It’s tax time, and most of us will spend time this next week supplying Uncle Sam with enough rope to hang us. But if you own a home, there are certain tax breaks reserved for you that renters simply can’t use. Here are some reminders as you fill out your Form 1040 this week:
1. Home Mortgage Interest is tax-deductible, and that can save you a lot of money. But know that there are limits on the amount you can deduct.
For starters, interest is only deductible on a mortgage you use to acquire or improve your principal or secondary residence. So let’s say you own your home free and clear of any debt and you decide to take a one-year cruise around the world, so you borrow $300,000 against your residence to buy the cruise tickets.
Because the interest is on money you used for a purpose other than to acquire the house (you already owned it) or improve the house (it all went to the cruise line), none of it would be deductible for income tax purposes.
So, what if you refinanced in 2012? Only the interest on the portion of the refinance loan that replaces the balance of the debt used to acquire (or improve) your home is considered tax-deductible. (See #3 for exception).
2. And only the interest on the first $1,000,000 is deductible. That is a total for both primary and secondary residence.
So if you borrowed $750,000 to buy your principal home, and then you borrowed another $750,000 to buy that beach house, you would not be able to deduct mortgage interest paid on the total of $1.5 million dollars. Instead, only the interest paid on the first million would be deductible.
3. But wait, there is one exception to the million dollar limit. It's called the special exception for Home Equity Lines of Credit, and you are allowed to deduct mortgage interest on up to $100,000 of secured debt regardless of the way the money is used. For our purposes, Home Equity debt is loosely interpreted as almost any debt secured by your principal or secondary residence, so in the above example you could actually deduct interest paid on the first $1.1 million.
4. If you purchased your principal residence during 2012 and your lender charged Loan Discount Points in conjunction with the acquisition financing, then you can deduct those points, regardless of who paid them. That is, of course, provided they meet these tests: a) they must be normal and reasonable (probably less than 4%), and b) they must be expressed as a percentage of the loan amount on the settlement statement. In every other situation where points are paid for a home loan, the points must be amortized over the life of the loan, which greatly reduces their current value.
5. But what if you refinanced your loan during 2012 as a way to lock in a great rate?
If you were refinancing your original acquisition loan, then the points you paid this time must be amortized over the life of the loan, typically 15 or 30 years.
The same is true if you refinanced and paid off a refinance loan - many homeowners have refinanced multiple times over the past decade. But here is a major deduction that many homeowners miss:
If you are currently amortizing points from a prior refinance loan as described above, then decide to refinance again, you get to accelerate the remaining amortization period, and claim all of the unused deductible points as a deduction this year.
Accountants are reminded to always ask if a refinancing occurred, but sometimes even they overlook hidden gems like this.
6. Finally, don't confuse the amount you have paid to your lender as escrow payments for property taxes with the actual taxes paid.
Lenders usually analyze escrow accounts once a year to determine if there is any excess or shortage, then adjust your payment for the following year. But the IRS is only concerned with the actual dollar amount paid to the city or county for property taxes, even if it is more than you paid to the lender. You can call your tax commissioner or wait for your escrow statement to obtain the actual amount of taxes paid.
After covering all this, I have confused myself and decided to file IRS Form 4868 - Application for Automatic Extension of Time To File Income Tax Return. You can download the proper form at my Money99.com website, but the extension is only of time to file, not time to pay any tax owed.
As always, it’s best to consult your Certified Public Accountant when making decisions involving the Internal Revenue Service.
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