Home Ownership Guide

You may fully deduct mortgage interest paid on your principal residence and a second residence to the extent that (1) you use the mortgage proceeds in the acquisition, construction, or substantial improvement of the residence; and (2) the total indebtedness does not exceed $750,000 (or $1 million if the mortgage debt was incurred before December 15, 2017, or if you entered into a written binding contract before December 15, 2017, to close on the purchase of a principal residence before January 1, 2018, and you purchased the residence before April 1, 2018).

In 2017, you were able to deduct the interest paid on a home equity loan secured by your residence of up to either $100,000 or the value of your home reduced by any outstanding mortgage, whichever was less. This deduction has been suspended, and is not available in 2018. However, if you used the proceeds from your home equity loan to acquire, construct, or substantially improve your home, the interest payments may still be deductible subject to the limitations discussed above.

If you refinance your mortgage, you can continue to deduct the interest on the new loan, but only up to the balance of the old loan immediately before the refinancing.

You also can immediately deduct “points” paid on the debt you incurred in connection with the purchase or improvement of a principal residence. This deduction is available only if the payment of points is an established business practice in the area in which the indebtedness was incurred and the amount of the payment is not excessive. Points paid in connectio

Interest paid on a loan secured only by land does not qualify as mortgage interest. However, you may treat a residence that is under construction as your principal or second residence for up to two years, provided you move into it and occupy it as your principal residence when the construction is complete. (For further explanation of the residential interest deduction rules, see Home mortgage interest below.)

When You Sell Your Residence

If you sell your principal residence at a gain, some or all of the gain may be exempt from tax. However, if you incur a loss on the sale, you may not deduct that loss. If you file a joint return with your spouse, you together can exclude gain of up to $500,000 from the sale of your principal residence. Other taxpayers can exclude up to $250,000. The following conditions must be met:

  • You must have owned and lived in the property for two years during the previous five years; and
  • You must not have claimed the exclusion within the past two years. (If filing a joint return, this requirement applies to both spouses.)

A reduced exclusion amount may still be available if you fail to meet these requirements because of a change in place of employment, health issues, or another unforeseen event such as losing your job, getting divorced, an involuntary conversion of the residence, or another similar adverse circumstance that could not have been anticipated before buying and occupying the house. The amount of gain eligible for the exclusion can also be reduced under the “nonqualified use” rules if you have rented out your home (or left it vacant) at any time after 2008 and subsequently re-occupied the house before selling it.

Any gain from the sale of a principal residence that is not excludible under these rules is subject to tax as capital gain and, as explained earlier, may be subject to the 3.8% net investment income tax if modified AGI is above a certain threshold.

Example: Tom and Helen sell their home for $2 million. It had a basis of $800,000 (including capital improvements). Their net gain is $1.2 million, of which $500,000 is eligible for exclusion. The remaining gain of $700,000 is subject to tax at the applicable capital gains rate and may be subject to the 3.8% net investment income tax.

Second Homes and Rental Property

Depending on its usage, property you own—such as a house, condominium, or dwelling unit—that is not your principal residence may be classified as a second residence or as rental property. The classification affects the deductibility of interest, taxes, casualty losses, and other expenses, as well as whether you have to report any rental income from the property.

You do not have to report the rental income you receive on property you used as a home if you rent it to others for fewer than 15 days a year. However, you may not take any deductions for rental expenses for that property other than mortgage interest, taxes, and casualty losses.

Second Home

Property may be considered your second residence if you or a family member use it personally for more than the greater of 14 days or 10% of the number of days it is rented at fair market value (FMV). In this situation, you must apportion expenses such as utilities, repairs, and insurance between rental and personal use. You can deduct these and other rental expenses only up to the excess of gross rental income over the rental-use share of interest, taxes, and casualty losses. Although you must divide the interest expense between personal and rental use to determine the deductible amount of other rental expenses, you can deduct the interest subject to the home mortgage interest expense limitations. Real estate taxes must also be allocated between rental and personal use, and the personal use portion can be deducted on Schedule A (subject to the $10,000 limitation discussed in State and local income tax deductions).

Rental Property

If you use a home for less than the greater of 14 days or 10% of the days the property is rented at FMV, it is considered a rental property. Again, you must apportion all expenses between rental and personal use if both occur during the tax year. Special rules apply in the year you convert a rental property to or from your principal residence.

Income and deductions allocable to any rental activity generally are subject to the passive loss rules (see Understanding passive activity rules, below). However, if you actively participate in a rental real estate activity, and if your adjusted gross income (AGI), subject to certain modifications, is less than $150,000 before any passive losses, you may be able to deduct up to $25,000 of net losses from the rental activity. Rental real estate participation that is considered active includes approving new tenants, deciding on rental terms, approving capital or repair expenditures, and making similar decisions. The $25,000 rental real estate exception phases out as your modified AGI rises from $100,000 to $150,000 for single taxpayers as well as for married individuals filing joint returns. (Special rules apply to married taxpayers who file separately). Any additional net losses from rental real estate are subject to the general passive loss rules (see Understanding passive activity rules, below).

Rental real estate activities are not treated as passive if you qualify as a “real estate professional” and you materially participate in the rental activity. (Note that the threshold for material participation is significantly higher than that for active participation, outlined above.) You may qualify as a real estate professional if you (1) devote more than half your time to one or more real estate trades or businesses in which you materially participate, and (2) perform more than 750 hours of service during the year in the real estate trades or businesses in which you materially participate.

If the average stay at the rental property is fewer than eight days, or if the average stay is less than 31 days and significant services are provided, income will be treated as trade or business income rather than passive rental income. Losses realized in a non-passive trade or business generally are fully deductible if you materially participate in the trade or business. This rule is especially useful for some vacation property. There are a limited number of other exceptions to the rule that rental activities are generally passive that may be relevant in specific situations.

Home Mortgage Interest

The new tax law makes significant changes to the deductibility of home mortgage interest that are especially likely to affect you if you purchase a new home during the years 2018–2025 and incur a mortgage to finance the purchase.

Under prior law, qualified residence interest could be claimed as an itemized deduction, subject to certain limitations. Qualified residence interest included interest paid on debt incurred to acquire, construct or substantially improve your principal or second residence (“acquisition indebtedness”), and also interest on home equity indebtedness, without regard to how the proceeds of the debt were used (except for purposes of the alternative minimum tax—AMT)

The new law suspends the deduction for interest on home equity indebtedness for 2018–2025. For the same tax years, the deduction for interest on acquisition indebtedness is also limited by reducing the amount of debt that qualifies as acquisition indebtedness from $1 million to $750,000. Any debt you may have incurred before December 15, 2017, is “grandfathered” and thus not affected by this reduction. Also, any debt you may have incurred before that date but refinanced later continues to be covered by the prior rules provided the amount of the debt does not exceed the amount refinanced. However, if you are considering moving your home during the years 2018–2025 and financing the purchase with a new mortgage, the reduced deduction for home mortgage interest is likely to affect you.

State and Local Income Tax Deductions

Under the new law, for tax years 2018–2025, itemized deductions for state and local income taxes, property taxes, and sales taxes are limited to $10,000 in the aggregate. This cap is not indexed for inflation. The cap does not apply to personal or real property taxes incurred in carrying on a trade or business or otherwise incurred for the production of income.

In addition, foreign real property taxes, other than those incurred in a trade or business (such as a rental activity) are not deductible to any extent.

Under prior law state and local property taxes and either state and local income or sales taxes were generally deductible in full (subject to the phase-out applicable to taxpayers whose income exceeded prescribed thresholds) and constituted some of the most significant reductions to taxable income. However, the new cap on such deductions will cause many individuals to claim the standard deduction rather than itemize. If you live in a state that imposes relatively high state income taxes it is likely that you will see a significant impact from the imposition of this cap and it might cause your tax liability to increase notwithstanding the overall reduction in tax rates

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