More than one kind of shelter
Tax breaks can soften the punch of that monthly mortgage bill
Newlyweds Michelle and Ryan Shelley are struggling to cover close to $3,000 in monthly expenses on their new $405,000 house in Moorpark, Calif.--more than twice what they paid in rent on an apartment. But the couple is getting help from their uncle. Uncle Sam, that is.
Federal tax deductions for the payment of home mortgage interest and real-estate tax will save about $6,288 in tax this year for the Shelleys, equal to a $524-a-month cut in their housing cost. (Those deductions will also save about $2,033 in state income tax.) "Every time we make a payment, we know we will get some of it back from the government," says Ryan, 25, a Web developer at healthcare insurer WellPoint. Michelle, also 25, is a forensics expert at the Santa Barbara sheriff's department. Without the house, the couple would have claimed a $9,700 fixed-amount standard deduction when filing their tax return. Now, they can claim a higher amount by itemizing tax-deductible spending.
"Homeownership is substantially subsidized by the tax system," says Gerald Robinson, an attorney and author of Homeowner's Tax Breaks . "These are immense incentives a renter doesn't get."
An even bigger bonus comes when you sell a house. Up to $250,000 of profit can permanently escape income tax, $500,000 for a couple. You can use the exemption time and again as you shift residences, but you must generally live in one place at least two years. For some people, the exemption is an incentive to cash in on a tax-free sale when their untapped gain hits the cap. But overshooting the cap may not be a big deal, assuming no future tax boost. The excess now typically faces a capital-gains tax of only 15 percent.
As sacred as the tax breaks can be, they aren't unlimited. Home buyers can deduct interest on no more than $1 million of mortgage debt. Interest can be deducted on home-equity loans that let you borrow against a home's value, but only on loans up to $100,000. And in today's overheated market, exceeding the cap on tax-free profit isn't uncommon. Higher-income people may face limits on their deductions, and the alternative minimum tax may bite. Still, it's often possible to squeeze more than you might expect from what financial planner Rob Johanson of NBS Financial Services in Westlake Village, Calif., calls "one of the most favored investments you can make."
Don't think of a home as just a house. Condos and co-ops also qualify for the breaks--as can a boat, mobile home, or RV with live-in facilities.
Only profit from the sale of a primary home qualifies as tax exempt, but people who have another home can get double duty from the break. They can move into the second home full time for at least two years after selling their main home. That can make the second home primary and qualify it for the profit exclusion when it is sold.
The mortgage deduction can cover combined interest on two homes. But there's a twist on points, the lump sum often charged when getting a loan. When you buy a principal residence, you can deduct the points paid in the year of purchase. But points to finance a secondary residence must be deducted over the term of the mortgage. That's also generally true for points to refinance a mortgage.
Tip: If deducting points gradually, don't forget the undeducted amount if you refinance the mortgage again or sell the second home. The leftover sum is fully deductible at that time.
Local property tax is deductible even when you own multiple homes, but don't lose out after a sale. You can claim a deduction for part of a year, typically allocated at the closing.
Unexpected sale? An exemption from tax on profit can't be claimed more than once in two years, but there are waivers for situations that may force an earlier move. Among them are medical problems, a job change, and a financial setback. And, because a house should also be a home--to get more space after the birth of twins.
This story appears in the December 6, 2004 print edition of U.S. News & World Report.
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