Home Ownership

The Basics

  • You can deduct the interest on your home loan and the real estate taxes you pay on the home.
  • Mortgage interest is tax deductible on loans of up to $1 million ($500,000 if Married Filing Separately) as long as you use the money to buy, build or improve on your home and the loan is secured by your home.
  • Points or origination fees paid when you purchase your home generally are tax deductible in full in the year you pay them.

Mortgage Interest Tax Deduction

Mortgage interest you pay on loans up to $1 million ($500,000 Married Filing Separately) is tax deductible, provided you used the money to buy, build or improve your home and the loan is secured by your home.

Plus, the interest you pay on loans secured by your home and used for a purpose other than to buy, build or improve your home is tax deductible for loans up to $100,000 ($50,000 Married Filing Separately). The limit may be reduced depending on the market value of the home at the time you take out the loan. Use equity lines of credit wisely. If you fail to make the payments, you put your home at risk.

If your income meets the requirements and your state or local government issued you a mortgage certificate credit, you may be eligible to claim a tax credit (the mortgage interest tax credit) based on the amount of interest you paid. If you claim the tax credit, you must reduce your interest deduction by the amount of the credit.

Loan Origination Fees

Finally, don’t forget about points, also called loan origination fees. One point equals 1% of your loan. Points you pay (and even points the seller pays) when you purchase your home are generally tax deductible in full the year you pay them.

Alternatively, you may choose to amortize the points over the term of your mortgage. This choice is usually made only when your itemized deductions are less than the standard deduction for the year you bought the home.

Points paid to refinance a loan must be deducted over the term of the loan. If you deduct points over the term of the loan and sell the home or refinance it again before the loan expires, you can deduct in the year of the sale or refinancing any points that you didn’t previously deduct.

Gain on the Sale of Your Home

When you sell your home, the IRS allows you to exclude gain on the sale from taxable income, up to $250,000 ($500,000 Married Filing Jointly and you both meet the use requirement).

You can claim the exclusion if you own and use the home as your main home for at least 2 years during the 5-year period ending on the date of sale. You may claim this exclusion only once in any 2-year period.

If you don’t meet the 2-year requirement, you may be eligible to claim a reduced exclusion if you sell your home because of an “unforeseen circumstance,” such as a change in employment or a divorce. A loss on the sale of your home, however, isn’t tax deductible.

If you used the home other than as your residence after 2008 (for example, as rental property), gain allocable to that use (nonqualified use) generally can’t be excluded. This rule does not apply to:

  • Any nonqualified use before 2009.
  • Any period during the 5-year period that is after the last period of use as a principal residence.
  • A period of temporary absence of up to 2 years for reasons of health, employment and unforeseen circumstances.
  • Any period (not to exceed 10 years) during which the taxpayer or spouse was serving on qualified official extended duty.

Interest Deduction Basics:

  • Interest is deductible on mortgage loans of up to $1 million used to buy, construct or substantially improve your second home ($500,000 if Married Filing Separately).
  • If you use your second home as a residence and rent it for 15 days of the year or more, you must report rental income.
  • Exclude up to $250,000 ($500,000 if Married Filing Jointly) on the gain of the sale of your second home if you owned and used the home as your main home for at least 2 years during the 5-year period ending on the date of sale.

A second home can be a house, condominium, cooperative, mobile home, house trailer or boat that has sleeping, cooking and toilet facilities. For example, an RV can qualify as a second home. If you own more than 2 homes, you must choose which home other than your main home to treat as the second home. However, you don’t have to choose the same home each year.

Second Home Deductions

If you take out a mortgage to buy, construct or substantially improve a second home, the interest is deductible if you itemize deductions. Your deduction may be limited if the mortgage exceeds the fair market value of the home or if the mortgages on your main home and your second home exceed $1 million ($500,000 if you’re Married Filing Separately). These limits do not apply to mortgages taken out before Oct. 14, 1987 (called grandfathered debt), but grandfathered debt reduces the $1 million and $500,000 limits.

If you take out a home equity loan or line of credit on your second home, the interest is fully deductible unless the mortgage exceeds the fair market value of the home reduced by the amount of the mortgages, including grandfathered debt, as previously described, or if the mortgages of this type on your main home and second home exceed $100,000 ($50,000 if Married Filing Separately).

Real estate taxes and points you pay over the life of a mortgage to acquire a second home are deductible if you itemize deductions. Points you pay on a mortgage to acquire a second home are also deductible over the life of the loan. If you refinance or sell the home before the mortgage is paid off, you can deduct in the year of sale or refinancing any points you didn’t previously deduct.

Renting Your Second Home

If you use the home as a residence and rent it for less than 15 days during the year, you don’t have to report the rental income. It’s considered a residence if you (or a family member) use the home for personal purposes for more than the greater of 14 days or 10% of the number of days that you rent the home at fair rental value. You may not deduct any expenses attributable to the rental, but you may deduct interest and taxes if you itemize your deductions.

If you use the home as a residence and rent it for 15 days or more, you must report the rental income. You may deduct your interest and taxes as described above. But you can deduct other rental expenses (including depreciation) only up to the amount of the income reduced by the deductions for interest and taxes. Any rental expenses not deductible under this rule are carried to the following year, when they are again subject to this limit.

If you don’t use the home as a residence, the above rules don’t apply. You report your income and expenses in the same manner as for other rental property, and you can’t deduct expenses other than interest, taxes and casualty losses attributable to your personal use of the home.

Selling Your Second Home

If you sell your second home, the gain will be taxed as capital gain, long-term if you owned it for more than a year and short-term if you owned it 1 year or less. A loss on the sale can’t be deducted. If the second home was rented for profit, gain generally is taxed as capital gain and a loss can be deducted. The part of the gain attributable to depreciation is taxed at a maximum rate of 25%. If you used the home for personal purposes and rented it, you have to treat the sale as part personal, part business.

If the second home was your main home for at least 2 years during the 5-year period ending on the date of sale, you can exclude up to $250,000 of the gain (up to $500,000 if Married Filing Jointly and you both used the home as your main home for the required period). You can’t claim the exclusion if you sold another home within the 2-year period ending on the date of sale and claimed the exclusion for that sale.

If you don’t meet the 2-year ownership or use requirement, you may claim the exclusion only if you sell the home because of a change in health, place of employment, or another “unforeseen circumstance.” In this situation, the maximum exclusion will be reduced. You may not exclude any gain attributable to depreciation you claimed after May 6, 1997.

If you sell a second home and use it other than as a principal residence (nonqualified use) at any time after 2008, the gain eligible for the exclusion may be limited. For this purpose, nonqualified use does not include:

  • Any nonqualified use before 2009.
  • Any period during the 5-year period that is after the last period of use as a principal residence.
  • A period of temporary absence of up to 2 years for reasons of health, employment and unforeseen circumstances.
  • Any period (not to exceed 10 years) during which the taxpayer or spouse was serving on qualified official extended duty.

 

See IRS Publication 530
See IRS Publication 936