- The Washington Times - Thursday, April 7, 2005

Complaints about the U.S. tax system are common, but consumers who own or sell a home should know that Internal Revenue Service rules favor homeownership. To be sure, few taxpayers pause to reflect on their gratitude to the government while negotiating the annual maze of tax forms. Yet homeowners’ tax bills can be significantly reduced by deductions associated with their homes.

“There are major tax consequences associated with buying a home, particularly if you are buying a home for the first time,” says Michael Martin, an enrolled agent certified by the IRS and a tax expert with Martin and Associates in Washington.

“When people make the transition from renters to homeowners, they probably will also make the transition from taking the standard deduction to itemizing on their taxes,” he says. “They’ll probably see a reduction in both their federal and state income taxes. Buyers need to throw this into the mix when they think about how much they can afford to pay each month. A $1,200 mortgage payment isn’t necessarily the same as a $1,200 rental payment.”

Workers complete an IRS W-4 form when they begin a job. It declares the number of allowances that will be used to determine the amount of income taxes withheld from each paycheck.

The larger the number of allowances declared, the smaller the amount of income tax that will be withheld. The allowances can be adjusted to change the amount of taxes withheld.

“It’s important to remember this is just a cash-flow situation,” says Bernie Fisken, an enrolled agent certified by the IRS and president of Fisken and Co., a taxation counseling service in Bethesda. “If you underestimate the allowances, you will get a tax refund, but you have to be very cautious. If you go to the extreme and have too little withheld, you can owe substantial taxes.”

The W-4 includes a work sheet, which can be helpful in determining which allowances to take.

“I often run a simplified trial tax return for people to get an estimate of what taxes will need to be paid that year,” Mr. Martin says. “For instance, if they will need to pay $12,000 in taxes, I tell them to make sure that $1,000 is taken out each month from their paycheck.”

Home buyers need to be ready with additional papers from settlement when they prepare their tax returns in the tax year of purchase. Homeowners also will need additional information to compute the deductions associated with their residence.

“The main thing that first-time buyers will need is to keep their HUD-1 statement from their settlement,” says Charles Adams, an enrolled agent certified by the IRS and a certified financial planner with Manna Financial Services in Annandale.

“Their mortgage company will send them a Form 1098 statement, a year-end statement which states how much they paid in mortgage interest and real estate taxes, both of which are deductible on Schedule A,” he says. “But the HUD-1 statement also shows any deductible points they may have paid at settlement, which are often given another name, such as a loan origination fee.”

In Washington, a tax credit is available for buyers who have purchased a home for the first time. According to Mr. Fisken, this credit could be fully deductible or partially reduced — depending on the income of the buyers.

Home buyers also often pay real estate taxes or interest at settlement to cover the period from settlement to the first mortgage payment.

“At least 50 percent of the time, mortgages are sold between the time of settlement and the end of the year,” Mr. Martin says. “Consumers may or may not be receiving a Form 1098 from each company. Consumers need to be careful to check that the information is accurate on these forms and check it against the HUD-1 statement, plus their monthly mortgage statements.”

Homeowners of an owner-occupied home that is their principal place of residence are able to deduct the real estate taxes and mortgage interest from their income tax, but there are different circumstances associated with other types of property.

“Owners of a second home, or vacation home, can also deduct real estate taxes and interest payments as long as the home is not rented out,” Mr. Fisken says. “Owners of investment properties or rental properties which are not owner-occupied must complete Schedule E for rental property.”

“This form requires the owners to list all income from the property, subtract all the operating expenses such as real estate taxes, mortgage interest, insurance, repairs and utilities paid to create a net profit or loss,” he says.

Homeowners who refinance their property need to keep track of the HUD-1 form given to them at the settlement for the new loan to check the real estate taxes and interest paid against the 1098, which will be sent from each mortgage company. Consumers who borrow through a home-equity loan or line of credit also can deduct the interest paid on those loans.

“As long as the loan is secured by the home, the interest paid on a home-equity loan is deductible,” Mr. Adams says.

Consumers sometimes pay points or loan origination fees at settlement for refinancing, but these points are not fully deductible in the tax year of the refinancing, as they are for the initial purchase of a home.

“Points paid during a refinance must be amortized over the length of the loan, usually 15, 20 or 30 years,” Mr. Martin says.

Selling a home also has tax consequences, and educated consumers will have been preparing for the sale of their home since the day of purchase.

“Homeowners should have been keeping a folder for the entire length of their ownership, which documents any permanent type of repairs or improvements to the property, including things like driveway resurfacing and landscaping,” Mr. Adams says. “Owners should be aware of maintenance issues to be sure they have a salable property down the road.”

Sellers need to have a record of the price they paid for their home, along with the HUD-1 statement from the sale.

“The new rules on the profit from a home sale are very liberal,” Mr. Martin says. “Now sellers can exclude up to $250,000 if they are single and up to $500,000 if they are married filing a joint return on the profit from the home sale.”

“To determine the profit from the house,” he says, “sellers will need to take the sales price of the home, subtract the cost of sale — including the commission paid to the Realtor and any fixing-up costs — and subtract the original cost of the house and the cost of improvements to the home.”

Mr. Fisken points out that the capital-gains exclusion for the sale of the home is available only for owner-occupied property that has been lived in for two of the past five years. The exclusion is not available for investment or rental property.

Although the IRS has information for taxpayers related to buying, refinancing and selling a home, consumers might want to consult an accountant or tax preparer to be sure they are preparing their returns correctly.

“If you come across anything of a technical nature in the tax world, it’s best to consult a professional,” Mr. Adams says.

More info —

For assistance in finding a tax consultant or preparer, visit the National Association of Enrolled Agents’ Web site (www.naea.org). Specialists are certified by the Internal Revenue Service and can be located by ZIP code.

The IRS Web site (www.irs.gov) includes downloadable publications that advise consumers of the tax laws.

• Publication 523: Selling Your Home.

• Publication 527: Residential Rental Property.

• Publication 530: Tax Information for First-Time Homeowners.

• Publication 936: Home Mortgage Interest Deduction.

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