May 22, 2015 2:58 pm

Your Home as a Tax Shelter

With the real estate market heating up in most locations across the United States, a personal residence is again an important tax shelter for homeowners. You can garner tax breaks when you buy, while you own, and when you sell a home.

Tax breaks for buying a home

Your down payment isn’t tax deductible. But certain direct and indirect costs may be deductible:

  • Points on a home mortgage. If you pay the lender points to lower your interest rate when you purchase a home, the points usually are deductible. To be deductible, the points must be for the use of money and not for specific services performed.
  • Mortgage insurance premiums. If you can’t put 20% down and are required by the lender to carry mortgage insurance, the premiums are treated as deductible interest (assuming this tax break is extended).
  • Moving costs. If the purchase of a new home is for work (a job or self-employment) and the distance between the new work location and former home is at least 50 miles more than the distance between the old work location and former home, then moving costs are deductible.

Tax breaks when owning a home

The cost of home ownership can be pricy, but tax write-offs can help. These costs can be deducted as itemized deductions:

  • Mortgage interest. Interest on a loan to buy, build, or substantially improve a home is deductible on a loan up to $1 million. Similarly, interest on a home equity loan (any other loan secured by a principal residence) is deductible on borrowing up to $100,000. These dollar limits are halved for married persons filing separately.
  • Real estate taxes. Real estate taxes are deductible; there is no dollar limit.

Other costs are not deductible. However, the cost of capital improvements, such as adding a room, buying new appliances, or replacing a roof, can be added to your home’s basis. This will reduce the resulting tax gain when you sell your home at a profit.

If you use a portion of your home for business, you can treat a portion of mortgage interest and real estate taxes, as well as homeowner’s insurance, utilities, and other home-related expenses, as a business deduction.

Tax breaks when selling a home

With property values increasing, more sellers are reaping handsome profits when they sell their homes today. Gain on the sale of a principal residence is tax free up to $250,000 ($500,000 for married persons filing jointly). The home must be owned and used as a principal residence for two of the five years preceding the date of the sale and the taxpayer cannot have used the exclusion within 2 years. Caution: Gain in excess of this exclusion is subject to capital gains and the 3.8% net investment income tax.

Homeowners who make short sales or have foreclosures in which some mortgage principal is forgiven by the lender usually have income from this debt forgiveness. However, a special rule excluding this income (up to $2 million, or $1 million for a married person filing separately) could be extended (it expired at the end of 2013, likely will be extended for 2014, and possibly extended beyond 2014).

Unfortunately, not all homes sell at a profit, and a loss on the sale of a principal residence is not tax deductible.

Conclusion

Tax breaks for home ownership are only one factor in deciding whether to own or rent a residence. But these tax breaks are significant and could tip the financial balance toward ownership.

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Tax Glossary

Assessment

The IRS action of fixing tax liability that sets in motion collection procedures, such as charging interest, imposing penalties, and, if necessary, seizing property.

More terms