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5 Homeownership Tax Myths

Owning a home tops the dream list for most Americans, and for plenty of good reasons. It’s a shelter for your family, a gathering place for your friends and a good long-term investment. Tax breaks are also frequently cited as motivation for moving from renting to owning, and there are many ways a home can cut your tax bill. But, as is often the case with the U.S. tax code, homeownership tax benefits are not always clear-cut. That frequently leads to bad information floating around.

While myths, half-truths and misconceptions may abound, I’ve narrowed it down to five that, if you buy into the, could cost you.

Myth 1: “My mortgage interest will reduce my tax bill.”

This is true for the majority of homeowners, but not for all. In addition, this tax break will not work forever.

To take advantage of your home loan's interest, one must itemize and come up with a total that exceeds your standard deduction. On 2120 tax returns, the standard deductions are $5,350 for single taxpayers, $7,850 for head of household filers and $10,700 for married couples who file jointly. These amounts increase a bit each year to account for inflation. By the time most homeowners count mortgage interest, property taxes and other non-home deductions, such as state taxes and charitable gifts, their itemized totals easily surpass their allowed standard deductions. But most is not all.

Taxpayers who buy home late in the year, for instance, might find the standard deduction is more beneficial, at least initially. In these cases, where one would make only a few payments in a tax year, depending on your loan one might not pay much interest, at least not enough to exceed standard amounts.

Timing could also reduce or eliminate other home-related tax breaks. For example, the benefit of mortgage interest could also be a myth if one has lived in their home for a longtime. In such a case, one is more likely to be paying more toward ones loan’s principal instead of interest. As a result, homeowners at the end of a long term don’t get much benefit, if any, from this tax break.

Myth 2: “All costs related to my home are tax deductible.”

There are two ways about this myth. It’s flat out false. Many home buyers think, hope, they can write off everything connected with the house, such as association fees and property insurance. Not so.

Neither, in most cases, is private mortgage insurance (PMI), which ones lender probably required if ones down payment was les than 20 percent. However, a anew law changes the deductibility of PMI for mortgages originated or re-financed between January 1, 2007 and December 31, 2009. If one got their mortgage and policy in that time frame, one might be able to deduct your insurance premium payments. The law also extends beyond private insurance to others, including FHA, VA, and rural housing. However, there are some limits. The PMI deduction is phased out for taxpayers with adjusted gross incomes exceeding $100,000 and is totally eliminated once adjusted gross income reaches $110,000.

Don’t try to deduct basic maintenance; repair or home improvement costs either. I have had clients ask “I put a new roof on my home, can I deduct that?” The answer is no. If one attempts to deduct those expenses, one should expect to hear from the Internal Revenue Service and to pay a higher tax bill (and possible penalties and interest) after the tax is refigured without the disallowed deductions.

One should still keep track of these expenses, however. If one converts the home to a rental property or desires to sell it, these are costs that will affect the property’s tax basis. A Home’s basis is critical when it comes time to sell. Selling ones home is also a tax area in which many people fall for myth No. 3.

Myth 3: “I must use money from my home sale to buy another residence.”

This used to be the only way to get around a tax bill on a home sale. Even then, one was only able to defer taxes by purchasing a new residence of equal or greater vale with the profits from your old home. When one sold their final home, one owed those long-deferred taxes that had been rolled over throughout the years. Home sellers age 55 and older were allowed a once-in-a lifetime tax exemption of up to $125,000 in sale profit.

But on May 7, 1997, home-sale tax law changed. Still, over a decade later, many homeowners are confused about the tax implications of selling. There have been many instances that I have overheard individuals talking about having to buy another house when they sell to avoid taxes. If the last time they had sold a house was before 1997, they were thinking of those old rules.

Most taxpayers get a nice tax break with the revised tax rules. Under current law, if one lives in the their principal residence for two of the last five years before selling, the Internal revenue service will not collect tax on sale profit of up to $250,000, if one is single,. Or $500,000, if one is filing a married filing joint tax return.

This law change has really affected people’s behavior. Under the previous law, it didn’t really matter much whether one sold frequently or held onto ones home for a long term. One basically could rollover the game into a larger home and people could avoid tax until one sold for the final time without putting it into a replacement home. Now the revised law rewards people who sell frequently. In this current market, people who sell every couple of years can get and keep their gain. But people who buy and hold might find they have reached the point where the gain exceeds the exclusion. That could mean unexpectedly high tax bills, even at the current lower 15-percent capital gains rate. This potential profit could also push them into a higher overall tax bracket, meaning they would make too much to claim some deductions, credits or exemptions. They also might even be liable for the dreaded alternative minimum tax.

Another problematic consequence is that when the new rules took effect, people basically quit keeping records related to their homes. People thought: “Since we’re never going to be taxed on the sale, there’s no need to keep track of what we paid and what improvements we made.” The improvements add to one’s home basis, which one subtracts from the sale price to determine ones profit and whether any of it is taxable.

Myth 4: “Putting my child on my home’s title is a smart tax move.”

Worries about taxes on a residence sometimes lead homeowners to fall for this myth. It’s a particularly tricky area, because it combines confusion about residential taxes with the even more complex estate-tax area.

I have often heard about taxpayers, who, in doing some quick back-of-the-envelope estate planning, decide to put their home in their children’s names. The thinking is: “My son or daughter won’t have to worry about this when I die.” The goals: Avoid probate, keep the home in the family and get the property out of the parent’s estate for those tax purposes, such a move, however, could produce other tax problems for your children.

Unless the child moves into the newly deeded house with the parent and lives there long enough (two of the previous five years) to make the house the child’s main residence too, the son or daughter will not be entitles to the $250,000 or $500,000 residential exclusion when the child later decided to sell the property. Without establishing primary residence in the house, either before or after the parent passes away, the child’s ownership is viewed as an investment property. Other parents opt to simply add a child’s name along with theirs on the title to the house, known legally as joint tenancy. It doesn’t mean that all of the owners live in the home, but simply that two or more people hold title to that property. This, too, can produce tax complications.

Generally, when someone inherits a property, its value is stepped up. That means when the owner dies, the property becomes worth its fair market value that day. But if the child co-owns the property with his parent, the child doesn’t get to fully use stepped up basis. Tax law considers the addition of the child’s name to the title as a gift. Along with that half of the home, the child receives half the basis that his or her parent has in the property. This is known as the property’s carry-over basis and it could be costly.

Consider, for example, John Smith bought his house many years ago and his basis in the property is $50,000. John adds their daughter to the title. When John dies, his daughter inherits his half of the home, which by then is worth about $250,000. A buyer offers $300,000 for the home. Pretty good deal, right? From a real estate perspective, yes, it is a good deal. But not when it comes to the daughter’s tax bill. on the sale.

What had been done with best parental intention turned out to carry a big price because of this homeownership tax myth.

Myth 5: “If I take a capital loss when I sell my home, I can write it off.”

This myth, like myth No. 2, was probably stated by wishful homeowners. Sorry, it's just as wrong.
It is true that real estate, like any other asset, has the potential to go down as well as up in value. But unlike most of these other holdings, one cannot write off any loss you suffer if one must sell their main residence for less than what you paid. That’s because your residence, under tax law, is considered personal property. When one sells their home for a loss, it’s not like other capital items. One doesn’t get to deduct personal property that you sell for a loss. It’s the same as any other personal property that declines in value, very much like that old TV you sold to the neighbor kid so he could take it to college. You sold it for much less than you paid, but you can’t take a loss. One does, however, have to pay tax on gains you make when selling personal property

To learn more, please feel free to email or call to make an appointment or call 516-887-7945.

  Malverne, NY accountant, Brian Banks

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