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 Wednesday, May 25 2022 @ 12:04 am UTC

Real Estate Tax Traps and Ways To Avoid It

General NewsThere are numerous tax traps if you sold a home, refinanced your mortgage or bought an investment property last year, but Tax time provides an opportunity to cash in many of the rewards of dabbling in last year's red-hot real estate market.

Here's a brief primer of four common real estate transactions that could leave you vulnerable in an audit, although the rules are too twisted to explain fully.


Couples can sell their home for a $500,000 profit without paying a cent of income tax. Single taxpayers can pocket $250,000, Most sellers can cash in one of the biggest perks in the tax code.

The house must be your principal home for two of the past five years - and even then there's flexibility because those periods don't have to be continuous and there are numerous hardship exceptions, to qualify.

Every $1,000 you track down will save nearly $250 in federal and state taxes, that is If your gain is over the exclusion amount, hunt for expenses such as the cost of home improvements, real estate commissions and title insurance that can pad your "tax basis."

The Tax Trap, If you traded up before the rules changed, you must count that deferred gain against your $250,000 to $500,000 exclusion, The rules changed dramatically in mid-1997.

It will be difficult to remember - let alone prove - what costs you incurred in your current home if you don't save receipts and records. Use photos to find evidence of kitchen remodeling, landscaping and other improvements - and hope you draw a forgiving auditor, but you can pluck the deferred gain from Form 2119, attached to your tax return for the year you sold the previous home.


That probably means you'll graduate into the class of taxpayers who can save more by itemizing mortgage interest, property taxes, certain loan costs and a raft of miscellaneous expenses rather than settling for the standard deduction every taxpayer is entitled to grab. One huge benefit of buying a home is that you generally can deduct the mountains of interest you pay.

You can deduct interest on up to $1 million of so-called acquisition debt and up to $100,000 of home equity debt. Because there is a limit to what you can write off.

Tax Trap, You can't deduct interest on what you borrow above that threshold, that $1 million can also include a loan on a second home .


Others took out home equity loans to tap the growing value of their real estate, As interest rates crept higher last year, many homeowners refinanced their mortgages to lower their payments and siphon out cash.

The charge for "points" - each point equals 1 percent of the loan - usually must be deducted incrementally over the life of the loan, that is an example of how refinancing can unleash some tax savings.

Tax Trap, Sometimes, even interest on refinanced loans can be limited. Tax pros increasingly are warning that home equity loans are ripe for audit because few homeowners understand when they can't deduct all the interest they pay.

But that can change, depending upon whether you borrowed more than $100,000, how you spent the cash, whether you owe the alternative minimum tax and other factors. Generally, you can borrow up to $100,000 of home equity and deduct the interest, regardless of whether you used the money to remodel your home, buy a car, pay college bills or take a vacation.


It's possible to pocket thousands of dollars in rent tax-free and defer taxes years into the future and potentially pay lower tax rates. Having that as an example of investors scooped up rental properties amid the housing boom, looking to profit from appreciation, rental income and a raft of tax breaks.

Tax Trap, It's highly recommended that you hire a pro to help you cut through the tangled rules of depreciation, passive activity income, capital gains and more. The rules of rental real estate are complex and often subject to dispute.

This is an Alice in Wonderland portion of the tax code in which landlords must depreciate an air conditioner in a window over seven years, while one on the roof takes 27 years. The most obvious puzzle involves determining whether a bill can be written off immediately as a straightforward business expense or whether it must be depreciated over a number of years.

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