Home sweet deductible home: whether you own a large house on an estate or a condominium in a high-rise building, your home is probably the last great widely available tax shelter - Personal Finance

Healthcare Financial Management, June, 2003 by Jim Weil

The real-estate market has been strong in recent years, and mortgage rates are at historic lows, encouraging many people to buy new homes or refinance existing mortgages. Home ownership offers not only the opportunity to invest in an asset that is likely to appreciate over time, but also a variety of tax benefits. These benefits increase the attractiveness of home ownership. To ensure that they take full advantage of available tax- shelter benefits, however, prospective home buyers and even those who already own their home should review some of the tax implications of home ownership, such as home mortgage interest, home-equity debt interest, and points.

Home mortgage interest. The rule used to be fairly simple: home mortgage interest was deductible. After Congress "simplified" the tax code, the rule became more complicated. Under current law, home mortgage interest incurred to purchase, construct, or substantially improve an owner's first or second home is deductible up to $1 million of total debt secured by either home. This "acquisition" debt will only go down over time. The debt generally cannot be increased by a subsequent refinancing. Mortgage loans obtained on or before October 13, 1987, are not subject to, but will count against, the overall $1 million limit.

"Home" for the purpose of these mortgage-interest rules includes just about any place you call home that has sleeping quarters, cooking facilities, and a bathroom. Therefore, not only houses but also condominiums, cooperative apartments, mobile homes, and houseboats all qualify. The rules permit home owners to deduct mortgage interest paid for both a first and a second residence. The first, or primary, residence generally can be thought of as the place you call home. The second residence maybe a vacation home. Home owners should be aware that special rules apply when a vacation home is rented out.

Home-equity debt interest. The interest on a total amount of $100,000 of home-equity debt secured by a first or second home also is deductible, almost regardless of the use of the loan proceeds. The $100,000 limit is further limited by the value of the home reduced by any acquisition indebtedness. For example, suppose you own a $350,000 house on which you still owe $90,000 on the original mortgage. In this situation, deductible interest would be limited to $60,000 of home-equity indebtedness.

Although the interest on traditional consumer car loans or ordinary credit-card purchases is no longer deductible, if the car loan or other consumer debt is incurred through a home-equity loan, the interest is deductible. However, the interest on debt incurred to purchase or maintain a position in municipal bonds is not deductible, even if the debt is incurred through a home-equity loan.

Points. Many home buyers are confused about points. A point is i percent of the amount of the mortgage, and the term is used to describe a variety of charges imposed by mortgage lenders.

With record-low mortgage rates, many home buyers no longer find it necessary to pay points when they apply for a mortgage. Home buyers who have paid points may deduct the points from their income tax, but special rules apply. For points to be fully deductible in the year in which they are paid, certain conditions must be met:

* The points must be incurred to buy or build a principal residence only.

* The points must represent additional interest and not pay for some other service.

* The loan must be secured by a principal residence.

* The charging of points must be an established business practice in the area in which the home is located.

* The points must be within the amount normally charged.

* The points must be clearly designated as points on the Uniform Settlement Statement.

* The points must be computed as a percentage of the loan amount.

* The points maybe paid by the borrower or seller.

Points paid when refinancing a mortgage generally are not currently deductible in full but must be deducted evenly over the term of the mortgage loan.

Home owners benefit from their investment in an asset that, hopefully, will increase in value overtime. Additional benefits accrue if they know how to wisely assess the tax-deductibility of their home.

Jim Weil, CFP, ChFC, is a partner, Financial Strategy Network, LLC, Chicago. His phone number is (312)831-4429, and his e-mail address is jweil@fsnplan.com.