Homeowner Tax Breaks: Recent Developments
Learn about recent tax credits and tax deductions for homeowners.
Congress regularly brings forth or revises the tax laws, often providing breaks for homeowners unfortunately, often at the same time that they take other breaks away or allow them to expire. Some recent tax provisions for homeowners include:
- tax credits for energy-saving purchases for your home
- a tax break for some defaulting homeowners
- tax credits for first-time and some returning homebuyers (since expired)
- a continuation of the mortgage insurance deduction, and
- elimination of a tax loophole for owners of vacation or rental homes.
Read on to learn about these new tax breaks and determine whether any are available to you. (To learn about long-standing tax breaks for homeowners, read Nolo's article Your Home as a Tax Shelter: Top Ten Tax Deductions for Owning Your Home.)
Energy-Related Tax Credits
Beginning in 2006, homeowners who install solar, geothermal, or wind systems to generate electricity, or in some cases heat water, are eligible for a tax credit worth 30% of the cost of the system, with no upper dollar limit. This credit is due to expire in 2016.
Another tax credit rewards people who install a fuel cell system to generate electricity. They get a tax credit of 30% of the cost, up to $500 per kilowatt of power generated.
Tax credits for qualifying energy-efficient home improvements are also available until December 31, 2011 for HVAC (heating, ventilation, and air conditioning) equipment, water heaters, roofing, doors, windows, and biomass stoves. The credit is worth up to 10% of the cost of the improvements, up to $500.
Taxpayers can claim the credits on IRS Form 5695 Residential Energy Credits, available from the IRS website at www.irs.gov. For the latest information on eligibility and expiration dates, see the Energy Star website.
Tax Break for Defaulting Homeowners
Ordinarily, debt that is forgiven by the lender is counted as income to the person who is no longer required to repay the debt. Under the Mortgage Forgiveness Debt Relief Act of 2007, homeowners whose lenders have forgiven their mortgage debt receive a tax break the amount of the forgiven debt is not counted as income for tax purposes. The law applies through the 2012 tax year.
The old law. Lenders sometimes allow homeowners who are defaulting on their mortgage to forgo payment of a portion of that mortgage for example, the lender might restructure a loan for less than the amount owed or permit a short sale, in which the homeowner sells the home for less than what's owed on the mortgage. Previously, when a lender forgave part of the homeowner's mortgage, the IRS treated this forgiven debt as taxable income.
The new law. Under the new law, debt that is forgiven by your mortgage lender does not count as taxable income by the IRS. There are some limits. The amount of forgiven debt that does not count as income is capped at $2 million. And the exclusion is available only for loans used to buy, build, or substantially improve a principal residence. Vacation homes, investment properties, and other second homes don't qualify.
Tax Credit for First-Time and Longtime, Repeat Homebuyers
The Worker, Homeownership, and Business Assistance Act of 2009 aimed to bring some relief to the housing crisis. Among its provisions was a fully refundable tax credit of up to $8,000 for some first-time homebuyers and up to $6,500 for certain returning homebuyers. Unfortunately, the law has expired, but we'll summarize its provisions here especially for those people who may need to make sure they won't eventually have to pay the money back.
Definition of first-time homebuyer. For purposes of the tax credit, "first-time homebuyer" means someone who has not owned a principal residence (that means a home you live in) for the past three years. For married couples, the test applies to both neither can have owned a home within the previous three years.
Definition of repeat homebuyer. This means someone who has owned and lived in the same home for at least five consecutive years out of the last eight. For married couples, the test applies to both.
Eligible home purchases. The tax credit is available for homes bought by either first-time or returning buyers on or after January 1, 2009 and before April 30, 2010 (meaning you must have entered into contract by that April date and closed the purchase by September 30, 2010, after an extension of the original June 30 deadline). The home MUST cost less than $800,000.
Determining the amount of the tax credit. The first-time buyer tax credit was 10% of the purchase price, but capped at $8,000. The returning buyer tax credit was 10% of the purchase price, but capped at $6,500.
Income eligibility for the tax credit. If your sale took place after November 6, 2009, you were eligible for the full tax credit if:
- you were a single taxpayer and your adjusted gross income (AGI) was less than $125,000, or
- you were a married couple filing a joint return and your AGI was less than $225,000.
You may have been eligible for a partial tax credit if:
- you were a single taxpayer and your AGI is more than $125,000 but less than $145,000, or
- you were a married couple filing a joint return and your AGI is greater than $225,000 but less than $245,000.
Note that if you sell the house or stop using it as your primary residence within 36 months of the purchase, you must pay back the credited amount.
The income limits under a previous version of this law were significantly lower and still applied to people who bought their houses after January 1, 2009 but on or before November 6, 2009. These limits were $75,000 for singles (with a phaseout, partial credit available up to $95,000) and $150,000 for couples who are married and filing jointly (with a phaseout, partial credit available up to $170,000).
The Mortgage Forgiveness Debt Relief Act of 2007 also extended a tax deduction for private mortgage insurance (PMI) that was set to expire in 2007. The extension allows eligible homeowners to deduct the cost of their mortgage insurance premiums through 2012.
What is mortgage insurance? Lenders require borrowers to purchase PMI if the borrower's down payment is less than 20% of the purchase price and other loans are not used to make up the difference. The reason is that mortgages with down payments of less than 20% are deemed riskier than loans with larger down payments. Although the mortgage insurance protects the lender, the homeowner must pay the premiums, which are based on the price of the home.
Who qualifies for the deduction? Home-owning families with an adjusted gross income of $100,000 or less qualify for the deduction. Families with incomes up to $109,000 are eligible for a partial deduction. To learn more, read the IRS's publications Home Mortgage Interest Deduction and Publication 53: Tax Information For First-Time Homeowners, available from the IRS website at www.irs.gov.
Second-Home Tax-Break Loophole Closed
Under current law, homeowners can exclude from taxation a certain amount of the gains from a home sale, provided the property was the primary residence for two out of the previous five years. The maximum exclusion is $250,000 for a single person and $500,000 for a married couple filing jointly.
Vacation and rental property owners figured out that they could legally double dip the exclusion by first selling their primary residence and avoiding tax on the capital gain. Then, after moving into the second home for two years to qualify it as their primary residence, they could sell the home and avoid paying taxes on the full amount of the capital gains earned on the second home.
This legal means to double dip ended on January 1, 2009, however. After that date, if you live in a home that you've also used as a vacation or rental home, you do not get tax relief on the capital gains earned while you did not live in the home. You can, however, get tax relief on the capital gains earned while you are using that home as your primary residence.
Example: Bob owns a vacation home for ten years. During the last two years of his ownership, he uses the vacation home as his primary residence. He sells the home and gets a $100,000 gain. Under the new law, $80,000 of that gain would be subject to capital gains tax (equal to the eight years the property served as a vacation home). The remaining $20,000 would qualify for the tax exclusion (equal to the two years he used the home as his primary residence).
Homeowners who moved into their vacation home before the end of 2008 will still be eligible for the benefits of the old law. For more information, see IRS Publication 523, Selling Your Home, available from the IRS website at www.irs.gov.
To learn more about tax credits and deductions for homeowners and how to keep your property tax bill low, get Nolo's book The Essential Guide for First-Time Homeowners: Maximize Your Investment & Enjoy Your New Home, by Ilona Bray and Alayna Schroeder.