Giant Tax Write-Offs When You Sell Your Main Residence
When most assets are sold at a profit, the IRS collects capital gains tax on those profits. If you make a profit on the sale of a stock investment, for instance, you pay a percentage to Uncle Sam on each and every dollar of it. This is not the case with the sale of your main home. HUGE EXCLUSIONS FOR HOME SELLERS: Almost everyone profits from a home sale, unless they turn it around very quickly. The federal government so favors homeownership, they allow married joint tax return filers to exclude up to $500,000 gain (net profit) from the sale of their main home. Single return filers can exclude up to $250,000. This means you will not have to pay any tax unless you gain more than these generous limits. Only main homes qualify for the exclusion. Your main home is your primary residence--the home you live in most of the time. It can be a house, houseboat, mobile home, cooperative apartment, or condominium. Gain from the sale of any other home is fully taxable. For how to handle the sale of rental property, second homes, or vacation homes, see Publ 544 Sales and other Dispositions of Assets (PDF) You must pass an OWNERSHIP AND USE TEST to qualify for the exclusion. During the 5-year period ending on the date of the sale, you must have: (1) Owned the home for at least 2 years (the ownership test), and (2) Lived in the home as your main residence for at least 2 years (the use test). The two years does not have to be consecutive, and only one spouse need meet the ownership test. Furthermore, during the same 2-year period, neither you nor your spouse could have excluded gain from the sale of another home. The IRS Interactive Web Tool, "Sale of Residence," is helpful in determining eligibility. EXCEPTIONS TO THE OWNERSHIP AND USE TEST: If you fail one or both of these tests, an exclusion may still be claimed if you sold the home due to: (a) A change in place of employment, (b) Health, or (c) Unforeseen circumstances, which has yet to be defined by the IRS. There are exceptions for disabled people too. Generally the exclusion in such cases is on a pro-rata basis. Your Date of Sale should be shown on Form 1099-S, Proceeds from Real Estate Transactions. If you sold your home before May 7, 1997, different rules apply. See Chapter 3 of Publ 523.
HOW TO CALCULATE GAIN OR LOSS: Gain limits are so liberal most homeowners do not have to calculate them; however, long time owners may yield enormous capital gains to report. Worksheets are included in IRS Publication 523 to help figure the adjusted basis of a home sale--the gain or loss on the sale--and the amount of gain that can be excluded. One cannot deduct capital losses on the personal residence portion of a main home. Home improvements reduce capital gain taxes when you sell your personal residence. So save improvement receipts and records. Their cost can be added to the purchase price to calculate the COST BASIS of the house when you sell it. The basis is subtracted from the sales price (with certain adjustments) to determine your gain, or loss if any. Page 8 of Publ 523 gives details and examples of qualifying home improvements. If you used part of your main home for business, or rented it out, the exclusion does not apply to that portion. It applies solely to the gain on the part you lived in. You must figure the gain or loss as though you had sold two separate pieces of property. See Chapter 3, Section 1231, in IRS Publication 523. You may also need 2001 Inst 4797 Instructions for Sales of Business Property (pdf). You cannot deduct a loss on your personal living quarters. OTHER SPECIAL SITUATIONS: There are different rules applying to Special Situations; like when a home is destroyed or condemned, or sold to relatives, sale of remainder interest, or for Expatriates. See Pages 15/16 of Publication 523. Home sold with undeducted points. If you did not deduct all the points you paid to secure a mortgage on your old home, you may be able to deduct the remainder points in the year of sale. See Points in Part 1 of Publication 936, Home Mortgage Interest Deduction. If you sell only the land your main home sits on, but keep the house, you cannot exclude any gain from the land sale. Do not report the sale of your main home on your tax return UNLESS you have a gain and at least part of it is taxable. FULL DETAILS, PUBLICATIONS, TOOLS & FORMS: IRS Publ 523 Selling Your Home IRS Interactive Web Tool: Sale of Residence For how to handle the sale of second homes, vacation homes, or separate rental property, see Publ 544 Sales and other Dispositions of Assets Publication 547, Casualties, Disasters and Thefts Publication 544, Sales and Other Disposition of Assets. Report any taxable gain on Form 1040 (Schedule D) Capital Gains and Losses Inst 1040 (Schedule D) Instructions for Capital Gains and Losses Form 1099-S, Proceeds From Real Estate Transactions Sales and other Dispositions of Assets Inst 4797 Instructions for Sales of Business Property
Tax Breaks for Home Buyers
When you bought your home, you probably paid settlement or closing costs in addition to the contract price. These costs are divided between you and the seller according to the sales contract, local custom, or understanding of the parties. If you built your home, you probably paid these costs when you bought the land or settled on your mortgage. CLOSING COSTS: The only settlement or closing costs you can deduct are home mortgage interest, certain points and certain real estate taxes. You deduct them in the year you buy your home if you itemize your deductions. You can add certain other settlement or closing costs to the BASIS of your home. There are some settlement or closing costs that you cannot deduct or add to the basis. You can include in your basis the settlement fees and closing costs that are for buying your home. You cannot include in your basis the fees and costs that are for getting a mortgage loan. A fee is for buying the home if you would have had to pay it even if you paid cash for the home.
POINTS: The term points is used to describe certain charges paid, or treated as paid, by a borrower to obtain a home mortgage. Points may also be called loan origination fees, maximum loan charges, loan discount or discount points. Because points are prepaid interest, you generally must deduct them over the life (term) of the mortgage. However, you may be able to fully deduct points in the year paid if the loan is secured by your main home, and paying points is standard practice in your area. Mortgage Interest Deductions are covered as a separate topic below. DETAILS, PUBLICATIONS, FORMS, TOOLS: Refer to Publication 530, Tax Information for First Time Homeowners Tax Trails Interactive Web Tool: Home Mortgage Points.
Deduct Moving Expenses
If your job-related move passes the IRS TEST FOR TIME AND DISTANCE, you may be able to deduct the cost of moving yourself, your dependents, household goods and vehicles. THE TIME TEST: Generally speaking, moving expenses incurred within one year from the date you start work at a new location are considered closely related in time. You need not have gotten a job before moving, as long as you actually do go to work. If you fail to move within one year, you cannot deduct moving expenses unless extenuating circumstances delayed the move. For instance, your family waited so a child could finish high school. THE DISTANCE TEST: If your new job is at least 50 miles farther from your former home than your old job was from your former home--by the shortest, commonly used route--your moving expenses are deductible. For example, if your old main job was 3 miles from your former home, your new main job must be at least 53 miles from that former home. A move failing the distance test MAY STILL QUALIFY IF: (1) A condition of employment requires you to live at your new home, or (2) You will spend less time or money commuting from your new home to your new job. WORK REQUIREMENT: After arriving at your new location, you should work full time as an employee or a self-employed person for at least 39 weeks in the first year, and a total of 78 weeks in two years, in order to qualify for the deduction.
QUALIFYING PERSONS MAY DEDUCT the reasonable expenses of: (1) Moving your household goods and personal effects (including up to 30 consecutive days of in-transit storage expenses), and (2) Traveling to your new home (including lodging but NOT MEALS). The IRS TAX TRAILS INTERACTIVE TOOL is very helpful in determining qualification. See below. NOTE: The moving mileage deduction has been raised to 12 cents a mile. EXCEPTIONS. Certain retirees and survivors may qualify to claim the deduction even if they are not starting new work. Foreign moves are treated differently. Military persons too. NOTE: If your employer hires a Relocation Company to facilitate your move, you may hire any Realtor willing to share commission with the Relo Company. The IRS treats moving money provided by your employer as taxable income. FOR FULL DETAILS, PUBLICATIONS, TOOLS AND FORMS, SEE: IRS Publication 521 - Moving Expenses (2002) IRS Tax Trails Interactive Tool: Are You Eligible to Deduct Moving Expenses? IRS Pub. 523 Selling Your Home CORRECTION to Publication 523 ?V Selling Your Home Download State forms for interstate moves. Forms, instructions, and pubs. PDF format. Form 3903, Moving Expenses Form 8822 Change of Address
Deduct Home improvements for Health Reasons
You can deduct as a medical expense home improvements you make, or for special equipment you install in your home, if their main purpose is medical care you for, your spouse, or a dependent. The cost of permanent improvements that do not increase the fair market of your home are fully tax deductible. For example, constructing wheelchair ramps, widening doorways, lowering kitchen cabinets, modifying stairways, modifying bathrooms, outlets, fixtures, appliances, smoke detectors, etc., do not generally increase a home's value and are therefore tax deductible. The cost of permanent improvements that DO INCREASE the value of a property may be PARTLY included as a medical expense. The cost of the improvement is reduced by the increase in the value of the property. The difference is a medical expense. As an example, your doctor recommends you not climb stairs because of your heart condition. So you install a $8,000 elevator, which increases the resale value of your main home by only $4,000. Consequently, you are allowed a $4,000 deduction. The presumption is you will recover the other half when you sell. The same might hold true if one installed a swimming pool for hydrotherapeutic treatment for paralysis. Yet a swimming pool would not be a deductible medical expense if installed merely to improve general health. In addition, any cost attributable to architectural and aesthetic compatibility is not a deductible medical expense. Operation and Upkeep are deductible on qualifying medical home improvements. Using the elevator example, the cost of electricity and maintenance are deductible for as long as the medical reason for the elevator exists. Deduct the amount you pay for actual nursing-type care for yourself and your dependents. Also deduct the caregiver's meals. But you CANNOT deduct the amount you pay the caregiver to provide household services, because it is not a medical need. If you are paying for nursing type care because you need someone to stay with a disabled dependent while you work, you might qualify for a bigger tax break using IRS Form 2441 for Child and Dependent Care Expenses. See below for the form and publication, which applies to a dependent adult as well, such as a disabled elderly parent who is your dependent.
Guidelines are strict. To qualify the IRS requires that you pass three tests: 1. To determine whether your home office qualifies, consider time spent and revenue generated there. It must be your principal place of business, where you work most frequently. It must be your most important business location, generally, the one where you generate revenue, but not always. If you work from two locations, you may take the deduction if, for part of your business, you see clients, patients, or customers face-to-face in your home-office OR use the space for administrative duties, paperwork and related activities "crucial" to your business or work, if there is no other fixed location to conduct such activities. This helps outside salespeople, plumbers and other tradespeople who work at job sites, as well as doctors who bill from home, tutors who grade from home, etc. Telecommuters also qualify if they work at home for the convenience of the employer, and the employee cannot be renting the office space to their employer. In addition, if your home isn't your principal place of business, but you use a free-standing structure on your property exclusively and regularly for business, that space is deductible. 2. Your home business must occupy a clear and identifiable space and be used exclusively and regularly for business. It can be a specially constructed addition, a converted bedroom, attic or basement, or even an alcove or converted closet. But the same space cannot double for personal purposes, like watching TV with the kids or playing computer games.
3. Home office deductions--along with other miscellaneous deductions--must exceed 2 percent of your adjusted gross income. The taxpayer must itemize deductions using Schedule A. For the self-employed, home office deductions, other than mortgage interest and real estate taxes, may not exceed your net income reported on Schedule C. Home office deductions exceeding net self-employment income may be carried forward to the next year, if your net income is sufficient. Home workers can also deduct a portion of home expenses, such as insurance, the cost of a security system, and utilities. Part of your home improvements may be deductible as business expenses through depreciation, if you operate a home business. Be aware that claiming home office deductions can reduce the $250,000 (single filers) and $500,000 (joint filer´s) exclusion from tax of the gain from the sale of a qualified principal residence. Claiming home office deductions can reduce the amount of the capital gain exclusion allowed when you sell your home, because the exclusion applies solely to a home´s residential space. The office space is not eligible until two years after it is converted back to residential use.
Deduct Mortgage Interest
You can deduct all mortgage loan interest paid, as long as the loan was used to buy, improve or build your main home or a second home, and you itemize your deductions on Schedule A of Form 1040. It can be a first or second mortgage, a home improvement loan, or a home equity loan. PROVISOS: 1. Joint tax filers can deduct a maximum of $1 million in mortgage debts. Individual filers can deduct a maximum of $500,000. 2. Joint tax filers can deduct up to $100,000 on home improvement loans or a home equity loan. Individual filers can deduct up to $50,000. If either of these situations applies to you, you will need to get IRS Publication 936. You may need Publication 936 again if you later refinance your mortgage or buy a second home. REFUND OF HOME MORTGAGE INTEREST: If you receive a refund of home mortgage interest that you deducted in an earlier year and that reduced your tax, you generally must include the refund in income in the year you receive it. For more information, see "Recoveries" in IRS Publication 525. The amount of the refund will usually be shown on the mortgage interest statement you receive from your mortgage lender. So if you make a $1,200 monthly mortgage payment, of which roughly 80% goes toward interest, you can deduct, depending on your tax bracket, up to $11,500 a year.
Home mortgage interest deductions are limited if your adjusted gross income is more than $132,950 ($66,475 if you are married filing separately). For more information, see the instructions for Schedule A (Form 1040). Deduct late charges and prepayment penalties as long they were not for specific services you received. Points are deductible in the year they were paid, as long as the loan was used to buy, improve or build your main and/or second homes, generally speaking. Otherwise, points must be deducted over the term of a mortgage. Points are charges paid, or treated as paid, by a borrower to obtain a home mortgage. They are deductible if the amount paid is considered a prepayment of interest. Other terms for points include loan origination fees, maximum loan charges, loan discount or discount points. Often a fractional portion of home mortgage interest appears on your settlement statement in the year of your purchase. This interest should be included in the Form 1098 statement provided by your lender. You may deduct points you pay, or points your seller paid on your behalf, if you meet all of the following requirements: 1. Your loan is secured by your main home (the one you live in most of the time) 2. Paying points is usual for your area. 3. The amount of the points isn't out of line for your area. 4. You use the cash method of accounting for expenses (you probably do). 5. The loan was used to buy, improve or build your home. 6. The points are computed as a percentage of the loan principal. 7. The points are clearly delineated on your settlement statement. 8. You put cash into your home purchase in an amount at least equal to the points you were charged. Personal interest is not deductible, so if you have a high-interest, non-deductible car loan or a large credit card balance, consider taking out a Home Equity Loan and paying them off, because home equity loan interest is deductible while car loan interest payments are not Deduct student loan interest if you qualify. For details, see IRS Publication 970, Tax Benefits for Higher Education. HOW TO REPORT: In January your lender should provide Form 1098, which lists your total 2002 mortgage interest payments. Record your interest deduction on line 10 of Schedule A, Itemized Deductions of Form 1040. If you didn't receive Form 1098, use line 11. If you pay your mortgage to a private party rather than an institution, you MUST include their name, address and social security number to avoid a penalty.
Deduct Real Estate Taxes on First and Second Homes
Property taxes on all real estate and personal property, including those levied by state and local governments and school districts, are fully deductible as ITEMIZED deductions. THE TAX MUST BE: 1. Charged on personal property at a uniform rate in the area and benefit the public. 2. Based only on the value of the personal property, and charged on a yearly basis, even if collected more or less often. A tax that meets these requirements can be considered CHARGED ON PERSONAL PROPERTY if it is for the exercise of a privilege. For example, a yearly tax based on value qualifies as a personal property tax even if it is called a registration fee for motor vehicles, or for highway use. EXAMPLE: Your state charges a yearly motor vehicle registration tax of 1% of value plus 50 cents per hundredweight. You paid $32 based on the value ($1,500) and weight (3,400 lbs.) of your car. You can deduct $15 (1% ??$1,500) as a personal property tax, since it is based on the value. The remaining $17 ($.50 ??34), based on the weight, is not deductible.
To determine which of your local taxes are deductible, review the real estate tax bill issued by your taxing authority. Limits apply to property tax deductions based upon adjusted gross income. Deductions cannot exceed $132,950 ($66,475 if married filing separately). Real property tax deductions are disallowed when calculating alternative minimum taxable income. MINISTER'S OR MILITARY HOUSING ALLOWANCE: If you are a minister or a member of the uniformed services and receive a housing allowance that is not taxable, you can still deduct your real estate taxes and your home mortgage interest. You do have to reduce your deductions by your nontaxable allowance. DETAILS, PUBLICATIONS, TOOLS & FORMS: IRS Personal Property Taxes - Frequently Asked Tax Questions and Answers about Property Taxes Use Schedule A of IRS Form 1040, list as Real Estate Taxes. (You can't use Form 1040A or Form 1040EZ.)
How Refinancing Impacts Taxes
Low interest rates enticed millions of Americans to refinance their mortgage loans in 2001. Many do not realize that for federal tax purposes, refinancing is treated starkly different from a new loan. Under the tax code, you can write off interest on your ACQUISITION INDEBTEDNESS, meaning your original mortgage principal balance minus the principal you've already paid off--plus another $100,000 of home equity debt. Refinancing proceeds that are used to make substantial improvements to your home count as net additions to your acquisition debt. Financial professional, Kenneth R. Harney, gives an example: Say you bought your house with a $200,000 mortgage in the 1990s, paid off $10,000 in principal, and later refinanced into a $275,000 loan, the proceeds of which you used for personal expenditures. Your last refinancing moved you within $15,000 of your interest-deductibility limit ($200,000 minus $10,000 equals $190,000. Add $100,000 for home equity debt and you've got a $290,000 cap.) Should you refinance and pull out more than $15,000, you would exceed your legal limit. KEY AUDIT TARGET: Although the IRS never announces or officially confirms its special targets for audit attention in advance, tax experts say auditors will be looking especially hard at 2001 tax filings this year for violations of federal restrictions on home mortgage refinancing write-offs. ANOTHER KEY AUDIT TARGET: Did you claim a deduction for the points you paid for your 2001 refinancing? One point equals one percent of the loan amount. Points typically are construed as interest paid in advance under the tax code, and are only deductible in the year in which they are paid on new home purchases or home improvement loans. Points on refinancing, however, must be written off on a year-by-year, pro-rata basis over the life of the mortgage. Generally you cannot claim them in the year you paid them. When you do finally pay off the loan, you can then write off whatever balance of the points remains. INTEREST FROM HOME REFINANCING: If you used today's low-interest environment to refinance a mortgage and still have unamortized points left to deduct from an earlier refinancing, you can claim all the unamortized points from the earlier refinancing this year as deductible interest. For details regarding your specific refinancing situation, be certain to check with a tax professional. SEE IRS PUBLICATION 936.
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When most assets are sold at a profit, the IRS collects capital gains tax on those profits. If you make a profit on the sale of a stock investment, for instance, you pay a percentage to Uncle Sam on each and every dollar of it. This is not the case with the sale of your main home. 
HOW TO CALCULATE GAIN OR LOSS: Gain limits are so liberal most homeowners do not have to calculate them; however, long time owners may yield enormous capital gains to report. Worksheets are included in IRS Publication 523 to help figure the adjusted basis of a home sale--the gain or loss on the sale--and the amount of gain that can be excluded. 
When you bought your home, you probably paid settlement or closing costs in addition to the contract price. These costs are divided between you and the seller according to the sales contract, local custom, or understanding of the parties. If you built your home, you probably paid these costs when you bought the land or settled on your mortgage. 
POINTS: The term points is used to describe certain charges paid, or treated as paid, by a borrower to obtain a home mortgage. Points may also be called loan origination fees, maximum loan charges, loan discount or discount points. Because points are prepaid interest, you generally must deduct them over the life (term) of the mortgage. However, you may be able to fully deduct points in the year paid if the loan is secured by your main home, and paying points is standard practice in your area.
If your job-related move passes the IRS TEST FOR TIME AND DISTANCE, you may be able to deduct the cost of moving yourself, your dependents, household goods and vehicles.
QUALIFYING PERSONS MAY DEDUCT the reasonable expenses of: (1) Moving your household goods and personal effects (including up to 30 consecutive days of in-transit storage expenses), and (2) Traveling to your new home (including lodging but NOT MEALS). The IRS TAX TRAILS INTERACTIVE TOOL is very helpful in determining qualification. See below. NOTE: The moving mileage deduction has been raised to 12 cents a mile.
You can deduct as a medical expense home improvements you make, or for special equipment you install in your home, if their main purpose is medical care you for, your spouse, or a dependent.
Here are the BASIC REQUIREMENTS FOR A HOME IMPROVEMENT TO QUALIFY as a medical expense:
Guidelines are strict. To qualify the IRS requires that you pass three tests:
3. Home office deductions--along with other miscellaneous deductions--must exceed 2 percent of your adjusted gross income. The taxpayer must itemize deductions using Schedule A.
Home mortgage interest deductions are limited if your adjusted gross income is more than $132,950 ($66,475 if you are married filing separately). For more information, see the instructions for Schedule A (Form 1040).
To determine which of your local taxes are deductible, review the real estate tax bill issued by your taxing authority.