E-Newsletter: Tax Law

Tax Issues for Homeowners

Home ownership brings a number of additional tax issues and benefits for taxpayers to consider. If a taxpayer has a mortgage on his or her home and is paying mortgage interest, the amount of interest paid is deductible, subject to certain limitations if the taxpayer reaches a certain level of adjusted gross income. The sale of a home has tax implications as well. In addition, if a taxpayer owns a second home that he or she rents out, there are additional tax issues to consider.

Mortgage Interest Deduction

Taxpayers who itemize deductions may be able to deduct home mortgage interest paid during the year, subject to limitations based on adjusted gross income. Home mortgage interest is interest that is paid on a loan secured by a taxpayer's main home or second home. The loan can be a mortgage to buy a home, a second mortgage, a home equity loan or a line of credit. A taxpayer who pays more than $600 of mortgage interest during the year receives a Form 1098 from the mortgage holder. Form 1098 shows the total interest paid during the year and any mortgage insurance premiums paid.

Property Taxes

Taxes on real property, generally based on property value, are typically assessed by local governments. Property taxes are also referred to as real estate taxes and are deductible. Thus, if a taxpayer owns a home in a city and must pay real estate taxes to the city, the amount of those taxes can be deducted on the taxpayer's income tax return.

Home Office Deduction

If a taxpayer works from home, he or she may be able to deduct certain expenses attributable to the business use of the home under section 280A of the Internal Revenue Code (IRC). A taxpayer can deduct expenses related to the business use of his or her home if part of the home is used exclusively and regularly as a principle place of business for any trade or business; as a place of business that the individual uses in the normal course of his or her trade or business to meet with clients, customers or patients; or if a separate structure on the property is used, it is used in connection with the taxpayer’s trade or business.

If the taxpayer works for a company or other business as an employee (and he or she is not self-employed), the business use of his or her home must be for the convenience of the employer. To be deductible, it is insufficient if the home office is merely helpful to the employer.

Sale of a Residence

Taxpayers may be able to exclude all or part of any gain from the sale of their main home from income. The main home is the one in which the taxpayer lives most of the time. To exclude the gain from income, the taxpayer must have owned the home for at least two years during the five-year period ending on the date of the sale (the ownership test) and lived in the home as the main home for at least two years during the five-year period ending on the date of the sale (the use test). A taxpayer can exclude up to $250,000 ($500,000 for a joint return) of gain on the sale of his or her main home. If a taxpayer's gain on the sale of his or her main home is less than this amount, there is no need to report the sale on a tax return. Any gain in excess of this amount is taxable and must be reported on Schedule D of Form 1040. Taxpayers cannot deduct any losses from the sale of their main homes.

Rental Income and Deductions for Vacation Homes

Under section 61(a)(5) of the IRC, rent is included in the definition of gross income. Therefore, money that a taxpayer receives from the rental of a vacation home is income that is subject to the federal income tax. In addition, under section 280A of the IRC, a taxpayer is generally entitled to deductions for expenses related to the rental of a vacation home that is also used as a residence. The expenses that a taxpayer is permitted to deduct depend on the number of days that the vacation home is rented and the number of days it is used as a personal residence. If a vacation home is rented for less than 15 days during the taxable year, the taxpayer is not allowed to take any deductions for the rental of the home and the rental income is not included in the taxpayer’s gross income.

Preparing for a Meeting with Your Tax Attorney

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Preparing for a Meeting with your Tax Attorney

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