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.
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.
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.
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.