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New laws in the past few years have brought several new tax breaks for homeowners, and taken one away. These include:
Read on to learn about these new tax breaks and determine whether any are available to you. (To learn about long-standing tax breaks for homeowners, read Nolo's article Your Home as a Tax Shelter: Top Ten Tax Deductions for Owning Your Home.)
The Energy Policy Act of 2005 provided a permanent tax credit (beginning in 2006) for homeowners who install photovoltaic systems to generate electricity. The tax credit is worth 30% of the cost of the system, up to $2,000. The same permanent tax credit is available for a solar water heater, provided the heater is not used to heat a pool or hot tub. Those who install a fuel cell system to generate electricity get a tax credit that amounts to 30% of the cost, up to $1,000 per kilowatt of power generated. Taxpayers can claim the credits on IRS Form 5695 Residential Energy Credits, available from the IRS website at www.irs.gov.
Unfortunately, tax credits for qualifying energy efficient home improvements, HVAC (heating ventilation air conditioning) equipment, roofing, doors, windows, and major appliances, expired in 2007 after a two-year run.
Ordinarily, debt that is forviven by the lender is counted as income to the person who is no longer required to repay the debt. Under the Mortgage Forgiveness Debt Relief Act of 2007, homeowners whose lenders have "forgiven" their mortgage debt receive a tax break -- the amount of the forgiven debt is not counted as income for tax purposes. The law applies to the 2007, 2008, and 2009 tax years.
The old law. Lenders sometimes allow homeowners who are defaulting on their mortgage to forgo payment of a portion of that mortgage -- for example, the lender might restructure a loan for less than the amount owed or permit a short sale, in which the homeowner sells his or her home for less than what is owed on the mortgage. Previously, when a lender "forgave" part of the homeowner's mortgage, the IRS treated this forgiven debt as taxable income.
The new law. Under the new law, debt that is forgiven by your mortgage lender does not count as taxable income by the IRS. There are some limits. The amount of forgiven debt that does not count as income is capped at $2 million. And the exclusion is only available for loans used to buy, build, or substantially improve a principal residence. Vacation homes, investment properties, and other second homes don't qualify.
The Housing and Economic Recovery Act of 2008 (enacted in July 2008) aimed to bring some relief to the housing crisis. Among its provisions is a tax credit of up to $7,500 for some first-time home buyers.
Definition of first-time homebuyer. For purposes of the tax credit, "first-time homebuyer" means someone who has not owned a principal residence (that means a home you live in) for the past three years. For married couples, the test applies to both -- neither can have owned a home within the previous three years.
Eligible home purchases. The tax credit is available for homes bought on or after April 9, 2008 and before July 1, 2009.
Determining the amount of the tax credit. The tax credit is 10% of the purchase price, but is capped at $7,500.
Income eligibility for the tax credit. You are eligible for the full tax credit if:
You may be eligible for a partial tax credit if:
If you are married but file a "married filing separately" tax return, each spouse can claim a credit of $3,750.
The credit is a no-interest loan. The credit is actually a no-interest loan that must be repaid over 15 years, beginning two years after receiving the credit. If the home is sold within 15 years, the balance of the tax credit payback is due, unless the sale will not result in any capital gain. In that case, the amount still due to pay back the tax credit is forgiven.
The Mortgage Forgiveness Debt Relief Act of 2007 also extended a tax deduction for private mortgage insurance (PMI) that was set to expire in 2007. The extension allows eligible homeowners to deduct the cost of their mortgage insurance premiums for three more years, through 2010.
What is mortgage insurance? Lenders require borrowers to purchase PMI if the borrower's down payment is less than 20 percent of the purchase price and other loans are not used to make up the difference. The reason is that mortgages with down payments of less than 20 percent are deemed riskier than loans with larger down payments. Although the mortgage insurance protects the lender, the homeowner must pay the premiums, which average $50 to $100 a month for a median-priced home.
Who qualifies for the deduction? Homeowners that are families with an adjusted gross income of $100,000 or less qualify for the deduction. Families with incomes up to $109,000 are eligible for a partial deduction. To learn more about this deduction, read the IRS's publications Home Mortgage Interest Deduction and Publication 53: Tax Information For First-Time Homeowners, available from the IRS website at www.irs.gov.
The same law that gives first-time homebuyers some tax relief also takes away a tax break previously enjoyed by second home owners.
Under current law, married homeowners can exclude from taxation up to $500,000 in gains from a home sale, provided the property was the primary residence for two out of the previous five years. The maximum exclusion for a single person is $250,000. Vacation and rental property owners can legally double dip the exclusion by first selling their primary residence and avoiding tax on the capital gain. Then, after moving into the second home for two years to qualify it as their primary residence, they can sell the home and avoid paying taxes on the full amount of the capital gains earned on the second home.
This double dipping ended on January 1, 2009. After that date, if you live in a home that was previously a vacation or rental home, you do not get tax relief on the capital gains earned while you did not live in the home. You can, however, get tax relief on the capital gains earned while you are using that home as your primary residence.
Example: Bob owns a vacation home for ten years. During the last two years of his ownership, he uses the vacation home as his primary residence. He sells the home and gets a $100,000 gain. Under the new law, $80,000 of that gain would be subject to capital gains tax (equal to the eight years the property served as a vacation home). The remaining $20,000 would qualify for the tax exclusion (equal to the two years he used the home as his primary residence).
Home owners who moved into their vacation home before the end of 2008 will still be eligible for the benefits of the old law. For more information, see IRS Publication 523, Selling Your Home, available from the IRS website at www.irs.gov.
To learn more about tax credits and deductions for homeowners, and how to keep your property tax bill low, get The Essential Guide for First-Time Homeowners: Maximize Your Investment & Enjoy Your New Home , by Ilona Bray and Alayna Schroeder (Nolo).
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