People that have purchased or sold a home during the year commonly ask what effect will this have on my tax return. Some of the rules governing the answers to those questions have changed over the past several years. Here is a general overview of the tax consequences of buying or selling a home.

BUYING A HOME: 

The first thing to remember is that there is no deduction for the cost of purchasing or building your principal residence. This also applies to a second residence that is solely for personal use (such as a vacation home). There is also no deduction allowed for the cost of improvements or additions to your primary residence, unless it is a necessary business or medical expense. This does not mean that the purchase of a home will have no effect on your tax return. The deductions come from a couple of side issues of home ownership mortgage interest and real estate taxes.

Mortgage Interest is interest paid on a debt incurred to acquire, construct or improve your main or second home. Interest on a third home is nondeductible personal interest unless the home is a business or investment property. Home Equity Interest generally qualifies as deductible mortgage interest. Points that are paid on a loan to purchase or improve your principal residence may be deducted in full in the year paid. If your mortgage is with a bank or other commercial lender your interest paid for the year is reported on Form 1098. There are some limitations on the mortgage interest deduction so check your circumstances with your tax advisor.

Real Estate Taxes are defined by IRS rules as “taxes imposed on interest in real property and levied for the general public welfare”. You generally cannot deduct fees paid for services to a particular home such as garbage collection fees. If you purchased your home during the year you may have paid some real estate taxes at closing. Your closing statement is a valuable document to include with your tax papers. The closing statement will show any real estate taxes you paid on the new home.

SELLING A HOME:

The tax consequences of selling your main home used to be very complicated. Currently things are much easier for people selling their home. The main rule is if you sell your house and it was your principal residence for any two (2) of the previous five (5) years you can exclude from income $250,000 of gain for a single person and $500,000 of gain for a married couple filing a joint return. If you sell a qualified primary residence and the gross sale price is less than the maximum amount of the exclusion, then the sale should not be reported to the IRS.

If you live in the home you sell less than the required two years or a part of the home was used for business the rules are more complicated. You should consult with your tax advisor if any of these circumstances apply in your case.