1. Divorce Problem
This problem can result in a major mistake for homeowners. No one should ever get divorced without first understanding this issue.
Here is the problem: If you sell your home to your spouse pursuant to a divorce, your spouse gets no benefit from the purchase. There is no increased basis as a result of the purchase. The buyer gets the original home basis that he or she had prior to the purchase from the spouse. However, the selling spouse gets no taxable income, either.
EXAMPLE: Sam and Jan bought their home for $100,000 many years ago; today, the fair market value is $800,000. Sam and Jane are now getting divorced and pursuant to the divorce, Sam sells his half-interest in the home for $400,000. But even though Jane paid Sam $400,000 for his half of the residence, her basis for all future sales is her original purchase price of $100,000. She gets no benefit from buying the home from Sam. Thus, Sam and Jane should sell their home to a third party and pocket the money. They can then each buy a new home.
2. Deduct Points for the Acquisition or Improvement of a Principal Residence
“Points” are the cost to obtain loans; one point equals one percent of your mortgage. Points are fully deductible if used to finance the purchase or improvement of your principal residence. Thus, if you incur points on financing a new room, these points would be fully deductible.
3. Don’t Forget to Amortize All Other Points
As noted above, any points that you incur for the purchase of improvement of your principal residence are immediately deductible. However, what happens to other types of points? For example, what happens if you incur points to purchase or improve a second home, for the purchase of rental property, or even to refinance a home? These points must be amortized over the life of the loan.
EXAMPLE: John and Kari buy a second home and pay $3600 for a 30-year loan. They must amortize these points over 360 months; in other words, they deduct $10 per month.
4. Deduct All Unamortized Points upon Sale of the Property or upon Refinancing
As you read above, all points incurred to purchase second home and rental property and points incurred on refinancing must be amortized over the life of the loan. However, what happens if you don’t keep the loan for the full loan term?
You might refinance again or sell the property that these points were incurred upon. Should this happen, you get to deduct all unamortized points in the year of sale of the property or the year of refinance of the loan. Thus, in the above example, if you were to keep the loan for two years (thus writing off $240 out of the $3600 in points), the remaining unamortized points get deducted immediately upon refinance or sale of the property, and you would deduct the remaining $3,360 of unamortized points.
Many people forget this because they incurred these points years ago. If you are ever in this situation, go back to your original loan settlement sheet to see if you have any unamortized points.
5. Deduct Any Casualty Losses
If you suffered any uninsured loss on your property that resulted from a sudden, unusual or “act of God” loss, you may take a deduction for this loss subject to certain limitations. A sudden or unusual loss would be a loss due to tornado, flood, earthquake, mudslide, fire, embezzlement, etc. (Slow losses due to rot, rust, termites, etc., are not deemed sudden enough for a deduction as a casualty loss.)
To qualify, the loss must not be covered by insurance, it must exceed a $100 floor (if for non-business), and must exceed 10 percent of your adjusted gross income. Many folks in earthquake-prone zones can claim the loss if they see any structural changes in their foundation after an earthquake. See your accountant about this.
6. Don’t Forget about Mortgage Prepayment Penalties
Various mortgages hit you with a penalty if you prepay your loan (pay ahead of schedule). Many people incur this upon refinancing because they can get a lower rate. These penalties are fully deductible as interest.
7. Deduct Prorated Property Taxes and Any Prorated Interest in the Year of Your Home Purchase
These taxes are usually collected in escrow as part of your closing. Your settlement sheet should show any prorated taxes or interest taken out at closing, based on the number of days of the year that you own the home. Please note, you will not receive an IRS form notifying you of this. You must check your settlement sheets for the year that you buy the property.
By following this list, you won’t miss many of the omitted real estate deductions that people often overlook on their homes.
Subscribe to Networking Times and receive a whole professional journal packed with similar insightful and motivational articles. A subscription to Networking Times includes the following benefits: