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2009 CCH Whole Ball of Tax
Owning a Home Still Brings Benefits At Tax Time
(RIVERWOODS, ILL., January 2009) – Owning a home brings with it a wealth of tax advantages, according to CCH, a Wolters Kluwer business and a leading provider of tax, accounting and audit information, software and services (CCHGroup.com). Home ownership is often the stepping-stone to taking more than the standard deduction on Form 1040, and equity in a home often represents a family’s principal source of wealth, even with home prices currently stagnant or sagging.
“Owning a home has traditionally been a cornerstone of the finances of a typical middle-class family,” said CCH Senior Federal Tax Analyst John W. Roth, JD, LLM.
Mortgage Interest Deduction Creates Itemizers
With the standard deduction at $10,700 for joint filers on 2008 returns, the deductibility of mortgage interest is the first of a number of building blocks that can pile up to take someone into the rarified air of itemized deductions.
The mortgage interest deduction is capped at $1 million a year, but it covers mortgage interest on any second home as well as a “principal residence,” plus, for ordinary income purposes, up to $100,000 of interest on home equity loans. For 2008 and on through 2010, mortgage insurance premiums also are deductible as mortgage interest. However, the mortgage insurance had to be originally acquired on or after January 1, 2007.
For purposes of the alternative minimum tax (AMT), interest on home equity loans is deductible only if the loan is used to acquire, build or “substantially improve” a home. Home equity loans used for other purposes – or a refinancing, to the extent it is greater than the original amount of the mortgage – is not deductible for AMT purposes.
“Since most people aren’t subject to the AMT, the restrictions basically amount to a disclaimer at the end of ads for home equity loans,” Roth noted. “As more people become subject to the AMT, which is a distinct possibility, the limitation could become more significant.”
With mortgage interest as a base, homeowners can then pile on a deduction for state and local taxes – property taxes at a minimum, but usually either state income taxes or state and local sales taxes, as well.
If the combination of these home-related deductions exceeds or approaches the standard deduction, homeowners then add on deductions for charitable contributions and, if they exceed certain minimums, deductions for medical expenses and miscellaneous itemized deductions, such as dues for unions or professional organizations.
Home Deductions without Itemizing
A provision in last year’s Housing and Economic Recovery Act permits homeowners who don’t itemize to take up to $500 ($1,000 for joint filers) of their state and local property taxes as an additional standard deduction on their 2008 return and 2009 returns.
“People who own their homes outright or whose mortgage payments are low or consist mainly of principal, rather than interest, may not qualify for itemizing, so this provision helps defray some of the costs of home ownership,” Roth said.
The deduction is taken as part of the standard deduction, rather than an “above-the-line” deduction that reduces adjusted gross income.
Although originally effective only for 2008 taxes, the provision already has been extended for one year and may be extended further.
“Congress usually finds it easier to confer a tax benefit than to take one back or even let it expire,” Roth observed.
Credit for First-time Buyers
Some homebuyers will benefit from another new provision of the Housing and Economic Recovery Act: a refundable, first-time homebuyer credit, intended to stimulate demand. The credit is available to those who purchase a home on or after April 9, 2008, and before July 1, 2009, and who haven’t had “ownership interests” in a principal residence during the three prior years. The credit is 10 percent of the purchase price or $7,500, whichever is less – but for married people filing separately the $7,500 limit becomes $3,750. Unmarried people who jointly purchase a home can divide the $7,500 credit, but how the division is to take place is left to IRS regulation-writers.
The credit begins to phase out at the $150,000 income level for joint filers ($75,000 for other filers) and is not available for joint filers with income above $170,000 ($95,000 for other filers). It’s also not available to nonresident aliens, those who qualify for a similar District of Columbia credit or those whose financing comes from tax-exempt mortgage revenue bonds. Since the credit is refundable, it has the potential not only to wipe out a taxpayer’s obligation but even create a payment from the Treasury.
Taxpayers who purchase homes in 2009 after having filed their 2008 income tax return, before the July 1 cutoff, also can treat the purchase as taking place on December 31, 2008, and filing an amended 2008 return to claim the credit.
Beginning in the second tax year after the purchase, though, homebuyers must begin repaying the credit. The interest-free repayment is scheduled over a 15-year period. If the homeowner sells the home before then, the entire repayment is due, but the amount to be repaid cannot exceed the gain realized on the sale of the home. If the homeowner dies before repayment is complete, the remaining amount is cancelled.
Thus, a couple who claims the first-time homebuyers credit of $7,500 on their 2008 income tax return will have an additional $500 tax liability to add to their total tax liability in 2010.
“Getting a big, refundable tax credit is attractive. Having the IRS as a creditor? Not as much,” Roth said. “New homebuyers who qualify should make sure they know what they’re getting into before they take the credit.”
Exclusion Biggest Benefit
For many people, the biggest tax benefit from real estate may be in the ability to exclude a large amount of gain from income on the sale of a personal residence. Married homeowners who meet certain simple conditions can exclude $500,000 in gains on the sale of their homes from their incomes. Single taxpayers who meet the requirements can exclude $250,000.
Although this has been the law for several years now, many homeowners are not aware of the details and implications, according to Roth.
“Being able to exclude a large gain entirely from your income is an enormous benefit,” Roth said. “It not only means the income from the sale isn’t taxed, but the exclusion also makes it easier to qualify for certain itemized deductions and various credits and other tax breaks.”
“The fact is, if they found the right bargain each time, a married couple can make a half-million dollar profit every two years by buying and selling their personal residence and not pay any tax on it,” Roth said. “The family home is the largest asset owned by many families, and a profitable sale of a long-time family residence is often a key to financing retirement.
Requirements for Exclusion
To be eligible for the exclusion, a taxpayer must have owned and occupied the home for two years out of the five years leading up to the sale. The periods of ownership and use don’t have to overlap and don’t have to be continuous. You could occupy the home for the first and last years during the five-year period, for example, and still qualify. The exclusion cannot be used more often than once every two years.
If someone becomes incapacitated but has lived in his home for one year during the five years before the sale, he also can count time he spent in a licensed facility (such as a nursing home) for the purpose of meeting the two-year test.
For 2008 returns, widows and widowers can claim the full $500,000 exemption (versus the individual filer’s $250,000) if they sell the home within two years after the death of their spouse.
A short-term or seasonal absence does not disqualify a home as a principal residence. It’s also important to note that something other than the traditional single-family home can qualify. Thus, a houseboat, mobile home, cooperative apartment or condominium you own may be your principal home.
The requirements for the exclusion have been tightened somewhat by last year’s housing bill. It used to be that you could buy a vacation home, or one you rented out, and later sell your principal residence, move into the second home, and take the full exclusion once again if you sold that home after living in it two years.
Now, time that you owned a second home after 2008, which is not used as a principal residence immediately, is counted against the full exclusion if you later sell it after using it as your principal residence.
The Internal Revenue Code pro-rates the exclusion between the time a home is used as a principal residence and the total length of ownership, which includes any “nonqualifying” use as a rental or vacation property prior to becoming a principal residence. Nonqualifying use before January 1, 2009, the effective date of the provision, isn’t used in the calculation, however. Nor are periods after a qualified use of the property or temporary absences of less than two years.
Suppose, for example, a couple buys a vacation home this year, when they are in their 50s, for $200,000. Ten years later, they retire, sell their old principal residence and make the vacation home their new principal residence. Fifteen years after that, they move to an assisted-living community and sell the home for $700,000, realizing a gain of $500,000.
Under previous law, the entire $500,000 gain would be excludable, but now they can exclude only 15/25, or 60 percent of the gain from their income. So they would exclude $300,000 and include $200,000 on their return as a taxable long-term gain.
With all the incentives in the tax code for home ownership, it’s been hard sometimes to see the disadvantages to it, but in fact there are a few, as many have found out.
One is that property taxes are one of the preference items that can subject you to the AMT. Also, some home-related interest that’s deductible for regular tax purposes is not deductible for AMT purposes.
Another difficulty arises if you have to sell a home for a loss. The loss is considered personal, and nondeductible, under the tax code.
“This is one situation in which you might wish you had invested your down payment in the stock market instead,” Roth said. “You can at least write off some of your losses if you make a bad investment there.”
Help for Troubled Borrowers
One other potential downside is that if mortgage debt is forgiven or wiped out through foreclosure and a subsequent sale, the amount can be considered income and taxed accordingly. With this possibility dimming the hopes of overstretched borrowers who might “work out” their debt or lose their homes only to be socked with a hefty tax bill, Congress has enacted legislation that excludes most forgiveness of debt for homeowners, at least on a temporary basis.
It excludes discharges of up to $2 million of indebtedness if the debt is secured by a principal residence and if it was incurred in the acquisition, construction or substantial improvement of the principal residence. This special relief is temporary and is available for six years, retroactively for discharges after January 1, 2007, through December 31, 2011.
Forgiveness of debt on vacation or other second homes or on home equity debt will still count as income. Also, homeowners who took advantage of the run-up in real estate prices to refinance their mortgages can only take advantage of the new law for higher mortgage debt used to improve the home. “Cash out” refinancings that went for other purchases or to pay off credit-card debt don’t qualify for the exclusion if they are forgiven.
Taxpayers who take advantage of this new provision will have to reduce their cost or “basis” in their homes by the amount excluded. For example, someone who paid $300,000 for their home and had $20,000 in mortgage debt forgiven will figure that their “basis” in their home is now $280,000. If they later sell their home for $350,000, their gain will be $70,000 rather than $50,000.
“Still, that’s a small price to pay for being able to straighten out your finances and keep your home,” Roth said.
About CCH, a Wolters Kluwer Business
CCH, a Wolters Kluwer business (CCHGroup.com) is a leading provider of tax, accounting and audit information, software and services. It has served tax, accounting and business professionals since 1913. Among its market-leading products are The ProSystem fx® Office, CCH® TeamMate, CorpSystem®, CCH® Tax Research NetWork™, Accounting Research Manager® and the U.S. Master Tax Guide®. CCH is based in Riverwoods, Ill.
Wolters Kluwer is a leading global information services and publishing company. The company provides products and services globally for professionals in the health, tax, accounting, corporate, financial services, legal and regulatory sectors. Wolters Kluwer has annual revenues (2007) of €3.4 billion ($4.8 billion), maintains operations in over 33 countries across Europe, North America and Asia Pacific and employs approximately 19,500 people worldwide. Wolters Kluwer is headquartered in Amsterdam, the Netherlands. For more information, visit www.wolterskluwer.com.
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