Thursday 16 October 2014

Real Estate Transactions and Their Tax Implications

Buying a home at a good price and with a good mortgage is only the first step of being a smart homeowner. Smart homeownership is actually a lifelong exercise, requiring that you keep the implications on and for your home in mind as you make major life decisions of any sort. Smart owners also keep in mind the tax implications or advantages involved in the major decisions and actions they take vis-a-vis their homes.

Buying a home. Buying a home triggers some major tax benefits. First, a large chunk of the transaction closing costs are tax deductible. Second, during the time you own the home, up to 100 percent of the interest you pay on your mortgage is tax deductible. This often drastically reduces a new owner's net income tax liability compared to the taxes they owed as a renter.
Selling a home. Selling a home sparks the potential for capital gains taxation. Also, selling your home in a short sale -- when the purchase price is less than the amount owed on the property, and the lender involved forgives some portion of the debt owed -- normally triggers an income tax on the amount of mortgage debt forgiven. This income tax is temporarily suspended through 2012 to eliminate the tax penalty on many short sellers.
Estate planning and family transfers. Normally, homes are reassessed for property tax purposes every time ownership is transferred. However, estate planning transfers -- like transfers to a living trust and transfers between parents and children, grandparents and grandchildren, and even between spouses -- are generally exempt from reassessment. This means that if your grandma gives you her home, you may end up keeping her 1973-based property tax rate!
Remodeling. Most folks do not consider remodeling a taxable event, but in some ways, it is -- in others, it isn't. When you obtain permits to remodel your home, many cities will increase the assessed value of your home to account for the improvements you have made. On the other hand, the money you spend to improve your home is added to your basis in the property for capital gains, allowing you to reduce the potentially taxable amount by the amount you have invested in improving your home.
Refinancing. As they are in a home purchase, the points paid on a home refinance mortgage are also tax deductible.
Becoming a landlord. Whether you are converting your home into a rental property or buying a place with the intention to use it as income property, there are several tax considerations to take into account when you lease a property out.
  • Increased income taxes. The rental income you receive will, in most cases, constitute additional taxable income.
  • Capital gains. The $250,000/$500,000 capital gains tax exclusion is applicable only to your residence. Your rental property may have no applicable capital gains tax exclusion, which means that when you sell it, you may incur a tax on every dollar of net appreciation unless you conduct a 1031 exchange, rolling your net gains into the purchase of a similar property.
  • Local business taxes. Some municipalities consider a rental property to be a going business concern and tax the rental income as they would take a business' receipts. Investigate whether and how your city views income properties and incorporate any local business taxes into your investment analyses before you buy.
NOTE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.

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