Deducting mortgage interest, as well as interest on home equity loans and HELOCs, can save money on taxes.
Know your loan limits: A good place to check out what you can deduct before you borrow is the chart on page 3 of IRS Publication 936. It’ll walk you through the requirements you must meet to deduct all of your home loan interest. It’s an hour well spent.
The first hurdle you’ll run into is the total amount of your loan or loans. In general, individuals and couples filing jointly can deduct the interest on up to $1 million ($500,000 if you’re married and filing separately) in combined home loans, as long as the money was used for acquisition costs, that is the cost to buy, build, or substantially improve a home, explains Scott O’Sullivan, a certified public accountant with Margolin, Winer & Evens in Garden City, N.Y. Any interest paid on loan amounts above the $1 million threshold isn’t deductible.
The same $1 million limit applies whether you have one home or two. Buying a vacation home doesn’t double your loan limits. And two homes is the max; you can’t deduct a mortgage for a third home. If you have a mortgage you took out before Oct. 13, 1987, you have fewer restrictions on claiming a full deduction. The calculations for “grandfathered debt” can get complex, so get help from a tax professional or refer to IRS Publication 936. You can also deduct the points and fees associated with a first or second mortgage when you initially buy your home.
Spend loan proceeds wisely: The other limitation on how much you can borrow and still get your deduction comes into play when you take out a home equity loan or HELOC that you don’t use to buy, build, or improve your home. In that case, you can deduct the interest you pay only on the first $100,000 ($50,000 if married filing separately). This loan limit also applies in a so-called cash-out refi, in which you refinance and take out part of the equity you’ve built up as cash, says John R. Lieberman, a CPA with Perelson Weiner in New York City.
That means if you decide to take out a $115,000 home equity loan to buy that Porsche, you can deduct the interest on the first $100,000 but not on the $15,000 that exceeds the limit. Use the same $115,000 to add a new bedroom, however, and the full amount is allowable under the $1 million cap. Keep in mind, though, that the $115,000 gets added into the pot of whatever else you owe on your other home loans. In many cases, points and loan origination costs for HELOCs are deductible.
Consider this simplified scenario: You borrow $250,000 against your home at 8% interest. That means you’ll pay $20,000 in interest the first year. Spend the $250,000 on home improvements, and all of the interest is deductible. Spend $150,000 on improvements and $100,000 on your kids’ college tuition, and all the interest is still deductible.
But spend $100,000 on improvements and $150,000 on tuition, and the improvement outlays are deductible, though $50,000 of the tuition expense isn’t. That’ll cost you $4,000 in interest deductions. Preserve the $4,000 deduction by coming up with the extra money for tuition from another source, perhaps a low-interest student loan or by borrowing from a retirement plan. For someone in a 25% bracket, a $4,000 deduction lowers taxes by $1,000, plus applicable state income taxes.
Beware the dreaded AMT: Even if you’ve followed all the loan limit rules, you can still get stuck paying tax on mortgage interest. How come? It’s all thanks to the Alternative Minimum Tax. Congress created the AMT, which limits or eliminates many deductions, as a way to keep the wealthy from dodging their fair share of taxes.
Calculating the AMT can be complex, but if you make more than $75,000 and have several kids or other deductions, you might well be subject to it. Problem is, if you fall into the AMT group, you may not be able to deduct interest on a home equity loan, even if the loan falls within the $1 million/$100,000 limit. If you’re subject to the AMT and borrow money against the value of your home, you’ll have to use it to buy, build, or improve your place, or you may not have a chance to deduct the interest.
The overall rate of IRS audits is low; but, despite a lack of hard numbers, being a real estate agents and small business professionals appears to increase the chances of getting extra attention during tax season.
While passive loss rules severely restrict the ability to deduct rental property losses from other non-rental income, individuals can claim an exemption; however, the IRS will look more closely at their return as a result—particularly if the filer has full-time employment and claims to be a property professional as well. The agency believes that most people with day jobs do not have the time to qualify as a real estate professional or other small businesses for tax purposes.
Another way to bring on IRS heat is to claim use of a vehicle 100 percent for business purposes when that is the only vehicle owned by the filer.
Also, small business professionals who fail to report all income could face an audit, since the IRS compares the 1099 forms that self-employed realty practitioners receive with the tax forms to determine if there are any discrepancies. Claiming ambiguous general expenses, making charitable donations that seem out of reach with income, and/or claiming large travel and entertainment deductions also could prompt the IRS to contact a filer.
The 3.8% tax that’s part of health care reform:
1. When you add up all of your income from every possible source, and that total is less than $200,000 ($250,000 on a joint tax return), you will not be subject to this tax.
2. The 3.8% tax will never be collected as a transfer tax on real estate of any type, so you’ll never pay this tax at the time that you purchase a home or other investment property.
3. You’ll never pay this tax at settlement when you sell your home or investment property. Any capital gain you realize at settlement is just one component of that year’s gross income.
4. If you sell your principal residence, you will still receive the full benefit of the $250,000 (single tax return)/$500,000 (married filing joint tax return) exclusion on the sale of that home. If your capital gain is greater than these amounts, then you will include any gain above these amounts as income on your Form 1040 tax return.
5. The tax applies to other types of investment income, not just real estate. If your income is more than the $200,000/$250,000 amount, then the tax formula will be applied to capital gains, interest income, dividend income and net rents (i.e., rents after expenses).
6. The tax goes into effect in 2013. If you have investment income in 2013, you won’t pay the 3.8% tax until you file your 2013 Form 1040 tax return in 2014. The 3.8% tax for any later year will be paid in the following calendar year when the tax returns are filed.
7. In any particular year, if you have no income from capital gains, rents, interest or dividends, you’ll never pay this tax, even if you have millions of dollars of other types of income.
8. It’s true that investment income from rents on an investment property could be subject to the 3.8% tax. But: The only rental income that would be included in your gross income and therefore possibly subject to the tax is net rental income: gross rents minus expenses like depreciation, interest, property tax, maintenance and utilities.
9. The tax was enacted along with the health care legislation in 2010. It was added to the package just hours before the final vote and without review. NAR strongly opposed the tax at the time, and remains hopeful that it will not go into effect. The tax will no doubt be debated during the upcoming tax reform debates in 2013.
FLINT, Mich. — An African-American nurse who is suing a Michigan hospital because she said it agreed to a man’s request that no African-American nurses care for his newborn recalled Monday that she was stunned by her employer’s actions.”I didn’t even know how to react,” said Tonya Battle, 49, a veteran of the neonatal intensive care unit and a nearly 25-year employee of the Hurley Medical Center in Flint.
Battle’s lawsuit states a note was posted on the assignment clipboard reading “No African American nurse to take care of baby,” according to the eight-page complaint against the medical center. Hurley, which according to its website was founded in 1908 and is a 443-bed teaching hospital, released a brief statement Monday, saying that it “does not comment on past or current litigation.”
Battle said she was working as a registered nurse in Hurley’s neonatal intensive care unit Oct. 31, when a man walked into the NICU, where Battle was at an infant’s bedside. He reached toward the child, according to the lawsuit filed in Genesee County (Mich.) Circuit Court last month.
“I introduced myself to him. ‘Hi, I’m Tonya and I’m taking care of your baby. Can I see your (identification) band?,’ ” Battle said, referring to the hospital-issued identification used to identify infants’ parents. “And he said in return, ‘And I need to see your supervisor.’ ”
Perplexed by his curtness, she asked for the charge nurse, who spoke separately to the man.
When the charge nurse returned, she told Battle that the father didn’t want African Americans to care for his child. Further, the charge nurse told Battle that he had rolled up his sleeve to expose what appeared to be a swastika.
“I felt like I froze,” Battle said. “I just was really dumbfounded. I couldn’t believe that’s why he was so angry (and) that’s why he was requesting my charge nurse. I think my mouth hit the floor. It was really disbelief.” Read the rest of the story here.