Tax Issues
What are property taxes and how much should I expect to pay?
When you buy and own a home, your local government (typically through what is called a County Tax Collector's office) sends you an annual or semi-annual, lump-sum bill for property taxes. Receiving this bill and paying it are never much fun because most communities bill you just once or twice per year.
Property taxes are typically based on the value of a property. Although an average property tax rate is about 1.5 percent of the purchase price of the property per year, you should understand what the exact rate is in your area. You can call the Tax Collector's office in the town where you're contemplating buying a home and ask what the property tax rate is and what additional fees and assessments may apply.
The current owner's taxes may very well be based upon an outdated and much lower property valuation. Real estate listings may contain information as to what the current property owner is paying in taxes. Your property taxes (if you buy the home) will probably be recalculated based upon the price you paid for the property.
If you make a small down payment (typically defined as less than 20 percent of the purchase price), many lenders insist upon property tax and insurance impound accounts. These accounts require you to pay your property taxes and insurance to the lender each month along with your mortgage payment.
Are mortgage interest and property taxes allowable deductions on my income tax return?
One of the treasures of homeownership is that the IRS and most state governments allow you to deduct, within certain limits, mortgage interest and property taxes when you file your annual income tax return. When you file your Federal IRS Form 1040, the mortgage interest and property taxes on your home are itemized deductions.
On mortgage loans now taken out, you may deduct the interest on the first $1,000,000 of debt as well as all of the property taxes. The good folks at the IRS also allow you to deduct the interest costs on a home equity loan (second mortgage) to a maximum of $100,000 borrowed.
Just because mortgage interest and property taxes are allowable deductions on your income tax return does not mean that the government is literally paying for these items for you. Consider that, when you earn a dollar of income and must pay income tax on that dollar, you don't pay the entire dollar back to the government in taxes. The amount of taxes you pay on that dollar is determined by your tax bracket.
Are there tax benefits I should be aware of when selling my home?
When you go to sell your home someday, the IRS allows you to deduct home improvement costs from your profits before paying taxes on them. To take advantage of this, it is in your interest to track the amount that you spend on improvements. IRS home sale tax rules also enable qualifying taxpayers to exclude from federal taxation a large chunk of profit -- up to $250,000 for single taxpayers, $500,000 for married couples filing jointly.
For tax purposes, at the time of sale the IRS enables you to deduct the cost of improvements but not money spent on maintenance. What's the difference? Well there is a difference but, as with all matters on which the IRS has an opinion, that difference isn't always crystal clear.
Capital improvements are things that you do to your home that permanently increase its value and lengthen its life. Capital improvements include such things as landscaping your yard, adding a deck, purchasing new appliances (as long as you leave them when you sell), installing a new heating system or roof, remodeling and adding rooms, and so on.
Maintenance and repair expenses, in contrast, include those types of fix-up items that need to be done throughout your home from time to time. Maintenance and repairs include such things as fixing a leaky pipe or toilet, painting, paying someone to cut your lawn and pull weeds, and the like.
So, when you buy a home, keep handy a file folder into which you can dump receipts for your home improvement expenditures. If you're in doubt as to whether an expense is an improvement or a maintenance item, keep the receipt and figure it out when the time comes to sell your home.
How much should I expect to spend each year on the maintenance of my home?
As a rule of thumb, expect to spend about 1 percent of the purchase price of your home each year on maintenance. Although some years you may spend less, other years you may spend more. When your home's roof goes, for example, replacing it may cost you several years' worth of your budgeted maintenance expenses. With some types of housing, such as condominiums, you actually pay monthly dues into a homeowners association, which takes care of the maintenance for the complex. In that case, you're only responsible for maintaining the interior of your unit. Check with the association in buildings where you might buy a unit to see what the dues are running and whether any new assessments are planned for future repairs.
In addition to necessary maintenance, you should also be aware of what you may spend on nonessential home improvements.
Are points tax deductible?
When you buy a home, the points are tax-deductible -- you get to claim them as an itemized expense on Schedule A of your IRS Form 1040. When you refinance, in contrast, the points must be spread out for tax purposes and deducted over the life of the new loan.
Should I keep the final closing statement for tax purposes?
The final closing statement is extremely important. Keep a copy for your files -- it will come in handy when the time comes to complete your annual income tax return. Some expenses (such as loan origination fees and property tax payments) are tax deductible. Furthermore, the closing statement establishes your initial tax (cost) basis in the property. When you're ready to sell your property, you may owe capital gains tax on any profit you've made by selling the property for more than your cost basis.
What are real estate property taxes based upon?
In most communities, real estate property taxes are based upon an estimate of your home's value. If home prices have dropped since you bought your home, you may be able to appeal your assessment and enjoy a reduction in the property taxes that you're required to pay.
Why should I keep the receipts related to the improvement of my home?
Sooner or later, you will spend money on your home. Some of what you spend money for should be tracked and documented for tax purposes in order to minimize the capital gain that you may owe tax on in the future. Capital gain simply means the difference between what you receive for the house when you sell it less what it cost you to buy the house -- with one important modification. The IRS allows you to add the cost of improvements to the original cost of your home in order to calculate what's known as your adjusted-cost basis.
Capital Gain = Net Sale Price - (Purchase Price + Capital Improvements)
For example, if you buy your home for $150,000 and, over the years, it appreciates so that (after paying the costs of selling) your net selling price is $200,000, your capital gain is $50,000. Remember, though, that the IRS allows you to add the value of the capital improvements that you make to your home to your purchase price.
A capital improvement is defined as money you spend on your home that permanently increases its value and useful life -- putting a new roof on your house, for example, rather than just patching the existing roof. So if you made $10,000 worth of improvements on the home you bought for $150,000, your capital gain would be reduced to $40,000. Money spent on maintenance, such as fixing a leaky pipe or replacing broken windows, is not added to your cost basis.
Before you sell your home, please be sure to understand the tax consequences of such a transaction. Many homeowners are eligible to shelter a large chunk of their home's capital gain from taxation when the time comes for them to sell.
