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Buying Your First House
By Dr. John L. Stancil
Tax Analyst, WebTaxCenter.com
At long last, you are about to realize the American Dream - owning your own home! Of course, you'll have to share it with the bank, but at least you will no longer be sending dollars down the rent-payment drain. With home ownership comes a number of changes - some good, some burdensome. Yes, you are now responsible for repairs to your home. And mowing the grass is not always fun, but it is good exercise. Now you can decorate the house as you desire and not worry about the landlord. And that back yard patio you have always wanted - nobody to stop you now!
One big change will be in your tax situation, for home ownership carries a number of benefits at tax time. These changes can be confusing and may even be overlooked. Exactly what is deductible on taxes when you own a home? What happens when you sell it? This article will take you through a few of the most common questions about home ownership.
Penalty-free IRA Withdrawal
Uncle Sam wants to help you get a house, so the law allows you to withdraw from your IRA without penalty to help you buy your first house. A first-time home buyer is permitted to withdraw up to $10,000 from a traditional IRA account to help pay for expenses associated with buying a home. This home may be for you, your spouse, child, or grandchild. The amount withdrawn is subject to regular income taxes, but the 10% penalty for early withdrawal does not apply. Also, the $10,000 is a lifetime maximum.
The definition of a first-time homebuyer is rather liberal, however. A person is a first-time homebuyer is they have had no ownership interest in a principal residence during the two-year period immediately prior to the date of purchase.
Deductions, Deductions
Generally, there are two home ownership items you can deduct on your taxes - mortgage interest and real estate taxes. Although this sounds simple, it can get complicated in practice. There are limits on the amount of interest you can deduct based on the amount of your mortgage debt. These are itemized deductions, shown on Schedule A of your 1040.
Normally, the premiums for private mortgage insurance are not deductible. However, the "Tax Relief and Health Care Act of 2006" (signed by the President on December 20) provides that certain premiums on PMI or other mortgage insurance will be deductible. In order to qualify for this deduction, the insurance contract must be issued in 2007 and the taxpayer's adjusted gross income must be less than $110,000.
There are a number of items that are not deductible. You cannot deduct the cost of repairs, utilities, depreciation, or most settlement costs paid at closing.
Mortgage Interest
Mortgage interest is deductible in the year it is paid. The lending institution will send you a Form 1098 indicating the amount paid during the year. If your mortgage is from an individual, you should show that person's name, address, and social security number on your return along with the amount of interest you paid.
There are three requirements for deducting this interest. First, loan must be secured by a recorded lien on the residence. Second, you must be legally liable for the debt. Finally, the mortgage payments must be paid with your funds. Late payment charges may be deducted as interest. You may also deduct any interest that you pay at closing.
If your mortgage exceeds $1,000,000 you may be limited in the amount of interest that you can deduct. Mortgage interest and points are deductible on Schedule A as an itemized deduction.
Points
Points are usually paid as a percentage of the amount of the mortgage at closing. With the purchase of a home, you may be able to deduct the points paid in the year you purchase the house. If the points are paid as part of a refinanced loan, they must be deducted annually over the life of the loan.
The seller cannot deduct points paid at closing, but may use that amount to reduce the gain on the sale of the property. Buyers are allowed to treat seller-paid points as if they had paid them.
Amounts charged for services such as appraisals, notary fees, mortgage insurance premiums and preparation costs for the mortgage note and deed of trust are not interest and may not be deducted. These items, however, will increase your basis in the house.
Mortgage Interest Credit
The mortgage interest credit is available to assist lower-income taxpayers acquire a home. It allows you a credit for part of the home mortgage interest you pay each year. A credit is preferable to a deduction because a $1 credit reduces your taxes by $1, where a $1 deduction only reduces your taxes by as little as ten cents.
If you qualify, you will receive a Mortgage Credit Certificate (MCC) from your state or local government. This document will show the certificate rate you will use to calculate your credit. The amount of the credit is determined by completing Form 8396.
This program is operated by state and local governments. You should contact the appropriate governmental agency in your locale before you get a mortgage and buy your home.
When You Sell
When you sell your house, you may be eligible to exclude up to $250,000 ($500,000 married filing jointly) of gain on the sale of the house. You qualify for this exclusion if you have owned the house for 24 of the past 60 months and lived in it as your main home for 24 of the past 60 months. Your gain is determined by subtracting your basis in the house from the proceeds of the sale.
Your original basis in the house is the initial cost of the house. If you inherited it, your basis is the fair market value as of the date of death. If it was a gift, your basis is the same basis the donor had in the house.
Basis is increased for capital improvements to the house. Capital improvements include items such as an addition to the house, replacing the roof, paving the driveway, or installing central air conditioning. In addition, basis in increased by assessments for local improvements such as sidewalks or sewers. Amounts spent to restore damaged property also increase basis.
Basis is decreased by insurance or other reimbursements for damage to your house, deductible casualty losses, or payments received for right-of-way access. If you use the house for business or rental purposes, depreciation will reduce your basis.
You should not undertake a large financial transaction without a full understanding of the consequences. Additional tax information can be obtained at www.webtaxcenter.com, www.irs.gov, or from your local tax professional.
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Dr. John L. Stancil, a tax analyst for WebTaxCenter.com, has been a member of the Florida Southern College faculty since 1998. He received his bachelors degree from Mars Hill College and holds a M.B.A. from the University of Georgia. He later earned his doctorate in accounting from the University of Memphis. He holds four professional certifications, including CPA, CMA, CFM and CIA. Stancil has received the Florida Institute of CPAs 2005 Outstanding CPA in Public Service Award. (This award is given annually to a Florida CPA who has demonstrated significant contributions through community and civic activities.) He has also been recognized as the Expert of the Month on several occasions by allexperts.com.
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