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Homeownership & Your Taxes

Homeownership and Your Taxes 

     Homeownership is a dream of many Americans. Interest rates may fluctuate, and economic circumstances may change, but owning a home remains an attainable goal.  Americans have enjoyed an era of low interest rates and these, coupled with the economic stimulus package for new home buyers, makes homeownership affordable for many. 

     Homeowners deduct their mortgage interest if they itemize their deductions. Itemizing is generally more beneficial than taking the standard deduction.

Getting Ready to Buy 

     The process of buying a home can be overwhelming.  The first step is to get organized, gather appropriate records and documents, and determine how much house you can afford.  How much money will you have for a down payment?  What amount can you afford to pay each month for the mortgage and home expenditures?   Gather your past three years’ tax returns, your credit report, and other documents and you’re ready to start the pre-qualification process for a mortgage loan.  Your loan officer will probably ask for two or three years of W-2 forms and current pay stubs, a two-year employment history, landlord references for two years, bank statements and credit card balances. Find out what information the loan officer needs before you go to your mortgage interview.

     Be familiar with the various types of mortgages. Comparison-shop your local mortgage companies.  There are conventional and adjusted rate mortgages (ARMs), as well as opportunities to purchase HUD and VA foreclosures.  With the many options available, educated customers can apply their research to make their best deal.  It’s wise to consult an experienced real estate agent for advice on the local market and various types of financing. 

Contacting the IRS for Tax Return Copies 

     If you need copies of past years’ tax returns, you can  request them from your tax preparer or from the Internal Revenue Service.  You can get these documents from the IRS by filing Form 4506, Request for Copy of Tax Return, for a $39 fee or Form 4506-T, Request for Transcript of Tax Return, at no charge.

     Call Liberty Tax Service, IRS Customer Service, or visit the IRS web site, www.irs.gov for either  form.  

Checking Your Credit Report 

     Check your credit reports before you start mortgage shopping, so that you’ll have time to correct any wrong information that you may find.  Mortgage loan officers can locate your credit report very quickly online, so be sure it’s correct.

     You can order your credit report for a minimal charge from credit bureaus listed in your yellow pages.  Here are the websites for the three main credit-reporting agencies:

Shopping for a Mortgage 

There are important documents to have with you when you interview with mortgage lenders. Possible items to take are:

  • Past three years’ tax returns with W-2 forms or payroll stubs
  • Past years’ profit-and-loss statements if you’re self-employed
  • Social Security cards
  • Driver’s licenses
  • Checking and savings account statements with name of lending institution
  • IRA and retirement account statements
  • Credit card statements
  • Mutual fund and stock statements
  • Documentation of current debts
  • Serial numbers and documentation of any U.S. Savings Bonds
  • Gift letters for down payment money received as a gift
  • Divorce decree and property settlements
  • Military ID or discharge papers
  • Any current mortgage company statements
  • Closing statement on current residence
  • Documentation of timely child support payments (received or paid)
  • Any bankruptcy petition
  • Car loan information

 

Documenting Your Home Purchase for Tax Purposes 

     When is the best time to buy a home?  For tax purposes, the earlier in the year the better.  If you close on your home during January rather than June, you have the advantage of deducting more months of mortgage interest that first year.  Your mortgage company will issue Form 1098, Mortgage Interest Statement, to list the tax-deductible mortgage interest and may also list real estate taxes paid for the year. This statement is to be mailed by January 31st. Keep all tax information in a safe place so that you’ll have it when you file.

     In most cases, homeowners are allowed to deduct all home mortgage interest paid on a loan made to secure a main home or second home.  The mortgage must be a secured debt financed by a mortgage or deed of trust on that property.  The taxpayer must be legally liable for the loan, and file Form 1040, U.S. Individual Income Tax Return, along with Schedule A, Itemized Deductions.

     Besides the mortgage interest, certain closing costs may be deductible, such as “points” paid by both the buyer and seller. Points are considered prepaid interest and are sometimes called loan origination fees. Generally points are deductible over the term of the loan, but home buyers can deduct them in the purchase year if all of the following conditions are met:

  • Taxpayer is legally responsible for the loan
  • Paying “points” is an established business practice in the area
  • Points paid are not more than are generally charged in the area
  • Taxpayer uses the cash method of accounting
  • Points were not paid for items such as appraisal fees, inspection fees, title fees, attorney fees, and property taxes
  • Taxpayer provided funds at closing that were more than the amount of points paid
  • Loan is used to purchase or build main home
  • Points were figured as a percentage of the principal amount of mortgage
  • The amount is clearly shown on the settlement statement as points

Real estate taxes paid on your home are also deductible.

     At your closing, you’ll sign a settlement statement created by the U.S. Department of Housing and Urban Development called a Form HUD-1 Settlement Statement (see example pages 6-7). The Form HUD-1 Settlement Statement shows a detail of monies transferred and paid to complete the real estate property transfer.  It is an important document that needs to be kept for tax purposes. The Form HUD-1 Settlement Statement has two columns: the left side is for the buyer, while the right is for the seller.

     Some items that pertain to your tax return in the year the home is purchased are listed on page 2: item (801) Loan Origination Fee; item (802) Loan Discount or Point(s) paid to secure the mortgage loan on the property, item (901) Prepaid Interest.

Refinancing 

     The current low interest rates have encouraged many homeowners to refinance their home mortgages for a lower payment. Homeowners who refinance their homes this year, and pay “points,”  must deduct them over the life of the loan, NOT all in the year of the refinance.

If the homeowner used part of the proceeds to improve a main residence qualifies, he or she may be able to deduct them in the year paid. Fees charged for specific services, such as preparation costs for a mortgage note, appraisal fees or notary fees are not interest and cannot be deducted. Points paid by the seller of a home cannot be deducted as interest on the seller’s return, but can be claimed as a selling expense which will reduce the amount of gain realized.

Tax Incentives for First-Time Home Buyers

The $8,000 first-time home buyer’s credit has been extended into 2010, and the eligibility criteria has changed so that more homeowners can reap a tax advantage for their home purchases.  “The Worker, Homeownership, and Business Assistance Act of 2009” extended the time for purchases of a new home to May 1, 2010 from December 1, 2009 for this credit, and broadened the pool of those eligible who can benefit.  Here’s what’s changed.  The definition of “new home buyer” now includes people who haven’t owned homes in three years who purchase a new subsequent home before the new deadlines and homeowners who have lived in their homes for five consecutive years out of the last eight years may qualify for a $6,500 credit.  Military members will not be penalized if they claimed the credit, and then have to deploy and sell their home within three years.

To act on this credit, qualified taxpayers must have a purchase contract for a principle residence in force before May 1, 2010 and must close on their home purchases by June 30, 2010.  There’s also an upper limit on the value of the purchases of homes after November 6, 2009 of $800,000 to be eligible for the credit.  The phase out level for the full credit increased for single filers to an annual income of $125,000, and for joint filers to $225,000.  Taxpayers who purchased a home after December 31, 2008 do not have to repay the amount of the credit if they use the home as their principal residence for 36 months.  The $7,500 first-time home buyer’s credit enacted in 2008, functions essentially as a 15 year loan and will require repayment starting with the 2010 tax return. 

Selling The Home 

A home seller who is a single taxpayer may qualify to exclude from income the first $250,000 of profit from the sale of a home he/she has owned and lived in for two of the last five years. (The two years of ownership and occupancy do not have to be consecutive years).  A married couple can exclude the first $500,000 of profit from income if both qualify.

Helpful Online Information 

The Internet is a wonderful resource for valuable information. Many Realtor web sites have online listings that allow “virtual tours” of properties for sale. Here are some web sites that can help you research the various facets of the home buying process:

www.libertytax.com - The official Liberty Tax Service web site.

www.newhomeownerguide.com - A web site with lots of tips on home projects and inexpensive repairs and improvements.  Topics include painting and lawn care, and a new homeowners forum. 

www.realtor.com - A web site that offers tips about finding a realtor, lender, neighborhood, and school district. There’s also a buyer’s guide with 10 steps to homeownership, moving information, mortgage options, and even a relocation wizard to establish a timeline for moving.

www.askthebuilder.com - The official web site of nationally syndicated columnist and builder, Tim Carter, that includes a helpful and thorough checklist for your home inspection.  Most of the information is for those building a new home.

www.move.com - A web site that includes tips on everything from buying your first home to remodeling. It also includes listings of homes for sale and rent.

www.irs.gov -The official IRS web site that has all forms and publications.


These publications may be of particular interest to those interested in buying, selling, or refinancing a home:


Publication 521 Moving Expenses
Publication 523 Selling Your Home
Publication 529 Miscellaneous Deductions
Publication 530 Tax Information for First-Time Homeowners
Publications 553 Highlights of Tax Changes
Publication 936 Home Mortgage Interest Deduction

Here are forms that home buyers and sellers may need:


Form 1040
Schedule A Itemized Deductions
Schedule D Capital Gains and Losses
Form 3903 Moving Expenses
Form 8822 Change of Address
Form 8396 Mortgage Interest Credit

Tax Deductible Moving Expenses

     If you purchase a home and meet distance and time tests relative to the location of your old home and your new job, you may deduct certain moving expenses on your tax return. The costs of renting a moving van, hiring movers, and the cost of gas or the standard mileage rate are examples of moving expenses that may be taken as an adjustment to income. Moving expenses paid by an employer may not be deductible.  The standard mileage rate for moving is 19 cents per mile (before July 1) and 27 cents per mile (after July 1) for 2008. Keep the IRS informed of your most recent address by using the IRS change of address acknowledgment, Form 8822, Change of Address.

Record Keeping For Your Home 

     What documents should you save regarding your home?  It’s very important to keep the Form HUD-1 Settlement Statement from the closing, real estate tax records, mortgage statements, tax returns from the year of the home purchase and any years you claimed expenses for a home office, and the costs of improvements made to your home.  When this primary residence is sold at a later date, the homeowner will need these documents to figure the adjusted basis of the home for tax purposes. 

The basis of the property is generally the cost of the home at the date of the purchase. It includes certain closing costs and improvements. Taxes owed by the seller and paid by the new owner add to the basis. The following settlement fees add to the basis: abstract of title fees, charges for utility installation, legal fees, recording fees, surveys, transfer fees, and title insurance. If the house is new, the basis includes the cost of land, home construction, labor, materials, contractor’s fees, building and legal fees.  From this original dollar figure for the basis, certain improvements and expenditures to the home may increase or decrease the original basis.  This adjusted amount is referred to as the adjusted basis.

What expenses add to a basis?  Improvement costs for the home add to the basis.  Repairs do not.  The IRS defines an improvement as an expense that adds to the value of your home, and “prolongs its useful life.” The IRS defines a repair as “a routine maintenance expense that keeps your home in an ordinary efficient operating condition.”  Here’s the exception: repairs that are part of extensive remodeling may be considered as an improvement. 

Improvements Repairs
Total roof replacement Patching leaks on roof
Electrical rewiring Fixing floors
Installing central air/heat Painting
Installing replacement windows Replacing glass in windows

Certain expenditures may decrease the original home basis.  One example is casualty losses taken on a tax return for home damages. If the taxpayer claims an office in the home, or if the house has been rented, the depreciation deduction also decreases the basis.

Glossary of Terms 

Escrow – Functions as an account to pay taxes and insurance. The homeowner pays into the account that is held by the lender.

Fair Market Value – Normal selling price of a home in the open market that is agreed upon by the buyer and seller. A Realtor can prepare a comparative market analysis of similar properties that are currently on the market, or have sold recently in the area to determine a fair market value.

Form HUD-1 Settlement Statement – The official statement of the U. S. Department of Housing and Urban Development that details all closing costs paid by the buyer and seller. This is completed by the settlement agent and both the buyer and seller must sign it at closing.

Improvements – Home expenditures that prolong the life of your home, such as the cost of total roof replacement.

Points – Charges at closing by lender in increments of 1 per cent of the mortgage amount. They may also be listed as loan origination fees or loan discounts. These may be deductible on the tax return.

Repairs – Expenditures that maintain a home, such as painting the interior.

Tax Questions? Liberty Tax Service Can Help! 

Liberty Tax Service operates 3,000 offices throughout the United States and Canada, and has prepared over 6,000,000 individual income tax returns. The company focuses on computerized income tax preparation, electronic filing and refund loans.  Emphasis on customer service including audit assistance, a money back guarantee and free tax return checking are just a few of the additional services offered by Liberty Tax Service. We provide answers to your tax questions free of charge.  Just call any office. Every fall, Liberty Tax Service offers tax preparation courses that are open to the general public.  Our instructors teach students about all the basics of completing a Form 1040, Form 1040A, and/or Form 1040EZ, as well as all credits and schedules that could apply to an individual tax filing.  Those involved in buying or selling a home will find the lessons that cover sale of personal residence and capital gains helpful.  Some take the course to become more savvy consumers, and to better prepare their own tax returns.  Others enroll and apply for seasonal employment opportunities.  To find out more about tax courses, or to locate the closest Liberty Tax Service office, call (866) 871-1040.