Chapter 8: Home ownership and Taxes

What is the primary tax benefit when selling your main home?

The ability to exclude a certain amount of profit (gain) from taxes

What is the maximum profit exclusion for married couples filing jointly when selling their main home?

$500,000

What is the maximum profit exclusion for individuals when selling their main home?

$250,000

What are the two main conditions to qualify for the main home profit exclusion?

You must have owned the home for at least two years and used it as your main home for at least two out of the past five years before the sale

Are there exceptions to the "two-out-of-five-year" rule for the main home exclusion?

Yes, if the sale was due to a job change, health reasons, or an unforeseen circumstance, the IRS might allow a partial exclusion

What part of a main home's gain is not excluded from tax, even if you qualify for the exclusion?

Any depreciation taken on your main home for a home office, or income from a separate rental unit (like in a duplex)

How are profits taxed if they are above the $250,000 or $500,000 exclusion limits?

The extra amount is taxed at long-term capital gains rates (e.g., 15% maximum, or 5.0% for those in 10% or 15% income tax brackets)

Can you deduct a capital loss if you sell your personal residence for less than you paid?

No, you cannot.

What is the basic formula to calculate the "gain" (profit) on a home sale?

Selling Price minus Selling Expenses, Cost of Home, Costs of Purchase, and Costs of Improvements.

What are "Selling Expenses" when calculating home sale gain?

Costs the seller incurs upon sale, such as real estate agent commissions, transfer taxes, and closing costs paid on behalf of the purchaser

What are "Costs of Purchase" for calculating home sale gain, and what do they not include?

Closing costs paid when you bought the home that were not deductible in previous years

What are "Costs of Improvements" for calculating home sale gain?

Money spent on "capital improvements" that increase the home's value after purchase and before sale, not for repairs

Are "Fix-Up Expenses" (costs to prepare a house for sale) deductible from the selling price?

No, they are no longer subtracted from the selling price

Does selling a rental property get the same tax breaks as selling a main home?

No, it does not; there is no profit exclusion or ability to roll over the gain

What is "Depreciation Recapture" when selling a rental property, and what is its tax rate?

Any depreciation previously taken on the rental property must be added back to the original purchase price when figuring the gain, which increases the taxable profit. The tax rate on this recaptured depreciation is 25%

What is a "Tax-Free Like-Kind (Starker) Exchange," and how does it work?

It's a way to avoid tax on the sale of a rental property by exchanging it for another income-producing property of equal value. The profit isn't taxed until the second property is sold

When might you owe a "recapture tax" if you bought your property through a state or local bond issue program?

If you sell the home in less than ten years from purchase and your income at the time of sale exceeds the program's maximum gross income limits in effect at the time of purchase

What is the general rule for deducting "points" paid on a mortgage for a primary residence purchase?

Fully tax-deductible by the borrower in the tax year they are paid

What is one of the main economic motivations behind real estate ownership?

The tax advantages

How are "points" for a refinance generally deducted?

Over the life of the mortgage

What is an exception to the rule for deducting refinance points over the life of the mortgage?

The portion of the proceeds utilized for home improvements

If the seller pays points, can the purchaser deduct them?

Yes, but it will reduce the cost basis of the home

Are real estate property taxes paid by the borrower during the purchase of a home deductible?

Yes, but only after money is actually paid to the taxing authority.

Name three types of costs paid at home purchase that are not deductible

• insurance

• recording fees

• transfer taxes

What are the two deductible components of a typical mortgage payment?

Mortgage Interest and Real Estate Taxes

Name three non-deductible components of a typical mortgage payment

• insurance

• HOA fees

• principal payments

What is the rule for mortgage interest on loans made before October 13, 1987?

Fully deductible as an itemized deduction

For mortgages made after October 13, 1987, what are the two classifications of deductible mortgages?

Acquisition Debt and Home-Equity Debt

What is the maximum deductible limit for "Home-Equity Debt"?

$100,000

What is the condition for home-equity debt to be deductible regarding fair market value?

Acquisition debt and home-equity debt cannot exceed the fair market value of the residence at the time of incurring the home-equity debt

Are home construction loans deductible as acquisition debt?

Yes, from the time construction begins to a period of up to 24 months or 90 days after completion, whichever comes first

What type of second home qualifies for mortgage interest deductions?

One used for personal (non-rental) purposes for the greater of 14 days or 10% of the rental days per year

When are real estate property taxes deductible by the homeowner

On the date paid by the homeowner or the lender on behalf of the applicant

What is the general rule for the deductibility of refinance costs (outside of interest and taxes)?

They are generally not deductible

What are the three conditions for a cash flow loss on a rental property to be fully deductible on an individual's tax returns?

• active management

• losses not exceeding $25k each year

• adjusted gross income not exceeding $100,000

How long is residential rental property depreciated, and what method is used?

27.5 years using the "straight-line method"

What is "Depreciation Recapture" when selling a rental property?

The calculation of gain increases by the amount of any real property depreciation previously taken on the property

What is the tax rate on the portion of the gain resulting from depreciation recapture on a rental property?

25%