As a homeowner, you should be aware of the many tax benefits that go along with ownership. At Dagley & Co., we compiled a list of tax benefits that will be helpful for the current and next year’s tax season:
Mortgage Interest Deduction – Although it may seem that you will never get that mortgage paid off, keep in mind that unmarried taxpayers and married couples can deduct, as an itemized deduction, the interest on up to $1 million of acquisition debt plus $100,000 of equity debt on their first and second homes, provided the loans are secured by the homes. A married taxpayer filing separately is limited to deducting the interest on $500,000 of acquisition debt and $50,000 of equity debt.
Home Improvement Loan Interest Deduction – If you took out a loan secured by your home to make improvements on your main or a second home, that mortgage is treated the same as home acquisition debt, and the interest you pay on that loan is deductible as acquisition debt, so long as the combined total acquisition debt of the two homes does not exceed the $1 million limit on acquisition debt. Even if it does exceed the $1 million limit, the excess interest on up to the $100,000 equity debt limit may still be deductible. However, if you used the loan money to make repairs rather than improvements, the debt would only qualify as equity debt.
Equity Debt – If you used the equity in your home to borrow money to buy a car, take a vacation, or for another use, interest paid on that debt is deductible up to the $100,000 equity debt limit. That is why it is sometimes better to finance large purchases with a deductible home equity loan rather than a non-deductible consumer loan.
Property Tax Deduction – If you itemize your deductions, you can deduct the property taxes you paid during the year on your home. However, be careful; generally property taxes are billed on a fiscal year basis, so the amount billed may cover parts of two years. You can only deduct what you actually paid during the year. If you have an impound account (sometimes called an escrow account) with your mortgage lender, the amount paid will be included on the lender’s annual statement. Also be aware that if you are subject to the alternative minimum tax (AMT), a deduction for taxes is not allowed when computing the AMT.
Private Mortgage Insurance Premiums – Generally when home buyers are unable to make a 20% down payment when purchasing a home, the lender will require them to obtain private mortgage insurance (PMI) and the insurance premiums that go along with it. To be deductible, the insurance contract must have been issued after December 31, 2006. Those premiums are deductible if incurred for the purchase of your first or second home, and they are not limited by the $1 million limitation on home acquisition debt.
The deductible amount of the premiums phases out ratably by 10% for each $1,000 by which the taxpayer’s AGI exceeds $100,000 (10% for each $500 by which a married separate taxpayer’s AGI exceeds $50,000). If AGI is over $109,000 ($54,500 married separate), the deduction is totally phased out.
Congress failed to extend this deduction, and thus 2016 is the last year for it. If you are stuck with a PMI and your equity in your property has grown to be greater than 20% (you’ve paid down the mortgage balance to 80% of the home’s original appraised value), you may want to contact your lender about removing the PMI, refinancing to get rid of it, or obtaining an updated appraisal. When the balance drops to 78%, the mortgage servicer is required to eliminate PMI. (These rules generally don’t apply if your loan is guaranteed by the Federal Housing Administration (FHA) or Department of Veterans Affairs (VA).)
Solar Energy Credits – Through 2021, taxpayers can get a tax credit on their federal tax return for purchasing and installing solar electric or solar water heating systems. The credit is 30% of the cost through 2019, at which time it begins to phase out and the credit is reduced to 26% for 2020 and 22% for the final year of 2021.
The credit is nonrefundable, which means it can only be used to offset a taxpayer’s current tax liability, but any excess can be carried forward to offset tax through 2021. Both the solar electric and the solar water systems qualify for credit if installed on a taxpayer’s primary and secondary residences. However, no credit is allowed for heating water for hot tubs and swimming pools.
Impairment-Related Home Expenses – If you, your spouse or a dependent living in your home has a physical handicap and you make modifications to the home or install special equipment to alleviate that disability, those costs may be deductible as a medical expense. The portion of the cost of permanent improvements that increases the value of the home is not deductible, but the difference can be included as a medical expense. However, home modifications made to accommodate a home for an individual’s handicap generally do not increase the value of the home and can be included in full with your medical deductions. These improvements include, but are not limited to, the following items:
- Constructing entrance or exit ramps for the home,
- Widening doorways at entrances or exits to the home,
- Adding handrails, support bars and grab bars,
- Lowering or modifying kitchen cabinets and equipment, and
- Installing porch and stair lifts.
Points Deduction – Points are a form of prepaid interest; one point is equal to 1% of a loan amount. Points are often labeled “loan origination fees,” “premium charges,” etc. At times, certain loan charges may be called points but are really amounts lenders charge for setting up a loan. Such “service charge points” aren’t normally deductible.
Generally, prepaid interest must be amortized (deducted) over the life of a loan; however, tax law carved out a special rule that allows points incurred for purchase of a primary residence to be fully deducted on the return for the year in which they are paid. This special rule also applies to loan points incurred for home improvement loans.
Home Office Deduction – If you are self-employed, you may qualify for a deduction for the business use of your home, commonly known as the home office deduction. You may also qualify if you are an employee and the use of the home is for the convenience of the employer. In either case the portion of the home used for business qualifies for the deduction only if it is used exclusively for business.
There are two methods that can be used to determine the deduction: (1) the actual expense method, where you prorate the home expenses such as utilities, insurance, maintenance, interest, taxes and depreciation, or (2) a simplified deduction, which is $5 per square foot of office space, with a maximum square footage of 300. If the latter method is used, mortgage interest and real property tax deductions may be claimed as usual as part of itemized deductions, but a proration of other home-related expenses isn’t deductible. In either case, the deduction is limited to the income from the business activity.
If you have questions about any of these tax related home ownership deductions/issues, give Dagley & Co. a call. Or, are you considering purchasing a home? Dagely & Co. will help you to understand how the home ownership will impact your taxes.
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Ever noticed an amount on line 45 of your tax return? If so, it this is because you are subject to the alternative minimum tax, also known as AMT. The AMT is a generally punitive method of computing income tax that does not allow some of the tax preferences and deductions that regular tax computation allows. When an AMT computation results in a higher tax, the higher tax applies, and the additional tax from the AMT is added on line 45 of your return.
The AMT was originally designed (nearly 50 years ago) to impose a minimum tax on higher-income taxpayers who were avoiding taxes by claiming certain (legal) deductions or other tax benefits (also termed “preferences”). However, years of inflation have caused an increasing number of taxpayers to be subject to the AMT.
It is complicated to determine when an individual will be subject to the AMT, for many tax preferences can trigger the AMT, alone or in combination. The following are some of the items that frequently trigger the AMT for the average taxpayer:
- Medical Deductions – Deductions for medical expenses are allowed for the AMT computation – but only to the extent that they exceed 10% of the taxpayer’s income. Although the limit is also 10% for regular tax purposes, through 2016, taxpayers age 65 and over enjoy a lower limit of 7.5%, which leads to an AMT adjustment. Sometimes, it is possible to defer or accelerate medical expenses from one year to another (for example, by paying an orthodontist in installments or all at once). If your employer offers a flexible spending plan, consider participating, as such plans allow you to pay medical expenses with pretax dollars while avoiding both regular and AMT deduction limitations.
- Deduction for Taxes Paid – When itemizing deductions, a taxpayer is allowed to deduct a variety of other taxes, such as real or personal property taxes and state income or sales taxes. However, for AMT purposes, none of these itemized taxes is deductible. For most taxpayers, this represents one of the largest tax deductions, and it frequently triggers the AMT. If you are affected by the AMT, conventional wisdom dictates deferring tax payments to a subsequent year when the AMT may not apply. When deferring, care should be exercised regarding late-payment penalties and interest on underpayments. In addition, taxpayers can annually elect to capitalize their taxes on unimproved and unproductive real estate. This means foregoing the deduction and adding the tax paid to the cost basis of the real property.
- Home Mortgage Interest – For both regular tax and AMT computations, interest paid on a debt to acquire or substantially improve a first or second home is deductible as long as it does not exceed the debt limit (generally $1 million). This is also true of refinanced debt, except that any increase in debt is treated as equity debt. For regular tax purposes, the interest on up to $100,000 of equity debt on the first two homes can also be deducted. However, equity debt is not deductible when computing the AMT; neither is acquisition or equity debt on a motor home or boat that may qualify as a second home. Therefore, taxpayers should exercise caution when incurring home equity debt. Generally, loan brokers are not aware of these limitations, and there are numerous pitfalls.
- Miscellaneous Itemized Deductions – Among miscellaneous deductions, the category that includes employee business and investment expenses is not deductible for AMT purposes. For certain taxpayers with deductible employee business expenses, this will often trigger the AMT. Employees with significant employee business expenses should attempt to negotiate an “accountable” reimbursement plan with their employers. Under this type of plan, reimbursement for qualified expenses is tax-free. An employee who has been reimbursed no longer claims a deduction for those expenses, thus eliminating the miscellaneous deduction. Another strategy would be to defer the expenses to a year that is not affected by the AMT.
- Personal Exemptions – The AMT computation does not allow a deduction for personal exemptions, which in 2016 is $4,050 each for the taxpayer, his or her spouse (if any) and any dependents. Divorced or separated parents should carefully consider which party should claim the exemption for their children if one of the parents is subject to the AMT.
- Standard Deduction – For regular tax purposes, taxpayers have the option of itemizing their deductions or taking the standard deduction. However, for AMT purposes, there is no standard deduction. Thus, a taxpayer who ends up with an AMT when taking the standard deduction should try to force itemized deductions, even if the result is less than the standard deduction. The result will be an increased regular tax but a reduced AMT, which could result in overall tax savings. Even the smallest of deductions will benefit those who are taxed at a minimum of 26% (the lowest bracket for the AMT).
- Incentive Stock Options – Although not frequently encountered, incentive stock options (ISOs) can have a profound impact on a taxpayer’s AMT. Generally, to achieve the beneficial long-term capital gains rates on stock acquired through an ISO, a taxpayer must hold the stock for more than one year after exercising the stock option and two years after the option is granted. However, the difference between the fair market value and the option price must be added to the taxpayer’s AMT income in the year the option is exercised. To avoid this substantial AMT preference income, the taxpayer can sell the stock in the year that the option is exercised and forego long-term capital gains rates. Alternatively, when doing so is beneficial, the taxpayer can exercise the option in small blocks over a period of years.
- Business Incentives – Taxpayers’ investments in businesses and partnerships sometimes provide tax incentives that the AMT does not allow. There is a long list of these incentives, but the most common are depletion allowances and intangible drill costs. Generally, these items appear on a Schedule K-1 (which the business activity issues to the investor) and are then included in the taxpayer’s AMT calculation.
AMT is a very complicated area of the tax law. You must be very careful while planning to minimize the effects of AMT as much as possible.
Dagley & Co., CPA is here to assist you with this planning. Please contact our office at (202) 417-6640 or send us an email at firstname.lastname@example.org.
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