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What's the Point?
Prepaid interest, sometimes called “points”, is generally tax deductible when a person pays them in connection with buying, building or improving their principal residence. When points are paid on a refinance, they are not a current deduction but have to be taken prorata over the life of the mortgage.
For instance, if $3,000 in points were paid on refinancing a 30 year mortgage, a deduction of $100 per year is allowed. When the loan is paid off or replaced by refinancing again or the home is sold and the mortgage paid off from the proceeds, the balance of any un-deducted points may be taken in that tax year.
Your tax professional needs to be made aware of any of these situations so that he or she can accurately reflect the deductions in your return. Currently, the most common situation is homeowners may be refinancing their home for the second, third or even, fourth time. If there are points that have not been completely deducted, they need to be treated in the year of refinancing.
For more information, see points in IRS Publication 936; there is a section on Refinancing in this publication. For advice considering your specific situation, contact your tax professional.
One of the drawbacks to low mortgage rates is that the total interest and property taxes paid for the year may be lower than the standard deduction. A little planning might be able to help you at least every other year.
Most homeowners know they can deduct their qualified mortgage interest and property taxes on their Schedule A of their 1040 tax return or to take the standard deduction if it is greater. See Your Deduction...Your Choice.
Deductions are taken in the year that they're actually paid. If a homeowner paid their 2012 property taxes in 2013, they would not be deductible on their 2012 tax return. Then, if the 2013 property taxes were paid in 2013, both the 2012 and 2013 taxes could be deducted on the 2013 Schedule A.
By delaying the payment of the 2012 taxes until 2013, the combination of the 2012 and 2013 taxes might exceed the 2013 standard deduction and provide a higher deduction.
Other Schedule A expenses such as charitable contributions and medical expenses may be bunched also. From a practical standpoint, since most mortgage payments are due monthly, the mortgage interest would not be bunched.
This information should be discussed with your tax advisor to see how it might apply to your individual situation. The key is you must be aware of the strategy early to be able to use it.
Taxpayers are allowed to decide each year whether to take the standard deduction or to itemize their deduction when filing their personal income tax returns. Roughly, 75% of households with more than $75,000 income and most homeowners itemize their deductions.
The 2012 standard deduction, available to all taxpayers, regardless of whether they own a home, is $11,900 for married filing jointly and $5,950 for single taxpayers.
Let's look at an example of a homeowner couple with a $150,000 mortgage at 3.5%. The standard deduction would give them $2,650 more than the total of their interest paid and property taxes of approximately $9,250. If they were in the 28% tax bracket, the actual tax savings would be $742.00.
When mortgage rates were considerably higher, many people expected the interest and property taxes to easily exceed the standard deduction but with today's low rates, a comparison is certainly justified.
There are other things that could come into consideration like charitable contributions, medical expenses and casualty losses. Tax professionals will compare available alternatives to find the one that will benefit the taxpayer most.
For more information, see www.IRS.gov and consult a tax advisor.
Choose Your Deduction
One third of all U.S. households, 75% of households with more than $75,000 income and most homeowners itemize their deduction on their federal income tax returns. It makes sense because the interest paid on their mortgage and their property taxes probably exceeds the allowable standard deduction.
However, with interest rates as low as they have been in the last two years and the price of homes having come down considerably, it is possible that the standard deduction may be the better choice.
Each year, the taxpayer can compare the total of the itemized deductions to the standard deduction to select which method will result in the most benefits. The 2011 standard deduction is $11,600 for married couple filing jointly and $5,800 for single filers.
The Housing and Economic Recovery Act of 2008 allows homeowners to take the standard deduction and the lesser of their actual property taxes of $1,000 if filing their return married jointly. For more information, see Schedule L found on www.IRS.gov and consult your tax advisor.
People are staying longer in their homes according to the National Association of Realtors and the U.S. Census. Over time, even a modest appreciation could result in a significant gain and homeowners should have a strategy to minimize possible taxes.
Maintenance on a principal residence is not deductible but improvements can add to the basis which can reduce the gain in the sale. Improvements are easily identified if they add to the value of a home, prolong its useful life or adapt it to new uses.
Receipts and other proof, such as pictures, should be kept during ownership and for several years after the sale of the home. They can include the closing statements from the purchase and sale of the home and all receipts for improvements, additions or other items that affect the home's adjusted basis or cost.
For a principal residence, basis includes the price paid, plus certain acquisition costs and capital improvements made. When the property is sold for more than the basis, there is a gain. Currently, homeowners that meet the requirements can exclude up to $250,000 of gain if single or up to $500,000 if married filing jointly.
A simple strategy is to put documents that affect the basis of the home in one envelope. Any receipt for money spent on the home that isn't the house payment or utilities, goes into the envelope. Your tax advisor will be able to sort through them to determine the capital improvements.
For more information on determining basis or capital improvements, see IRS publication 523, Selling Your Home.
