November 4, 2016 9:44 am

3 Favorable Tax Rules for an Improved Housing Market

While the rate of home ownership is still down, the value of homes has improved. The real estate market in some areas is booming, due to a recovering economy, low mortgage rates, and other factors. From a tax perspective, there are certain rules that can be of value in an improved housing market.

1. Mortgage interest limits

You can deduct interest on home mortgages as an itemized deduction, but there are limits. Interest is capped on acquisition debt to buy, build, or substantially improve the residence up to $1 million and home equity debt (non-acquisition debt) up to $100,000. These limits apply for single individuals and joint filers. When married couples file separately, the dollar limits are halved.

Until now there had been some controversy about which limits apply when there are two or more co-owners who are not married to each other. Last year, an appellate court said the limits apply per taxpayer, so that each co-owner had the full $1 million/$100,000 limit. Now the IRS has agreed to follow this decision. Co-owners who did not claim deductions but are entitled to them under this rule should consider filing amended returns for open tax years.

The mortgage interest limit applies for a principal residence and one other home designated by the taxpayer, such as a vacation home.

Note:For 2016 interest payments, lenders are now required to include both the mortgage origination date and the outstanding balance of the mortgage (as of the first of the year) on revised Form 1098. Homeowners should receive these forms from their lenders by January 31, 2017.

2. Gain on the sale

Following the steep drop in the housing market in 2008, it has been a while since there have been gains on home sales. With the improved market, homeowners can once again turn to a big tax break: the exclusion of gain on the sale of a principal residence up to $250,000 ($500,000 for married persons filing jointly).

The exclusion applies only if the homeowners meet two tests: They must own and use their home as their principal residence for two of the five years preceding the date of the sale. The 730 days for ownership and use need not be consecutive.

However, the opportunity to flip homes for quick tax-free gains is limited. The exclusion cannot be used if gain from the sale of another home was excluded during the two-year period prior to the sale.

If a homeowner sells before meeting these tests, it may be possible to prorate the exclusion. A proration is allowed if the sale is because of a change in the place of employment, health, or other unforeseen circumstances. The following are examples of unforeseen circumstances:

  • Becoming eligible for unemployment compensation
  • Condemnation, seizure, or other involuntary conversion
  • Damage to the home from a natural or man-made disaster or an act of war or terrorism
  • Death
  • Divorce or legal separation
  • Having more children, which renders the home unsuitable as a residence
  • Multiple births from the same pregnancy

3. Deduction for mortgage insurance premiums

Taxpayers trying to get into the housing market may lack sufficient funds for a 20% down payment. They may be able to swing the mortgage if they obtain mortgage insurance. They can treat the premiums as deductible interest if they itemize deductions.

A deduction may be limited or barred if adjusted gross income (AGI) is too high. More specifically, a full deduction of premiums is allowed if AGI does not exceed $100,000 ($50,000 if married filing separately).

If a homeowner prepays the premiums, they are fully deductible only if the insurance is through the Department of Veterans Affairs or the Rural Housing Authority. If they are through the Federal Housing Administration or it is private insurance, the premiums are deductible over the shorter of the term of the mortgage or 84 months, beginning with the month the insurance is obtained.

Note:This deduction opportunity is set to expire at the end of 2016. However, Congress may extend it as it has done in the past.


With mortgage rates low, now is a good time to become a homeowner if you have been thinking about it. Those who already own homes can take advantage of tax breaks.

Tax Glossary

Original issue discount (OID)

The difference between the face value of a bond and its original issue price. OID is reported on an annual basis as interest income.

More terms