Congratulations, you've just taken another step up the American-dream ladder and are a homeowner. Along with the joy of painting, plumbing and yard work, you now have some new tax considerations.
The bad news is, to take full tax advantage of your home, your taxes will likely get more complicated. In most cases, homeowners itemize. That means you're not living on "EZ" Street anymore; you've moved to the 1040 long form and Schedule A, where you'll have to detail your deductible expenses.
For many homeowners, the effort of itemizing is well worth it at tax time. Some, however, might find claiming the standard deduction remains their best move, especially since recent law changes allow for at least some home costs to be counted as part of the standard deduction.
If you do find that itemizing is best for your tax situation, here's a look at homeowner expenses you can deduct on Schedule A, ones you can't and some tips to get the most tax advantages out of your new property owning status.
Your biggest tax break is reflected in the house payment you make each month since, for most homeowners, the bulk of that check goes toward interest. And all that interest is deductible, unless your loan is more than $1 million. If you're the proud owner of a multimillion-dollar mortgaged mansion, the Internal Revenue Service will limit your deductible interest.
Interest tax breaks don't end with your home's first mortgage. Did you pull out extra cash through refinancing? Or did you decide instead to get a home equity loan or line of credit? Generally, equity debts of $100,000 or less are fully deductible.
What if you're the proud owner of multiple properties? Mortgage interest on a second home also is fully deductible. In fact, your additional property doesn't have to strictly be a house. It could be a boat or RV, as long as it has cooking, sleeping and bathroom facilities. You can even rent out your second property for part of the year and still take full advantage of the mortgage interest deduction as long as you also spend some time there.
But be careful. If you don't vacation at least 14 days at your second property, or more than 10 percent of the number of days that you do rent it out (whichever is longer), the IRS could consider the place a residential rental property and ax your interest deduction.
Did you pay points to get a better rate on any of your various home loans? They offer a tax break, too. The only issue is exactly when you get to claim them.
The IRS lets you deduct points in the year you paid them if, among other things, the loan is to purchase or build your main home, payment of points is an established business practice in your area and the points were within the usual range. Make sure your loan meets all the qualification requirements so that you can deduct points all at once.
A homeowner who pays points on a refinanced loan is also eligible for this tax break, but in most cases the points must be deducted over the life of the loan. So if you paid $2,000 in points to refinance your mortgage for 30 years, you can deduct $5.56 per monthly payment, or a total of $66.72 if you made 12 payments in one year on the new loan.
The same rule applies to home equity loans or lines of credit. When the loan money is used for work on the house securing the loan, the points are deductible in the year the loan is taken out. But if you use the extra cash for something else, such as buying a car, the point deductions must be parceled out over the equity loan's term.
And points paid on a loan secured by a second home or vacation residence, regardless of how the cash is used, must be amortized over the life of the loan.
The other major deduction in connection with your home is property taxes.
A big part of most monthly loan payments is taxes, which go into an escrow account for payment once a year. This amount should be included on the annual statement you get from your lender, along with your loan interest information. These taxes will be an annual deduction as long as you own your home.
But if this is your first tax year in your house, dig out the settlement sheet you got at closing to find additional tax payment data. When the property was transferred from the seller to you, the year's tax payments were divided so that each of you paid the taxes for that portion of the tax year during which you owned the home. Your share of these taxes is fully deductible.
Property taxes usually must be deducted as an itemized expense on Schedule A. However, homeowners who use the standard deduction can add at least some of their property tax payments to their 2009 tax return standard amount.
A single homeowner can add up to $500 of property tax payments to the $5,700 standard deduction; that same amount can be added by a head-of-household filer to the $8,350 standard deduction. Married taxpayers filing a joint return can add up to $1,000 to their $11,400 amount. To include the property tax amounts in your standard deduction, you'll need to file Schedule L.
This option helps homeowners who don't have enough deductions to itemize, but who pay property taxes on their personal residence.
When you sell
When you decide to move up to a bigger home, you'll be able to avoid some taxes on the profit you make.
Years ago, to avoid paying tax on the sale of a residence, a homeowner had to use the sale proceeds to buy another house. In 1997, the law was changed so that up to $250,000 in sales gain ($500,000 for married joint filers) is tax-free as long as the homeowner owned the property for two years and lived in it for two of the five years before the sale.
If you sell before meeting the ownership and residency requirements, you owe tax on any profit. The IRS provides some tax relief if the sale is because of a change in the owner's health, employment or unforeseen circumstances. In these cases, the tax-free gain amount is prorated.
A ruling by the IRS in late 2002 could put more dollars in homeowners' pockets when they must sell before they qualify for the full tax break. The Treasury has defined the unforeseen circumstances that often force homeowners to sell and under which they now can get some tax relief.