Debt settlement home finance

IT IS THE AMERICAN WAY--mom, apple pie, and owning your own home. Let us look at all the deductions and benefits you get when you pay homage to the mortgage gods and go into more debt than your parents earned in their lifetimes.

First, you can deduct all the real property taxes you pay. That includes every cent of state and local taxes for the general welfare. It does not count any trash or garbage collection fees or homeowner association charges specifically stated and billed. If you are escrowing for the taxes, you get the allowance when your bank makes the payment, not when you escrow with the bank. Even if you are a tenant shareholder in a co-op, you may deduct your share of any property taxes paid. There is no limit on the number of properties on which you can deduct taxes paid. If you have 10 homes, you can do it for each.

The government wants to subsidize your home purchase. It does that by making your interest payments deductible. Interest paid on the purchase of your principal residence is deductible. You even can finance the acquisition of additional land, adjacent to your home, and deduct the interest as qualified residence interest. You also can deduct the interest you pay to buy a second residence or vacation home.

There is a cap of $1,000,000 of acquisition indebtedness on which you can take a personal interest deduction. Moreover, you can deduct the interest on as much as $100,000 worth of home equity debt. As long as the house has the equity and the debt is secured by that amount, the Internal Revenue Service does not care what you do with the borrowed money. Use it for whatever you want, including vacations, or a party to celebrate your newfound deductions. If you are in the 30% bracket, that means that $100 in interest paid takes $70 out of your pocket. Uncle Sam pays the other $30 in income taxes foregone. Not a bad deal.

IRS gives up the farm

With gain exclusion, meanwhile, the IRS "gave up the farm." The deal on this one is so good it makes my eyes glaze over. Forget about having to roll over your gain into a new home. Forget about the $125,000 gain exclusion if you are age 55 or older. They are ancient history and no longer sound tax law. Here is the new rule--good no matter what your age. If the property was your principal residence for any two of the five years prior to sale, you can exclude $250,000 in gain ($500,000 on a joint return)! If you qualify under the two out-of-five rule, you normally sign an affidavit at settlement. If the house sold for less than $250,000/$500,000, the sales amount is not even reported to the IRS because you have no tax liability on that sale.

This is not a one-time exclusion. You do not have to buy a new house. Even if you rent, you can get another full exclusion every two years, or whenever you qualify. However, if you have a $250,000/$500,000 gain every two years, I would like to meet your real estate agent. You even can get a partial exclusion based on the time of use and ownership. Remember, though, that you only receive the partial exclusion if the sale is because of a change in place of employment or health reasons or unforeseen circumstances.

The partial exclusion is based on the maximum exclusion, not on the basis of your actual realized profit. Say you purchased a home for $250,000 and sold it because of a job change for a $25,000 profit after one year. Because the sale was covered by a change in employment, you qualify for a partial exclusion. It was your principal residence for one year out of two, so 50% of the maximum exclusion, up to $125,000 in gain, is excluded. Since that is more than the $25,000 gain, no tax is due on the sale. You exclude half the maximum allowed, not half the $25,000 in gain. That is a major tax break. Not many properties are going to appreciate more than $125,000/5250,000 in one year.

Partial exclusions

The key is to qualify for the partial exclusion if possible. "Change in employment" covers anyone who lives in the household. He or she does not even have to be an owner of the property. The "change in employment" must be the primary reason for the move. There is a "safe harbor" which assumes that it was the primary reason if your new job is at least 50 miles farther from the residence sold than where you used to work. If you fail to meet the "safe harbor," all is not lost. You merely must prove (if you are audited) that it was the primary reason for the move based on the facts and circumstances of your case.

Health reasons include advanced age-related infirmities, the need to relocate to care for a family member, or to obtain or provide medical or personal care for a qualified individual suffering from a disease, illness, or injury.

The area of "unforeseen circumstances" is where the IRS really has become consumer friendly. Safe harbors are, among others, divorce, death, multiple births from the same pregnancy, and even a shift in employment or self-employment status that results in your inability to pay the costs and living expenses of your household. So, if your income goes down, or even if your spouse or other co-owner's income goes down, you can qualify for a partial or even a full exclusion. Even if you fail to meet one of these safe harbors, you still might qualify on the basis of your specific facts and circumstances. I guess Dorothy was right in the "Wizard of Oz." "There's no place like home!"

Jeff A. Schnepper, Associate Economics Editor of USA Today, is an attorney and estate planner in Cherry Hill, N.J., and author of How to Pay Zero Taxes.