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Personal Finance > Your Home
Homes can limit tax pain
June 21, 2000: 12:43 p.m. ET

Ah, the joys of home ownership: privacy, security and tax breaks
By Staff Writer Mark Gongloff
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NEW YORK (CNNfn) - If you rent a home, you've probably heard that you're throwing away your money. You could be wasting more money than you think, though, considering the tax breaks that come with home ownership.

The Internal Revenue Service lets homeowners deduct their mortgage interest, property taxes and some other expenses of home ownership. If these and other deductible expenses amount to more than your standard graphicdeduction, then home ownership could save you a bundle of money.

"The tax breaks are significant," said David Block, a licensed tax preparer with Tax Masters Financial Services in New York. "The government is subsidizing your mortgage and property taxes."

Mortgage interest


If you have a "home-acquisition" mortgage to buy, build, or improve a home, and the mortgage balance is less than $1 million, you can deduct all the interest you pay in a year.

In other words, a $2,000 monthly mortgage payment is actually cheaper than a $2,000 monthly rent payment, Block said.

Let's say you're in the 28 percent tax bracket and your mortgage payment is $2,000. Let's say $1,800 of that is interest and $200 is principal. You can deduct that $1,800 and put $304 - that's $1,800 multiplied by 28 percent -- back in your pocket.

"If you rent, the landlord gets the deduction," Block said.

But there are some conditions to the perk.

The mortgage has to be on your main residence or a second home. The mortgage can't be more than the total value of the home. Also, if your annual income is more than $126,600, you'll lose some of the deduction. And the deduction will grow smaller during the life of your mortgage, as you pay off more and more of the principal.

graphicAnother thing to keep in mind is you have to get the mortgage within 90 days of the home purchase, or after work is done to build or improve a home in order to get the deduction.

You will get a Form 1098 from your lender every year showing the interest you paid during the year. If the amount of your debt exceeds the government's dollar limits, you'll have to calculate the amount of interest you can deduct. IRS Publication 936 has instructions for doing this, but this publication is not for the faint of heart; you might want to consult a tax preparer for help.

Home-equity and 'grandfathered' debt


You can also deduct the interest for "home-equity debt," which is a mortgage on your property that isn't used to buy, build or maintain a house. The limit to of deductible home-equity debt is $100,000 or the amount of equity in the property - whichever is less. With home equity debt, it doesn't matter what you use the money for.

Interest on a line-of-credit mortgage is also deductible, and is treated as either home-acquisition or home-equity debt, depending on how you use the line of credit. A line-of-credit mortgage is like a credit card secured by your house. You only start paying when you use it, as with a credit card.

If you have more than one mortgage, you can deduct the interest paid on all of them if they all meet government requirements that they must be on a main or a second home. But the same deduction limits apply.

People with older mortgages will be able to take advantage of a grandfather clause that allows you to deduct any mortgage you got before October 14, 1987, regardless of how you use the money. However, the amount of the grandfathered debt counts against your dollar limits for home-acquisition and home-equity debt.

Property taxes


Real-estate taxes you pay during the year and at the closing of your property are also deductible, as are assessments by government agencies for maintenance or repairs to your property.

Mortgage interest credit


Lower-income families can get a tax credit for some of the mortgage interest they pay. The amount of the credit - which you can calculate using IRS Publication 530 for first-time homeowners - directly reduces the amount of your tax.

If you claim the credit, you must subtract it from any mortgage-interest deduction you claim. But the two don't cancel each other out, David Block said.

"You always want a credit rather than a deduction," he said. "A credit goes dollar-for-dollar against your tax, while a deduction is based on your tax rate."

You must get a mortgage credit certificate from your state or local government before you get a mortgage in order to qualify for the credit.

Should you pay off your mortgage early?


Though mortgages can have happy tax consequences, many people can't get over the discomfort that comes with having such a large debt, and they want to pay it off as quickly as possible. Believe it or not, it might be better to resist that urge.

If your mortgage has a 9-percent interest rate, David Block pointed out, you're actually only paying about 6.5 percent, because the government is giving you back part of that interest. Block suggested that, rather than spending a ton of money to pay off a mortgage early, you could invest that money in a mutual fund, which would likely have a rate of return much better than that 6.5 percent.

"To get the most use of your money," Block said, "it makes very little sense (to pay off a mortgage early) if you have a low interest rate."

But some people just can't live with debt, and want to get rid of it at any cost. For those people, Block said the most effective way of quickly paying off a mortgage is to double the portion of your monthly payment attributed to principal, rather than taking a 15-year mortgage or paying twice a month.

John Gin, a certified financial planner with American Express Financial Advisors in Metairie, La., said keeping a mortgage is not the best option for everybody.

"For younger couples today, their job situation is so fluid that it makes sense to keep the mortgage," Gin said, in order to have more cash and more flexibility. On the other hand, he continued, "if your situation is such that you're close to retirement and have plenty of assets, you should just pay off the debt," especially if you're at the end of a mortgage term, when most of your payment is principal, and you're not getting much of a deduction.

Selling without fear


You also get tax breaks when you sell your home. The biggest break, according to Cindy Hockenberry of the National Association of Tax Practitioners, is the new exclusion from taxation you can make of up to $250,000 ($500,000 for married couples filing jointly) of the gain on the sale.

graphic"It used to be, if you sold your main residence, you had to either pay tax on the gain or buy another home that cost more than the home you sold," Hockenberry said. Otherwise, people had to scramble to reduce their gain. "Because the rules have changed, you no longer have to worry about that gain," Hockenberry said.

If for some reason you don't qualify for the exclusion, then you will have to do things the old-fashioned way and reduce your gain. Hockenberry said many closing costs and home-improvement costs are deductible, but you must keep receipts and closing statements to mollify the IRS. See IRS Publication 523, "Selling Your Home," for details. Back to top

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