A home is the single most valuable asset in many people’s possession. So it’s important to always remain aware of the tax impact of home ownership. The good news is that, at each of the three general stages of owning a home, an important tax break is available:
1. Buying/owning: Mortgage interest deductions. One of the biggest tax perks of buying a home is the ability to deduct your mortgage interest payments. So be sure to carefully track the debt you incur to buy, build or improve your home — known as “acquisition indebtedness.”
Generally, taxpayers may deduct the interest on up to $1 million in acquisition indebtedness on their principal residence and a second residence. Plus, you may be able to write off interest on an additional $100,000 in home equity debt (known as “equity indebtedness”).
In the past, the IRS has challenged some equity indebtedness claims where the debt was used to acquire the home. But more recent U.S. Tax Court decisions have bolstered confidence that most taxpayers should be able to deduct interest on the full $1.1 million amount.
2. Improving: Energy-related incentives. The American Taxpayer Relief Act of 2012 (ATRA) passed back in January included some provisions of which every homeowner should be aware.
Under the act, a homeowner may claim a 10% credit for energy-efficient improvements to the home, up to $500 in 2013 (reduced by any credits claimed in previous years) for qualifying purchases and installation costs. Eligible thermal replacement windows and skylights installed may account for up to $200 of this amount.
3. Selling: The home sale exclusion. Taxpayers may exclude up to $250,000 ($500,000 for married couples) in capital gains on the sale of a principal residence (including condominiums, manufactured or modular homes, recreational vehicles, and even houseboats), subject to certain limitations.
To be eligible, you must have owned the residence for at least two years, used it as a principal residence for two of the five years preceding the sale, and not have claimed the home sale exclusion within the last two years. If you’re forced to sell your home in less than two years because of an unexpected life change (such as death, loss of employment or a natural disaster), you may be allowed a pro-rata exclusion amount based on how long you’ve lived in the home.
One interesting, recent twist on this tax break: Gains eligible for the $250,000 home sale gain exclusion are also excluded from the new 3.8% Medicare contribution tax on net investment income brought about by the health care act.