Ginny: My husband and I are seriously thinking about buying our first house (or maybe a condominium). I know you have probably written about this before, but can you highlight the tax benefits of home ownership? — Cheryl D., Boulder, CO.
Cheryl, homeownership has always been the great American dream. To foster and encourage this dream, Congress has consistently enacted tax legislation that favors homeowners. Indeed, much has been written that our tax laws discriminate against renters, by giving unfair and unequal tax benefits to those who own homes.
Every four years, some candidate for high political office tries to focus our attention on equalizing the tax laws and repealing the homeowner benefits, but these arguments have consistently fallen on deaf ears.
This interesting political year will be no exception.
Here is a list of the itemized tax deductions available to the average homeowner. Every year, you are permitted to deduct the following expenses:
● Taxes: Real property taxes, both state and local, can be deducted. However, it should be noted that real estate taxes are only deductible in the year they are actually paid to the government. Thus, if in year 2016, your lender held in escrow money for taxes due in 2017, you cannot take a deduction for these taxes when you file your 2016 tax return.
Mortgage lenders are required to send an annual statement to borrowers by the end of January of each year, reflecting the amount of mortgage interest and real estate taxes the homeowner paid during the previous year.
● Mortgage interest: Interest on mortgage loans on a first or second home is fully deductible, subject to the following limitations: acquisition loans up to $1 million, and home equity loans up to $100,000. If you are married, but file separately, these limits are split in half.
You must understand the concept of an acquisition loan. To qualify for such a loan, you must buy, construct or substantially improve your home. If you refinance for more than the outstanding indebtedness, the excess amount does not qualify as an acquisition loan unless you use all of the excess to improve your home. However, any other excess may qualify as a home equity loan.
Let us look at this example: Several years ago, you purchased your house for $150,000 and obtained a mortgage in the amount of $100,000. Last year, your mortgage indebtedness had been reduced to $95,000, but your house was worth $300,000.
Because rates were low last year, you refinanced and were able to get a new mortgage of $175,000. Your acquisition indebtedness is $95,000. The additional $80,000 that you took out of your equity does not qualify as acquisition indebtedness, but since it is under $100,000, it qualifies as a home equity loan.
Several years ago, the Internal Revenue Service ruled that one does not have to take out a separate home equity loan to qualify for this aspect of the tax deduction. However, if you had borrowed $200,000, you would only be able to deduct interest on $195,000 of your loan — the $95,000 acquisition indebtedness, plus the $100,000 home equity.
The remaining interest is treated as personal interest, and is not deductible.
●Points: When you obtain a mortgage loan, you can pay one or more points to get a lower rates. Because rates are historically low now, most people don’t bother with points.
But to understand the concept, each point is one percent of the amount borrowed; if you obtain a loan of $170,000, each point will cost you $1,700. And typically, each point should reduce the interest rate by between one-eighth and one-quarter of a percentage point.
The IRS has determined that even if points are paid by sellers, they are still deductible by the home buyer. Points paid to a lender when you refinance your current mortgage are not fully deductible in the year they are paid; you have to allocate the amount over the life of the loan. For example, you paid $1,700 in points for a 30-year loan.
Each year you are permitted to deduct only $56.66 ($1,700 divided by 30). However, when you pay off this new loan, any remaining portion of the points you have not deducted is then deductible in full.
Needless to say, if you have any questions about these tax benefits, discuss them with your financial and legal advisers.