How owning or selling a home affects your taxes
Owning a home is exciting, challenging and the biggest investment of many people鈥檚 lives. It鈥檚 also a good way to reduce your tax bill.
聽begin as soon as you close on your new abode and last throughout your time in the聽house. But to maximize them, you need to follow some rules.
A home isn鈥檛 just a house
American homeowners own a variety of types of homes聽鈥� and the federal Internal Revenue Code recognizes this.
When it comes to tax breaks, your home can be a house, a condominium, a co-op apartment, a mobile home or even a recreational vehicle or boat. As long as it has sleeping, cooking and bathroom facilities, the IRS聽will allow you to claim several home-related expenses.
Itemizing deductions is the key to saving
Once you own a home, you鈥檒l probably have to change your tax-filing habits. Taking full tax advantage of a聽property requires most people to itemize instead of using the standard deduction. This means filling out the longer Form 1040 and accompanying Schedule A, where you detail your home-related tax-deductible expenses.聽Most homeowners find itemizing worth the effort, and plenty of聽聽takes the pain out of the process.
There are two key sections of Schedule A that deal with home deductions:
MORTGAGE AND HOME-RELATED INTEREST
Many homeowners鈥� biggest tax break comes via their monthly mortgage payment, a large part of which goes toward loan interest. As long as your home loan is $1 million or less, all of that interest paid is tax deductible. And if you paid聽聽to get a lower loan rate, you usually can deduct those points from your taxes, too.
If you鈥檝e taken聽out a聽, you can generally deduct the interest you paid on that debt. It doesn鈥檛 matter if you used the funds on your residence, as long as you received $100,000 or less.
Private mortgage insurance 鈥� which you鈥檙e likely paying if you didn鈥檛 make聽a 20% down payment 鈥� is treated as mortgage interest and thus is deductible, at least for the 2016 tax year. The catch is you can鈥檛 deduct it if you have an income greater than $109,000.
PROPERTY TAXES
In most cases, another portion of your monthly mortgage payment covers聽your annual property taxes. (Your lender then pays your tax bill.) In others, homeowners pay them directly. Either way, you can deduct these payments as long as you own your residence.
If this is your first year in the聽house, double check the settlement sheet you received聽at closing. You probably聽split the year鈥檚 real estate taxes with the seller based on the date of sale. The share you paid will appear聽on this closing document and it鈥檚 fully tax deductible.
No tax on the sale of your home (up to a point)
All those years you spend in your home can provide substantial tax savings. The best tax break, however, is likely to come when you sell.
When single taxpayers sell a primary residence, they can pocket up to $250,000 in profit and not owe any聽. The allowance聽doubles for married couples who file a joint return.
Note that this tax-exclusion amount is based on your profit, not your sales price. You could sell your home for $1 million and still not owe Uncle Sam as long as your profit is no more than $250,000 or, if married, $500,000.
HOW TO FIGURE OUT YOUR HOME鈥橲 BASIS
Profit from a home sale is calculated as it is with any other capital asset you sell: Subtract your home鈥檚 adjusted basis from the price you got.
For most homeowners, the basis equals the original purchase price plus the value of all capital improvements made to the property. These improvements must add to your home鈥檚 value and don鈥檛 include routine maintenance and repairs.
Keep track of upgrades to your property. The greater your home鈥檚 basis, the lower your sale profit, ideally to a tax-free level. (And even if you do make some taxable profit on your home sale, at least it will be taxed at the lower long-term capital gains tax rate.)
QUALIFYING FOR A TAX-FREE HOME SALE
With such a great tax savings, you might be tempted to become a serial home seller. That could work, but you must meet some requirements in order to qualify for the tax-free home-sale profit.
- The property must be your principal residence. This is the place where you live and literally call home.
- You must own the property for at least two years before you sell it.
- You must have lived in the property for two of the five years before you sell. The good news here is that the residency doesn鈥檛 have to be continuous. You could have lived in the house for a year, then taken an out-of-town job posting for three years, before coming back to the home for another year and then聽selling.
- You can鈥檛 have sold a home and avoided the tax on your profit within the two prior years.
Most folks聽meet these requirements. So in addition to packing your personal belongings onto a moving van, you pack away a nice tax-free check into your bank account.
This story originally appeared on .
