Mortgage Interest Deduction Overview
The IRS states that mortgage interest on "qualified homes" is exempt from tax under most circumstances. According to the IRS, a "qualified home" is defined as a primary or secondary home. It can be a house, condo, cooperative, mobile home, or boat with sleeping, cooking, and toilet facilities.
The Place You Live Most Of Your Time Is Considered The Main Home. The IRS Has Provided Two Definitions Of Second Homes:
A Second Home That Isn't Rented Out:
If it isn't up for rent or sale during the year, you can consider it a qualified home. You don't necessarily need to use the home during the year.
A Second Home That Is Rented:
If the home is rented for part of the calendar year, it must be used as a residence for the remainder of that calendar year. The minimum time the home is used must be 14 days or 10% of the total days the property is rented. The IRS will classify the property as a rental property if it isn't used for a sufficient time.
A secured property loan is one that places a lien on the property, such as a loan, trust deed, or land contract, to pay mortgage interest.
This Includes Any Loan That Is Used To Buy A Home, A Secondary Mortgage, Or A Line Credit, As Long As The Loan Does Not Meet One Of These Exceptions:
To Itemize Deductions, You Must File IRS Form 1040 With Schedule A.
You Took Out A Mortgage On Or Before October 13, 1987:
This debt can be deductible because it is "grandfathered."
Mortgage Loans After Oct.13, 1987:
Mortgage loan amounts can be limited to $1 million ($500,000 if married filing separate) to "acquisition debt," which can be used to purchase, build, or improve your home.
Mortgage Loans After October 13, 1987:
Mortgage loan amounts are limited to $100,000 (or $50,000 if married filing separately). This is for "home equity debt," which can be used to purchase, build, or improve the property. The total liens attached to the property cannot exceed its fair market value.
Rent Property: Mortgage Interest Deduction
The rental property interest deduction is used to offset any rental income claimed. This contrasts with the mortgage interest deduction for "qualified homes," which is an itemized deduction.
Two Types Of Investors May Be Affected By The Rental Property Interest Deduction According To The IRS:
Active Income From Real Estate Investment:
Real estate professionals are those who meet the IRS definition. You must work at least 750 hours a year in the realty industry to meet this requirement. Professionals are paid employees who own at most 5 percent of a real-estate business. A real estate professional is someone who works full-time as a developer on your own account or as a full-time agent for a commission-only real estate company. These two situations allow you to use income from other real estate businesses to offset losses you have made on your investments.
Other Than Real Estate Professionals:
If you manage rental real estate properties but aren't a real estate agent, your income qualifies for passive income. You might be eligible to claim part of losses against your active income. You can claim losses up to $25,000 per year as an individual, a married couple filing jointly, or $12,500 as a married couple filing separately if your adjusted gross earnings as a married couple exceed $100,000 or $50,000 if you file separately. Your AGI will be higher than the threshold, and the amount of loss you can claim is reduced by 50 cents per dollar of income. Passive income cannot be claimed against other income if you have an AGI above $150,000 or $75,000 for married filing separately.
You don't need to be eligible for itemization to get the rental property deduction. It is also not subject to the maximum loan amount that can be placed on "qualified" properties.
Closing Costs/Points Deduction
Primary Or Second Home:
Third-party closing costs, such as title insurance, appraisal fees, and recording fees, are generally not tax-deductible. However, you may deduct origination fees and/or discount points if they are considered prepaid interest.
The Deduction Can Be Made In The Year They Occur If The Following Conditions Are Met:
In the region where the loan was made, paying points has been a long-standing business practice.
The points paid were no more than those generally charged in the area.
Cash accounting is used. This means that income is reported in the year it is received, and expenses are deducted in the year they are paid. This is the most common method used by individuals.
The points were not paid to replace amounts that are normally listed separately on the settlement statement, such as title fees, appraisal fees, title fees, and property taxes.
You provided funds at closing or before and any points paid by the seller that were at least equal to the points charged. You are not required to apply the funds to the points. You can include a downpayment, an escrow or earnest deposit, and any other funds that you have paid before closing. These funds cannot be borrowed from your mortgage broker or lender.
You provided funds at closing or before and any points paid by the seller that were at least equal to the points charged. You are not required to apply the funds to the points. You can include a downpayment, an escrow payment, earnest money, or any other funds that you have paid before closing. These funds cannot be borrowed from your mortgage broker or lender.
Your loan can be used to purchase or build your primary home.
Points were calculated as a percentage of the principal amount of the mortgage.
As points for the mortgage, the amount will be clearly indicated on the settlement statement (such as the Settlement Statement Form HUD-1). Points may be paid from your funds or the seller.
If you pass all these requirements, you have the option to deduct the points completely in the year you paid them or over the term of your loan.
Loan For Home Improvement:
If you pass all six tests, you can deduct the number of points paid in the previous year.
Refinance:
Generally, the points paid to refinance your mortgage are not deductible in their entirety in the year they are paid. This applies even if your primary home is used to secure the mortgage.
Second-Home:
The year you pay points on second-home loans is not enough to fully deduct the amount. These points can only be deducted over the term of the loan.
Rental Property:
Third-party closing expenses are not tax-deductible, just as primary and secondary homes. However, spread over the loan's life, origination fees/discount point are deductible (same for second homes).
Deductions For Property Taxes, Hazard Insurance, And Mortgage Insurance
Real estate property taxes paid for "qualified houses" are exempt from tax. They can be deducted as itemized deductions in the same year they are paid (like mortgage interest). In addition, they can be deducted from rental income, just like mortgage interest, to reduce passive gains.
Homeowners insurance, also known as Hazard Insurance (homeowners insurance), is not deductible for "qualified homes" but is considered an expense that is completely deductible for rental properties.
Mortgage Insurance: Primary Property
Premiums paid by borrowers to ensure their mortgages are exempt from tax (as an itemized deduction).
A household with an adjusted gross income (AIG) below $100,000 will be eligible to deduct 100 percent of their mortgage insurance premiums. However, for every $1,000 additional in adjusted household income, the deduction is reduced by 10 percent. The deduction will be phased out after $109,000.
Separate returns filed by married individuals with adjusted gross incomes below $50,000 will allow them to deduct 50% of their mortgage insurance premiums. For every $500 additional in adjusted gross income, the deduction is reduced by 5%. The deduction will be phased out after $54,500.
For second homes and rental properties, mortgage insurance does not cover a deductible.
Federal Income Tax Credits To Energy Home Improvements
Installing qualified energy-generating equipment is one of the best ways you can lower your taxes.
A federal tax credit can be applied to 30 percent of the price of qualifying geothermal heat pumps, solar water heaters, and solar panels. This credit is available for new or existing construction homes through December 31, 2016. The credit is not available for fuel cells, which must be installed in your primary residence to be eligible. However, it can be used for items that are installed in vacation or second homes. The credit is not available for rental properties.
The credit of 30% applies to the total cost, including labor, installation, and fuel cell costs. There is no maximum limit. For example, if you buy and install a small wind turbine for $10,000, you will get a $3,000 tax credit. This does not include future savings on your electric bills.
To qualify, the tax credit must be claimed in the tax year in which the item was put in service.
Capital Gain Exclusion
You may be eligible to exempt the profit you make from the sale of your primary residence. This is how it works.
$250,000 Exclusion From The Sale Of A Main House
A person can exempt up to $250,000 from the sale or $500,000 for married couples filing jointly if they have lived in the house for at least two years. These two years don't have to be consecutive. However, you must have lived in the house at least 24 hours in the five years preceding the sale. This means that the house must be your primary residence. This rule can be used to exempt your profits from any sale or exchange of your primary residence. The exclusion is generally only available once every two years. Some exceptions do apply.
Exceptions From The 2 Out 5 Year Rule
You may be eligible to exclude some of the gains if you live in your home for less than 24 months. You could make exceptions if your home was sold because your job moved, for health reasons, or because of some other unforeseeable circumstance.
1. Change In Place Of Your Job
If you have lived in your home for less than two years, you may be able to exclude some of the gains from the sale of your house. This exception applies if your job has changed or you move to a different location.
2. Health Concerns
You should prepare a letter from your doctor if you're selling your house to cover medical reasons. This letter doesn't need to be submitted with your tax return. Instead, keep the documentation in your records for future reference.
3. Unforeseen Circumstances
You should be prepared to explain why you are selling your house due to unforeseen circumstances. The IRS defines an unforeseen circumstance as "an occurrence that you cannot reasonably have anticipated prior to buying and occupying your primary residence."
Natural disasters
War acts
Terrorist acts
You are unable to pay basic living expenses because of a change in your employment or unemployment
Death
Divorce
Separation
Multiple births in the same pregnancy
Partial Exclusion
If you sell your home, live in it for less than two years, or meet one of these exceptions, you can exclude a portion. Your time in your home determines how much you are exempt.
Add up the months that you have lived in your house. Divide that number by 24. Divide that number by 24. Next, multiply this ratio with $250,000 (if you are not married) or $500,000 (if you are married). This is how much gain you can subtract from your taxable income.
Example: Let's say you are unmarried and lived in your home for 12 months. Your employer requested that you move to another office. Your partial exclusion is calculated as 12 months divided by 24 months (for a ratio equal to.50) times the maximum exclusion of $250,000. You can exclude as much as $125,000 of your gain. You can exclude any gain greater than $125,000 if your taxable income is less than $125,000. Therefore, your gain of less than $125,000 can be excluded from your taxable income.
This capital gain exclusion is available for second homes and rental properties.