Homeowner Tax Tips

It's tax time again, so don’t forget home-related deductions you are entitled to.

Our income tax returns will be due on April 16th this year since the 15th falls on a Sunday, so you will have an extra day to procrastinate. However, if you want to make sure that you are getting all the deductions you deserve you better start sooner. And if you are one of the millions of homeowners likely to get a federal and/or state refund, you might want to start a lot sooner. Until you get your refund you are loaning the government money interest free, and it would be better off earning interest for you in your own account.

Most homeowners know that they can deduct interest on mortgage loans up to $1 million, and home equity loans up to $100,000 on a first and second home. For married couples filing separately that amount is cut in half. Homeowners can also deduct state and local property taxes. If you made your January 2007 monthly mortgage payment in December, or prepaid state and/or local real estate taxes in 2006, that interest and those taxes can also be deducted in 2006 (however 2006 mortgage escrow contributions for 2007 state and local taxes aren’t deductible, because the mortgage lender will not be paying those taxes until very close to when they are actually due in 2007).

For married homeowners who sold their home in 2006, up to $500,000 of net profit can be excluded from taxable income ($250,000 for singles). The profit (capital gains in tax parlance) is what’s left over after subtracting the original home purchase price plus any capital improvements (things like additions, but not normal repairs and maintenance) from the net selling price after selling expenses, such as commissions. Any loan origination fees (also called points) that you initially paid to get your current mortgage are also tax deductible, but should have been pro-rated over the life of the loan. Since your current mortgage’s life ended when you sold the home, any of those points not yet deducted can be taken in the year of the sale.

Homeowners who bought their home in 2006 you can deduct transfer taxes and several related costs, including moving expenses in some cases, and any portion of the prepaid taxes that they reimbursed their seller for. These should be on Line 106 on page 1 of your settlement statement. They won’t appear on the annual statements that current mortgage lenders must send to borrowers by the end of January of each year (many mortgage lenders miss this deadline, however).

If you made energy efficiency home improvements in 2006, like adding insulation or replacing old windows with insulated ones, they are eligible for federal tax credits.

For your future reference another new tax law allows homeowners with taxable incomes under $100,000 to deduct private mortgage insurance expenses as mortgage interest on mortgages originated in 2007. That deduction expires at the end of 2007, but has a good chance of being extended by Congress, along with the energy efficiency tax credits and a number of other homeowner-friendly tax deductions.

More and more homeowners are finding themselves subject to the Alternative Minimum Tax (AMT), which can negate otherwise perfectly good tax deductions, and couples who both work can often find that their combined income is above the eligibility ceilings for some types of deductions. If you find yourself losing deductions because of the AMT or eligibility phase outs, there may be some alternative filing strategies you can use. For example sometimes two-income couples can reduce their taxes by filing separately rather than jointly if one has substantial unreimbursed medical bills or casualty losses. If you have a child in college and they have some income, it may make more sense from a tax standpoint to let them take the tuition deduction and not claim them as a dependant. They may be in a lower tax bracket, but if you are unable to take advantage of the deductions, they might as well use them. AMT rules may make it more advantageous for taxpayers to itemize deductions even if the standard deduction is greater and deduct state sales taxes on their state returns, even if the total sales taxes paid are less than state and local income taxes paid (you can only deduct one or the two). It may make more sense for Americans working in other countries to take foreign tax credits instead of using the foreign earned income exclusion.

If you have a part or full time home-based business, home-related business tax deductions can also reduce your income taxes. This applies even if you are a contractor or other type of businessperson who does most of their work outside of the home, so long as the home is where you conduct your administrative activities.

You can deduct the proportionate costs (based on square footage) of parts of the home used exclusively for business purposes. These include the cost of utilities, maintenance, and improvements to your business work area. Capital expenses, such as business equipment, can also be expensed (up to $108,000 annually) or depreciated over their useful life, as you prefer. The business mileage deduction when you use your car to make sales calls or drive to outside job sites is 44.5 cents per mile for 2006, but you must keep a record of business miles. Some other restrictions on business use of vehicles also apply – check with IRS to be safe. Most other normal business expenses are also deductible.

You can also take a depreciation deduction on the portion of your home used for business activities. IRS will require that you recapture profits from the depreciated value of the business use portion if you sell the home for more than you paid for it. The current depreciation schedules for buildings are not very generous, so it won’t generate much of a deduction if you are only using a small room or part of a room for business purposes. And because of the recapture provisions the effort may not be worth the later accounting hassle if you are only using a small room or part of a room for your business.

Collectively the numerous home business tax deductions can often offset all or most of the revenue for a part time business. IRS won’t let you use home business “paper” losses to consistently reduce your overall tax liability, but you can roll home business paper losses in one year into the next to offset part of the following year’s profits.

Many of the forms which the IRS had already published are outdated as a result of tax law changes last December. Among the new tax law changes is the retroactive cancellation of a telephone tax, which many can get refunded. Go to www.IRS.gov , and click on "What’s Hot." to get the most current forms. Also on the IRS website, which is quite user friendly, are guidance documents which provide more detail about the specifics of the aforementioned deductions and tax credits.

There are plenty of other sources for assistance with your tax returns. You can hire a professional tax accountant or use H&R Block or one of the other mass market tax services (we don’t recommended mass market services for complex returns). The costs of tax preparation assistance are also deductible if you file an itemized return. Many local community groups such as local AARP chapters and groups serving low and moderate income taxpayers provide free tax preparation assistance. If your adjusted gross income is less than $52,000 (95 million taxpayers qualify) you can use the Free File program on the IRS’s website to get a fast refund which can be automatically be deposited in up to three accounts you specify.

One service to avoid if possible is a "refund anticipation loan" or RAL. Companies offering this service advance you your anticipated refund. The charge for the advance is often quite high. According to the National Consumer Law Center and the Consumer Federation of America, "The effective annual interest rate (APR) for a RAL can range from about 40 percent (for a loan of $9,999) to over 700 percent (for a loan of $200). If administrative fees are charged and included in the calculation, RALs cost about 70 percent to over 1,800 percent APR.” A much better alternative for lower income taxpayers, if they can wait about two weeks for the money, is to use the IRS electronic filing service and request IRS to directly transfer your refund into up to three of your accounts. Higher income taxpayers also often get their refunds fairly promptly, especially if they file earlier in the tax season.

Also beware of the phony IRS “phishing” emails that are beginning to turn up. They feature IRS graphics and claim that you are entitled to a refund (or they will help you get a refund) if you click on their link to provide the necessary information to deposit the refund in your bank account. Don’t do it – you won’t get a refund, but you’ll get your bank account raided instead.

The answers to many of your questions are also available on the IRS web site ( www.IRS.gov ). You can also call IRS at 800-829-1040 (tip: call early in the morning unless you are willing to wait a long time to speak to an advisor). Finally, all is not lost if your returns aren’t done by April 16. The law allows taxpayers to get an automatic six month extension (until October 15, 2007) but only if you file form 4868 Application for Automatic Extension of Time to File no later than the April 16th due date. Eligible taxpayers can use Free File to file a Form 4868.
 

Home Sales Helpers

The housing market has changed, and in 2007 home sellers will need to look for every opportunity to improve their home’s value and saleability.

If your home has been on the market a while and you’ve not received any offers, an obvious option is reduce your price. Most real estate brokers and agents are also urging prospective sellers to price their homes very competitively in the current market. If you have the flexibility, another option is to be patient and hope that the market improves to meet your price. However, no one knows how long that will take. For that reason renting your home, especially with a rent-to-own option to an interested tenant can be a very good third alternative.

Other strategies include making cost-effective home improvements specifically aimed at improving marketability, and/or providing owner financing for part of the purchase price. All of these options have both potential benefits and risks.

A fair rent-to-own option offers benefits and risks for both sellers and tenants/prospective buyers. Typically the tenants/prospective buyers will pay above-market rental rates but will get the difference (and then some) credited towards their down payment if they decide to buy. The selling price or the formula to determine it are often specified in the rental agreement as well. The benefits for the seller is the possibility of avoiding a real estate commission and above market rental revenue from what might be an otherwise unoccupied home. The risk for sellers is that they may lose out on some potential profit if they’ve specified a selling price and home values start appreciating again. If you owned and occupied the home as your primary residence for two of the last five years, you will get a capital gain tax exclusion for up to $500,000 in profits per couple/$250,000 for singles. However home sellers can lose their capital gain tax exemption if it takes more than three years to sell the home.

Only a few potential home improvements will likely increase a home’s selling price by more than their cost. Many come close and can be worth it if they make the difference between a sale and no sale. Relatively inexpensive “curb appeal” investments – the things that potential buyers first see – are usually the most cost effective. A few hundred dollars invested in shrubs and flowers you plant yourself to landscape a relatively barren yard are a great curb appeal investment that will usually add more than their cost to the value of your home. You’ll probably not recoup most of the costs of a $10-20,000 professional landscaper’s makeover, however.

Similarly, repainting a faded home exterior or dark/dingy interior walls with neutral colors is a worthwhile investment, especially if you have the time and inclination to do it yourself, or with the assistance of neighborhood teenagers, or if you can get a very competitive price from a contractor. Minor upgrades to very dated kitchens and baths will also recover most of their cost and help your saleability. Candidates for upgrades are cabinet refacing (not replacing), new appliances if yours are very old and/or in poor condition, and new counter tops.

Offering to finance part of the purchase, if you are in a position to do so, can be a benefit for the buyer and seller. Many home sellers wisely decide to save part of their home sales’ proceeds anyway. Providing the seller a second mortgage at slightly below what the buyer can get in the commercial marketplace can provide a very good return to sellers compared to many other investment alternatives, and can also help sellers get a higher price for the home (or clinch a deal they might not otherwise get).

Sellers need to be aware of a number of potential pitfalls of owner financing. Second mortgages are riskier than first mortgages, and few sellers have the sophistication to assess the risk. They call them “second” mortgages because they get paid only if there’s enough money (and to the extent that there’s a surplus) after the first mortgage is paid. If the buyer starts missing payments, forcing a borrower into foreclosure is also costly, and there might not be enough left over to fully repay the amount you lent. Sellers who offer owner financing also have to keep track of (and be able to document) payments, penalties and late payment fees.

For these reasons the buyer’s credit-worthiness and the buyer's down payment are critical. The buyer's credit score (FICO) is available from credit-scoring agencies. Jack Guttentag, a professor of finance emeritus at the Wharton School of the University of Pennsylvania, and founder of the helpful home finance website www.mtgprofessor.com , suggests that home sellers not offer second mortgages “unless the [selling] price increment was 30 percent of the second mortgage or more. If that condition were met but the buyer puts nothing down, I would require a FICO score of 750 or more. If the buyer put 10 percent down, I would accept a score of 675.”

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Real Estate Property Rights Expanding

The permissible uses of eminent domain were expanded by the Supreme Court in 2005, but since then states have added new protections for property rights.

The U.S. Supreme Court’s widely condemned Kelo v. City of New London decision affirmed that emi­nent domain procedures can be used for strictly economic develop­ment purposes. It allows a state or local government to take land from a homeowner, and sell or give it to another private owner, such as a commercial developer, if the government officials believed that the new owner would use the land in a more productive manner to create jobs and increase tax revenues.

Historically eminent domain has been used for the legitimate purpose of taking private property only for broadly used public facilities such as public buildings, roads, and parks. As a result, the Court has substantially strengthened the ability of politically powerful developers to game the system at the expense of the property rights of individual homeowners and small businesses.
In many states, intense citizen anger at the Kelo decision led elected officials to enact much stronger state laws and constitutional amendments to better protect individual property rights and to prohibit Kelo-type takings. Unfortunately in other states such efforts failed, and many big businesses in cooperation with local officials have used the Kelo decision as justification for their expanded use of eminent domain for economic development purposes.

Efforts to address the problem in the last Congress were unsuccessful. The Pri­vate Property Protection Act of 2005 (H.R. 4128) would have prevented any government entity receiving federal funds from using eminent domain for economic development. It passed the House in November 2005 by a vote of 376 to 38. The House also passed Private Property Rights Implementation Act (H.R. 4772) which would have allowed property rights cases to be filed in federal court as well as in state courts. Unfortunately the Senate did not act on either before adjourning.

Some efforts to strengthen homeowners’ property rights preceded the Kelo decision. Oregon’s 2004 Measure 37 required offsetting compensation to property owners for diminished value caused by any land use reg­ulations that would limit pre-existing development rights. In 2004 the Michigan Supreme Court unanimously reversed an earlier decision, which would have allowed the city of Detroit to use eminent domain to acquire more than 1,000 homes and 600 businesses and churches and transfer the property to General Motors for a new factory. Given the recent fortunes of the U.S. automotive industry, the decision may also have saved General Motors the expense of an empty factory. Unfortunately in other similar cases the courts have more often sided with local governments.

Within months of the Kelo decision numerous bills were introduced in many state legislatures across the country, and ballot initiative petitions were circulated in many states that allow voter referenda. The U.S. Government Accountability Office reported that between June 23, 2005, and July 31, 2006, 29 states made changes to their eminent domain laws: 23 restricted its use for economic development; 24 expanded procedural requirements; and 21 redefined more narrowly their definitions of "blight," "economic development," and "public use”.

Since then there have been many successful efforts (and some failures) to strengthen property rights at the state level through ballot initiatives and legislation.

Most recent was on February 24, 2007 when the Virginia state legislature passed legislation more narrowly defining “public use” as it relates to eminent domain. Similar legislation failed last year. The bill now goes to Governor Kaine, who can sign, veto, or propose modifications to the measure.

By last July 21 other states had passed laws that in various ways restricted the misuse of eminent domain procedures. In Florida the legislature prohibited, for the next decade, the use of eminent domain to take property from one private owner for transfer to another. South Carolina legislators and voters both passed a constitu­tional amendment limiting the use of eminent domain for economic development and private benefit. Georgia's legislature passed a new law prohibiting takings of small businesses and homes by local governments for economic develop­ment purposes. The legislation also tightened the definition of "blight." Alabama prohibited eminent domain actions on non-blighted areas for private use.

Further north, Maine passed a measure similar to Alabama’s. Ohio legislators established a brief moratorium on emi­nent domain use to allow a commission to study the issue and make recommendations. Laws restricting or prohibiting the government’s use of eminent domain for economic development and private benefit were also passed in Kan­sas, Minnesota, and Pennsylvania. Stronger property rights protections were passed in other states in 2006 including Connecticut, Hawaii, Maryland, Mas­sachusetts, New Jersey, New Mexico, New York, and Washington.

Not all the changes occurred in the state legislatures. Last November was also a historical month. Voters in 10 states passed ballot initiatives or other measures which expanded property rights protection. South Carolina voters approved by a huge margin an amend­ment to the state constitution prohibiting the use of eminent domain for economic development, except for public use and conditions that pose a danger to public health and safety. Floridians also passed a state constitutional amendment prohibiting the government from tak­ing property for reasons of blight by a substantial margin. Also in the southeast and also by a substantial margin, Georgians supported a constitutional amendment requiring a formal vote by elected officials for or against each proposed use of eminent domain in their communities.

The Michigan electorate approved a constitutional amendment that reinforced the Michigan Supreme Court's reversal of the General Motors decision. The amendment requires that property owners receive 124% of their property’s fair market value when eminent domain is used, prohibits eminent domain use solely for economic development or tax revenue expansion, and requires a higher standard of evidence for condemnations based on blight. In New Hampshire voters ratified a constitutional amendment passed by the state legislature, in both cases by the over­whelming margins. The new law states that "No part of a person's property shall be taken by eminent domain and transferred, directly or indirectly, to another person if the taking is for the purpose of private development or other private use of the property."

In the west Nevada voters placed their bets on State Question No. 2, a ballot initiative that limits the use of eminent domain by more narrowly defining "public use”. An Arizona initiative restricted misuse of eminent domain by more narrowly defining "blight" and "public use", and imposed limitations on regu­latory takings. Oregon voters passed Measure 39, a citizen ini­tiative that requires that a “public body…may not condemn private real property used as a residence, business establishment, farm, or forestry operation if at the time of the condemnation the public body intends to convey fee title to all or a portion of the real property, or a lesser inter­est than fee title, to another private party.” North Dakota voters voted for a state con­stitutional amendment prohibiting eminent domain use to effectively transfer property from one private owner to another.

There have been many positive changes but the property rights of homeowners in many states are still at risk. Most at risk are lower income and other homeowners who don’t have the resources or political power to fight the efforts of developers to influence local officials. The American Homeowners Grassroots Alliance will continue to urge the federal government and other states to take similar steps to protect the property rights of homeowners.

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