Title:
Homeowners
Rejoice: Tax Breaks Are Here....
Word Count:
1303
Summary:
Let's be honest:
April 15th is a day of reckoning, the moment when we find out what we really
owe for taxes. In households nationwide wallets are drained and many who were
rich on the 14th are greatly impoverished by the 16th.
Keywords:
Article Body:
Let's be honest:
April 15th is a day of reckoning, the moment when we find out what we really
owe for taxes. In households nationwide wallets are drained and many who were
rich on the 14th are greatly impoverished by the 16th.
But for those with real estate the load is made lighter by tax rules which
encourage the ownership of homes and investment property. Such rules are not
only good for homeowners, they're also good for the country: About 20 percent
of all economic activity nationwide is related to real estate, so policies
which encourage real estate activity help everyone.
It seems that almost every year changes to the tax code require the production
of new forms and a re-education process. That said, the real estate basics
remain in place and they're good news for buyers, sellers, borrowers and
owners.
Mortgage interest is generally deductible.
The IRS says there are three categories of deductible home mortgage interest:
Mortgages you took out on or before October 13, 1987 (called grandfathered
debt).
Mortgages you took out after October 13, 1987, to buy, build, or improve your
home (called home acquisition debt), but only if throughout 2005 these mortgages
plus any grandfathered debt totaled $1 million or less ($500,000 or less if
married filing separately).
Mortgages you took out after October 13, 1987, other than to buy, build, or
improve your home (called home equity debt), but only if throughout 2005 these
mortgages totaled $100,000 or less ($50,000 or less if married filing
separately) and totaled no more than the fair market value of your home reduced
by (1) and (2).
Substantial profits can be sheltered when a prime residence is sold.
When a prime residence is sold, up to $500,000 in profits can be sheltered from
federal taxes if married, $250,000 if single, providing the home has been used
as a prime residence for two of the past five years. Generally this deduction
cannot be used more than once every two years, according to the IRS.
There are also provisions which may be helpful to individuals who must sell a
prime residence in less than two years. Under the 2004 safe harbor rules,
individuals may be able to get some capital gains relief under certain
circumstances, such as being forced to move because a job has been relocated at
least 50 miles or a home that must be sold because of multiple births resulting
from the same pregnancy.
Also, individuals in the Armed Forces and the Foreign Service may be entitled
to special consideration under the Military Family Tax Relief Act of 2003
(MFTRA). For instance, you may have longer to take a capital gains deduction or
to amend a tax return. There are other provisions under MFTRA that also may be
helpful, so check with a tax professional for specifics.
Points may be deducible by both buyers and sellers.
Picture a situation where a home is sold for $500,000 and the owner -- to help
close the sale -- offers to pay 1 point for the buyer. If the property was
financed with a $350,000 mortgage, a point would be worth $3,500. According to
the IRS, "the seller cannot deduct these fees as interest. But they are a
selling expense that reduces the amount realized by the seller."
Interestingly, in this situation the buyer can also deduct the points when the
home is sold.
"The buyer," says the IRS, "reduces the basis of the home by the
amount of the seller-paid points and treats the points as if he or she had paid
them."
In effect, the seller gets to write-off the $3,500 cost by reducing any profit
from the sale. The buyer essentially lowers the purchase price of the property
when the home is sold at some point in the future -- thus increasing the size
of any profit. However, since up to $500,000 in sale profits may be untaxed,
most buyers will effectively never pay a tax on the seller's contribution for
points.
If a prime residence is refinanced then the deal with points is different: The
expense of a point must deducted over the life of the loan. If the home is sold
before the loan term ends, then any undeducted cost for points can be used to
reduce owner's profit from the sale.
Home offices may be deductible.
If a portion of your home is used regularly and exclusively as your principal
place of business or for the convenience of your employer it may be possible to
write off a portion of such costs as mortgage interest, property taxes and
utilities. There are a number of tests which must be met to take this
deduction, see IRS Publication 587, Business Use of Your Home for details.
In some cases there may be tax advantages associated with not deducting your
home office in the year or two before you move. Speak with a tax professional
for specifics.
Natural Disasters
The Katrina Emergency Tax Relief Act of 2005 provides extensive tax benefits
and assistance to those who were victims of hurricanes Katrina, Rita and Wilma.
For details, go to the IRS Katrina relief page or call 1-866-562-5227.
If you have been in a natural disaster -- a flood, hurricane, tornado, etc.,
contact your local congressional office to see if special tax help is
available. Links to congressional offices can be found by pressing here.
Investment real estate can generate substantial write-offs.
If you own rental property you must seek a fair market rental for your
property. You may generally deduct mortgage interest, property taxes, repair
costs, management by an outside party, depreciation, advertising, insurance,
utilities, legal services and other expenses.
It's possible with rental properties to have both a positive cashflow and a
loss for tax purposes. However, the ability to use real estate losses to reduce
overall taxes may be phased out as income rises above $100,000.
If a rental involves relatives special rules and restrictions may apply. Check
with a tax pro for details.
A 1031 exchange may allow investors to defer all capital gains taxes.
With a 1031 transaction, investment property is exchanged for "like"
real estate. The basic requirements are that within 45 days after the
"relinquished" property has been sold, a "replacement"
property must be identified. The identified replacement property must then be
acquired within 180 days after the sale of the relinquished property.
What's important about a 1031 exchange is that the capital gains tax on the
relinquished property is deferred -- but it does not disappear. What really
happens is that the basis for the new property (the "replacement
property") is reduced by the adjusted value of the "relinquished property"
(the old property).
A 1031 exchange is complex and requires the services of a "qualified
intermediary." Among other tasks, a qualified intermediary holds the money
from the sale of the relinquished property and applies it to the purchase of
the replacement real estate. This must be done because under the rules for 1031
exchanges, the seller of a relinquished property cannot touch money from the
sale -- it must be held by the qualified intermediary.
Accounting for a 1031 exchange is also complex. Essentially there is a need to
figure out the sale value of the relinquished property, add back depreciation
and account for financing. Ed Horan, a well-known exchange authority and the
author of How To Do a Like Kind Exchange of Real Estate, has posted a free
13-page exchanging guide with an accounting worksheet that's well worth
reviewing before meeting with a tax pro.
Sources and Publications
As always with taxes, nothing is ever simple or easy. Speak with a qualified
tax professional for specific advice -- an enrolled agent, a CPA or an attorney
who specializes in tax issues.
Also, the IRS itself has excellent information at its website, www.irs.gov, by
phone at 1-800-829-1040 and with specialized publications such as those below:
Publication 523, Selling Your Home
Publication 527, Residential Rental Property
Publication 530, Tax Information for First-Time Homeowners
Publication 535, Business Expenses
Publication 587, Business Use of Your Home
Publication 936, Home Mortgage Interest Deduction
Publication 946, How To Depreciate Property