Taxes and Home Ownership

Whether buying a first home or in the process of selling one, home ownership can have a big effect on tax returns.

Some of the settlement fees and closing costs can be deducted in the tax year the home is bought. These costs include certain real estate taxes, mortgage interest and points that meet certain requirements.

Other costs may be included in the basis of the property. Basis is a way to measure the investment in a home for tax purposes. Costs like abstract and recording fees, surveys and owner’s title insurance are included in the basis.

People who itemize deductions can deduct interest on most mortgages secured by their first or second home. They can deduct qualifying points on a loan to buy or improve their main home in the year they paid them. And they can usually deduct real estate taxes imposed by state or local governments for the general public welfare.

The Taxpayer Relief Act of 1997 replaced two tax breaks for home sellers with a more generous one. Under the old law, those 55 and older could exclude up to $125,000 of gain. And anyone who bought a replacement home within two years of the sale might postpone taxes on some or all of the gain. Under the new law, taxpayers can exclude up to $250,000 of gain ($500,000 on a joint return, if both meet the residency requirement) from the sale of a home.

The new exclusion is allowed once every two years, but only if the person used the home as a principal residence for at least two out of the five years before the sale. The seller must pay tax on any gain exceeding the exclusion - the replacement home rule no longer applies. If a person sells before satisfying the two-year residency requirement because of a change in employment or health, the maximum exclusion amount ($250,000 or $500,000) is prorated by the percent of the two-year time met. This proration also applies to anyone who owned a home on Aug. 5, 1997, and sells it before Aug. 5, 1999, regardless of whether there was a change in employment or health.

Because of this larger exclusion of gain, the average person may not need to keep track of the home’s cost basis once the two-year residency requirement is met. Only if the home sells for more than the maximum exclusion amount will the taxpayer even have to figure the gain. In that case, one would need accurate records of all items affecting the basis. This includes improvements such as adding a room, finishing a basement or putting up a fence.

More information on buying, owning or selling a home is covered in the following free publications. Call 1-800-829-3676 or check them out here.

1. Publication 523, Selling Your Home
2. Publication 530, Tax Information for First-Time Homeowners
3. Publication 936, Home Mortgage Interest Deduction

Educational Incentives Give Tax Breaks

People continuing their education or planning for a child to attend college should learn about the educational incentives available to them. These incentives could change the bottom line on their tax returns.

The Hope credit lets people below certain income levels claim a credit for the first two years of post-secondary education expenses. The credit is limited to $1,500 per year for qualified tuition and expenses. Tuition expenses eligible for the credit must be reduced by any tax-free funds, such as grants or scholarships. Graduate and professional level fees are not allowed. The credit applies to payments made after 1997, for academic periods starting after that year.

People can claim the Hope credit for each eligible student in their family. The student must be enrolled in at least half of the full-time work-load for the course of study. The credit is not allowed to students convicted of a felony drug offense. A person can claim the Hope credit for only two tax years for each eligible student.

The lifetime learning credit applies to qualified tuition and expenses for undergraduate, graduate, and professional degree courses paid after June 30, 1998, for courses starting after that date. People under certain income levels can claim this credit for an unlimited number of years. The credit is 20 percent of expenses, up to a maximum credit of $1,000 per return. The credit amount doesn’t increase with additional eligible students in the family, and it cannot be claimed for students’ expenses during years when the Hope credit is claimed for those students.

Both the Hope and lifetime learning credits are reduced rateably as a taxpayer’s adjusted gross income rises from $40,000 to $50,000 (double those amounts for a married couple filing jointly).

In addition to these credits, people under certain other income levels can deduct a limited amount of the interest paid on qualified higher education loans, but only for the first 60 months of loan payments. The maximum deduction is $1,000, and students must have been enrolled for at least half the normal full-time course load required. This deduction phases out as adjusted gross income rises from $40,000 to $55,000 ($60,000 to $75,000 for married couples filing jointly). Taxpayers do not have to itemize on Schedule A to claim the student loan interest deduction.

People who are dependents and married couples filing separate returns cannot claim the student loan interest deduction or the Hope and lifetime learning credits.

Individual retirement arrangements (IRAs) can help provide for education as well as retirement. People who have IRAs can tap into them to pay for qualified higher education expenses. They won’t have to pay the 10 percent penalty tax on early withdrawals, but they will have to pay tax on the amount withdrawn.

The Education IRA is set up as a funding vehicle to pay educational expenses of a named beneficiary. It features nondeductible contributions of up to $500 a year per beneficiary, with no tax on the earnings if withdrawals are less than qualified higher education expenses in the year of the withdrawal. The beneficiary must be under 18 when the contribution is made. The $500 limit is reduced if a contributor has income above certain levels.

And for people whose employers pay for their education, the employer-provided educational assistance is excluded from their wages. The maximum exclusion amount is $5,250 and is for undergraduate courses, not for graduate level courses.

Publications 590, Individual Retirement Arrangements (IRAs), and Publication 970, Tax Benefits for Higher Education, have more details about these tax breaks and the income phaseout rules. To order, call 1-800-829-3676 or download here.

Tax Breaks After Disasters

Losing personal or business property due to a fire, flood, hurricane, theft or other similar event is devastating. But many people can recover some disaster losses through federal income tax breaks.

People who suffer a casualty, loss or theft may be able to deduct the loss when they itemize deductions on their tax returns. If the loss happens in an area declared a disaster area by the president, people can choose to deduct the loss when they file their tax returns for the year of the loss, or amend their returns for the year before the loss, whichever provides the better tax result.

If additional time is granted to disaster victims for the filing of returns and paying taxes, interest will not be charged for that period.

For details, get free Publications 547, Casualties, Disasters, and Thefts (Business and Nonbusiness), and 1600 (1600SP in Spanish), Disaster Losses. Call 1-800-829-3676.

Standard Deduction for Dependents

People who can be claimed as a dependent by another get a higher standard deduction for 1998. The standard deduction is the greater of $700 or the person's earned income plus $250, up to the regular standard deduction of $4,250 for a single person. This helps relieve many working dependents with under $250 of investment income of the need to file a tax return or to have any tax withheld from their pay.

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