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Tax
Breaks For Homeowners |
In
a way, tax planning is a lot like a chess game. Congress or
the economy makes a move, and then it’s your turn. For
example, moving to a new principal residence in 2001 might be
a good idea if you expect to reap a gain on the sale of your
home. That’s because the tax law allows you to receive
— tax-free — up to $250,000 of qualifying gain ($500,000
for married couples). But that’s not the only tax-saving
opportunity your home may offer.
Playing Musical Homes
If both your vacation home and primary residence have appreciated
in value, you may be able to use the hefty capital gains exclusion
— not once but twice — in just over two years. The
rules allow taxpayers to exclude their gain within the above
limits once every two years.
The law changes are especially good news for retirees or empty
nesters wanting to downsize. For example, a couple could sell
their primary residence, excluding up to $500,000 in capital
gains, then move into their vacation home. If they sold it two
or more years later, they could exclude up to another $500,000
in gain on their former vacation home.
You don’t automatically forfeit the exclusion if you move
out of your home and rent it. But it must be your principal
residence for two of the five years preceding the sale. If you
expect your home to increase greatly in value a year or two
after you move, delay the sale. But be sure to sell the home
before the three years’ grace expires or you will entirely
forfeit the gains exclusion. Don’t forget: You must report
gain attributable to depreciation claimed during the rental
period.
Maximize Your Interest Deduction
You may be able to deduct points or prepaid interest in connection
with a mortgage on the purchase of your principal residence.
You can deduct mortgage interest on the first $1 million of
debt incurred to acquire, construct or substantially improve
a qualified residence. You also can deduct interest on $100,000
of home-equity debt, regardless of how you use the funds, but
not for purposes of the alterna-tive minimum tax. Be careful
if you refinance your mortgage — only the amount not exceeding
the current outstanding principal balance will generally qualify
as mortgage debt. But the excess may qualify as home-equity
debt.
Tax Breaks on Vacation Homes
If you want a tax-free sale, keep careful records. You’ll
have to prove that you meet the main home occupancy requirement.
Proof can consist of utility bills, voter and auto registration
and other indications of pri-mary residence. Suppose you sell
your vacation or second home after having lived in it as your
principal residence for an aggregate of at least 24 months over
the past five years. You won’t owe any tax on the first
$250,000 of gain ($500,000 for married cou-ples).
You may not regard your vacation home as a tax shelter while
you own it, but here are four scenarios under which it may provide
annual tax savings:
1) You rent it to paying guests
for fewer than 15 days a year. You owe no tax on the rent and
don’t even have to report it. You can deduct mortgage
interest, property tax and any uninsured casualty loss on Schedule
A.
2) You rent it — or have it
available for rent all year — and you stay there only
for clean-ups and repairs, subtract mortgage interest, property
tax, insurance, utilities, operating expenses, repairs and deprecia-tion
from rental income and report on Schedule E. You’ll probably
have a loss. If your adjusted gross income (AGI) was less than
$100,000 and you "materially partici-pated" in managing
your second home, you can generally deduct up to $25,000 passive
loss from your ordinary income — or an unlimited amount
if you are a real estate professional. This benefit is phased
out when your AGI exceeds $100,000 and is unavailable if your
AGI is $150,000 or more.
3) You use it less than the greater
of 14 days a year or 10% of the rental days during the year.
Your loss deductions (subject to the passive loss rules) are
unlimited.
4) You use it more than the greater
of 14 days or 10% of the rental days. You can’t deduct
any secondary home loss on your tax return. You must report
income and expenses on Schedule, and any resulting loss cannot
shelter ordinary income. Deduct expenses in this order: mortgage
interest, property tax, uninsured casualty losses, operating
expenses and depreciation. But deduct the excess of the first
three items as itemized deductions on Schedule A if their total
exceeds rental income. These items are always deductible.The
excess of other expenses can be carried forward and considered
an expense from the same property next year.
The excess and next year’s expenses will be subject to
the same rules discussed above.
Seek Advice
Obviously, taking full advantage of tax breaks for homeowners
requires careful planning. Please call us for assistance in
plotting your next move. Our experts who specialize in such
matters will be glad to help you.
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