.
3. I lost money on the sale of my home. Do I get to deduct the loss?
Loss on the sale of a personal residence is treated like a loss on the sale of any personal property. It is not deductible. Losses on investment properties are deductible.
4. I bought or refinanced a home this year. Are my closing costs tax deductible?
You can claim a deduction for real estate taxes you paid as part of your mortgage closing costs. The same goes for prepaid interest. It will be included on the 1098 form your lender sends you. What about points? The IRS has a flowchart that you can use to see when points are and are not deductible. In general, you must have paid points to build, buy or improve your primary residence in order to deduct the entire amount in the year they were paid. Otherwise they may still be deducted but on a prorated basis.
5. What happens with points on a refinance?
This deduction is often overlooked, and it could be worth a lot. When you pay points on a refinance, they have to be prorated. For example, if you pay $3,000 in points on a 30-year mortgage, you can deduct $100 a year for 30 years. But if you refinanced again this year and have prorated points that have not yet been deducted--for example, you are 10 years into a 30-year loan and have only deducted $1,000 of $3,000 in points paid--you can deduct the remaining $2,000 in the year you refinance.
6. Does a mortgage modification affect my taxes?
If you modify your mortgage, one consequence might be that you pay so much less interest that you will save more by choosing the standard deduction rather than itemizing. Don't just assume that itemizing is always best because you did it in the past.
7. Does a mortgage foreclosure affect my taxes?
The Mortgage Forgiveness Debt Relief Act of 2007 generally allows you to exclude income from the discharge of debt on your primary residence. However, this law does not cover investment properties and vacation homes, nor does it apply to forgiven home equity loans. You could end up paying income tax on this canceled debt. In addition, states' rules for the treatment of forgiven mortgage debt vary, so check with a tax professional.
8. Can I deduct prepayment penalties?
Prepayment penalties paid on a mortgage are tax deductible in the year that they are paid.
9. What expenses am I NOT allowed to deduct from my income?
Unless your property is a rental or investment, you don't get tax breaks for the following:
* Hazard insurance;
* Homeowners association dues;
* Principal payments on the mortgage;
* General closing costs like appraisal fees or title insurance;
* Local assessments to improve your neighborhood.
10. Does the health care tax have an effect on gains from property sales?
This tax, which is 3.8%, is one of the most misunderstood additions to the tax code. Reasons not to worry:
* It doesn't apply until 2013;
* Your annual income must exceed $200,000 ($250,000 for married couples filing jointly);
* The tax is only applied to gains over $250,000 on a primary residence (or $500,000 if married).
Knowing what tax deductions are available to you can help minimize the tax man's bite come filing April 15. After all, the law says you have to pay taxes--but there's no reason to leave Uncle Sam a tip.
About the author:
Gina Pogol has been writing about mortgage and finance since 1994. In addition to a decade in mortgage lending, she has worked as a business credit systems consultant for Experian and as an accountant for Deloitte. She graduated with High Distinction from the University of Nevada with a BS in Financial Management.