It’s human nature to want to amass as many tax deductions as you can when you purchase a home. Many taxpayers, though, are too aggressive, confusing personal property and investment property tax rules. They wind up trying to take deductions they are not entitled to, risking fines and penalties (and perhaps missing other tax breaks).
It is vital to understand your personal residence tax deductions, including what you can and cannot deduct on your personal home. “The interest you pay on your home is the largest deduction you’re gonna get for owning your home,” says Frank Ellis, an advisor with Harbor Financial in Traverse City, Mich.
Taxes on Your Personal Residence
Unlike rental property purchases, you cannot deduct the purchase price of your personal residence in any way whatsoever. The IRS considers personal residences to be personal property and not a business expense. Nor can you deduct the cost of repairs, maintenance or renovations on your personal residence. Before we get into the nuts and bolts, let’s deal with the “Thou Shalt Nots.”
Nondeductible Expenses for Personal Residences
I. Thou shalt not deduct insurance premiums on a personal residence.
II. Thou shalt not deduct for repairs and maintenance costs.
III. Thou shalt not take depreciation on personal residences, for thou already hast a capital gains exemption.
IV. The laborer is worth his wages. But thou shalt not deduct the wages paid to thy maidservant, nor thy manservant, nor thy cook, carpenter, or layer of tiles; for thy home is not a business investment, but for thine own use.
V. Thou shalt not deduct closing or settlement costs, nor appraisal costs, nor stamp fees and document fees. It is an abomination. But amounts thou payest as advance payments on interest – these thou shalt deduct gradually over the life of the loan.
VI. Thou shalt not deduct utilities, gas, cable, or electricity, except if thou engage in a trade or business from thy home, in proportion to thy square cubits.
VII. Thou shalt not deduct special assessments on a property, except if the tax applies to all properties, uniformly, in the jurisdiction.
VIII. Thou shalt not deduct the principal portion of thy personal mortgage payment.
IX. Thou shalt not deduct fees paid to thy landlord, nor thy property tax collector for services rendered to thee concerning thy personal dwelling. Nay, even unto the trash collection fee.
X. Thou shalt not deduct amounts you pay for improvements to common areas. Thy payments for sidewalk improvements, building recreation areas and repaving parking lots for thy property complex are thine own.
But enough of the Thou Shalt Nots. What can you deduct? Well, it turns out that there are “Ten Commandments” you can refer to here, as well:
Deductible Expenses for Homebuyers
I. Thou shalt deduct thine interest payments on home mortgages up to $1 million ($500,000 if married and filing separately), provided that the debt is secured by thine own residence.
II. Thou shalt deduct any points paid at closing in lieu of interest, reporting the payment on IRS Form 1098 – Mortgage Interest Statement. But thou shalt not deduct all points paid that year, except if thy points are not excessive, points are standard practice in thine area, and the loan is secured by thy primary dwelling.
III. Thou shalt deduct the interest on home improvement or home equity loans with principal of up to $100,000, provided that the debt is also secured by a lien on thine own home.
IV. Thou shalt deduct property taxes attributable to the date of sale and after. The seller shall pay property taxes attributable for the year up to the date of sale. Therefore you may not deduct them.
V. Thou shalt deduct any penalties for prepayment of mortgages, as well as fees for late payments, provided the fees are not connected with any specific service.
VI. Thou shalt deduct any prepaid interest, except that if the prepayment is for a period of greater than one year, thou must deduct the interest in the year it would have been paid, hadst thou not paid the interest in advance in a prior year. Yea, verily.
VII. Thou shalt prepare an IRS Form 1098 – Mortgage Interest Statement.
VIII. Thou shalt deduct premium payments for PMI, or primary insurance, except if your adjusted gross income is above $109,000 for married couples filing joint tax returns, and $54,500 for individual filers.
IX. Thou shalt deduct thine interest payments, deductible points, sales and property taxes by preparing an IRS Form 1040, Individual Tax Return, and a Schedule A, Miscellaneous Itemized Deductions.
X. Thou shalt not use a Form 1040EZ for this purpose. It is an abomination.
Chances are, if you are a homeowner, you will be better off itemizing, rather than taking the standard deduction. “If you itemize your taxes, you’ll get a much bigger deduction on property taxes paid, as opposed to just $1,000 on the standard deduction,” advises Ellis. “So if you do the standard deduction, you’re not gonna get back all the taxes you paid – you’ll just get the standard deduction.”
Capital Gains Tax Exemption
While personal residences don’t qualify for many of the same tax breaks that investment properties qualify for, there is at least one powerful tax advantage to owning your personal home: the capital gains tax exemption. Normally, you have to pay capital gains taxes of between 5 and 15 percent on property you have held for over a year. However, the IRS exempts the first $250,000 of profit on the sale of a qualified personal residence. Married taxpayers can exempt up to $500,000 of profit from capital gains taxes. Special rules apply to active duty military personnel.
Income Limit on Home Mortgage Deduction
If your income is over $100,000 for the year, the IRS may reduce your allowable exemptions. If your adjusted gross income is over $109,000, or $54,500 if you are married and file separately, the IRS disallows your mortgage interest deductions.
Tax Deductions on Multiple Homes
You can deduct home mortgage interest on your primary residence and on one second home. You cannot deduct mortgage interest on other homes, except insofar as that interest is a business expense on rental properties.
There are many additional rules governing the taxation of personal residences not listed here. These are the basics, but the legislative environment is constantly changing. There is no substitute for enlisting the services of a qualified financial or real estate expert.
For more information on deductions available to homebuyers, see IRS Publication 530, Tax Information for Homeowners.
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