Why Sell With DREAM REALTY?

• Free Market Analysis
• Quick Sell
• Preparing Your House for Sale Part 2
• Remodeling? Which Improvements payback most.

TAX ADVANTAGES OF HOME OWNERSHIP:

An owner can deduct the mortgage interest for two residences at a time. Mortgage interest and real estate taxes paid on a principal residence and a second home that isn't rented more than a certain number of days a year can be deducted by taxpayers. However, only two homes may qualify for the deduction at any one time and the total amount of the two mortgages cannot exceed $1 million.

A homeowner may NOT deduct all money spent on improving a home as expenses in the year the money was spent. Money spent on capital improvements to a residence may usually be added to the basis of the home, thereby lowering the realized capital gain when the home is sold. However, expenses may NOT be deducted against income UNLESS the property is an investment property or the money was spent specifically to make the home ready for sale.

For tax purposes, deductions for residential real estate held for personal use generally fall into two main categories:

· costs that can be deducted as expenses from a buyer's or seller's personal income on a tax return
· costs that can be used to alter the basis of the home, with the idea of lowering the capital gains

Note that a second, or vacation, home generally qualifies for all of the same deductions as a principal residence provided that it isn't rented for a significant portion of the year.

Buyers may deduct the following items associated with buying a home as expenses on their personal income tax in the year that they buy the home.

Points—including loan origination fees and loan discounts, provided that the home is your principal residence, the amount is clearly stated on the settlement statement, and the purchase meets the nine criteria for deducting points established by the IRS. (See www.irs.gov/prod/forms_pubs/pubs/p53001.htm for details on these criteria.)

If the buyer doesn't satisfy all of these criteria, points must be prorated and deducted over the life of the mortgage.

Buyers may add the following costs associated with a purchase to the basis of their home. These additions will increase the basis and serve to lower the capital gains liability when the home is eventually sold:

1. Transfer or stamp taxes and recording fees, if paid by the buyer.

2. Title abstracts.

3. Title insurance.

4. Attorney's fees for preparing their documents for closing.

CANNOT DEDUCT: Buyers cannot deduct as expenses on their income tax or add to the cost basis of the home:

1. Fees for an appraisal required by the lender.

2. Rent paid to occupy the home before closing.

3. Cost of credit reports.

4. Loan assumption fees.

Homeowners may NOT deduct:

1. Homeowners association dues or assessments.

2. Premiums for fire or homeowners' insurance. (Note that this is often included in the monthly house payment.)



CAN DEDUCT: During the period of homeownership, owners of single-family homes, condominiums, coops, and other types of property occupied as a principal residence may deduct the following items as expenses each year on their income tax returns:

1. Interest paid on a mortgage loan(s) of $1 million or less taken out to buy, build, or improve a home. If the loan amounts you owe on your first and second home together exceed $1 million, not all interest is deductible. Note that married couples filing separately may each deduct interest on a total mortgage debt of $500,000.

2. Late payment charges on mortgage payments

3. Real estate taxes paid on the home in the year they are paid

At the time of the sale, the sellers may deduct the following expenses from their income taxes:

1. Any reserved real estate taxes credited to the buyer at closing. However, these deductions can't be taken until the year that the property taxes are actually paid to the taxing body.

2. Any mortgage interest paid for the portion of the year that the house was owned.

3. Any remaining, undeducted points for the satisfied mortgage.

In calculating the capital gains resulting from a sale, the sellers may add the costs following items to their existing basis:

1. Transfer or stamp taxes and recording fees, if paid by the seller.

2. Recording fees, if paid by the seller.

3. Attorney's fees for preparing their documents for closing.

4. Real estate commissions paid to a broker and sales associates.

5. Money spent to repair the house prior to sale, if spent within 90 days of the sale.

Capital gains are the net profits realized from the sale of any investment held for more than 12 months. A principal residence, which can be a single-family home, a condominium, a cooperative, or a manufactured home, is treated as a capital asset. The capital gains rate is currently 15 percent. (The capital gains rate for properties acquired after 2000 and held for five years or more is 18 percent.)

· Since 1997, homeowners may exclude the first $250,000 in gain ($500,000 if married and filing jointly) on the sale of one home every two years. To qualify for this exemption, homeowners must have lived in the home as their principal residence for two out of the last five years. Note that the 24 months don't have to be consecutive to qualify.

Calculating Capital Gains
1. Take the contract sale price of the home

2. Subtract: The amount paid for the home, Plus OR Minus

Any adjustments to the sale price

3. = The result is the net capital gains realized on the sale

To calculate capital gains, you must know the total cost or adjusted cost basis of your home.

The cost basis is:
· the amount you paid for the home
· the cost of the land and the cost of building your home
· the amount you paid for your cooperative share, if your home is a coop
· the fair market value of the home as of the date you inherited it, or alternate valuation date which is within 6 months of the date of death.

Your basis can also be increased or decreased by any allowable "adjustment to the basis" that you have made. The higher the basis is the lower the gain will be, and therefore, the lower the potential tax liability.

Common adjustments that INCREASE your basis, are capital improvements, i.e. any expenditures that
· materially adds value
· will last more than 12 months
· creates a new use

Capital improvements include items such as a renovation of all or part of the house; adding new rooms; adding new roof, a fence, or a pool; paving your driveway; or putting in new plumbing, wiring, or appliances. (Note that if you do any work yourself, the cost of your labor CANNOT be added to the basis.)

Keep in mind that the costs of REPAIRS —including painting inside or out, fixing gutters or leaks, re-plastering, and replacing a broken window—are NOT considered capital improvements unless they are done as part of a major renovation.

Improvement vs. Repair

Improvements	Repairs
Garbage disposal	Interior painting
Wall to wall carpeting	Repair/patch worn carpeting
Install built-in storage units	Refinish wood floors
Add storm windows	Replace one cracked window
Add pet run	Replace belt on furnace
Install burglar alarm system

Owners may continue to add capital improvements to the basis for as long as they live in the house; there is NO time limit. However, they MUST keep records of dates, vendors, and amount actually spent to support their claims.

Common adjustments that REDUCE your basis:

1. Energy conservation subsidies received from a utility

2. Depreciation you deduct from your income taxes on the portion of your home you use as a home office

In addition, certain costs associated with the buy-sell transaction may be added to the basis.

For the buyers, these include:

1. Recording fees

2. Buyers' attorney fees associated with the closing

3. Inspection fees, if the buyers pay them

For the sellers, these include:

1. Transfer taxes and stamp fees

2. Sellers' attorney fees associated with the transaction

3. Real estate commission

THREE SAMPLE TRANSACTION SCENARIOS:

Scenario 1: Bob and Sally Reiner bought their home five years ago for $125,000 and spent $1,200 in closing costs and $1,250 in points to acquire their loan. Their annual real estate taxes are $1,000 a year and they pay a yearly fee of $50 to the homeowners association. During the time they have lived there, the couple has added a stone patio to the back of the house ($1,200), painted the exterior of the house ($850), and put a new roof on the house ($2,000). They also installed a new furnace ($1,800), which entitled them to a $200 energy conservation rebate from their utility. They have just sold the house to the Levinsons for $158,000 and paid a commission of $9,480. The Reiners paid their attorney $350 to prepare documents for closing and paid $1,300 in recording fees and transfer taxes. They used $96,000 of the money they received to pay off their existing mortgage. a. What is the Reiners' basis in their home at the time of sale? Initial purchase price of home:	$125,000
	1,200
PLUS
Additions to basis
Patio (capital improvement)	1,200
New roof (capital improvement)	2,000
New furnace (capital improvement)	1,800
Real estate commission	9,480
Attorney's fee for closing	350
Recording fees	1,300
MINUS
Reductions to basis
Energy rebate from utility	200
Adjusted basis at time of sale	$140,930
Possible errors: The exterior painting is a repair; only capital improvements may be factored into the basis. Property taxes and mortgage payments may be deducted as expenses, but do not apply to basis.
b. What capital gains did the Reiners realize on the house?
Sale price of house	$158,000
MINUS
Adjusted basis at time of sale	$140,930
Capital gain	$ 17,070
c. What are the Reiners tax liabilities on this capital gain?
Because they have owned and lived in the property for more than two years, the Reiners are entitled to a capital gains exemption of $500,000 (for a married couple). They have no tax liability.

SCENARIO 2:

Blanche and Tom Williams bought a home in April 2000 and are now getting the records together to pay their 2000 income tax. In buying the house, the Williams's spent $2,000 on points (which they will take as a single deduction), $500 on attorney's fees for the closing, $125 for title insurance, and $250 for an appraisal required by their lender. They spent $600 on a new water heater and had two rooms repainted for $200. During their first partial year of ownership, they paid $5,000 in mortgage interest, plus one late fee of $75, and deposited $1500 in their tax escrow account. On their behalf, the bank made the first tax payment due in January 2001 of $1,020.

a. How much in expense deductions are the Williams entitled to on their 2000 federal tax return?

Mortgage interest	$5,000
Mortgage late fee	75
Points	2,000
Total deductions	$7,075
Although real estate taxes can be deducted as expenses for income tax purposes, they cannot be deducted until the year they are actually paid. Since taxes were not paid until 2001, the Williams are not eligible to deduct the amounts they deposited.
b. Based on this scenario, how much can the Williams add to the basis of their home?
Attorney's fees	$500
Title insurance	125
Water heater	600
Total additions to basis	$1,225
Possible error: Neither the appraisal fee nor the painting qualify as either an expense or an addition to basis.

SCENARIO 3: John and Marcia Houser bought their home 30 years ago for $25,000. Fifteen years ago, the couple did a major renovation of the house, which cost a total of $35,000. Since they are now over 65 and retired, the Housers haven't done much to keep their house up, although they did repave their driveway two years ago ($1,000) and install air conditioning ($1,500).

When they listed their home with Jeff Vesos, he suggests repainting the house inside and out ($1,400), adding new landscaping ($900), and replacing the carpeting on the first floor ($2,300). Jeff's strategy proved correct; just 55 days after the work was completed, the Housers closed on a sale and receive $350,000 for their home. Jeff received a commission of $17,500. The Housers paid other closing costs—attorney's fees and recording fees of $3,600.

a. What is the Housers basis in their home?

Initial purchase of house	$25,000
PLUS
Additions to basis
Major renovation	35,000
Pave driveway	1,000
Air conditioning	1,500
Real estate commission	17,500
Closing costs	3,600
*Repaint house	1,400
Landscaping	900
Carpet replacement	2,300
Total adjusted basis:	$88,200
*This item may be added to basis because the work was done within 90 days of the sale.
b. What were their capital gains on the sale?
Sale price of house	$350,000
MINUS	88,200
Capital gains realized	$261,800
c. What are their tax liabilities for the sale?
None. Because the Housers are a married couple filing joint, their combined capital-gains exclusion is $500,000. If the house were owned by only one person, the exemption would be only $250,000 and the owner would owe capital-gains taxes on $11,800

OTHER RESOURCES AVAILABLE TO OUR DREAM REALTY CLIENTS:

REALTOR.org and search for "taxes." Also, you'll find a complete summary of the current treatment of capital gains for residential real estate sales under the 1997 Tax Relief Act.

Visit the Internal Revenue Service's site, and use its search feature to find information and updates on tax issues. Publication 523 is particularly helpful.

Visit the "Buying a House" section at nolo, a free site with legal advice.

Visit www.cpaonline.com for a directory of tax resources.

The following articles on taxation are available here, at Realtormag.com:

"Tax Tools: Software," Christina Hoffmann Spira, REALTOR^® Magazine, February 1999.

"Managing Your Money: A Profitable Exchange," Robert Sharoff, REALTOR Magazine, September 2000.

"Buyer's Guide Plus: Number Crunchers," Michael Antoniak, REALTOR Magazine, May 2000.