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Home-Buying Fees

Homebuyers incur two major sets of fees: closing costs and points. Closing costs are generally not deductible, but they add to the cost basis of the home, and so, reduce the gain when the house is sold.

Points, on the other hand, may be fully deducted in the year they are paid, if the loan is secured by your home, if the loan is for purchase or improvement of the primary home, and if the points are for the use of money (not a service charge). If these conditions aren't met, the points may still be deducted in monthly increments over the life of the loan. If the mortgage ends early because of prepayment or refinancing, the remaining, or unamortized points may be deducted at that time.

When refinancing, points paid on the new loan may be deducted immediately if the proceeds are used to improve the principal residence. If you are refinancing to improve your interest rate, the points are deductible over the life of the loan.

Points paid by the seller are also deductible by the buyer. If you purchased a home after 1995 and the seller paid the points, consider amending your return if you did not deduct them. Remember, you only have three (3) years to file an amended return and be entitled to receive a refund.

Home Equity Loans

Interest paid on home equity loans, unlike other consumer loans such as credit cards and auto loans, is generally deductible. Home equity loans may be used for any purpose - such as paying off other consumer loans. The home equity loan must be for an amount equal to or less than the equity in your home up to a maximum of $100,000 or $50,000 (married/separate). Thus, the interest paid on the 125% home equity loans currently being offered won't be fully deductible.

Remember, these loans are secured by your home, so you could lose your home if you default. And, in the case of a 125% loan, assuming the home could be sold at its fair market value, you would still be on the hook for the additional amount borrowed, including additional interest and penalties.

Second-Home Deductions

Some deductions are available if you own a second home. A qualified second home for tax purposes must offer a place to sleep, a toilet, and cooking facilities, whether it be a condominium, recreational vehicle, or boat.

You may be able to deduct interest on a loan for a second home, provided your primary and secondary mortgages including funds used to improve the homes, don't total more than $1 million. If you rent out the second home, you must use it personally for the greater of 14 days or 10% of the rental days. In addition to mortgage interest, you may be able to deduct property taxes and prorated monthly portions of your points paid over the life of the loan.

If you rent the home out for more than 14 days a year, you can also deduct the appropriate portion of upkeep, insurance, and utility costs. The property may be depreciated, which will help reduce your rental income without expending cash. And, as long as you use the place yourself for less than 14 days or 10% of the rental days, you can claim a rental loss (subject to certain limitations).

Finally, you can rent your secondary or primary home for less than 15 days without reporting the income! Rental expenses are not allowed.

Losses From Selling A Home

Losses from the sale of a home (Primary or Second Home) cannot be deducted. If the home is rental property, you may be able to deduct an annual operating loss. And, for the years that the home produces rental income, you can claim a depreciation deduction based on the lesser of the cost or its fair market value. Certain requirements must be met to convert a home into rental property.

You can take extra deductions by staying in the home but converting part of it to business use. Whether as rental property or business use, when you sell your home you can claim a business loss if the property declines in value below its current tax basis.

Gains From Selling A Home

Married couples can now exclude up to $500,000 of gain when they sell their home ($250,000 for individuals). The home must have been the principal residence for a least 2 of the last 5 years. Homeowners can receive a portion of the exclusion based on how long they live in the home, as long as the sale is due to a change in place of employment, health, or unforeseen circumstances.

For example, a married couple lives in a home for only a year and then sells it, due to unforeseen circumstances, for a $60,000 profit. They are allowed to take up to 50% (because they lived in the home for 50% of the 2 years required) of the $500,000. Thus they can exclude every penny of their $60,000 gain. The exclusion, which can be used once every 2 years and at any age, applies to sales after May 6, 1997.

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