What You Can Expect From Your New Home
When one acquires his or her first new home, there is great expectation of a new income tax deduction. This expectation exists for both single folks and married couples as they wander into the new world of itemized deductions. No more do we get to fill out the short income tax forms, we must now use federal form “schedule A” to get the tax goodies that others have promised. What lies in store for the first time home buyer? What income tax benefits really do exist and how does the first time home buyer go about getting the benefits? This is what we came to discuss and we will not rest until a firm understanding of first time home buying is reached.
Step One-The Settlement
Before moving into a new residence, the all anticipated settlement date must arrive. Are there income tax deductions on the settlement sheet? There certainly could be. If points are paid to obtain financing, these points are income tax deductible and include points paid by the seller. There must be enough money paid by the borrower at settlement to cover the amount of points paid in order to get a current income tax deduction. When seller paid points are taken as a tax deduction, the cost basis of the home must be reduced by the seller paid points. For example, if a new home is purchased for $400,000, and the seller pays one point or $4,000, the buyer can deduct this amount but will reduce the home’s cost basis to $396,000. The deduction of points in the year of settlement is unique to the purchase of a principal residence. Any other purchase of real estate would require the amortization of points to expense over the life of the loan.
Real estate taxes paid at settlement are also deductible. This is the amount on page one of the settlement sheet that reimburses taxes paid by the seller in advance of his leaving the property. Taxes placed in escrow (usually displayed on page two of the settlement sheet) are not currently deductible as settlement expenses but will be deductible when disbursed by escrow. The remaining items on the settlement sheet are not currently deductible and should be capitalized as cost of the residence.
The time of year that settlement on a new residence occurs can have a significant impact on the availability of income tax deductions. For instance, suppose a married couple settles on a new home in December. Because this is their first home, they have not been itemizing deductions but instead have been using the standard deduction of $10,300 (2006 standard deduction for married couples filing a joint return). They will not make their first mortgage payment until January of the next year. Because of this, it is likely that the deductible settlement costs will be of little or no value to the happy home owners. They would have been better off to push settlement over to January and into a year where they would have twelve mortgage payments, real estate taxes, and could make maximum use of deductible settlement costs. Please plan your transaction accordingly.
Going Forward
Looking ahead, the first time home owner can look forward to deducting mortgage interest expense from their income taxes. This is true as long as their original acquisition debt does not exceed $1 million. Real estate taxes will also be deductible providing that the home owner or owners are not in the alternative minimum tax. Assuming that alternative minimum tax does not apply, the first time home buyer can expect to get tax deductions for both the mortgage interest and the real estate taxes paid during the year. It is even possible to get the tax advantages of home ownership immediately by changing withholding allowances. Let’s assume that a single taxpayer will have $20,000 in mortgage interest deductions and $4,000 in real estate taxes. Because this taxpayer’s standard deduction of $5,150 is built in to the tax withholding tables, we know that he can take an additional $18,150 in deductions ($24,000 less the standard deduction of $5,150). In order to get the tax benefit currently, the taxpayer would file a new W-4 form (withholding allowances form) with the payroll department where he works. This taxpayer would be eligible to claim an additional 5 exemptions ($18,150 divided by $3,300 which is the personal exemption allowance) which would thane serve to increase net pay over the upcoming weeks. This process works similarly for married couples except that the standard deduction used for determining additional deductions is $10,300. I should mention this caution. If both husband and wife work, each has a standard deduction built-in to their respective withholding tables. In this case, the amount that is used to calculate excess deductions is $20,600. Don’t forget that other deductions making up itemized deductions include state income taxes withheld or paid, charitable contributions, casualty and theft losses, medical expenses exceeding adjusted gross income limits, and miscellaneous deduction (typically from un-reimbursed employee business expenses). Remember, if a taxpayer is in the alternative minimum tax, there will be no benefit for income and real estate taxes paid and no benefit for miscellaneous itemized deductions. This is supposed to be a simple overview of what a new homeowner can expect in the way of income tax benefits. Unfortunately, nothing is ever really simple.
Ron Piner, CPA
Host of “Better Business”
Saturday Mornings at 10ET
On WBIS AM 1190
www.wbis1190.comwww.mwibonline.com[email protected]
