Tax Time Again

Tax Time Again
What about housing deductions?
For those of us who own homes, and are preparing to file our 2005 tax returns, here is a list of the itemized tax deductions available to most homeowners:
· Mortgage Interest. Interest on mortgage loans on a first or second home is fully deductible, subject to the following limitations: acquisition loans up to $1 million, and home equity loans up to $100,000. If you are married, but file separately, the limits are split in half.
The concept of an acquisition loan is very important, and has confused -- and even trapped -- a large number of homeowners. To qualify for such a loan, you must buy, construct or substantially improve your home. If you refinance for more than the outstanding indebtedness, the excess amount does not qualify as an acquisition loan unless you use all of the excess to improve your home. However, any other excess may qualify as a home equity loan. As this column has reported in the past, both the IRS and this columnist do not support loans which exceed the total equity in your house. It is too dangerous a risk to take, with perhaps your most valuable asset.
Let us look at this example: Several years ago, you purchased your house for $180,000 and obtained a mortgage (or deed of trust) in the amount of $130,000. Last year, your mortgage indebtedness had been reduced to $120,000, but because the market dramatically increased, your house was worth $300,000.
Because you wanted to pull out some cash from the equity in your home, you refinanced and were able to get a new mortgage of $200,000. For tax purposes, your acquisition indebtedness is $120,000 (i.e. the amount of your existing loan). The additional $80,000 that you took out of your equity does not qualify as acquisition indebtedness, but since it is under $100,000, it qualifies as a home equity loan.
Several years ago, the Internal Revenue Service ruled that one does not have to take out a separate home equity loan to qualify for this aspect of the tax deduction. However, if you would have borrowed $225,000, you are only able to deduct interest on $220,000 of your loan -- the $120,000 acquisition indebtedness, plus the $100,000 home equity.
The remaining interest is treated as personal interest, and is not deductible.
You should also note that for all practical purposes, there are no restrictions on the use of the money obtained from a home equity loan. You no longer have to justify your loan as meeting certain educational or medical requirements.
· Taxes. Property taxes, both state and local, can be deducted. However, it should be noted that real estate taxes are only deductible in the year they are actually paid to the government. Thus, if last year you escrowed monies with your lender for taxes to be paid in 2006, you cannot take a deduction for these taxes when you file your 2005 return.
However, if you bought a house last year, you may have reimbursed your seller for a portion of the prepaid taxes through the end of 2005. (My note: In Ohio property taxes are rarely prepaid. Normally the seller reimburses the buyer at closing for unpaid taxes. This is reflected on both the buyers’ and sellers’ HUD-1 statements). Review your settlement sheet carefully. Line 106 on page 1 of that statement should reflect this tax adjustment. Since this was a current payment by you for real estate taxes, it is a deductible item (My note: refers again to buyer reimbursing seller). Indeed, when you receive your annual statement from your lender showing the amount of taxes paid last year, that may not be included in that statement. Lenders are required to send these annual statements to borrowers by the end of January of each year, reflecting interest and taxes paid for the previous year. (My Note: If you received a credit from the seller, you may not be able to deduct that portion of your payment, as it was reimbursed to you).
· Points. When you obtain a mortgage loan, you often have to pay one or more points to get that loan. Whether referred to as "loan origination fees," "premium charges," or "discounts," they are still points. Each point is one percent of the amount borrowed; if you obtain a loan of $250,000, each point will cost you $2,500.00. (A buyer can normally deduct points paid whether paid by the buyer or by the seller. The seller cannot deduct points paid for the buyer during the year that payment was made, but can handle it on a longer term write off).

The above was extracted from the original article as published January 16, 2006 in Realty Times
Housing Counsel: Income Tax 101by Benny L. Kass