Last year, we spent as much time talking about the love saga of Brad Pitt and Angelina Jolie as we did the housing market.

The big difference, though, is that Brad and Angelina probably don't stay up nights worryingabout how they're going to make their next mortgage payment. The rest of us do.

And to make matters worse, if you bought, sold or refinanced a home in 2005, that whole stressful situation will again rear its ugly head this April when you have to deal with the tax consequences. (Again, I doubt the Jolie-Pitts have this problem.)

So for us Average Joes, here's what you need to know.


If you sold a home in 2005 and didn't make money on it, there better be a good reason. Even money pits were getting into bidding wars. So we're going to presume you're sitting on some sort of gain.

The home-sale exclusion rules say that you won't owe tax on any gain up to $250,000 as a single person and $500,000 as a married couple, presuming you lived in the house as your primary home for two of the last five years.

But the market was nutty last year. Some folks were blessed with big gains. It's not far-fetched for a single guy to have purchased a $1 million Manhattan apartment three years ago, only to have flipped it for $1.3 million last year.

So now what? Well, first he gets the $250,000 freebie. He will then owe tax on the extra $50,000. He'll need to report it on Schedule D - Capital Gains and Losses, just like a stock sale.

Overall, though, there's a big difference between stock sales and housing claims. "You can't claim a loss on your tax return for a house," says Mark Luscombe, a principal federal tax analyst with CCH Inc., a provider of tax and business-law information.

Same goes for the sale of your vacation home. Sell it at a loss, and it's your problem. But if you sell it at a gain, Uncle Sam does the happy dance, because the gain from the sale of a second home doesn't qualify for the home-sale exclusion. You owe tax on the whole amount.

Here's a planning tip: If you still own a vacation home and are contemplating retirement soon, sell your principal residence and let the gain qualify for the exclusion. Then move into your vacation home. As long as you live there for at least two years, it will then become your principal residence, and that gain will qualify for the exclusion when you sell, says Luscombe.

Buy, Buy, Baby

The homebuying market last year was comical, at least for those who weren't involved in the mayhem. In many hot markets, anything decent was priced near $1 million and still needed kitchen and the bathroom renovations.

Let's say you bit the bullet, overextended yourself with a fat mortgage and took a home equity loan on top of that to remodel that 1970s kitchen. The least you can hope for now is some kind of retribution on your tax return.

Well, not so much. Sure, you'll get a mortgage-interest deduction on Schedule A - Itemized Deductions, but if you signed on for a low-interest rate loan, that deduction may not be as juicy as you hoped.

And remember the rules. You can deduct the interest on home-mortgage loans up to $1 million. So if your mortgage is $1.2 million (how do you sleep at night?), you can only deduct the interest on the first $1 million.

The home-equity world is different. Typically, you can only deduct interest on home-equity loans up to $100,000. That's because many folks use home-equity loans to buy cars or finance that trip around the world, so the IRS has to set some limitations for pleasurable uses. But if you can prove that the loan is used strictly for home improvements, the $100,000 limit doesn't apply. In that case, your loan can max out at $1 million, and the interest will still be deductible.

Keep in mind that $1 million is an aggregate maximum. While you can also deduct the mortgage interest on a second home, that $1 million cap applies to both loans.

Thankfully, your real estate tax deduction is unlimited. So if you pay taxes on two homes, deduct away.

That's about all the 2005 tax benefits you're going to find from your purchase. But now you need to keep track of your basis, the starting point in figuring later gains and losses. Remember, when you decide to sell (I know, the boxes aren't even unpacked), your gain is the difference between the selling price and the basis. So the higher your basis, the smaller your capital gain. And you need to keep that gain within the exclusion limits to avoid a tax hit.

So tally your basis. Start with your purchase price and add your closing costs, including legal fees and costs for surveys and titles.

And don't forget about that mansion tax some states impose. For instance, in New York, if the purchase price of the home is $1 million or more, the buyer must pay a "mansion tax" equaling 1% of the total price. Be sure to add that to your basis as well.

Then keep track of any big improvements. If you add a second level to a ranch, keep all that paperwork. If you update the kitchen, add on those costs. Same goes for new windows and updated bathrooms. Check out the IRS Publication 936 - Home Mortgage Interest Deduction for more details.

Bonus Points

You may have paid points -- a.k.a. loan-origination fees or discount points -- when you got your mortgage. Points are extra charges paid upfront to get a lower interest rate on your mortgage. If you paid points in 2005, deduct them on your Schedule A.

On the flip side, if you paid points on a refinancing, they must be amortized over the life of the loan, says Luscombe. So if you paid $3,000 in points on a 30-year-loan, deduct $100 each year.

But say you refinanced a second time in 2005, which isn't implausible. The points you were amortizing on the first refinance are now fully deductible. So deduct those and get rid of them, because the loan is gone. The points you paid on the newly refinanced loan must again be amortized.

With any mortgage, you should have gotten a Form 1098 - Mortgage Interest Statement bythe end of January showing the amount of deductible interest you paid on that loan in 2005. Form 1098 also reports any points paid in that year. But the form doesn't keep track of amortized points. So make sure you explain to the IRS that you're deducting points from a prior year, and include a note on the back of your return showing how you calculated the amortized point deduction.

While you may not have homes all over the country like Brad and Angelina, you still have a fabulous place to hang your hat at the end of the day. And whether that house is sucking the financial life out of you or not, it's still a good feeling to know you have a roof over your head.

Tracy Byrnes is an award-winning writer specializing in tax and accounting issues. As a freelancer, she has written columns for and the New York Post and her work has appeared in SmartMoney and on CBS MarketWatch. Prior to freelancing, she spent four years as a senior writer for Before that, she was an accountant with Ernst & Young. She has a B.A. in English and economics from Lehigh University and an M.B.A. in accounting from Rutgers University. Byrnes appreciates your feedback; click here to send her an email.

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