Mortgage Interest Deduction

That big fat mortgage payment you now have to pay every month has an upside. The interest portion of every payment is tax deductible.  Keep in mind that, at the beginning of your mortgage, most of your payment is interest, meaning that the overwhelming majority of your payment is tax deductible.

Real Estate Tax Deduction

Every dollar you pay in real estate taxes is deductible.  While it’s never fun to learn that your property taxes have gone up again, at least you will be able to take some solace in knowing your tax deductions (and your resulting income tax savings) will increase at the same rate.

Charitable Donation Deduction

While the charitable donation deduction might seem unrelated to a home purchase, this is income taxes we’re talking about.  Before you purchased your home, you may not have had enough tax deductions to itemize your deductions.

Why?  Since your standard deduction was greater than your itemized deductions, you did not benefit from any of the itemized deductions you could have otherwise taken.  But when you became a homeowner, the mortgage interest and real estate taxes alone often make it so that you will be able to itemize and you are now eligible for additional tax deductions. The most common of these is the charitable donation deduction. So, if you tithe at church or give clothes to the Vietnam Veterans, you will now also receive a tax benefit from doing so.

Other Considerations for First Time Home Buyers

Save your closing form (HUD).  When you file your tax return for the first time after buying a home, additional expenses incurred on your HUD may be deductible, including prepaid interest (points) you pay at closing.

Save all of your home improvement receipts.  You are likely to sell your home one day.  Most home sales do not result in income tax.  However, it is possible if you move very quickly or make a very big profit. To lessen the odds you will owe capital gains taxes on the sale of your home, save your receipts!

Welcome to the world of home ownership. It can be wonderful and expensive. Make sure you take advantage of every opportunity to keep your costs in line.  Start with taking maximum advantage of the tax deductions available to you.

Don’t worry about knowing all of these tax deductions, TurboTax will ask you simple questions, and give you the tax deductions you’re eligible for.  If you have questions, only TurboTax lets you talk to CPAs, Enrolled Agents, and tax attorneys while you prepare your tax return, free.

When we think about vacation homes, taxes are rarely the issue that commands our attention. Yet while the beach out back or the stellar restaurant down the street might be more exciting to think about, taxes are a huge consideration in their own right. Failure to properly plan and budget for property taxes could transform your dream vacation home (or timeshare) from an uplifting getaway into a financial nightmare.

Property Tax

Here, we explore how the details of your vacation home situation affect your property tax obligations and preparation strategies.

How Frequency of Use Affects Property Taxes

Contrary to some assumptions, the government does not simply apply a blanket tax obligation to all vacation home owners. Rather, they consider how frequently the home is occupied, and whether the primary occupants are you (the owner) or tenants that you rent to.

SmartMoney helpfully divides vacation home ownership (for tax purposes) into three categories:

• Use a lot, rent a lot
• Rent a lot, use a little
• Use a lot, rent a little

Each category is summarized and explored in more detail below.

If you use your vacation home a lot, and also rent it a lot…

Your vacation home is considered a personal residence. As SmartMoney explains, this is potentially beneficial for you:

Specifically, this applies to homes that are rented more than 14 days a year and have personal use of more than 14 days or 10% of the rental days, whichever is greater. Personal use includes use by family members and anyone else who pays less than market rental rates. Vacation homes fitting this description are considered personal residences.

“This helps you, because Uncle Sam lets you deduct interest on up to $1 million of mortgage debt (and up to an additional $100,000 for home equity loans). Property taxes are generally deductible, no matter how many homes you own. Those fortunate enough to own more than two homes can pick the two with the most mortgage interest each year which is usually the main residence and the vacation home with the biggest loan.”

The main thing to keep in mind is that you must deduct the expenses from your own use of the house and the expenses incurred while renting separately.

EXAMPLE SCENARIO:

To use SmartMoney’s example, we will assume your vacation home is rented for three months, used by your family for two, and vacant for the other seven. Vacant time, it should be clarified, is considered personal use for tax reasons. Thus, you would deduct three months worth (25%) of the interest and taxes from rental income, and nine months (75%) from your itemized deductions on Schedule A of your tax return.

Keep in mind that this category applies to “homes that are rented more than 14 days a year and have personal use of more than 14 days or 10% of the rental days, whichever is greater.”

If you rent your vacation home a lot, but only use it yourself a little…

You are treated differently for tax purposes. Specifically, the rule is that your vacation home will fall under the category of “rental properties rather than for personal residences if you rent more than 14 days a year and if your personal use doesn’t exceed 14 days or 10% of the rental days, whichever is greater.”

This scenario varies considerably from the first category. For one thing, since your home is a rental property, rather than a personal residence, you cannot deduct the interest expenses incurred during your own use. But there are benefits as well. If you incur rental losses, you can write these off as a taxable loss as long as you “actively participate” in the property by making day-to-day management decisions and meet personal income limits.

If you use your vacation home a lot, but only rent it out a little…

By far the simplest and most beneficial category, this applies to homes “that are rented for fewer than 15 days a year and used by the owner for more than 14 days.” If this describes you, then your vacation home is actually a personal residence for tax purposes. As such, you can deduct the interest and property taxes as itemized deductions, in the same manner you do for your actual home.

Best of all: you do not have to legally declare any rental income. Although you don’t get any write-offs for operating expenses, this is a benefit well worth taking advantage of!

Interactive by Column Five

How does your state’s property tax fare?  Well, at least property taxes are tax deductible.

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First-Time Homebuyers Tax Credit

Under 2008 legislation designed to stimulate the housing market, first-time homebuyers could claim a tax credit of up to $7,500 if they purchased a home between 4/8/08 and 12/31/08. But there was a catch: the credit wasn’t a gift from the government, it was really an interest-free loan that had to be repaid over fifteen years, beginning in 2010.

So, beginning in 2010 you had to file Form 5405 with your tax return each year and add 1/15 of the credit to your taxes owed. For example, if you received the maximum credit of $7,500, you’d divide that credit by 15 and add $500 to your income taxes each year for the next 15 years.

But here’s the problem – most people don’t stay in their home for 15 years. And when you sell your home, the remaining unpaid tax credit is added to your taxes for that year. So if you claimed the $7,500 credit in 2008, repaid $500 with your 2010 tax return, and sold your home in 2011, be prepared for an additional $7,000 tax bite when you file your tax return in April. Ouch!

What if your house didn’t increase in value, and you end up making next to nothing on the sale? Recognizing that the credit repayment could easily exceed the amount you realize, the IRS caps the amount you owe in recapture to the amount of the gain you realize. So if you bought your home for $150,000 and your sales proceeds after costs of sale are only $152,000, the maximum credit you’d have to repay is $2,000.

Here’s another trap to beware of. You don’t have to sell the home to become liable for the tax credit repayment. You can trigger the tax recapture by moving out of your home, even if you continue to own it. So if you moved out in 2011 and kept the home as a rental property, boom – you owe the rest of the tax credit with your 2011 tax return.

Fortunately the IRS has some mercy when circumstances are beyond your control. For example, if you deed your home to your spouse in a divorce settlement, there’s no recapture of the tax credit (but your spouse does have to repay the credit over the remainder of the fifteen years and triggers the recapture if he or she moves out within the 15-year period).

If you lose your home in a foreclosure, your repayment is limited to the amount of the gain. And if you die, you are off the hook as well. And if you or your spouse are in the military and sell because of an order to relocate for extended duty, you don’t have to repay the credit.

The 2008 credit had its traps and pitfalls, but it did help people buy the house they wanted and stimulated home sales. That’s why Congress later extended it to 2009 and 2010. Sorry to say, this isn’t a case where the early bird gets the worm.

When the credit was extended, it was increased to $8,000, expanded to include a reduced credit for those who were not first-time homebuyers, and only has to be repaid if the taxpayer moved out within three years. Unfortunately, those features were not applied retroactively to 2008, leaving early-adopters with an obligation to repay the tax credit that those who came later to the party didn’t have to.

Refinance Points

Buying a Home and Points

We purchased our house 2 years ago and found a fantastic deal with a mortgage lender for a fixed 5% interest rate for 30 years. As we looked through the paperwork we examined all the numbers, including points we’d have to pay to get the mortgage.

In case you’re not familiar with the term, points (also known as loan origination fees or discount points) are basically an up-front payment from a borrower to get a specific rate from the lender. One point is equal to 1% of mortgage loan. In some cases a borrower will pay more in points to get a lower interest rate over the life of the mortgage.

If you buy a house and you plan on staying there for many, many years, then paying those points can be financially beneficial to you and your family over the life of that loan. Run the numbers to see how long it would take to break even by paying more points. If it’s longer than you intend to stay in the house, then you may be better off paying the slightly higher interest rate.

When it comes to taxes, buying a house has some great benefits. For one thing, if you itemize your deductions, you can deduct the interest paid that year for your mortgage. Another bonus is generally you can deduct the points you paid in full for your home (primary residence), provided you meet the requirements as set out by the IRS.

If you purchased a home last year you should have received a document from your lender that includes the amount of mortgage interest you paid (Box 1 ), the points you paid (Box 2), and the mortgage insurance premiums you paid, if applicable (Box 4).

When I Refinance Can I Deduct the Points Upfront?

Now, just 2 years later, we’re back looking at mortgages, this time we’re considering refinancing our home. Interest rates are even lower – we recently had quotes for 3.5% and less. Since we have equity in our home, refinancing has become a financially attractive option for us.

When it comes to filing our taxes, it’s going to be a slightly different story. Unlike a regular mortgage where you can deduct the points upfront, with refinancing, the points you paid to refinance your mortgage are deducted over the term of the new loan.

Thoughts on Deducting Points

I’d love to hear your home financing plans for 2012. How many of you are buying a house this year? How many of you are planning on refinancing you current mortgage?

But if you are selling your current home so you can buy another one, the buyer’s market may work against you on the sale side due to fewer customers and customers’ ability to offer lower prices for your old home. If it takes longer to sell than you expected, the timing may be troublesome: sell your old home before you find a new one, and you’ll be scrambling to find a new home and may find yourself settling for the not-so-perfect house. Buy first, before your old home has sold, and you’ll be under the gun to sell your old home, and might not be able to hold out for the best price.

Try making your purchase offer contingent on you selling your old home – that may work if you can demonstrate to a seller that there’s a good chance your house will sell quickly. And be sure to get qualified with a mortgage company before you shop so that you have the financing in place and know how much house you can afford.

If you find the perfect new home and want to close on it before the old one sells, how do you bridge the financial gap? If your old house has plenty of equity, and you have enough income to pay two mortgages, you may take out a bridge loan, which is a short-term loan using your old home as collateral. That will give you the funds you need to close on the new house, and the bridge loan will be paid off when you sell the old home. Or you can borrow from family or friends who are well-heeled, if you have any in that fortunate position who are willing to help.

If you’re lucky enough to make that purchase happen, you may benefit from more tax deductions. You get a tax deduction for interest paid on your mortgage, but what about the bridge loan and the loan on the new residence that you buy while waiting for the old residence to sell? Good news. Interest on loans for the purchase or improvement of up to two residences is deductible, so it is likely that you can deduct the interest on both mortgages and the bridge loan. And property taxes are deductible on all properties that you own as well.

Capital gains on the sale of your home may also have tax consequences. Ordinarily you would owe tax on the difference between the net sales price and your cost basis, but most home sellers don’t owe tax — since 1987, homeowners have been able to exclude most or all of the gain when they sell.

The general rule is that if you sell your primary residence, you can exclude a gain of as much as $500,000 if you’re married and filing a joint return with your spouse, or $250,000 if you’re single or married filing separately. To be eligible for the full exclusion, you must have owned the home and lived in it as your principal residence for at least two of the five years prior to sale.

If you have to sell your home but you’ve owned it less than two years, all is not lost. You can claim a reduced exclusion if the sale occurred because of a change in your place of employment, health reasons or “unforeseen circumstances” such as divorce, multiple births or job loss. So if you’ve owned and lived in the home for just 18 months when you sell, not 24 months, then 18/24 or 75% of the $250,000 per person exclusion would apply.

Most taxpayers are fortunate enough not to owe taxes when they earn money on the sale of their principal residence, but what about selling at a loss? Unfortunately, you can’t claim a loss from the sale of your principal residence.

What Is The Residential Energy Tax Credit?

It’s a tax credit given by the IRS to reward homeowners for making eligible energy-saving improvements to their principal residences.   A tax credit directly increases your refund or reduces your tax liability. A principal residence is a home that you own and live in most of the time.

Home improvements eligible for the credit are:

•    Biomass stoves, heating, ventilating, air conditioning, water heaters, and installation costs for these items.

•    The costs of windows, skylights, energy-efficient doors, insulation, and certain roofs also qualify for the credit.

Another related credit available to taxpayers is the Residential Energy Efficient Property Credit.  This tax credit remains unchanged for 2011 and covers qualifying property such as solar electric systems, solar hot water heaters, geothermal heat pumps, wind turbines, and fuel cell property.

How Did the Residential Energy Tax Credit Change in 2011?

In 2010, the Residential Energy Tax Credit was 30% of the cost of eligible energy saving home improvements up to $1,500, but now the credit is considerably lower as follows:

•    10% up to $500 for insulation, roofs, and doors

•    Windows capped at $200, but must meet ENERGY STAR qualifications

•    Furnace and boilers capped at $150

•    $50 for advanced main air circulating fan

•    $300 for air conditioners, air source heat pumps, water heaters, and Biomass stoves

•    $500 lifetime limit. If you received over $500 in these tax credits from 2006-2010, you are not eligible for anything more.

Most Common Reasons You May Not Receive the Tax Credit You’re Expecting

1.    Appliances such as refrigerators, dishwashers, washers, and dryers are not eligible for the credit even if they carry the Energy Star label.  Your state may have a rebate program for these types of appliances.  Check with your individual state online.

2.    The energy credit is a non-refundable credit.  Non-refundable tax credits are tax credits that cannot be more than your tax liability.  For example, if your tax liability is $250, you will not be eligible for a tax credit greater than $250.

3.    Beginning January 1, 2011, there is a $500 lifetime limit on the tax credit, so if you already received energy efficiency tax credits from 2006-2010 that counts toward the limit and it can’t go over the new limit of $500.

Claiming the Residential Energy Tax Credit

If you took the steps to make your home green in 2011 and your purchases meet the new eligibility requirements, congratulations!  You can claim the credit on IRS Form 5695 and file it with your 2011 taxes.  Don’t worry about the calculations.  TurboTax guides you and follows IRS guidelines to calculate the correct energy tax credit based on your entries.  Make sure you save all of your receipts and the Manufacturer’s Certification Statement for your records.

Still trying to decide whether to make your home energy-efficient? Compare the cost of your energy-efficient improvement with what you will be saving in energy costs.  Also, make sure the product meets the new eligibility requirements according to the Manufacturer’s Certification Statement.  The Manufacturer’s Certification Statement certifies that the product qualifies for the tax credit.  Go to the Energy Star website for more information.  Haven’t filed your 2010 taxes yet? Check our Take the Chill Off blog for the 2010 residential energy tax credit law.

1. Add space. Converting a storage attic into a bedroom, building an entertainment deck, or finishing a musty basement is a smart way to add usable square footage to a home, which will increase its livability as well as its resale value. You can even add a second story, enlarge the garage or create an extra bathroom for a busy household. With many families sharing space with other family members or roommates, having more bedrooms and living space is a definite plus.

2. Increase curb appeal. Install a new front door with pizazz, redo an entry, landscape the front yard, paint the house or replace worn siding. All these projects spruce up your home and give the exterior a fresh appeal.

3. Remodel kitchen and baths. Up-to-date kitchens are always in demand, so replacing counter tops and appliances can add a great deal to the saleability of your home. Likewise, bathrooms can sparkle with new fixtures, flooring, paint and mirrors, at relatively little cost.

4. Save energy. Replacing windows and doors that leak and adding insulation will save heating and cooling costs. These improvements may also save tax dollars. For 2011, you can garner an income tax credit of up to $200 for Energy Star-qualified windows and skylights and up to $500 for Energy Star-qualified doors. Replace your water heater with a new efficient one, and you can receive up to $300 in credits. Furnace improvements and central air conditioning may yield tax credits of as much as $300. In most cases, the tax credit is 10% of the amount you spend, and the overall credit is limited to $500. To claim the energy tax credit, file Form 5695 with your 2011 tax return.

5. Go solar. Because they are so efficient, the government is offering a 30% tax credit for solar energy systems and geothermal heat pumps, as well as small wind turbines with no limit on the credit you can claim. This credit is available through 2016.

Our property taxes for our town home are due by the end of December every year. We get a letter from our county and municipality during the summer to let us know what our tax obligation is. By having a portion of our mortgage payments allocated for the bill, we’re able to have it taken care of painlessly.

What are Property Taxes?

Curious to find out more about property taxes, I decided to check online and dig around a bit. Property taxes are used as a source of revenue for local government.The revenue is used for public services such as fire, police, and school funding. Property tax is determined by the assessed value of your piece of real estate and the current rate in your location.

Most Expensive Places for Property Taxes

CNN had a fascinating piece on some of the most expensive counties in the United States for property taxes. It may come as no surprise to many to see that the Northeast had the highest property taxes in the nation.

• New York
• New Jersey
• Connecticut
• New Hampshire

Since tax rates can change through the years, it’s helpful to check lists like the one CNN has regularly.

Learning How Much You Owe

If you’re curious to see what your municipality’s current tax rate is or if you want to see what your house is assessed for, go online to your local government’s tax/revenue department’s site. We used the site for the city of Raleigh and we were able to see our past tax bills as well. It’s quickest and easiest way to stop on top of it.

Due to the downturn in real estate with some areas of the country, it doesn’t hurt to check to make sure your assessment is accurate. You may be able to dispute your tax bill and get it lowered if you can prove that property value has decreased since the last assessment.

Your Property Taxes

I’d love to see how much everyone is paying with their property taxes. What is your local property tax rate? Does your escrow account take care of the annual payments or do you take care of it yourself?