TAXES AND YOU
THE LEAST YOU NEED TO KNOW
Montana 1 of 5 states without sales tax
HELENA – Montana is one of five states without a general statewide sales tax, but it imposes individual income taxes on most Montanans and property taxes on homeowners. Some nearby states such as Wyoming and Washington have no state income tax but impose a sales tax. Oregon’s system mirrors Montana’s with income and property taxes but no sales taxes.
Montana also has a number of selective sales or excise taxes on products such as cigarettes, alcoholic beverages, gasoline and hotel and motel rooms. Here, using reference documents from the Montana Legislative Fiscal Division and the Department of Revenue, is a look at the main taxes paid by most individual Montanans.
Individual income taxes. Montanans pay at rates ranging from 2 to 11 percent of their Montana taxable income. The higher their income, the higher the tax rate. Taxable income is calculated by taking total income, minus adjustments, plus various additions and subtractions, to yield Montana adjusted gross income. This adjusted gross income is reduced by personal exemptions and either itemized deductions or the standard deduction to come up with the final Montana taxable income figure.
Montana is one of four states that allow individual taxpayers to fully deduct their federal income taxes from their adjusted income as they compute their taxes. This tax is projected to raise $556.8 million in fiscal 2004 and $594.3 million in fiscal 2005 for the state general fund. Individual income taxes make up 45.4 percent of Montana’s projected general fund revenue pie.
- Property taxes on homes. For this example provided by the Revenue Department, let’s take a home with a market value of $100,000. A 31 percent homestead exemption is applied to reduce the net assessed value to $69,000 in tax year 2002. The $69,000 is multiplied times the tax rate of 3.46 percent, which yields a taxable value of $2,387. The $2,387 is multiplied times the local and mill levy, which is measured in mills. In this example, let’s assume it’s a total of 400 mills, which would provide for property taxes of $955 for tax year 2002. (Multiply $2,387 by .400.)
- Some of the property-tax levy goes to local governments and school districts, while other parts go to the state. Cities, counties, school districts and other districts, such as fire districts, issue property-tax levies. Counties are required to levy a county equalization levy of 55 mills against all taxable value of property. In addition, state law requires counties to levy a 40-mill state equalization levy against all taxable value in the state. In addition, Montana has a statewide 6-mill levy that helps fund the Montana University System.
- These levies are applied against all classifications of property, including agricultural and forest lands, business equipment and other categories. The calculations of these taxes vary by classification.
- In tax year 2000, state and local governments and school districts collected $795 million in property taxes from all classifications of property. Of that total, $305.6 million came from residential property, $125.7 million from commercial land and the balance from other sources.
- In addition, individual Montanans pay a variety of excise taxes.
Here’s a look at a few of them:
- Lodging or bed tax. Montana imposes a 4 percent bed tax on the cost of hotel and motel rooms. This tax is expected to bring in $13 million in fiscal 2004 and $13.6 million in fiscal 2005.
- Cigarette taxes. Montana charges a tax of 18 cents per pack of 20 cigarettes, with wholesalers paying a $50 license fee and each retailer paying a $5 license fee. This tax is expected to raise $10.8 million in fiscal 2004 and $10.7 million in 2005.
- Gasoline tax. Montana charges a tax of 27 cents a gallon of gasoline that is expected to yield $133.2 million in fiscal 2004 and $133.9 in fiscal 2005. In all, 98.4 percent of this revenue goes for highway purposes, primarily construction and administrative costs.
Montana also charges a corporate income tax of 6.75 percent times the Montana adjusted corporate taxable income. That tax will raise an estimated $65.8 million in 2004 and $71.4 million in 2005. The state also has a variety of natural resource taxes, including the coal-severance tax, electrical-energy tax, federal forest receipts, metalliferous-mines tax, oil- and natural-gas production tax, resource-indemnity tax, U.S.mineral royalty and wholesale energy tax.
A 1031 Exchange can be a valuable tool in your Real Estate Transaction.
Information and resources on 1031 Exchanges.
Anyone involved with advising or counseling real estate investors should know about tax-deferred exchanges, including Realtors, lawyers, accountants, financial planners, tax advisors, escrow and closing agents, and lenders. Taxpayers should never have to pay income taxes on the sale of property if they intend to reinvest the proceeds in similar or like-kind property.
The Advantage of a 1031 Exchange is the ability of a taxpayer to sell income, investment or business property and replace with like-kind replacement property without having to pay federal income taxes on the transaction. A sale of property and subsequent purchase of a replacement property doesn’t work, there must be an Exchange. Section 1031 of the Internal Revenue Code is the basis for tax-deferred exchanges. The IRS issued “safe-harbor” Regulations in 1991 which established approved procedures for exchanges under Code Section 1031. Prior to the issuance of these Regulations, exchanges were subject to challenge under examination on a variety of issues. With the issuance of the 1991 Regulations, tax-deferred exchanges became easier, affordable and safer than ever before.
The Disadvantages of a Section 1031 Exchange include a reduced basis for depreciation in the replacement property. The tax basis of replacement property is essentially the purchase price of the replacement property minus the gain which was deferred on the sale of the relinquished property as a result of the exchange. The replacement property thus includes a deferred gain that will be taxed in the future if the taxpayer cashes out of his investment.
Exchange Techniques. There is more than one way to structure a tax-deferred exchange” under Section 1031 of the Internal Revenue Code. However, the 1991 “safe-harbor” Regulations established procedures which include the use of an Intermediary, direct deeding, the use of qualified escrow accounts for temporary holding of “exchange funds” and other procedures which now have the official blessing of the IRS. Therefore, it is desirable to structure exchanges so that they can be in harmony with the 1991 Regulations. As a result, exchanges commonly employ the services of an Intermediary with direct deeding.
Exchanges can also occur without the services of an Intermediary when parties to an exchange are willing to exchange deeds or if they are willing to enter into an Exchange Agreement with each other. However, two-party exchanges are rare since in the typical Section 1031 transaction, the seller of the replacement property is not the buyer of the taxpayer’s relinquished property.
Montana 1031 Tax Change Information
M E M O R A N D U M
DATE: January 12, 2006
TO: Glenn Oppel, Government Affairs Director
Montana Association of REALTORS
FROM: Mike Green, Attorney at Law
RE: Impact of Department of Revenue´s Proposed Amendment to Montana Source Income
MAR, in conjunction with the Montana Taxpayers Association, hired me to analyze and attempt to
defeat the Montana Department of Revenue´s (Department) proposal to amend the definition of Montana Source Income. We believe the Department´s proposal will expand Montana´s authority to tax nonresidents and is an amendment that should be considered, if at all, by the Legislature, rather than the Department. However, the Director of the Department has informed us that confusion exists over the impacts of the proposed amendment. This memo is intended to correct misunderstandings that have developed over the treatment of tax deferred exchanges (i.e. Section 1031 like-kind exchanges) under the Department´s proposal. In summary, we believe the Department´s proposal expands Montana´s taxation of gains from out-of-state sales, but does not change the timing of when taxes will be due in the context of like-kind exchanges.
Although MAR disagrees with the Department about its interpretation of the Montana Source Income statute, we are working through the administrative rules process to resolve this disagreement. In the meantime, however, it is important for MAR members to understand that the Department´s interpretation may be upheld, either by adoption of the rule or subsequent legal or legislative action.
Therefore, members should advise their clients appropriately.
WHAT THE PROPOSED RULE DOES NOT DO
This proposal does not change Montana´s recognition of the right to defer tax through a like-kind exchange and does not change the time of recognition of gain for tax purposes. Stated more simply, the
Department´s proposal does not change the timing of when tax comes due, if at all, on the sale and exchange of property. It does not allow Montana to impose a tax on like-kind exchanges entitled to deferral under the federal section 1031. In its current form, it does not require exchangers to pay tax when they exchange from Montana property to out-of-state property. As a result, parties involved in like-kind exchanges should not see any immediate tax impact from the Department´s proposal, but will likely have increased recordkeeping requirements.
The impact of the Department´s proposal will be felt when property acquired in a like-kind exchange is sold in a cash-out sale. Such a sale has always been, and continues to be, a taxable event, and triggers tax at both the state and federal level. The changes under the proposed rule is that some portion of the gains from the sale of out-of-state sales by nonresidents may now be taxable by Montana if the property was acquired in a like-kind exchange involving Montana property. Until now, the Department has not taxed such gains by nonresidents. While this is a substantial expansion of Montana´s taxing authority, it does not destroy the timing and deferral benefits that may be achieved through like-kind exchanges.
Your members should contact you at the MAR state office or me if they have further questions regarding the Department´s proposed amendment. As always, taxpayers must contact their own tax professional to determine their personal tax implications from the Department´s proposal.
Dan Bucks Brian Schweitzer
Customer Service (406) 444-6900 ?? TDD (406) 444-2830 ?? www.mt.gov/revenue
Montana Department of Revenue
State Tax Treatment of Gains from Sale of Property in 1031 Exchanges
The Department of Revenue is providing this information because we have received inquiries from persons that reflected inaccurate tax information provided to them by Montana realtors. Specifically, persons selling property in the “first leg” of a 1031 exchange were incorrectly advised that they would be required to pay state taxes on the gain on the sale in the current year and without the benefit of the tax deferral available under Section 1031. That information is wrong. We want Montana realtors to be fully informed as they talk to clients about complex issues such as 1031 exchanges. Misinformation serves no good purpose. For those reasons, we submit the following information:
Montana law provides that both residents and non-residents can defer taxation of the gain on the sale of property if the property is replaced by other qualified property in a properly executed 1031 exchange. A state tax is due in Montana on the gain on the property only when and if the owner of the replacement property ends the deferral. Montana´s practice of recognizing and following federal law applies to both residents and non-residents. It is commonly and correctly understood that Montana residents pay a tax on any gains at the time their federal 1031 tax deferral ends. There is, however, widespread misunderstanding concerning how Montana law treats out-of-state residents who engage in 1031 exchanges, including exchanges of Montana property for out-of-state property.
Simply put, out-of-state residents who engage in 1031 exchanges with Montana property are treated in the same manner as Montana residents. Montana law does not exempt non-residents from Montana income taxes on their gains realized on Montana property once the out-of-state person ends their federal deferral. To the contrary, Montana law clearly and explicitly provides that non-residents must include the “gain attributable to the sale or other transfer of tangible property located in this state” in their Montana source income [15-30-101(18)(a)(ii),MCA]. However, they, along with
Montana residents, do not report this gain and pay the tax until their federal tax deferral expires. Further, they are not subject to Montana tax on gains attributable to non-Montana property. Montana law ensures that non-residents are taxed equally as compared to residents on the gains on the sale of Montana property.
State Tax Treatment of Gains from Sale of Property in 1031 Exchanges
In summary, Montana law recognizes and follows federal law in deferring the state tax on gains involved in a valid 1031 exchange until the federal deferral expires. Montana neither taxes the gain on a current basis when the exchange first occurs, nor does it exempt nonresidents from a tax on the Montana gain once their federal deferral expires. So Montana´s
tax treatment of 1031 exchanges is simple to understand:
• Yes, there is a deferral of the state tax like the deferral of the federal tax.
• No, there is no current taxation of the gains at the time a valid 1031 exchange
• No, there is no preferential exemption for non-residents as compared to residents on their Montana gains once the deferral ends. Non-residents will pay a tax equal to the tax paid by residents in the same situation [15-30-105(1)(a),MCA].
The department is in the process of adopting a rule amendment that follows the
interpretation of Montana law explained above.
Protect Your Profit from Capital Gains Taxation
Tax-free profit on the sale of your principal residence is alluring, but it can be elusive. Under the federal Income Tax Act, property owners are entitled to tax-free profit on the sale of their principal residence, provided they follow the Canada Revenue Agency (CRA) guidelines. Capital gain is the net difference between the cost of a property and the sale price.
Many Canadians take the tax-free status of their home for granted. To protect your principal residence exemption from capital gains taxation, seek professional advice before you act. For instance, if you made a profit on the sale of your cottage, but did not report it on your tax return, the CRA may consider the cottage as your designated principal residence and disallow tax-free status for your home. You can also lose the exemption if you move frequently since that may be considered a business activity which does not qualify.
“Capital gains are the second least taxed type of income after the principal residence tax-free exemption,” said Louis J. Sapi, CA, MBA, a founding partner of Toronto-based Hinchcliffe Sapi LLP, who agreed to participate in a Q & A session, drawn from reader queries and common concerns. Sapi stressed that the information provided in his answers does not replace professional advice and is not intended to provide a professional opinion or advice for a specific tax issue. Contact professional tax and legal advisors to assess your particular situation and needs.
Question: I lived in my home for 10 years then rented it out for 3 years while renting another place. What would the tax consequences be if I now decide to sell my home?
Answer: If you move from your home, rent it out and then decide to sell after several years, tax rules permit you to designate your home as a principal residence for four years after a change of use. Write the Minister of Revenue a letter to “elect” to designate your home as a principal residence at change of use. You must not claim any capital cost allowance or depreciation on the home while it is rented during the election period. The same rule would apply if you bought another home.
In that case, during the first four years, the new home would not be designated a “principal residence” if you elected your former residence (rental) property as your principal residence for those same years. You and your significant other (including common law or same sex partner) cannot own two principal residences at the same time for tax purposes. You must choose one during the over-lapping period after 1981. Professional advice will help you optimize tax benefits.
Question: I used part of my home as an office and part as a principal residence. Will this impact on my claim for tax-free status if I sell my home?
Answer: If you also use your home as a place of business and claim capital cost allowance, you would need to assess that portion of the home used for business and prorate the capital gain between the tax free principal residence portion and the business portion. The business portion would be taxed at the current capital gains inclusion of 50 percent of the gain taxed at your marginal tax rate. If you use one room in your home as an office or nominal use of your home and do not claim capital cost allowance, you may be able to avoid any capital gains tax on the sale of the home. The particulars of your case would need to be assessed by your tax advisor to ensure that you could avoid capital gains tax on the sale of this home.
Question: I have a family cottage that I inherited while I owned a principal residence. The cottage has sky-rocketed in value since I got it and now I want to sell. Do I need to pay tax on this property and, if so, how much?
Answer: The cottage property was inherited at its fair market value at the time of title registration in your name. If you renovated the cottage, additional costs would be added to the fair market value at inheritance. The cottage value and costs of renovation would be the tax cost of the cottage for purposes of capital gains tax. In certain circumstances, you may also add property taxes paid for the cottage. The proceeds you receive are reduced by the legal fees/disbursements and sales commission to the real estate agent, if any, and the tax cost of the property. Fifty percent of the capital gain is included in your income and taxed at your marginal tax rate. Contact a tax advisor to evaluate the net after-tax result before you sell.
Question: What if I move back into the cottage? How long would I need to wait before I could sell it as my principal residence tax free?
Answer: It does not matter if you move back in. The tax rule requires you to allocate the number of years that you held the cottage as your principal residence. Remember that only one principal residence can be owned after 1981. If you own two residences during the same or part of the time, you will need to prorate the capital gain on the sales of each residence to the extent the residence sold was designated your ‘tax free’ principal residence. The necessary calculations are best carried out by those well versed in the tax rules.
Question: I want to buy properties, rent them out and have the tenants pay the mortgage and expenses while I write-off net rental losses against my other income. Is there any tax problem with this plan?
Answer: The properties need to be available for rent during the tax period. The tenants should be paying rents at prevailing market rates. Your children or relative tenants renting at discounted rates would increase net loss and raise a flag with tax authorities. You must add the costs of renovation to the value of the building during the period the rental unit is not available for rent. The value of land, if any, is separated from the building value that is subject to capital cost allowance. You may reduce rental profit by the capital cost allowance for that particular rental property. You may not increase a rental loss by capital cost allowance. Mortgage interest, not mortgage principal, would be tax deductible expense. Net rental losses would be deducted against other income.
Question: I want to give my home to my son and his wife. What are the tax issues?
Answer: If you give your home to your child, there would be a deemed disposition and capital gains tax would accrue only to the extent that the property was not your principal residence. This is determined by counting the years you claim the gifted property as your principal residence plus 1 year, then divide this number by the total number of years you owned a principal residence. The prorated gain, if any, would be included in your taxable income at the current inclusion rate of 50 per cent and taxed at your marginal tax rate.
Complications could include the following:
- Issues that may arise under family law that could result in the donated residence being attached by your former daughter or son in-law upon dissolution of your child’s marriage.
- If your child is spend-thrift or possibly insolvent and subject to creditors, they may attach liens on the property that you donated.
- Transferring the property to a family trust may prove wise. Your tax and legal adviser and an estate planner can help you to decide on the best way to gift property to your children or to provide financial support to relatives and avoid unexpected disappointment.
Yes, capital gains issues are complex, but the right professional advisor will help you find the best tax strategy to achieve your real estate and related goals, short- and long-term. Ask a lot of questions before you act.
Housing Counsel: Income Tax 101
On November 1, 2005, the President’s Advisory Panel on Federal Tax Reform issued its final report. The Panel proposed a number of tax reforms, many of which can directly impact on real estate investors and homeowners alike.
The most significant recommendation was that the deduction for mortgage interest be replaced with a Home Credit which would be available to all homeowners. This Home Credit would be equal to 15 percent of the mortgage interest paid by a taxpayer on a loan which was secured by the taxpayer’s principal residence, and used to acquire, construct, or substantially improve that residence. The Panel also recommended that the deduction for mortgage interest on second homes and on home-equity loans be eliminated.
According to the Panel’s final report:
The Home Credit would encourage home ownership, not big homes. More Americans would be able to take advantage of tax benefits for owning a home, while the current subsidy for luxury and vacation homes would be curtailed. In addition, the Home Credit would reduce the incentive to take on more debt by eliminating the deduction for interest on home equity loans.
Recognizing that such limitations could adversely affect individuals who purchased or refinanced homes on the assumption that they would be able to deduct interest on up to $1.1 million of mortgage debt (which is current law), the Panel further suggested that there be a gradual phase-in of the cap over a five-year period for pre-existing home mortgages.
Will any of the Panel’s recommended reforms be enacted by Congress this year? Perhaps some will become law, but the great majority of the proposals will be stalled by lobbyists, the Congressional elections coming up in November, and other priorities such as aiding Katrina victims, Iraq and of course the legal and political battles in which the White House is currently fighting.
Reverse 1031 Exchange
What is certain, however, is that tax time is once again here. This year, April 15th falls on a Saturday, and thus all income tax returns must be postmarked by midnight, Monday, April 17. However, the Internal Revenue Service has given taxpayers a new break this year. Instead of the four month automatic extension, you can now opt for a six month automatic extension by filing application form 4868.
According to an IRS press release:
The new regulations provide streamlined and simplified procedures that are expected to save taxpayers between $73 million and $94 million, annually, by eliminating or consolidating several existing IRS forms. As a result, beginning Jan. 1, 2006, most individuals and businesses will be able to request a full six- month tax-filing extension, without a reason or even a signature.
The new procedures will replace the existing two-step process under which noncorporate taxpayers could only get a six-month extension by first obtaining an extension, usually automatic, for part of that period and then requesting a discretionary extension for the remainder. A tax-filing extension does not extend the tax-payment deadline.
The last sentence is extremely important. It must be understood that even if you get an extension to file your tax return until October 15, you must still pay the tax you owe by the original due date — April 17th.
There are a number of tax advantages available for most American homeowners, but you have to understand them and report them properly to the IRS.
Our tax laws are complex. According to the President’s Panel, “We have lost sight of the fact that the fundamental purpose of our tax system is to raise revenues to fund government.” In l913, the Sixteenth Amendment to our Constitution was ratified, which ended all debate as to whether an income tax was constitutional. A few months after the amendment was ratified, Congress enacted an income tax.
Over the years, the tax code has been used by Congress to favor certain constituencies, and the code is replete with exemptions, exclusions and other benefits for individuals and corporations.
This series of articles is designed to assist the homeowner in understanding the real estate tax laws — both residential and investment — so that you can take advantage of every tax benefit that is available. Keep in mind that if you are in a 31 percent Federal tax bracket, for example, for every additional dollar you can legally deduct, you will be saving 31 cents that does not have to go to Uncle Sam.
There are a number of real estate definitions and concepts which must be understood:
- “basis” — this is the initial cost of the property, plus any improvements you have made over the years.
- “gross profit” — the difference between what you originally paid for your house and the sales price.
- “net profit” — you have to subtract any improvements you have made to the property, and also any real estate commissions paid when you sold the property. The bottom line net profit is also called “capital gain.”
Homeownership is still the Great American dream, and until repealed or amended, is encouraged and supported by our Federal Tax Code. Consider this typical scenario: In 1970, you bought your first home for $30,000. You and your spouse had two children, and your first home was just too small. You sold your home for $60,000, and bought another for $80,000.
Your profit — not taking into consideration expenses, improvements, or real estate commissions — was $30,000. But since you were then able to take advantage of a tax benefit known as the “rollover,” you did not have to pay tax on these capital gains in the year of sale. The rollover was completely eliminated when President Clinton signed into law the Taxpayer Relief Act of 1997. One of the principal features of the great American dream was to encourage homeowners to continue to move up in their lifestyles. However, the Taxpayer Relief Act dramatically changed this concept. As will be seen in subsequent columns, homeowners are now permitted to exclude up to $250,000 of profits made on their principal residence ($500,000 for married taxpayers filing joint returns). And this exclusion is not limited to any one sale, but can be taken every two years — so long as you meet certain eligibility criteria.
Congress also repealed the “once in a lifetime” exemption, whereby homeowners over the age of 55 were given a one-time absolute exclusion of up to $125,000 of the overall profit made on the sale of their principal residence.
Thus, the “rollover” and the “once in a lifetime” exclusion are history, having been replaced by a more simplistic — and more financially rewarding — concept: up to $500,000 of profit can be excluded every two years.
For those of us who own homes, and are preparing to file our 2005 tax returns, here is a list of the itemized tax deductions available to most homeowners:
Mortgage Interest. Interest on mortgage loans on a first or second home is fully deductible, subject to the following limitations: acquisition loans up to $1 million, and home equity loans up to $100,000. If you are married, but file separately, the limits are split in half.
The concept of an acquisition loan is very important, and has confused — and even trapped — a large number of homeowners. To qualify for such a loan, you must buy, construct or substantially improve your home. If you refinance for more than the outstanding indebtedness, the excess amount does not qualify as an acquisition loan unless you use all of the excess to improve your home. However, any other excess may qualify as a home equity loan. As this column has reported in the past, both the IRS and this columnist do not support loans which exceed the total equity in your house. It is too dangerous a risk to take, with perhaps your most valuable asset.
Let us look at this example: Several years ago, you purchased your house for $180,000 and obtained a mortgage (or deed of trust) in the amount of $130,000. Last year, your mortgage indebtedness had been reduced to $120,000, but because the market dramatically increased, your house was worth $300,000.
Because you wanted to pull out some cash from the equity in your home, you refinanced and were able to get a new mortgage of $200,000. For tax purposes, your acquisition indebtedness is $120,000 (i.e. the amount of your existing loan). The additional $80,000 that you took out of your equity does not qualify as acquisition indebtedness, but since it is under $100,000, it qualifies as a home equity loan.
Several years ago, the Internal Revenue Service ruled that one does not have to take out a separate home equity loan to qualify for this aspect of the tax deduction. However, if you would have borrowed $225,000, you are only able to deduct interest on $220,000 of your loan — the $120,000 acquisition indebtedness, plus the $100,000 home equity.
The remaining interest is treated as personal interest, and is not deductible.
You should also note that for all practical purposes, there are no restrictions on the use of the money obtained from a home equity loan. You no longer have to justify your loan as meeting certain educational or medical requirements.
Taxes. Property taxes, both state and local, can be deducted. However, it should be noted that real estate taxes are only deductible in the year they are actually paid to the government. Thus, if last year you escrowed monies with your lender for taxes to be paid in 2006, you cannot take a deduction for these taxes when you file your 2005 return.
However, if you bought a house last year, you may have reimbursed your seller for a portion of the prepaid taxes through the end of 2005. Review your settlement sheet carefully. Line 106 on page 1 of that statement should reflect this tax adjustment. Since this was a current payment by you for real estate taxes, it is a deductible item. Indeed, when you receive your annual statement from your lender showing the amount of taxes paid last year, that may not be included in that statement. Lenders are required to send these annual statements to borrowers by the end of January of each year, reflecting interest and taxes paid for the previous year.
Points. When you obtain a mortgage loan, you often have to pay one or more points to get that loan. Whether referred to as “loan origination fees,” “premium charges,” or “discounts,” they are still points. Each point is one percent of the amount borrowed; if you obtain a loan of $250,000, each point will cost you $2,500.00.
Top 10 Tax Breaks, On The House
The New Year always turns thoughts to the new tax season and when it comes to taxes there’s no place like home to find shelter.
Your home offers a score of tax deductions and credits designed to help offset the cost of housing and to keep the housing market fueled with new buyers.
Some federal-level politicians would like to separate you from some of those benefits and they may or may not be successful, so take advantage of them while you can.
Here’s a look at the Top 10 Tax Breaks, On The House. Visit the Internal Revenue Service’s website for more details on each item.
- Mortgage Loan Interest: The Mother Of All Tax Breaks, because interest payments comprises a large portion of your mortgage payment in the early years of the loan’s term, mortgage interest on a maximum of $1 million in mortgage debt secured by a first and second home is deductible. Deductions reduce your taxable income against which your taxes due are calculated. The $1 million level applies to joint tax filers. You get half the deduction if you file single or separately. Likewise, home equity loan interest is deductible, but limited to the smaller of $100,000 (half as much for each member of a married couple if they file separately), or the total of your home’s fair market value as determined by a complicated formula you may need a tax professional’s help to decipher.
- Home Improvement Loan Interest: The interest on a home improvement loan is also deductible, but calculated differently. You can deduct all the interest on a home improvement loan provided the work is a “capital improvement” rather than repairs, maintenance or cosmetic upgrades. Capital improvements typically increase your home’s value (say, because you added a room), prolong it’s life (a new roof) or adapt it to new uses (universal design improvements to assist older people or people with disabilities). You get tax benefits from repair work (painting, repairing, etc.) only when you sell your home but you can use a home equity loan to make repairs and deduct the interest — up to the limits.
- Points: Points, each equal to 1 percent of the loan principal, are charged by lenders as part of the cost of the loan. You can fully deduct points associated with a home purchase mortgage, but not a mortgage broker’s commission. Refinanced mortgage points are deductible too, but only when they are amortized over the life of the loan. Once you refinance a second time, the balance of the old points from a refinanced loan offer an immediate write off, as you begin to amortize the new points.
- Property Taxes: Property taxes or real estate taxes are fully deductible. Any local city or state property tax refunds reduces your federal property tax deduction by the same amount.
- Capital Gains Exclusion: Home buying investors’ best tax shelter comes from provisions in the Taxpayer Relief Act of 1997 which allows married taxpayers who file jointly to keep, tax free, up to $500,000 in profit on the sale of a home used as a principal residence for two of the prior five years. The amount is halved for those filing single or separately. You can use the benefit as often as you qualify.
- Home-Based Business Deduction: Home offices that use a portion of your home exclusively for business could qualify you to deduct a percentage of costs related to that portion. Included are a percentage of your insurance and repair costs, utility bills and depreciation. Under clarified provisions of the Taxpayer Relief Act of 1997, if your home office qualifies, you don’t have to allocate a home sale’s capital gains between the home and the business. Previously if you used, say, 10 percent of your home for a home-based business, 10 percent of the gain from a sale would be subject to capital gain taxes and you couldn’t use the capital gains tax exclusion on that portion. The clarified provision does not excuse you from a recapture tax if you’ve taken a depreciation deduction because of the home-based business.
- Selling Costs and Capital Improvements: When you sell your home, you can reduce your taxable capital gain by the amount of your selling costs, which include real estate commissions, title insurance, legal fees, advertising and inspection fees. Cost typically stemming from decorating or repairs — painting, wallpapering, planting flowers, maintenance, and the like — are also selling costs if you complete them within 90 days of your sale and with the intention of making the home more saleable. Selling costs are deducted from your gain. Gain is your home’s selling price, minus deductible closing costs, minus selling costs, minus your tax basis in the property. Your basis is the original purchase price, plus the cost of capital improvements, minus any depreciation.
- Moving Costs: A move triggered by a new job comes with some deductible moving costs. To qualify, you must meet certain requirements including, moving within one year of starting your new job, moving 50 miles farther from your old home than your old job was and working full-time at the new job for 39 of 52 weeks following the move. Deductions include travel or transportation costs and expenses for lodging and storing your household goods.
- Mortgage Tax Credit: Mortgage Credit Certificates (MCCs) allow qualifying low-income, first-time home buyers to take a mortgage interest tax credit of up to 20 percent (the amount varies by jurisdiction) of the mortgage interest payments made on a home. This credit is available every year you keep the loan and live in the house purchased with the certificate. Unlike a deduction that reduces your income, the credit is subtracted, dollar for dollar, from the income tax owed. For example, with a 20 percent tax credit, if you paid $10,000 in interest, your tax credit would be $2,000. If you owe $2,000 in income taxes without the credit, you would end up owing nothing to the IRS after the credit was applied. The remaining 80 percent of your mortgage interest — $8,000 — is taken as a normal mortgage interest deduction.
- Energy Tax Credits: The newest home-based tax credits were made possible last year by the Energy Policy Act of 2005. Tax credits of up to $500 in 2006 and 2007 are available for upgrading heating and air conditioning systems, insulations, windows, doors and thermostats, caulking leaks, installing pigmented metal roofs and for otherwise putting the bite on energy waste in your home. Qualified solar energy and fuel cell systems can net tax credits of up to $2,000. Some states also offer tax credits or rebate deals that could reduce the federal credit. Related tax credits are available for consumers who buy alternative- and clean-fuel burning cars and for entrepreneurial consumers who install clean-fuel vehicle refueling property at the principal residence of the taxpayer.