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HOMEOWNER TAX MYTHS
Not only is
buying a home a great investment, it provides
shelter for you and your family. Owning a house will
entitle you to great
homeowner tax breaks. However, the actual tax breaks
homeowners receive is not clear-cut. Below are some of
the most common misconceptions people have about owning
Mortgage interest reduces taxes
This is true for many homeowners, but not all. Also,
this tax break does not last forever.
In order to reap the benefits of your loan's interest,
your itemized total must surpass your standard amount.
For example, on 2006 tax returns, the standard
deductions will be $5,150 for single taxpayers, $7,550
for head of household filers and $10,300 for married
couples who file jointly. These amounts increase a bit
each year to account for inflation.
Because of the high price of homes, many Americans are
itemizing their tax returns. Adding up property taxes,
mortgage interest and other non-home deductions (i.e.
charitable gifts, state taxes), results in the totals of
these itemized items to easily surpass the standard
deductions. On the contrary, homeowners that buy their
home's in the later part of the year are going to find
that standard deductions are going to be more beneficial
for them. This is a result of not paying a full years
worth of interest payments on your mortgage.
If you have lived in your home for may years, you are
likely paying more towards principal than to interest.
As a result, homeowners near the end of their loan term
are not going get much of a tax break.
Any cost associated with my home are deductible
This is not true. For example,
private mortgage insurance, association fees and
property insurance costs are not deductible. You won't
be able to deduct basic
home improvements repairs and/or maintenance either.
If you attempt to write off any sort of home
improvement, you will likely be hearing from the IRS.
They will recalculate your taxes correctly, resulting in
penalties, interest, and a higher tax bill.
Please note that it is important to keep track of all
expenses incurred for repairs and improvements. If you
decide to sell your property after making any sort of
repair or conversions, the property's tax basis is going
to be affected, i.e. turning your home into a rental
Money from the sale of your home has to be used to
buy a another house
This used to be the sole method for avoiding a tax
bill on the home that your selling. Even then, the only
way to defer taxes was to
buy a new home of equal or greater value with the
earnings from your old home.
Once you sold your final home, long-deferred taxes that
were rolled over the years are were due. It used to be
that sellers 55 and older were entitled to a
once-in-a-lifetime tax exemption of up to $125,000 in
sale profit. However, on May 7, 1997, the home-sale tax
law changed. Even a decade later, many people do not
understand the tax implications of selling and still
think that they are entitled to this exemption.
Selling your home still entitles you to a nice tax break.
If you reside in your home for two of the years before
you sell, you will not have to pay taxes on a sale
profit of up to $250,000 if you're single or $500,000 if
you and your spouse file a joint return.
Placing my child's name on the home's title is a wise
It is very common for people doing estate planning
to put the home in the child's name. The intent of doing
something like this is to avoid probate,
keep the home in the family and get the property out of
the parent's estate for those tax purposes. However,
these actions are only going to generate tax problems
for your children.
Only if the child decides to move into the newly deeded
house with the parent and lives there long enough (two
of the previous five years) to make the house the
child's main residence, the child will not receive the
$250,000 or $500,000 residential tax break when they
decide to sell the home. The child's ownership is only
going to be looked at as an investment property if the
child does not establish primary residency in the home
before the parent passes away.
Establishing joint tenancy is another instance when
parents will choose to add a child's name along with
theirs on the title to the house. This does not mean
that all owners reside in the house, but merely that
more than one person holds title to the property.
Typically, when property in inherited, the property
becomes worth its
fair market value that day, thus increasing in
value. However, if the child co-owns the property with
their parent, the child will not be entitled to thee
stepped-up basis. According to tax laws, it is
considered a gift for the child when their name is added
onto the title; resulting in half of the home ownership
and half of the basis being received.
This is more commonly known as the property's carry-over
basis and is very expensive. For example, suppose you
purchased your property years ago and the basis in the
home is $80,000. You add your son to the title. When you
die, he will inherit half of the home which is now worth
$300,000. They are offered $400,000 by a potential buyer
for the property.
This may seem like a good deal from a real estate
perspective. However, the tax bill of this sale can be
quite surprising. Instead of owing taxes on just $50,000
more than the house's stepped-up market value, your son
is going to owe on three times that amount. Here's the
Parent owns home with a basis of: $50,000
Parent adds child to title, "giving" child carry-over
basis of: $25,000
At parent's death, house is worth $300,000, producing on
the inherited half a stepped-up basis of: $150,000
Home subsequently sells for: $400,000
Child's total adjusted basis is:
(line 2 plus line 3) $175,000
Taxes due on sale profit of:
(line 4 sale price less line 5 basis) $250,000
Taxes to be remitted to the IRS:
(Sales profit of $250,000 x 15 percent long-term capital
Although the intentions of the parent were for the best,
the cost was ultimately very expensive for the child.
I end up selling my home for less than what it is
worth. I can write this off
Wrong. Like an asset, your home has the potential to
rise and fall in value. The reason is because your home
is considered personal property and you can not write
off any sort of personal property.
On the contrary, you will have to pay taxes on any gains
you earn as a result of
selling your home.