As we head into 2012 it’s time to start thinking about those dreaded income taxes and April 15th will be here before you know it. If you’re a homeowner, you probably know that one of the benefits of owning a home is the great tax benefits you can receive. Usually folks think only of the interest they pay as tax deductible. Most consumers, however, do not understand that several other great tax benefits are available to homeowners as well. So, let’s take a look at some of the major tax benefits of owning real estate and see what gifts our government gives away to us when we own a home.
The deduction of mortgage interest. A homeowner can deduct not only the interest they pay on their primary residence but also for a second or vacation home that they own. The deductible interest is limited to a million dollars in total debt. You can also deduct up to $100,000 in home equity loan debt, regardless of your use of the money. In the vast majority of the states the homeowner will receive a deduction on their state income taxes as well. This is usually the largest tax deduction a home can receive.
The deduction of real estate taxes. In addition to the interest costs on a loan, homeowners may also deduct the total amount of real estate taxes paid on primary residences and second homes. Combined with the interest costs, this can be a substantial tax deduction. What this simply means is that the cost of a mortgage is really much less than the cost of the monthly payment once you account for the deductibility of these items.
As an example, let’s say a homeowner is in the 28% tax bracket and they are paying $2,500 monthly on their mortgage and $2,000 of this payment is comprised of interest and taxes, the payment after taxes is actually $1,800 ($2,500 multiplied by 1 minus the marginal tax rate of 28% or in this example, 72%). Remember also that the principal portion of the payment is a kind of forced savings account that builds up equity as well. Therefore, more than 90.0% of the payment can be working to help your financial situation. The $1,800 payment “after taxes” is actually the rental equivalent. For this person, a payment of $1,800 in rent is the same as a $2,500 mortgage.
“Points or Origination Fees”. Points or a Loan Origination Fee refer to charges or certain fees paid by a borrower to obtain a home mortgage. If you have your first mortgage, you can deduct these charges in the year that you paid them if the loan is for your primary residence and you didn’t pay excessive points. If you have refinanced your mortgage, you must deduct any points paid over the life of the loan.
The sale of your home may be tax free. When you sell a home, if that home has been your primary residence for at least two out of the last five years, you can exclude from taxes any gain on the sale of up to $500,000 for a married couple and $250,000 if you are single. You get to keep the equity you built-up through appreciation and you can use this exclusion again and again. Most other investments require the payment of a capital gains tax on any gain after a sale.
Use of your home as an office. If you use an office in the home for work, you can deduct the value of the home through depreciation, as well as other expenses such as insurance, in the same percentage as the square footage of the office compared to the total square footage of the home. For example, if the office is 15.0% of the total home, you can depreciate 15.0% of the value of the home, excluding the value of the lot. You do have to deal with depreciation recapture once you sell your home later so be sure to consult your tax advisor carefully before doing this.
Owning rental properties. If you convert your present home to a rental or purchase a rental property, you can deduct losses on the rental as long as your income doesn’t exceed $100,000 annually. The deduction phases out over $100,000 and will disappear if your income is over $150,000. Even if your cash flow is positive, there may be a loss because you can depreciate the value of the property and expense this prior to determining our taxable income from the property. If you show a loss, the maximum loss that can be deducted is $25,000 annually.
Mortgage Insurance Deduction. Qualified borrowers with adjusted gross incomes of up to $109,000 if married and filing jointly or up to $54,500 for single filers may be able to deduct the mortgage insurance premiums they paid during 2011. If the mortgage insurance is financed (as in VA funding fees, USDA guarantee fees), it may be deducted over a period of 84 months. This mortgage insurance deduction is available for mortgages closed for purposes of January 1, 2007 through December 31, 2011 that qualify as “home acquisition debt“.
Energy Star Improvements. Installing energy-efficient windows, doors, and skylights can result in another tax deduction. In order to take advantage of this tax break, you must have installed the items by the end of 2011. Additionally, they must be installed at your primary residence, and they need to meet Energy Star program requirements.
If you meet the necessary criteria, you can receive a tax credit equal to 10% of the cost of the products. The credit for windows and skylights is capped at $200, the limit for doors is $500, and you cannot deduct installation costs. The IRS does not state what documentation you need to prove that you paid for these costs. However, you should hold on to all receipts and Energy Star labels for any qualified improvements you make on your home. There are quite a few green energy tax deductions for home improvement.
So, as you can see, many tax benefits exist for owners of real estate. In fact, you would be hard pressed to find comparable tax benefits with any other investment. A house is a very important shelter but can be an even more significant tax shelter. Remember, it is important consult your tax advisor when deciding which tax benefits apply to your situation.