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Tax Benefits of Home Ownership

May 17, 2011

John Jastremski Presents:


Tax Benefits of Home Ownership

In tax lingo, your principal residence is the place where you legally reside. It’s typically the place where you spend most of your time, but several other factors are also relevant in determining your principal residence. Many of the tax benefits associated with home ownership apply mainly to your principal residence–different rules apply to second homes and investment properties. Here’s what you need to know to make owning a home really pay off at tax time.
First-time homebuyer tax credit

You may qualify for a federal income tax credit of up to 10 percent of the purchase price of a principal residence (subject to the dollar limitations described below) if you meet certain requirements:

  • The home must have been purchased on or after January 1, 2009 and before May 1, 2010. If you entered into a written binding contract before May 1, 2010, you can still qualify if you close on the home before October 1, 2010. (The time period is extended for members of the uniformed services and others who receive government orders for qualified official extended duty.)
  • If you, and your spouse if you’re married, haven’t owned a principal residence in three years, you may qualify for a credit of up to $8,000 ($4,000 if you’re married and file a separate return).
  • For home purchases after November 6, 2009, you may qualify for a credit of up to $6,500 ($3,250 if you’re married and file a separate return) if you, and your spouse if you’re married, have maintained the same principal residence for at least five consecutive years in the eight years preceding the purchase.
  • For home purchases after November 6, 2009, you can’t claim the credit if the purchase price of the home exceeds $800,000.

Note: Special rules relating to the first-time homebuyer credit, not discussed here, apply to home purchases made on or after April 9, 2008, and before January 1, 2009.

Generally, you won’t have to pay back the credit (prior to January 1, 2009 the credit had to be paid back over 15 years in equal installments). There’s one important exception, however: If the home ceases to be your principal residence in the 36 months following the purchase, you’ll have to pay the credit back. If you’re married at the time of purchase, the home must remain the principal residence of either you or your spouse for the 36-month period.

The credit is reduced or eliminated for individuals with higher modified adjusted gross income (“MAGI”). The income levels that apply depend on your filing status and when the purchase is made:

Qualifying home purchase:
Filing status: 1/1/09 through 11/6/09 11/7/09 through 4/30/10
Married Filing joint Credit reduced if MAGI exceeds $150,000, eliminated when MAGI reaches $170,000 Credit reduced if MAGI exceeds $225,000, eliminated when MAGI reaches $245,000
All Others Credit reduced if MAGI exceeds $75,000, eliminated when MAGI reaches $95,000 Credit reduced if MAGI exceeds $125,000, eliminated when MAGI reaches $145,000

Additional restrictions apply as well. For example, you can’t claim the credit if you’re a nonresident alien. And, for purchases after November 6, 2009, you can’t claim the credit if you’re under age 18 at the time of the purchase (unless you’re married and your spouse is at least 18), or if you can be claimed by someone else as a dependent.

If you purchased a qualifying principal residence in 2009, you could elect to treat the purchase as if it occurred on December 31, 2008. Similarly, a qualifying purchase in 2010 can be treated as if it occurred on December 31, 2009, allowing you to claim the credit on your 2009 federal income tax return.
Temporary additional standard deduction for non-itemizers

For tax years 2008 and 2009, homeowners were able to claim an additional standard deduction for property tax if they did not itemize. The additional amount that could be claimed was the lesser of:

  • The amount of real estate property taxes paid during the year to state and local governments; or
  • $500 ($1,000 if married filing jointly)

Deducting mortgage interest

One of the most important tax advantages of home ownership is the deduction of mortgage interest. If you itemize deductions on Schedule A of your federal income tax return, you can generally deduct the qualified residence interest that you pay on certain home mortgages taken on your principal residence. (This also applies to second homes.) That is, you may be able to deduct the interest you’ve paid on a mortgage to buy, build, or improve your home, provided that the loan is secured by your home. Such a mortgage is known as acquisition indebtedness by the IRS. Your ability to deduct interest depends on several factors.

Up to $1 million of acquisition mortgage debt ($500,000 if you’re married and file separately) qualifies for interest deduction. (Different rules apply if you incurred the debt before October 14, 1987.) If your mortgage loan exceeds $1 million, some of the interest that you pay on the loan will not be deductible.

Although this deduction also applies to certain home equity loans secured by your home, the rules are different. Home equity debt involves a loan secured by your main or second home that exceeds the outstanding mortgages on the property. Home equity debt is limited to the lesser of:

  • The fair market value of the home minus the total acquisition debt on that home, or
  • $100,000 (or $50,000 if your filing status is married filing separately) for main and second homes combined

The interest that you pay on a qualifying home equity loan is generally deductible regardless of how you use the loan proceeds. For more information, see IRS Publication 936.

Note: Qualified mortgage insurance payments paid in 2007 through 2011 can be deducted in the same manner as qualified mortgage interest, but only for mortgage insurance contracts issued on or after January 1, 2007 and before January 1, 2012. In addition, the deduction is phased out if your adjusted gross income exceeds $100,000 ($50,000 if married filing separate).
Tax treatment of real estate taxes

Along with mortgage interest, you can generally deduct the real estate taxes that you’ve paid on your property in the year that they’re paid to the taxing authority. Only the legal property owner can deduct the real estate taxes. In some cases, prepaid real estate taxes can be deducted in the year of the prepayment. Taxes placed in escrow but not yet paid to the taxing authority, however, generally aren’t deductible.
Tax treatment of home improvements and repairs

Home improvements and repairs are generally nondeductible. Improvements, though, can increase the tax basis of your home (which in turn can lower your tax bite when you sell your home). Improvements add value to your home, prolong its life, or adapt it to a new use. For example, the installation of a deck, a built-in swimming pool, or a second bathroom would be considered an improvement. In contrast, a repair simply keeps your home in good operating condition. Regular repairs and maintenance (e.g., repainting your house and fixing your gutters) are not considered improvements and are not included in the tax basis of your home. However, if repairs are performed as part of an extensive remodeling of your home, the entire job may be considered an improvement.

If you make certain improvements to your home that improve your home’s energy efficiency, you may be eligible for one or more federal income tax credits.
Deducting points and closing costs

Buying a home is confusing enough without wondering how to handle the settlement charges at tax time. When you take out a loan to buy a home, or when you refinance an existing loan on your home, you’ll probably be charged closing costs. These usually include points, as well as attorney’s fees, recording fees, title search fees, appraisal fees, and loan or document preparation and processing fees. You’ll need to know whether you can deduct these fees (in part or in full) on your federal income tax return, or whether they’re simply added to the cost basis of your home.

Before we get to that, let’s define one term. Points are costs that your lender charges when you take a loan secured by your home. One point equals 1 percent of the loan amount borrowed. As a home buyer, you can deduct points in the year that you buy your home if you itemize your deductions. However, you must meet certain requirements. You can even deduct points that the seller pays for you. More information about these requirements is available in IRS Publication 936.

Refinanced loans are treated differently. The points that you pay on a refinanced loan generally must be amortized over the life of the loan. In other words, you can deduct a certain portion of the points each year. There’s one exception: If part of the loan is used to make improvements to your principal residence, you can generally deduct that portion of the points in the year that the points are paid.

And what about other closing costs? Generally, you cannot deduct these costs on your tax return. Instead, you must adjust your tax basis (the cost, plus or minus certain factors) in your home. For example, if you’re buying a home, you’d increase your basis with certain closing costs. If you’re selling a home, you’d decrease your amount realized from the sale (i.e., your sale price). For more information, see IRS Publication 530.
Exclusion of capital gain when your house is sold

Now let’s see what happens when you sell your home. If you sell your principal residence at a loss, you generally can’t deduct the loss on your tax return. If you sell your principal residence at a gain, however, you may be able to exclude from taxation all or part of the capital gain.

Generally speaking, capital gain (or loss) on the sale of your principal residence equals the sale price minus your adjusted basis in the property. Your adjusted basis is the cost of the property (i.e., what you paid for it initially), plus amounts paid for capital improvements, less any depreciation and casualty losses claimed for tax purposes.

If you meet the requirements, you can exclude from federal income tax up to $250,000 ($500,000 if you’re married and file a joint return) of any capital gain that results from the sale of your principal residence, regardless of your age. In general, an individual, or either spouse in a married couple, can use this exclusion only once every two years. To qualify for the exclusion, you must have owned and used the home as your principal residence for a total of two out of the five years before the sale.

For example, you and your spouse bought your home in 1981 for $200,000. You’ve lived in it ever since and file joint federal income tax returns. You sold the house yesterday for $350,000. Your entire $150,000 gain ($350,000 – $200,000) is excludable. That means that you don’t have to report your home sale on your income tax return.

What if you fail to meet the two-out-of-five-years rule? Or what if you used the capital gain exclusion within the past two years with respect to a different principal residence? You may still be able to exclude part of your gain if your home sale was due to a change in place of employment, health reasons, or certain other unforeseen circumstances. In such a case, exclusion of the gain may be prorated.

Additionally, special rules may apply in the following cases:

  • If your principal residence contained a home office or was otherwise used partially for business purposes
  • If you sell vacant land adjacent to your principal residence
  • If your principal residence is owned by a trust
  • If you rented part of your principal residence to tenants
  • If you owned your principal residence jointly with an unmarried taxpayer

Note: Members of the uniformed services, foreign services, and intelligence community, as well as certain Peace Corps volunteers and employees may elect to suspend the running of the 2-out-of-5-year requirement during any period of qualified official extended duty up to a maximum of 10 years.

Consult a tax professional for details.

This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of John Jastremski, Jeremy Keating, Erik J Larsen, Frank Esposito, Patrick Ray, Robert Welsch, Michael Reese, Brent Wolf, Andy Starostecki and The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.

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John Jastremski is a Representative with FSC Securities and may be reached at


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