Many taxpayers have misconceptions about what expenses of owning a home or a second home are deductible for tax purposes. To make the issue more complicated, the deductible items may be currently deductible or deductible at the time the property is sold. In addition, your deductions must generally be itemized to gain any benefit from currently deductible items.
• Purchase Escrow Costs – Generally, escrow fees, title fees and real estate agent commissions paid by the buyer are not currently deductible, but do add to the cost basis of the home, and are used to reduce the gain when the home is ultimately sold. Therefore, it is important that a copy of the purchase escrow closing statement is retained. There are, however, certain items (such as points, prorated interest and taxes) included in the escrow statement that may be currently deductible. In the year of the home’s purchase, it is always best to provide us with a copy of the closing escrow, so we can review it and pick up any currently deductible items that are included in that document.
• Taxes – Unlike the deduction for mortgage interest, which is allowed only for a taxpayers’ primary and second homes, real property taxes paid for any number of homes, as well as vacant land, can generally be deducted. However, depending upon where the taxpayer resides, there may be some service fees included in the property tax bill that are not deductible. For purposes of the alternative minimum tax (AMT), taxes are not deductible at all. Thus, to the extent the taxpayer is subject to the AMT, he or she will not benefit from the property tax deductions.
• Points – Generally, points paid on a loan to acquire or substantially improve a principal residence is a currently deductible expense. Points for another purpose must be amortized over the life of the loan. Where the loan is mixed acquisition debt and other debt, the points are prorated by debt type.
• Interest – Interest paid on debt to acquire a home and a second home is fully deductible for both the regular tax and AMT, so long as the combined acquisition debt does not exceed $1 million. In addition, interest on another $100,000 of equity debt is also deductible for regular tax purposes, but not the AMT. Refinanced debt can also be acquisition debt to the extent it replaces existing acquisition debt or is used for substantial home improvements.
• Mortgage Insurance Premiums – Certain amounts paid or accrued for mortgage insurance premiums can be deducted as home mortgage interest, through tax year 2016. This applies only for insurance contracts issued after 2007.
• Home Improvements – Are not currently deductible, but do add to the basis of the home. Keep a record of the improvements, since they can be used to offset any gain that cannot be excluded when the home is subsequently sold. Improvements are generally items that increase the value of the home and are not repairs or maintenance to keep the home in its original condition. There is one exception for impairment-related improvements, which may be deductible as a medical expense. If a tax benefit was derived from the improvement, such as a credit for installation of certain energy-improvement property, the value of the tax benefit is a reduction of basis.
• Home Repairs – Home repairs and maintenance (not improvements) are work that is done to keep the home in its original condition. Examples: A new home is purchased. 20 years later, the exterior is painted and the roof is replaced. The painting is considered maintenance for normal wear and tear and is not deductible either currently or as an adjustment to basis, but the new roof is treated as an improvement and its cost is an increase to the home’s basis. If the roof had leaked in one section and only the defective portion was replaced, then the repair cost would be treated as a nondeductible maintenance expense that also is not an addition to basis. As with all tax matters, there are exceptions; please give us a call if your repair might qualify as a special circumstance.
• Sales Escrow Costs – Costs to sell a home are generally not currently deductible, but do add to the cost basis of the home, and are used to reduce the gain from the home sale. As with the purchase escrow, there are certain items (such as prepaid interest, deferred interest, prorated interest and taxes) included in the escrow statement that may be currently deductible. In the year of the home’s sale, it is always best to provide us with a copy of the closing escrow document. We can review it with a trained eye and pick up any currently deductible items that are included in that document.
If you are planning to buy or sell a home, it is generally wise to call this office before completing the transaction. We can review the sale, determine how the title should be held, and discuss your financing arrangements to help you avoid any surprises at tax time.