You've
been told that there are tax breaks for owning your own home, but you
might not be sure what they are.
While the cost of renting a home or apartment is
usually not deductible, homeowners can claim an itemized deduction for the
interest paid on up to $1 million worth of
mortgage debt
that is used for a primary residence. The same applies for home equity
debt interest on up to a $100,000 loan. Your real estate property taxes
are also deductible, too. You can usually deduct any point you pay or the
seller pays on your behalf to secure your mortgage.
That's the basics. But there are
catches t the tax laws that you may not have been warned about. They help
give you a realistic idea of how owning a home really affects your future
tax bills.
Standard-Deduction
Factors
Your actual deductions for interest
and real estate taxes may not be more than your standard deduction. Your
standard deduction is a free deduction given you by the IRS. You don't
have to have any other deductions or itemize to receive it. For 2005, the
standard deduction for joint returns is $10,000, $5,000 for single filers
and $7,300 for heads of households.
When your itemized deductions are
less than the standard deduction, you simply forget about the itemized and
claim the standard instead. Most people will find that their home
ownership deductions, with other itemized deductions, are usually enough
to exceed the standard deduction amount.
You need to know how much of a tax
break you need to receive from your home ownership. For example, you file
a joint return with your spouse with the standard deduction of $10,000.
You then buy a house and pay $12,000 a year for mortgage interest and
$2,500 in property taxes. You may just assume that you have lowered your
taxable income by $14,500. But that's not how it really works.
Assume you pay state income taxes of
$2,000 and contribute $450 to a qualified charity. Both of these items are
also itemized deductions. Now you have a total of $16,950. You have
itemized deductions of $6,950 over what you would have claimed by using a
standard deduction. Buying a home has given you $6,950 worth of additional
write-offs. You have to remember that you would have received the standard
deduction of $10,000 whether or not you purchased a home.
Now if you already itemizing before you buy a home,
your additional deductions from mortgage interest and taxes will reduce
your taxable income dollar for dollar. Make sure that
you consider the standard deduction factor when calculating how much
buying a home will give you in tax savings. That way, you don't get a
surprise come April.
High-income phase out
factor
If you have a high income, you may
not be affected by the standard deduction factor. You probably already
have enough itemized deductions through state and local taxes paid and
charitable contributions to exceed the standard deduction without a home
mortgage write off. But you will have to worry about the dreaded
deduction-phase out rule that affects those with high incomes.
Once your 2005 adjusted gross income
is higher than $145,950 (for both joint and single filers), the phase out
rule reduces your itemized deductions by 3% of the excess. For example,
you have an AGI of $300,000. Your itemized deductions will be reduced by
$4,662. This amount is found by subtracting $145,950 from your AGI of
$300,000. Then multiply the result by .03.
Not all itemized deductions will be
affected, but mortgage interest and real estate property taxes are. You
aren't able to lose more than 80% of your deductions, but that still
leaves a large loss. Many high income taxpayers are taken back to the
standard deduction under this law. When that happens, owning a home adds
no tax benefit at all.
If you expect to have an adjusted
gross income of over $145,950, you need to figure out your actual
home-ownership savings. Each year, the phase out amount is adjusted for
inflation.
Home equity loan
factor
If you already own a home, you may
want to take out a home-equity loan. You can usually claim an itemized
deduction for interest on a home equity loan up to $100,000. Pay attention
to that usually. You can't deduct the interest if the home equity loan and
the first mortgage together are more than the value of your home. For
example, your first mortgage is has a remaining principal of $150,000 and
you take out a home equity loan of $75,000. If your home is only worth
$200,000, you can only deduct interest on $50,000 of the home equity loan
principal. The remaining $25,000 is a nondeductible personal
expense.
There is another rule that you should be aware of
also. The rule disallows any alternative minimum tax deduction for home
equity loan interest unless the loan funds were used to improve the
property. If you take out $75,000 to pay off a car loan
and
credit cards, with a regular tax preparation, you are fine; you can deduct
the interest on your Schedule A. If you file using the alternative minimum
tax, you cannot deduct any of the interest.
If you use the $75,000 to build a
new patio and pool area onto your home, you are allowed to deduct the
interest for both regular tax and alternative minimum tax purposes. But
don't forget, the high income phase out discussed earlier can also affect
your home equity loan interest deduction.
You now know some of the tax laws
that you've never been told. Most of the time, buying a home works out to
be a good tax break. It will be much better if you sell for a big tax-free
gain in a few years. If you are married, you can make as much as $500,000
on the sale of your home, tax free.
