Home Buying, Home Selling … and Your Taxes
The tax part doesn’t have to be overwhelming – help is available.
Buying a home is one of the biggest expenses in an individual’s life – so making sure you know the tax implications is crucial! This article outlines the allowable deductions associated with securing and paying a home mortgage – including but not limited to the home mortgage interest deduction, allowable points, mortgage insurance premiums, the steps involved in refinancing, and, finally, the tax effects in the event of a sale of your property.
Home mortgage interest deduction
Ordinarily, any mortgage interest paid on a secured loan for a qualified (primary and secondary) residence is considered an allowable itemized deduction – subject to limitation. Any mortgage signed after December 16, 2018, that exceeds $750,000 is subject to a mortgage interest limitation, essentially disallowing a portion of the deduction. However, the limitation does not affect an individual whose mortgage predates December 16, 2018. Please note that the allowable indebtedness amount is a total amount, not a limit per property.
Additionally, under the 2017 federal Tax Cuts and Jobs Act, or TCJA, interest paid on a home equity loan may be considered a qualified deduction when the home equity loan proceeds are used to make qualified improvements on the home; all other uses would be considered personal interest and not deductible. For example, using an equity line to pay for a remodel on your home would qualify as deductible mortgage interest, subject to the interest deduction limits, but using an equity line to buy a new pickup truck would not be deductible.
Points are another allowable deduction associated with home mortgages. “Points” refer to the fees paid directly to the lender at closing in exchange for a reduced interest rate on your loan. Generally, points paid at closing for the purchase of said home are fully deductible in the year of purchase. Points paid on home improvement loans are also fully deductible in the year paid. Electing to amortize points over the life of the loan is allowed, and for certain tax situations this may be advantageous. Remember to give your tax preparer a copy of your closing statement, so they can look for points and other possible deductions.
Mortgage insurance premiums
Mortgage insurance premiums are a form of insurance required of homeowners who pay less than 20% of the home’s value as a down payment. These insurance premiums are treated the same as the home mortgage interest deduction, as an allowable itemized deduction subject to the same limitations. This amount, if applicable, is included on the year-end statement, Form 1098-Mortgage.
Unique Tax Scenarios:
The IRS has outlined several items that can be treated as a home mortgage, subject to limitation. These include:
- Late payment penalties charged on mortgage payment(s)
- Penalties associated with the prepayment of a mortgage
- Interest up to the date before sale of residence
- A home in the process of construction
- A home destroyed by a natural disaster
- Second home that is rented out (special rules)
- Clergy and military members who receive a housing allowance
Refinancing Your Home Mortgage:
Mortgage interest on a refinanced home is still considered a deductible expense. However, it may be less advantageous to individuals who were grandfathered into the old rules and whose acquisition indebtedness is over $750,000 because once you refinance, the mortgage interest is now subject to the $750,000 limitations. A mortgage refinanced at a lower rate, however, may prove to be better for cash flow and can save an abundance in interest over the life of the loan.
Refinancing points are recognized over the life of the loan. But there are exceptions. When a portion of the proceeds from the refinanced mortgage is used to make qualifying improvements on the home, the points incurred may be fully deducted in the year paid. Finally, in the instance of prepayment of mortgage any unrecognized amount of the points can be taken in full in the final payment year.
Sale of Property:
Another important consideration a taxpayer must contemplate is if and when the primary residence is sold. The tax code allows individuals to exclude the gain on the sale of property up to $250,000 / $500,000 (depending on your filing status) if you meet the ownership and residency eligibility. These requirements state the taxpayer must own and live in the home for at least 24 months out of the last five years. Most individuals will fall into that criterion but there are special circumstances that could disqualify you from this exclusion, so unique situations should be brought to the attention of your accountant.
No matter if it’s your first home or your retirement home, buying a house is an exciting event but one that can also feel overwhelming. Many questions about making this purchase / sale may arise as you navigate through the process and the JCCS tax professionals are here to ease the uncertainty and work with you to answer any questions you may have. Understanding these tax implications is key to achieving your financial goals and planning for your future!
* This article is not a complete listing of all the details related to this tax topic and you should contact your CPA for a more detailed discussion regarding these items and how they may apply to your specific situation.
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