There are a number of real estate tax benefits available to homeowners. Retirees, vacation homeowners, fixer-upper aficionados, and many others may be able to realize a tax savings through their home. However, to obtain the most accurate and up-to-date information, consult with your tax advisor as tax laws are subject to change.
When Selling Your Home
When selling your primary residence, most homeowners can avoid paying capital gain taxes. Internal Revenue Code 121 (IRC 121) requires you to have owned and occupied your home for at least two of the previous five years. (The two years do not have to be consecutive.) If you qualify, $250,000 of the sale profits is tax-free for single tax payers and $500,000 for married couples who file jointly. There is no limit to how many times this benefit can be used as long as it is not more frequently than once every two years. For homeowners that have done a number of improvements, these expenditures are taken into account in the calculations, reducing the capital gains and any resulting taxes. In order to fully understand all the components of this benefit, including what are considered allowable improvements, work with you tax advisor.
IRC 121 can be useful for many different situations, such as:
- Retiring on a budget: If you are on a fixed income, consider downsizing. When you sell your home and replace it with something smaller, you will avoid paying capital gains taxes on the profit. These savings can be used to supplement your fixed income.
- Starter home: First-time homebuyers are often limited by what they can afford. A fixer-upper may be their only option. Once they have improved the house and lived in it for at least two years, they can sell if for a profit. Because they won’t have to pay capital gains taxes, for each house they fix up and sell, they will build up their equity faster.
- A vacation home as a tax incentive: If you want to avoid capital gains taxes on a vacation home or second residence, occupy the home as your primary residence for at least two of the five years before the sale. Then when you sell it, the profits will not be taxed.
If you want to buy a home as an investment property, Internal Revenue Code 1031 provides a capital gains tax break for properties other than your personal residence. It allows you to sell one investment property and purchase another as a way to defer capital gains taxes, as long as the new property is of equal or greater value. There are a number of requirements you must meet in order to successfully take advantage of this benefit, such as a six-months transaction window. Because of its complexity and to avoid getting caught by changing tax laws, consult with you tax advisor and/or financial institution before undertaking such an initiative.
Other Tax Benefits
- Also consider these often overlooked tax breaks available to homeowners. Because some of these have complex
- requirements and tax laws are prone to change, be sure to consult your tax advisor first.
- Your mortgage interest and property taxes are deductible for both your primary residence and a second or vacation home.
- Home office expenses can be deductible. If you are self-employed and use your home as your sole, fixed business location, you can deduct a portion of your household expenses (e.g., utilities, homeowner’s insurance, repairs) proportionate to the square footage percentage your business occupies. In order to claim these deductions, you must have a dedicated room or part of a room that is used for no other purpose than for your business. This benefit is also available to full-time employees when they work at home for the convenience of the employer.
- When you rent your second home, you can deduct a variety of expenses depending upon how many days it is rented versus personal use.
- Moving costs are deductible when you change your job and residence location. The distance from your old home to your new job must be at least 50 miles further than the distance from your old home to your old job. You must also be employed at least 39 weeks during the next 52 weeks (not necessarily for the same employer but it must be in the vicinity). Either spouse can qualify.
- Any mortgage prepayment penalty you were charged when selling or refinancing your home can be deducted.
- Mortgage refinance fees are deductible. In the year of a refinance, you can also deduct past loan refinance fees that were never deducted.
- The IRS considers points to be a form of prepaid interest. They can be deducted as long as you itemize your mortgage interest expense on Schedule A. The IRS generally requires that you deduct points over the term of the mortgage loan, unless you meet certain requirements.