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2011 CCH Whole Ball of Tax
CCH Updates Tax Benefits of Home Ownership
(RIVERWOODS, ILL., January 2011) – Whether it’s been 30 days or 30 years, walking through the front door of your own home generates plenty of pride and peace of mind. Owning a home may also open the door to tax benefits. CCH, a Wolters Kluwer business and a leading provider of tax, accounting and audit information, software and services (CCHGroup.com), updates the tax benefits homeowners should be aware of for this tax season.
Who Qualifies for the First-Time Homebuyer Credit?
While now officially at an end, the First-Time Homebuyer Credit remains very much in play for many taxpayers as they file their 2010 tax returns. The popular credit ended for most home sales not under contract by April 30, 2010 and not closed by September 30, 2010. (In a nod to our troops, Congress gave individuals on extended active duty outside the United States until May 1, 2011 to enter into a contract and July 1, 2011 to settle on their purchases.)
Since its inception on April 9, 2008, the homebuyer credit has enjoyed several iterations in which benefits were raised and extended. In all, the rules kept changing under four separate tax laws: the 2008 Housing Assistance Act, the 2009 Worker, Homeownership Act, the 2009 Recovery Act and the 2010 Homebuyer Assistance and Improvement Act. At no time, however, did Uncle Sam show up at a house closing with a check. The credit must be claimed afterwards, attached to the new homeowner’s Form 1040.
As a result, homebuyers who made their purchases earlier in 2010 when the credit was still available must now take the extra step when filing their 2010 tax return to claim the credit if they have not already done so. They have the option of claiming it on a 2009 amended return or on their 2010 tax returns. In either case, homebuyers claim their one-time credit on Form 5405, First-Time Homebuyer Credit, which needs to be attached to their Form 1040 along with certain other documents, to be submitted to the IRS on paper – electronic filing is not available for those claiming the First-Time Homebuyer Credit. Also, taxpayers claiming the homebuyer credit should be prepared to wait to file their return as Form 5405 is one of the forms the IRS has indicated will be affected by the processing delay. The IRS has indicated it should be ready to start processing these returns in mid- to late February.
A first-time homebuyer is defined as an individual who, with his or her spouse if married, has not owned any other principal residence for three years prior to the date of purchase of the new principal residence for which the credit is being claimed. According to the IRS, after 2008, qualified first-time homebuyers may claim a refundable credit equal to 10 percent of the purchase price up to a maximum of $8,000 ($4,000 if married filing separately). In addition, up to $6,500 may be claimed for a home purchased after November 6, 2009 by a “long-time resident.” The credit still causes some confusion because of the various forms it has taken over the past couple of years, according to CCH Senior Federal Tax Analyst John W. Roth, JD, LLM.
“The credit sounds really attractive, but the actual amount that may be obtained and who may receive it has been adjusted several times,” Roth said. “Homeowners need to make sure they qualify for the credit before claiming it on their returns.”
The Homebuyer Assistance and Improvement Act of 2010 was the last tax law to amend the First-Time Homebuyer Credit. It generally extended until September 30, 2010 the last day on which a buyer who went to contract on a purchase before May 1, 2010 could close on a home and get the credit. There was one wrinkle, however:
“Taxpayers who signed a contract to purchase a home on or before April 30 must have originally contracted to complete the purchased on or before June 30, 2011,” said Roth. “A copy of the contract must be attached if the buyers took advantage of the extension for closing on the purchase on or before September 30.”
The IRS defines a long-time resident for purposes of the $6,500 credit on post November 6, 2009 purchases as someone who, with his or her spouse if married, has owned and used the same home as a principal residence for any period of 5 consecutive years during the 8-year period ending on the date of purchase of the new principal residence for which the credit is being claimed.
For people who purchased homes after November 6, 2009, the full credit is available to taxpayers with a modified adjusted gross income (MAGI) up to $125,000, or $225,000 for joint filers. However, for homes purchased before November 7, 2009, the previous income limits (MAGI up to $75,000, or $150,000 for joint filers) still apply.
Taxpayers may not claim the First-Time Homebuyer Credit if:
- The taxpayer exceeds the income limits;
- The home is located outside of the United States;
- The home is sold or no longer is the taxpayer’s principal residence in the year the taxpayer bought the home;
- The home, or any part of it, is received as a gift or from inheritance; and
- The taxpayer is a non-resident alien.
Recapture of the Credit
As tax season gets under way for 2010 returns, some taxpayers may find themselves in the uncomfortable position of being required to pay back all or part of their homebuyer credit when they file for 2010.
Homeowners who took their credit for a purchase in 2008 (but not later purchases), after enjoying a two-year grace period, now must start to pay back the credit ratably over the next 15 years. That means for those who took the maximum $7,500 credit in 2008, $500 must be paid back when filing their 2010 tax returns.
“Ironically, when Congress waived the mandatory pay-back requirement for purchase in 2009 and 2010 except under special circumstances, everyone thought 2008 claimants would ultimately be included,” noted Roth. “Unfortunately, Congress never took any action and those individuals now must start repaying their First-Time Homebuyer Credit.”
If a homeowner disposes of the principal residence for which a first-time homebuyers credit was allowed (or ceases to use it as a principal residence), irrespective of whether the credit was taken in 2008 or in 2009 or 2010, a full and immediate pay-back of the applicable credit, subject to certain exceptions, may be triggered:
- In the case of disposition or other disqualifying use of a residence on which a 2008 credit was taken, all remaining credit amounts not yet paid back must be returned to the IRS in the year of disposition; and
- If the disposition or other disqualifying use involves a 2009 or 2010 purchase on which the credit was claimed and the event takes place within 36 months of that purchase, the total credit amount must be returned in the year of sale or other disposition. The credit is repaid by including the amount of the credit as additional tax on the tax return for the year in which the repayment event occurs.
Exceptions to Recapture
Fortunately, there are exceptions to the rules for repayment of the credit:
- The taxpayer sells the home to someone who is not related to them. The repayment in the year of the sale is limited to the amount of the gain received from the sale – to the extent the homeowner doesn’t make a profit on the sale, no repayment is required;
- If the home is destroyed, condemned or disposed of under threat of condemnation and the taxpayer acquires a new principal residence within two years of the event, the taxpayer does not have to repay the credit; and
- If as part of a divorce settlement, the home is transferred to a spouse or former spouse, the spouse who receives the home is responsible for repaying the credit if required.
Tax Benefits from Selling Your Home
The biggest tax benefit from real estate, for some, may be the ability to exclude a large amount of gain from income on the sale of a personal residence.
Married homeowners may exclude up to $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 a huge benefit,” Roth said. ”In many cases, one’s home is not only his castle but the largest single asset which is counted on to help fund one’s retirement.”
“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.”
And what of any gain that is not sheltered by the homeowners’ exclusion? Usually, any gain that is taxed qualifies for favorable capital gains tax rates. For 2011 and 2012, the recent Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, signed by the president on December 17, 2010, keeps the maximum capital gains tax rate at a low 15 percent.
After 2012, however, another recent tax law – the 2010 Health Care and Education Reconciliation Act – may raise the effective rate on such gain for taxpayers in the higher income brackets and is worth watching. Dubbed “the homesale tax” by some opponents to underscore its impact on once-in-a-lifetime sales as well as regular investments, the new law imposes a 3.8 percent Medicare contribution tax on qualified unearned income of higher-income individuals. Opponents hope to convince Congress to carve out an exception for the sale of residences before the new law goes into effect in 2013.
Requirements for Home Sale Tax 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.
Also, 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.
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.
If you have more than one home, the IRS only allows you to only exclude the gain from the sale of your primary residence. Therefore, those with two homes face a potential trap if they keep both homes but change their “primary residence” from one home to the other.
For example, a couple has a city condo and a beach house. The condo is the couple’s principal residence until retirement, but the two keep the condo for occasional use and make the beach house the new principal residence.
“After three years of using the beach house as their principal residence, they can no longer claim the exemption if they decide to sell the condo,” Roth warns.
Mortgage Interest Deduction Benefits
The home mortgage interest deduction continues to be one of the largest deductions afforded to taxpayers. Home mortgage interest, as defined by the IRS, is any interest you pay on an acquisition loan secured by your home (main home or a second home).
A qualified loan may be a mortgage to buy your home, a second mortgage, a line of credit or a home equity loan. In order to qualify for the deduction, you must file Form 1040 and itemize deductions on Schedule A (Form 1040) and the mortgage must be a secured debt on a qualified home in which you have an ownership interest. A secured debt is where a borrower signs an instrument (such as a mortgage, deed of trust or land contract) with the property being put up as collateral to protect the interests of the lender.
Taxpayers may deduct interest on the loan balance of up to $1,100,000 of home mortgage debt, including any home equity indebtedness, secured by a qualified primary or secondary residence. As of 2010, the IRS allows a combined amount of $1 million limit for acquisition indebtedness with $100,000 maximum home equity indebtedness for a single mortgage that’s more than a million dollars.
Certain premiums paid for qualified mortgage insurance during the tax year in connection with acquisition indebtedness on a qualified residence are treated as interest that is qualified residence interest and, therefore, deductible. The 2010 Tax Relief Act, among its many provisions, extends for one more year, through 2011, the deduction for private mortgage insurance premiums.
On the other hand, the 2010 Tax Relief Act brought disappointing news to homeowners who do not otherwise itemize their deductions. It did not also extend the additional standard deduction for real property taxes, which expired at the end of 2009. For 2008 and 2009, homeowners who claimed the basic standard deduction were also allowed to claim an additional standard deduction for real estate taxes paid on a principal residence up to $1,000 in the case of joint returns ($500 for others).
With mortgage interest as a base, homeowners who itemize their deductions can then add 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. And don’t forget to include donations of cash or property to qualified charitable organizations.
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. CCH is based in Riverwoods, Ill. Wolters Kluwer is a leading global information services and publishing company. Wolters Kluwer is headquartered in Alphen aan den Rijn, the Netherlands (www.wolterskluwer.com).
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