Understanding the Tax Consequences in Buying and Selling Your Hawaii Home
Understanding the tax implications of your real estate dealings can be most useful to your financial future. Many times, by applying the tax benefits of home ownership, it turns out that buying a home is often less expensive than renting. When you acquire a home you are entitled to acquisition debt, that is, the debt you incur which is used for buying, building, or improving your home.
Since 1986, you have been able to have acquisition debt on your second home as well. The ceiling for acquisition debt that is eligible for tax deductions is $1,000,000. The debt ceiling (have you heard that term lately?) applies to the combined debt secured against both primary and secondary homes. Additionally, you can borrow up to $100,000 against your home, use the money for any purpose, and deduct the interest. You may have heard local lenders like Central Pacific, Bank of Hawaii, and KCFCU promoting their home equity lines lately.
When a buyer acquires their first home, it can be a great opportunity to investigate combining all or some of their debt into one loan. Since interest on the acquisition debt is deductible and interest on personal loans like credit card debt are not, consolidating your debt in your home acquisition will provide additional tax savings for the buyers. As you shop for a loan, if you are like most home buyers, most folks do not understand all of the individual terms and costs on the loan.
One of the disheartening things I see in working with many homeowners who secured homes through interest-only loans and pay option ARM loans in 2004-2006 is that most buyers did not understand the type of loan they were getting, and how much money the homeowner would ultimately be paying for the home.
One of the terms a home buyer will hear when shopping for a loan are “points.” “Points” are a term used to describe the cost of borrowing money and the charges paid in connection with originating a loan. Think of a “point” as a percent. If you are paying 1.5 points on securing your loan, you would be paying 1.5% percent of the loan amount. These points are considered prepaid interest and are fully deductible in the year paid. If you are fortunate enough to have the seller pay discount points on behalf of the buyer (this makes the home even more affordable for the buyer), this is also a deductible cost.
Let’s say you were purchasing your first home for $210,000 and securing a FHA loan, one of the best loans available today with a minimum down-payment. While the down payment is low, there would be PMI (primary mortgage insurance). Did you know that currently PMI is deductible as interest for the cost of financing your home? However, if your adjusted gross income is over $100,000, the deduction is reduced or even eliminated.
It’s a wise idea when purchasing your home to maintain a record of your costs of ownership. The average American family sells their home every six to seven years. When you purchase the home you establish your cost basis for the purchase. Over time, you may make capital improvements that will add to your cost basis. When you do get around to selling the home, you will need to calculate the gain on the sale, and by keeping a record from the beginning, you can have that information at your fingertips.
Ask your Realtor to provide such a form if they do not offer it to you first. When you calculate the gain after selling expenses and then subtract the basic (costs), and any exclusions, you will have your taxable gain (recognized gain). Fortunately, there is a homeowner exclusion for selling this principal residence as long as you have owned the home for five years and have lived in the home for two out of the last five years. The two years don’t need to be consecutive. There is no limit to how many times a taxpayer can take this exclusion, hooray! Single filers can exclude up to $250,000 of gain. Couples filing jointly can exclude up to $500,000 of gain. This is one of the most significant tax-saving opportunities for home owners. You can find out more information by navigating to www.irs.gov and downloading the Publication 523 – Selling your Home.
Statistically, 60% of American’s wealth is found in their home equity. By understanding the tax advantages and keeping good records, you’ll know where you stand with regards to this important asset in your fiscal world. If you would like an analysis of renting vs. buying a home here on Kauai, I’m happy to assist you in developing that financial understanding.
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