Buying & Selling a Home

This Financial Guide discusses the home mortgage interest deduction. It explains what tests must be met for interest on a home mortgage to be deductible and discusses the rules that apply in hybrid situations such as the business use of a home.

Note: For a discussion of the deductibility of points, please Click here.

Deductibility of Home Mortgage Interest, In General

Generally, home mortgage interest is any interest you pay on a loan that is secured by your main home or by a second home. The loan may be a mortgage to buy your home, a second mortgage, a line of credit, or a home equity loan.

You can deduct home mortgage interest as an itemized deduction only if you are legally liable for the loan. In other words, you cannot deduct payments you make for someone else if you are not legally liable to make them. Further, there must be a true debtor-creditor relationship between you and the lender.

And, finally, the mortgage must be a "secured debt" on a "qualified home." These two terms are explained later.

When Is Mortgage Interest Fully Deductible?

In most cases, you can deduct all of your home mortgage interest. Whether it is all deductible depends on the date you took out the mortgage, the amount of the mortgage, and your use of the mortgage proceeds.

If all of your mortgages fit into at least one of the following three categories at all times during the year, you can deduct all of the interest on those mortgages. If one or more of your mortgages does not fit into any of these categories, you may be able to deduct part of the interest. The three categories are:

1. Mortgages you took out on or before October 13, 1987.
2. Mortgages you took out after October 13, 1987, to buy, build, or improve your homes as long as these mortgages plus any mortgages in (1) totaled $1 million or less throughout the year ($500,000 or less if married filing separately).
3. Mortgages you took out after October 13, 1987, for reasons other than to buy, build, or improve your home (home equity debt), as long as these mortgages totaled $100,000 or less throughout the year ($50,000 or less if married filing separately) and totaled no more than the fair market value of your home reduced by (1) and (2).

The dollar limits for the second and third categories apply to the combined mortgages on your main home and second home.

What is "Secured Debt"?

You can deduct home mortgage interest only if your mortgage is a secured debt. A secured debt is one in which you sign an instrument (such as a mortgage, deed of trust, or land contract) that:

1. Makes your ownership in a "qualified home" security for payment of the debt,
2. Provides, in case of default, that your home can be used to satisfy the debt, and
3. Is recorded or is otherwise perfected under any state or local law that applies.

In other words, your mortgage is a secured debt if you put your home up as collateral to protect the interests of the lender. If you cannot pay the debt, your home can then serve as payment to the lender to satisfy the debt.

Note: A debt is not secured by your home if it is secured solely because of a lien on your general assets or if it is a security interest that attaches to the property without your consent (such as a mechanic's lien or judgment lien).

A wraparound mortgage is not a secured debt unless it is recorded or otherwise perfected under state law.

Example: Beth owns a home subject to a mortgage of $40,000. She sells the home for $100,000 to John, who takes it subject to the $40,000 mortgage. Beth continues to make the payments on the $40,000 note. John pays $10,000 down and gives Beth a $90,000 note secured by a wraparound mortgage on the home. Beth does not record or otherwise perfect the $90,000 mortgage under the state law that applies. Therefore, that mortgage is not a secured debt, and the interest John pays on it is not deductible as home mortgage interest.

What is a "Qualified Home"?

To deduct home mortgage interest, the debt must be secured by a qualified home. This means your main home or your second home, but not a third home except as described below under "More than one second home". A home includes a house, condominium, cooperative, mobile home, house trailer, boat, or similar property that has sleeping, cooking, and toilet facilities.

Tip: The interest you pay on a mortgage on a home other than your main or second home may be deductible if the proceeds of the loan were used for business, investment, or other deductible purposes. Otherwise, it is considered personal interest and is not deductible.

Main home. You can have only one main home at any one time. Generally, this is the home where you spend most of your time.

Second home. A second home is a home that you choose to treat as your second home.

Second home not rented out. If you have a second home that you do not hold out for rent or resale to others at any time during the year, you can treat it as a qualified home. You do not have to use the home during the year.

Second home rented out. If you have a second home and rent it out part of the year, you also must use it as a home during the year for it to be a qualified home. You must use this home more than 14 days or more than 10% of the number of days during the year that the home is rented at a fair rental, whichever is longer. If you do not use the home long enough, it is considered rental property and not a second home.

More than one second home. If you have more than one second home, you can treat only one as the qualified second home during any year. However, you can change the home you treat as a second home in the following three situations.

1. If you get a new home during the year, you can choose to treat the new home as your second home as of the day you buy it.
2. If your main home no longer qualifies as your main home, you can choose to treat it as your second home as of the day you stop using it as your main home.
3. If your second home is sold during the year or becomes your main home, you can choose a new second home as of the day you sell the old one or begin using it as your main home.

Hybrid Situations

The only part of your home that is considered a qualified home is the part that you use for residential living. If you use part of your home for other than residential living, such as for a home office, you must allocate the use of your home. You must then divide both the cost and fair market value of your home between the part that is a qualified home and the part that is not. These calculations may reduce or even negate your deduction.

Renting out part of home. If you rent out part of a qualified home to another person (tenant), you can treat the rented part as being used by you for residential living only if all three of the following conditions apply.

1. The rented part of your home is used by the tenant primarily for residential living.
2. The rented part of your home is not a self-contained residential unit having separate sleeping, cooking, and toilet facilities.
3. You do not rent (directly or by sublease) the same or different parts of your home to more than two tenants at any time during the tax year. If two persons (and dependents of either) share the same sleeping quarters, they are treated as one tenant.

Office in home. If you have an office in your home that you use in your business, you may be entitled to deductions for the business use of your home, including the business part of your home mortgage interest.

Other Situations

You can treat a home under construction as a qualified home for up to 24 months, but only if it becomes your qualified home at the time it is ready for occupancy.

The 24-month period can start any time on or after the day construction begins.

You may be able to continue treating your home as a qualified home even after it is destroyed in a fire, storm, tornado, earthquake, or other casualty. This means you can continue to deduct the interest you pay on your home mortgage, subject to the limits described in this guide.

You can continue treating a destroyed home as a qualified home if, within a reasonable period of time after the home is destroyed, you:

1. Rebuild the destroyed home and move into it, or
2. Sell the land on which the home was located.

This rule applies to your main home and to a second home that you treat as a qualified home. It also applies whether or not your home is in a federal disaster area.

You can treat a home you own under a time-sharing plan as a qualified home if it meets all the tests for a qualified home. If you rent out your time-share, it qualifies as a second home only if you also use it as a home. To know whether you meet that requirement, count your days of use and rental of the home only during the time you have a right to use it or to receive any benefits from the rental of it.

Married Taxpayers

If you are married and file a joint return, your qualified home(s) can be owned either jointly or by only one spouse.

If you are married filing separately and you and your spouse own more than one home, you can each take into account only one home as a qualified home. However, if you both consent in writing, then one spouse can take both the main home and a second home into account.

Note: If a divorce or separation agreement requires you or your spouse or former spouse to pay home mortgage interest on a home owned by both of you, the payment of interest may be alimony.

Special Rules

This section describes certain items that can be included as home mortgage interest and others that cannot. It also describes certain special situations that may affect your deduction.

Late payment charge on mortgage payment. You can deduct as home mortgage interest a late payment charge if it was not for a specific service in connection with your mortgage loan.

Mortgage prepayment penalty. If you pay off your home mortgage early, you may have to pay a penalty. You can deduct that penalty as home mortgage interest provided the penalty is not for a specific service performed or cost incurred in connection with your mortgage loan.

Sale of home. If you sell your home, you can deduct your home mortgage interest (subject to any limits that apply) paid up to, but not including, the date of the sale.

Example: John and Peggy Harris sold their home on May 7. Through April 30, they made home mortgage interest payments of $1,220. The settlement sheet for the sale of the home showed $50 interest for the 6-day period in May up to, but not including, the date of sale. Their mortgage interest deduction is $1,270 ($1,220 + $50).

Prepaid interest. If you pay interest in advance for a period that goes beyond the end of the tax year, you must spread this interest over the tax years to which it applies. You can deduct in each year only the interest that qualifies as home mortgage interest for that year. However, there is an exception for points.

Mortgage interest credit. You may be able to claim a mortgage interest credit if you were issued a mortgage credit certificate (MCC) by a state or local government. If you take this credit, you must reduce your mortgage interest deduction by the amount of the credit.

Ministers' and military housing allowance. If you are a minister or a member of the uniformed services and receive a housing allowance that is not taxable, you can still deduct your home mortgage interest.

Mortgage assistance payments. If you qualify for mortgage assistance payments under section 235 of the National Housing Act, part or all of the interest on your mortgage may be paid for you. You cannot deduct the interest that is paid for you.

Rental payments before real estate closing occurs. If you live in a house before final settlement on the purchase, any payments you make for that period are rent and not interest, and therefore not deductible. This is true even if the settlement papers call them interest.

Mortgage proceeds invested in tax-exempt securities. You cannot deduct the home mortgage interest on debt used to buy securities or certificates that produce tax-free income.

Refunds of interest. If you receive a refund of interest in the same year you paid it, you must reduce your interest expense by the amount refunded to you. If you receive a refund of interest you deducted in an earlier year, you generally must include the refund in income in the year you receive it. However, you need to include it only up to the amount of the deduction that reduced your tax in the earlier year. This is true whether the interest overcharge was refunded to you or was used to reduce the outstanding principal on your mortgage.

Mortgage Interest Statement (Form 1098)

If you paid $600 or more of mortgage interest (including certain points) during the year, you will usually receive a Form 1098, Mortgage Interest Statement from the mortgage holder, showing the amount of interest you paid.

Tip: You should receive the statement for each year by January 31 of the following year. A copy of this form is also sent to the IRS.

If you bought your home when mortgage rates were higher than today's rates are, or have an adjustable-rate loan and would like to change it to a fixed rate, then you are probably a candidate for refinancing your mortgage. Here are some factors to consider when deciding whether to refinance and how to get the best deal.

If you decide to refinance your mortgage, you can expect the process to be similar to what you went through in obtaining the original mortgage because in reality, refinancing a mortgage is simply taking out a new mortgage. You will encounter many of the same procedures and the same types of costs the second time around. In this Financial Guide, we will give you some pointers on how to get the best possible deal.

Who Can Benefit From Refinancing?

Refinancing does not make good financial sense for everyone. A general rule of thumb is that refinancing is worthwhile if the current interest rate on your mortgage is at least two percentage points higher than the prevailing market rate. This figure is generally accepted as the safe margin when balancing the costs of refinancing a mortgage against the savings. However, a rule of thumb is not ironclad: every individual's circumstances need to be analyzed. If your loan amount and the particular circumstances warrant it, you might choose to refinance a loan that is only 1-1/2 percentage points higher than the current rate.

Tip: Lenders may be offering zero point loans and low-cost refinancing. Therefore, even if your rate change is less than one percentage point, you may be able to save some money by refinancing.

Most experts say that it takes at least three years to fully realize the savings from a lower interest rate, given the costs of refinancing. You may find, however, that you could recoup the refinancing costs in a shorter time than three years. Again, every homeowner's circumstances should be analyzed individually. Generally, refinancing is a good idea if you:

• Want to get out of a high interest rate loan to take advantage of lower rates. (This is a good idea only if you intend to stay in the house long enough to make the additional fees worthwhile.)
• Want to convert to an ARM with a lower interest rate or more protective features (such as a better rate and payment caps) than the ARM you currently have.
• Want to build up equity more quickly by converting to a loan with a shorter term.
• Want to draw on the equity built up in your home to get cash for a major purchase or for your children's education.
• Have an adjustable-rate mortgage (ARM) and want a fixed-rate loan in order to know exactly what the mortgage payment will be for the life of the loan.

Planning Aid: For information on fixed rates, see the Financial Calculator: Which Loan Is Better, Fixed or Adjustable?

Tip: If you decide that refinancing is not worth the costs, ask your lender whether you may be able to obtain all or some of the new terms you want by agreeing to a modification of your existing loan instead of a refinancing.

How to Go About Making the Decision

Talk to several lenders to find out what the current rates are and what costs are associated with refinancing. These costs (explained in more detail below) include appraisals, attorney's fees, and points. Once you know what the costs will be, determine what your new payment would be if you refinanced. You can then estimate how long it will take to recover the costs of refinancing by dividing your closing costs by the difference between your new and old payments.

Be aware that the amount of money that you ultimately save depends on many factors, including your total refinancing costs, whether you sell your home in the near future, and the effects of refinancing on your taxes.

If you are thinking of refinancing an adjustable rate mortgage (ARM), you should also consider these questions:

• Is the next interest rate adjustment on your existing loan likely to increase your monthly payments substantially? Will the new interest rate be two or three percentage points higher than the prevailing rates being offered for either fixed-rate loans or other ARMs?

• If the current mortgage sets a cap on your monthly payments, are those payments large enough to pay off your loan by the end of the original term? Will refinancing to a new ARM or a fixed-rate loan enable you to pay your loan in full by the end of the term?

You also might want to consider refinancing if you have an adjustable rate mortgage with high or no limits on interest rate increases. You might want to switch to a fixed-rate mortgage or to an adjustable rate mortgage that limits changes in the rate at each adjustment date as well as over the life of the loan.

How to Determine Your Refinancing Costs

When you refinance your mortgage, you usually pay off your original mortgage and sign a new loan. With the new loan, you again pay most of the same costs you paid to get your original mortgage, including settlement costs, discount points, and other fees. You may also be charged a penalty for paying off your original loan early, called a prepayment penalty, if such a practice is not prohibited by your state.

The total expense for refinancing a mortgage depends on the interest rate, number of points, and other costs required to obtain a loan. You should plan on paying an average of 3 to 6% of the outstanding principal in refinancing costs, plus any prepayment penalties and the costs of paying off any second mortgages that may exist.

Tip: When shopping for a lender, ask each one for a list of charges and costs you must pay at closing. Some lenders may require that some of these costs be paid at the time of application.

The fees described below are the ones that you are most likely to encounter in a refinancing. (Some of the costs are expanded on in the paragraphs that follow.) Because costs may vary significantly from area to area and from lender to lender, the following chart should be regarded only as an estimate. Your actual closing costs may be higher or lower than the ranges indicated below.

• Application Fee $ 75 to $300
• Appraisal Fee $300 to $700
• Survey Costs $150 to $400
• Homeowners Hazard Insurance $300 to $1,000
• Lenders Attorney's Review Fees $500 to $1,000
• Title Search & Title Insurance $700 to $900
• Home Inspection Fees $175 to $350
• Loan Origination Fees 1% - 2% of loan
• Mortgage Insurance 0.5% to 1.0%
• Points 1% to 3%

Tip: To save on some of these costs, check with the lender who holds your current mortgage. The lender may be willing to waive some of them, especially if the work relating to the mortgage closing is still current (such as the fees for the title search, surveys, inspections, and so on).

Let's look at some of these costs in greater detail:

Application Fee. This charge imposed by your lender covers the initial costs of processing your loan request and checking your credit report.

Title Search and Title Insurance. This charge will cover the cost of examining the public record to confirm ownership of the real estate. It also covers the cost of a policy, usually issued by a title insurance company that insures the policy holder in a specific amount for any loss caused by discrepancies in the title to the property.

Tip: Be sure to ask the title insurance company carrying the present policy if it can re-issue your policy at a re-issue rate. You could save up to 70% of what it would cost you for a new policy.

Lender's Attorney's Review Fees. The lender will usually charge you for fees paid to the lawyer or company that conducts the closing for the lender. Settlements are conducted by lending institutions, title insurance companies, escrow companies, real estate brokers, and attorneys for the buyer and seller. In most situations, the person conducting the settlement is providing a service to the lender. You may also be required to pay for other legal services relating to your loan which are provided to the lender.

Tip: You may want to retain your own attorney to represent you at all stages of the transaction, including settlement.

Loan Origination Fees. The origination fee is charged for the lender's work in evaluating and preparing your mortgage loan.

Points. Points are prepaid finance charges imposed by the lender at closing to increase the lender's yield beyond the stated interest rate on the mortgage note. One point equals one percent of the loan amount. For example, one point on a $75,000 loan would be $750. The total number of points a lender charges will depend on market conditions and the interest rate to be charged. To give you the lowest rate offered, most lenders will charge several points, and the total cost can run between three and six percent of the total amount you borrow. For example, on a $100,000 mortgage, the lender might charge you between $3,000 and $6,000. However, some lenders may offer zero points at a higher interest rate, which may significantly reduce your initial costs, although your payments may be somewhat higher.

Tip: In some cases, the points you pay can be financed by adding them to the loan amount. This means that the points will be added to your loan balance, and you will pay a finance charge on them. Although this may enable you to get the financing, it also will increase the amount of your monthly payments.

Tip: To decide what combination of rate and points is best for you, balance the amount you can pay up front with the amount you can pay monthly. The less time you keep the loan, the more expensive points become. If you plan to stay in your house for a long time, then it may be worthwhile to pay additional points to obtain a lower interest rate.

Appraisal Fee. This fee pays for an appraisal which is a supportable and defensible estimate or opinion of the value of the property.

Prepayment Penalty. A prepayment penalty on your present mortgage could be the greatest deterrent to refinancing. The practice of charging money for an early pay-off of the existing mortgage loan varies by state, type of lender, and type of loan. Prepayment penalties are forbidden on various loans including loans from federally chartered credit unions, FHA and VA loans, and some other home-purchase loans. The mortgage documents for your existing loan will state if there is a penalty for prepayment. In some loans, you may be charged interest for the full month in which you prepay your loan.

Miscellaneous. Depending on the type of loan you have and other factors, another major expense you might face is the fee for a VA loan guarantee, FHA mortgage insurance, or private mortgage insurance. There are a few other closing costs in addition to these.

How Does Refinancing Affect Your Tax Situation?

With a lower interest rate on your home loan, you will have less interest to deduct on your income tax return. That, of course, may increase your tax payments and decrease the total savings you might obtain from a new, lower-interest mortgage.

Interest (points) paid up front for refinancing must be deducted over the life of the loan, not in the year you refinance, unless the loan is for home improvements. This means that if you paid a certain number of points, you would have to spread the tax deduction for those points over the life of the loan. If, however, the refinancing is for home improvements (or a portion of the loan is for this purpose) you may be able to deduct the points (or a portion of the points) under certain circumstances.

If you are thinking about refinancing your mortgage, you might want to consider other types of mortgages. For example, you might want to look into a 15-year, fixed-rate mortgage. In this plan, your mortgage payments are somewhat higher than a longer-term loan, but you pay substantially less interest over the life of the loan and build equity more quickly. Of course, this also means you have less interest to deduct on your income tax return.

Tips for Getting the Best Deal

Here are some tips for getting the best deal when refinancing of your mortgage:

1. Shop Around

If you decide to refinance your mortgage, it pays to shop around by calling several lending institutions to find out what interest and fees they charge. This helps you get the best deal available. Also ask each about their "annual percentage rate" (APR) and compare them. The APR will tell you the total credit costs of the refinancing, including interest, points, and other charges.

Tip: You do not have to refinance your mortgage with the same lender that provided your original mortgage. However, to keep your business, some lenders will offer their original mortgage customers the incentive of lower mortgage interest rates, sometimes with reduced closing costs.

2. Obtain a "Lock-In" or Guarantee

If you decide to apply for refinancing with a particular lender, and if you do not want to let the interest rate float until closing, then get a written statement guaranteeing the interest rate and the number of discount points that you will pay at closing. This binding commitment, or lock-in, ensures that the lender will not raise these costs even if rates increase before you settle on the new loan. You might also consider requesting an agreement where the interest rate can decrease but not increase before closing. If you cannot get the lender to put this information in writing, you may want to choose one that will.

Most lenders place a limit on the length of time (60 days for example) that they will guarantee the interest rate. You must sign the loan during that time or lose the benefit of that particular rate. Because many people are refinancing their mortgages, there may be a delay in processing the papers. Therefore, contact your loan officer periodically to check on the progress of your loan approval and to see if additional information is needed

3. Review the Disclosure Form

When refinancing, the lender must give you a written statement of the costs and terms of the financing before you become legally obligated for the loan. This is required under the Truth in Lending Act. Typically, you receive this information around the time of settlement, although some lenders provide it earlier. Review this statement carefully before you sign the loan. The disclosure tells you the APR, finance charge, amount financed, payment schedule, and other important credit terms.

Related Guide: Please see the Financial Guide: MORTGAGE LOCK-INS: Questions To Ask.

4. Be Aware Of Your Right to Rescind

If you refinance with a different lender, or if you borrow beyond your unpaid balance with your current lender, you also must be given the right to rescind the loan. In these loans, you have the right to rescind or cancel the transaction within three business days following settlement, receipt of your Truth in Lending disclosures, or receipt of your cancellation notice, whichever occurs last.

5. Find Out If the Application Fee Is Refundable

When you apply for a mortgage, some lenders require you to pay a special charge to cover the costs of processing your application. The amount of this fee varies, but generally is in the range of $75 to $300. Usually, you must pay this charge at the time you file the application. Some lenders do not refund this application fee if you are not approved for the loan or if you decide not to take it.

If you elect to cancel the transaction within three business days after you close the loan, as discussed above, you are entitled to a refund of all costs and charges imposed for the credit transaction.

Tip: Before you apply for a mortgage, ask lenders whether they charge an application fee. If they do, find out how much it is and under what circumstances and to what extent it is refundable.

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As you can see, there are many financial factors to consider when refinancing a mortgage, so you may want to think about getting professional guidance if you're considering your refinancing options.

Sample Refinancing Savings

The charts below illustrate the monthly and yearly differences in your mortgage payments if you refinanced to a 6 % or an 8 %, 30-year fixed-rate mortgage for $75,000. Remember, however, that the actual amount you may save by refinancing depends on many factors, such as your tax bracket and how long you plan to remain in your home.

Many tax benefits are available to you when you sell your principal residence. However, the rules are complex and personal guidance is necessary to take full advantage of these benefits, so that you and your tax advisor can best work together to minimize the tax on the gain. This financial guide discusses the key rules so that you and your tax advisor can best work together to minimize the tax on the gain.

The IRS allows an exclusion of up to $250,000 of the gain on the sale of your main home ($500,000 if you are married and file a joint return. Most taxpayers can take advantage of the exclusion and will not have to pay any tax on the sale of a main home as long as they meet the IRS ownership and use tests (see below).

Note: If you do have a loss from the sale, it is a personal loss. You cannot deduct the loss.

If you don't qualify for exclusion, your gain exceeds the exclusion, or you used part of the property in business or for rent, you have a taxable gain and must report the sale of your main home on your tax return on IRS Form 8949 and Schedule D.

Principal Residence

Usually, the home you live in most of the time is your main home. In addition to a standard dwelling unit, your home can also be a houseboat, mobile home, cooperative apartment, or condominium.

Example: You own and live in a house in town. You also own beach property, which you use in the summer months. The town property is your main home; the beach property is not.

Example: You own a house, but you live in another house that you rent. The rented home is your main home.

Tip: Where a second residence has soared in value and you want to sell, some tax advisors have suggested moving to the second residence for the required period to qualify for exclusion on its sale. If this is your situation, please consult with a tax professional.

How to Figure Gain or Loss

Key information for determining gain or loss is the selling price, the amount realized, and the adjusted basis.

The selling price is the total amount you receive for your home. It includes money, all notes, mortgages or other debts assumed by the buyer as part of the sale, and the fair market value of any other property or any services you receive. Next, you deduct the selling expenses such as commissions, advertising, legal fees, and loan charges paid by the seller from the selling price.

The difference is the "amount realized". If the amount realized is more than your home's "adjusted basis," discussed later, the difference is your gain. If the amount realized is less than the adjusted basis, the difference is your loss.

However, it does not include amounts you received for personal property sold with your home. Personal property is property that is not a permanent part of the home, such as furniture, draperies, and lawn equipment.

Non-Traditional Sales

The following discussion covers how to determine your gain or loss if you trade one home for another, if your home is foreclosed on or repossessed or if you transfer a jointly owned home.

Jointly owned home. If you and your spouse sell your jointly owned home and file a joint return, you figure and report your gain or loss as one taxpayer. If you file separate returns, each of you must figure and report your own gain or loss according to your ownership interest in the home. Your ownership interest is determined by state law.

If you and a joint owner other than your spouse sell your jointly owned home, each of you must figure and report your own gain or loss according to your ownership interest in the home. Each of you applies the exclusion rules individual basis.

Trading homes. If you trade your old home for another home, treat the trade as a sale and a purchase.

Foreclosure or repossession. If your home was foreclosed on or repossessed, you have what the IRS calls a disposition and will need to determine if you have ordinary income, gain, or loss. The amount of your gain or loss depends on whether you were personally liable for repaying the debt secured by the home and whether the outstanding loan balance is more than the fair market value (FMV) of the property.

If you were not personally liable for repaying the debt secured by the home, the amount you realize includes the full amount of the outstanding debt immediately before the transfer. This is true even if the FMV of the property is less than the outstanding debt immediately before the transfer.

If you were personally liable for repaying the debt secured by the home and the debt is canceled, the amount realized on the foreclosure or repossession includes the smaller of the outstanding debt immediately before the transfer reduced by any amount for which you remain personally liable immediately after the transfer, or the Fair Market Value (FMV) of the transferred property.

In addition to any gain or loss, if you were personally liable for the debt you may have ordinary income. If the canceled debt is more than the home's fair market value, you have ordinary income equal to the difference. However, the income from cancellation of debt is not taxed to you if the cancellation is intended as a gift, or if you are insolvent or bankrupt.

Example: You owned and lived in a home with an adjusted basis of $41,000. A real estate dealer accepted your old home as a trade-in and allowed you $50,000 toward a new house priced at $80,000 (its fair market value). You are considered to have sold your old home for $50,000 and to have had a gain of $9,000 ($50,000 minus $41,000). If the dealer had allowed you $27,000 and assumed your unpaid mortgage of $23,000 on your old home, $50,000 would still be considered the sales price of the old home (the trade-in allowed plus the mortgage assumed).

Transfer to spouse. If you transfer your home to your spouse, or to your former spouse incident to your divorce, you generally have no gain or loss, even if you receive cash or other consideration for the home. Therefore, the rules explained in this Guide do not apply.

If you owned your home jointly with your spouse and transfer your interest in the home to your spouse, or to your former spouse incident to your divorce, the same rule applies. You have no gain or loss.

If you buy or build a new home, its basis will not be affected by your transfer of your old home to your spouse, or to your former spouse incident to divorce. The basis of the home you transferred will not affect the basis of your new home.

Basis

You will need to know your basis in your home as a starting point for determining any gain or loss when you sell it. Your basis in your home is determined by how you got the home. Your basis is its cost if you bought it or built it. If you acquired it in some other way, its basis is either its fair market value when you received it or the adjusted basis of the person you received it from.

While you owned your home, you may have made adjustments (increases or decreases) to the basis. This adjusted basis is used to figure gain or loss on the sale of your home.

Cost as Basis

The cost of property is the amount you pay for it in cash or other property.

Purchase. If you buy your home, your basis is its cost to you. This includes the purchase price and certain settlement or closing costs. Your cost includes your down payment and any debt, such as a first or second mortgage or notes you gave the seller in payment for the home.

Seller-paid points. If you bought your home after April 3, 1994, you must reduce the basis of your home by any points the seller paid, whether or not you deducted them. If you bought your home after 1990 but before April 4, 1994, you must reduce your basis by the amount of seller-paid points only if you chose to deduct them as home mortgage interest in the year paid.

Settlement fees or closing costs. When buying your home, you may have to pay settlement fees or closing costs in addition to the contract price of the property. You can include in your basis the settlement fees and closing costs that are for buying the home. You cannot include in your basis the fees and costs that are for getting a mortgage loan. A fee is for buying the home if you would have had to pay it even if you paid cash for the home.

Settlement fees do not include amounts placed in escrow for the future payment of items such as taxes and insurance.

Some of the settlement fees or closing costs that you can include in the basis of your property are:

• Abstract fees (sometimes called abstract of title fees),
• Charges for installing utility services,
• Legal fees (including fees for the title search and preparing the sales contract and deed),
• Recording fees,
• Surveys,
• Transfer taxes,
• Owner's title insurance, and
• Any amounts the seller owes that you agree to pay, such as back taxes or interest, recording or mortgage fees, charges for improvements or repairs, and sales commissions.

Some settlement fees and closing costs not included in your basis are:

• Fire insurance premiums.
• Rent for occupancy of the house before closing.
• Charges for utilities or other services relating to occupancy of the house before closing.
• Any item that you deducted as a moving expense (settlement fees and closing costs incurred after 1993 cannot be deducted as moving expenses).
• Fees for refinancing a mortgage.
• Charges connected with getting a mortgage loan, such as mortgage insurance premiums (including VA funding fees), loan assumption fees, cost of a credit report, and fee for an appraisal required by a lender.

Real estate taxes. Real estate taxes for the year you bought your home may affect your basis, as follows:

If you pay taxes that the seller owed on the home up to the date of sale and the seller does not reimburse you, then the taxes are added to the basis of your home.

If you pay taxes that the seller owed on the home up to the date of sale and the seller does reimburse you, then the taxes do not affect the basis of your home.

If the seller pays taxes for you (taxes owed beginning on the date of sale) and you do not reimburse the seller, then the taxes are subtracted from the basis of your home.

If the seller pays taxes for you (taxes owed beginning on the date of sale) and you reimburse the seller, then the taxes do not affect the basis of your home.

Construction. If you contracted to have your house built on land you own, your basis is the cost of the land plus the amount it cost you to complete the house. This amount includes the cost of labor and materials, or the amounts paid to the contractor, and any architect's fees, building permit charges, utility meter and connection charges, and legal fees directly connected with building your home. Your cost includes your down payment and any debt, such as a first or second mortgage or notes you gave the seller or builder. It also includes certain settlement or closing costs. You may have to reduce the basis by points the seller paid for you. If you built all or part of your house yourself, its basis is the total amount it cost you to complete it. Do not include the value of your own labor, or any other labor you did not pay for, in the cost of the house.

Cooperative apartment. Your basis in the apartment is usually the cost of your stock in the co-op housing corporation, which may include your share of a mortgage on the apartment building.

Condominium. Your basis is generally its cost to you. The same rules apply as for any other home.

Basis Other Than Cost

If your home was acquired in a transaction other than a traditional purchase (such as gift, inheritance, trade, or from a spouse), you may have to use a basis other than cost, such as fair market value.

Note: Fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither having to buy or sell, and both having reasonable knowledge of the relevant facts. Sales of similar property, on or about the same date, may be helpful in figuring the fair market value of the property.

Home received as gift. If your home was a gift, its basis to you is the same as the donor's adjusted basis when the gift was made. However, if the donor's adjusted basis was more than the fair market value of the home when it was given to you, you must use that fair market value as your basis for measuring any loss on its sale.

If you use the donor's adjusted basis to figure a gain and get a loss, and then use the fair market value to figure a loss and get a gain, you have neither a gain nor a loss on the sale or disposition.

If you received your home as a gift and its fair market value was more than the donor's adjusted basis at the time of the gift, you may be able to add to your basis any federal gift tax paid on the gift. If the gift was before 1977, the basis cannot be increased to more than fair market value of the home when it was given to you. On the other hand, if you received your home as a gift after 1976, you would add to your basis the part of the federal gift tax paid that is due to the home's "net increase" in value (value less donor's adjusted basis).

Home received from spouse. You may have received your home from your spouse or from your former spouse incident to your divorce.

• If you received the home after July 18, 1984, you had no gain or loss on the transfer. Your basis in this home is generally the same as your spouse's (or former spouse's) adjusted basis just before you received it. This rule applies even if you received the home in exchange for cash, the release of marital rights, the assumption of liabilities, or other consideration.
• If you owned a home jointly with your spouse and your spouse transferred his or her interest in the home to you, your basis in the half interest received from your spouse is generally the same as your spouse's adjusted basis just before the transfer. This rule also applies if your former spouse transferred his or her interest in the home to you incident to your divorce. Your basis in the half interest you already owned does not change. Your new basis in the home is the total of these two amounts.
• If you received your home before July 19, 1984, in exchange for your release of marital rights, your basis in the home is generally its fair market value at the time you received it.
• Home acquired from a decedent who died before or after 2010. If you inherited your home from a decedent who died before or after 2010, your basis is the fair market value of the property on the date of the decedent's death (or the later alternate valuation date chosen by the personal representative of the estate). If an estate tax return was filed or required to be filed, the value of the property listed on the estate tax return is your basis. If a federal estate tax return did not have to be filed, your basis in the home is the same as its appraised value at the date of death, for purposes of state inheritance or transmission taxes.
• Surviving spouse. If you are a surviving spouse and you owned your home jointly, your basis in the home will change. The new basis for the interest your spouse owned will be its fair market value on the date of death (or alternate valuation date). The basis in your interest will remain the same. Your new basis in the home is the total of these two amounts.

Example: Your jointly owned home had an adjusted basis of $50,000 on the date of your spouse's death, and the fair market value on that date was $100,000. Your new basis in the home is $75,000 ($25,000 for one-half of the adjusted basis plus $50,000 for one-half of the fair market value).

In community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), each spouse is usually considered to own half of the community property. When either spouse dies, the fair market value of the community property becomes the basis of the entire property, including the portion belonging to the surviving spouse. For this to apply, at least half of the community interest must be included in the decedent's gross estate, whether or not the estate must file a return.

Home received in trade. If you acquired your home in a trade for other property, the basis of your home is generally its fair market value at the time of the trade. If you traded one home for another, you have made a sale and purchase. In that case, you may have realized a gain.

Adjusted Basis

Adjusted basis is your cost or other basis increased or decreased by certain amounts.

Increases to basis include:

• Additions and other improvements that have a useful life of more than 1 year.
• Special assessments for local improvements.
• Amounts spent after a casualty to restore damaged property.

Decreases to basis include:

• Discharge of qualified principal residence indebtedness that was excluded from income (but not below zero).
• Gain from the sale of your old home before May 7, 1997 on which tax was postponed.
• Insurance payments for casualty losses.
• Deductible casualty losses not covered by insurance.
• Payments received for granting an easement or right-of-way.
• Depreciation allowed or allowable if you used your home for business or rental purposes.
• Residential energy credit (generally allowed from 1977 through 1987) claimed for the cost of energy improvements that you added to the basis of your home.
• Adoption credit you claimed for improvements that you added to the basis of your home.
• Nontaxable payments from an employer's adoption assistance program that you used for improvements you added to the basis of your home.
• Nonbusiness energy property credit (allowed beginning in 2006 but not for 2008) claimed for making certain energy saving improvements you added to the basis of your home.
• Residential energy efficient property credit (allowed beginning in 2006) claimed for making certain energy saving improvements you added to the basis of your home.
• First-time home buyer's credit (allowed to certain first-time buyers in the District of Columbia--beginning on August 5, 1997).
• Energy conservation subsidy excluded from your gross income because you received it (directly or indirectly) from a public utility after December 3l, 1992, to buy or install any energy conservation measure. An energy conservation measure includes an installation or modification that is primarily designed either to reduce consumption of electricity or natural gas or to improve the management of energy demand for a home.

Discharges of qualified principal residence indebtedness. You may be able to exclude from gross income a discharge of qualified principal residence indebtedness. This exclusion applies to discharges made after 2006 and before 2013. If you choose to exclude this income, you must reduce (but not below zero) the basis of your principal residence by the amount excluded from gross income.

Amount eligible for the exclusion. The exclusion applies only to debt discharged after 2006 and before 2013. The maximum amount you can treat as qualified principal residence indebtedness is $2 million ($1 million if married filing separately). You cannot exclude from gross income discharge of qualified principal residence indebtedness if the discharge was for services performed for the lender or on account of any other factor not directly related to a decline in the value of your residence or to your financial condition.

Improvements. These add to the value of your home, prolong its useful life, or adapt it to new uses. You add the cost of improvements to the basis of your property.

Example: Putting a recreation room in your unfinished basement, adding another bathroom or bedroom, putting up a fence, putting in new plumbing or wiring, installing a new roof, or paving your driveway are improvements.

Here are some other examples:

• Additions: Bedroom, bathroom, deck, garage, porch, patio
• Lawn and grounds: Landscaping, driveway, walkway, fence, retaining wall, sprinkler system, swimming pool
• Miscellaneous: Storm windows or doors, new roof, central vacuum, wiring upgrades, satellite dish, security system
• Heating and air conditioning: Heating system, central air, furnace, duct work, central humidifier, filtration system
• Plumbing: Septic system, water heater, soft water system, filtration system
• Interior: Built-in appliances, kitchen modernization, flooring, wall-to-wall carpet
• Insulation: attic, walls, floor, pipes, duct work
• Improvements no longer part of home. Your home's adjusted basis does not include the cost of any improvements that are no longer part of the home.

Example: You put wall-to-wall carpeting in your home 15 years ago. Later, you replaced that carpeting with new wall-to-wall carpeting. The cost of the old carpeting you replaced is no longer part of your home's adjusted basis.

Repairs. These maintain the good condition of your home. They do not add to its value or prolong its life, and you do not add their costs to the basis of your property.

Example: Repainting your house inside or outside, fixing your gutters or floors, repairing leaks or plastering, and replacing broken window panes are examples of repairs.

Tip: The entire job is considered an improvement, however, if items that would otherwise be considered repairs are done as part of an extensive remodeling or restoration of your home.

Recordkeeping. You should keep records of your home's purchase price and purchase expenses. Furthermore, you should also save receipts and other records for all improvements, additions, and other items that affect the basis of your home.

Tip: You must keep records for 3 years after the due date for filing your return for the tax year in which you sold, or otherwise disposed of, your home. But if the basis of your old home affects the basis of your new one, such as when you sold your old home before May 7, 1997 and postponed tax on any gain, you should keep those records forever.

The records you should keep include:

• Proof of the home's purchase price and purchase expenses;
• Receipts and other records for all improvements, additions, and other items that affect the home's adjusted basis;
• Any worksheets or other computations you used to figure the adjusted basis of the home you sold, the gain or loss on the sale, the exclusion, and the taxable gain;
• Any Form 982 you filed to exclude any discharge of qualified principal residence indebtedness;
• Any Form 2119, Sale of Your Home, you filed to postpone gain from the sale of a previous home before May 7, 1997;
• Any worksheets you used to prepare Form 2119

Exclusion for Sales After May 6, 1997

If you sell your main home after May 6, 1997, you may qualify to exclude up to $250,000 of the gain ($500,000 if married filing jointly) on the sale of your main home; however, to claim the exclusion, you must meet the ownership and use tests. This means that during the 5-year period ending on the date of the sale, you must have:

• Owned the home for at least 2 years (the ownership test)
• Lived in the home as your main home for at least 2 years (the use test)
• During the 2-year period ending on the date of the sale, you did not exclude gain from the sale of another home.

Exception. If you owned and lived in the property as your main home for less than 2 years, you can still claim an exclusion in some cases. However, the maximum amount you may be able to exclude will be reduced.

If you sell the land on which your main home is located, but not the house itself, you cannot exclude any gain you have from the sale of the land.

If you have more than one home, only the sale of your main home qualifies for excluding the gain. If you have two homes and live in both of them, your main home is the one you live in most of the time.

Note: If you owned and used the property as your main home for less than 2 years, you may be able to claim a reduced exclusion.

The two years of ownership and use during the five-year period don't have to be continuous. You meet the tests if you can show that you owned and lived in the property as your main home for either 24 full months or 730 days during the five-year period. Short temporary absences, e.g., for vacations, are counted as periods of use, even if you rent out the property during that time.

Example: From 1994 through August 2007, Anne lived with her parents in a house that her parents owned. On September 29, 2007, she bought this house from her parents. She continued to live there until December 15 of 2007, when she sold it at a gain. Although Anne lived in the property as her main home for more than 2 years, she did not own it for the required 2 years. Therefore, she cannot exclude any part of her gain on the sale, unless she sold the property due to a change in health or place of employment.

Example: Professor Moore bought and moved into a house on January 4, 2005. He lived in it as his main home continuously until October 1, 2006, when he went abroad for a one-year sabbatical. During part of the leave, the house was unoccupied, and during the rest of the time he rented it out. On October 1, 2007, he sold the house. Because his leave was not a short temporary absence, he cannot include the period of leave to meet the 2-year use test.

Ownership and Use Tests Met at Different Times. You can meet the ownership and use tests during different 2-year periods. However, you must meet both tests during the 5-year period ending on the date of the sale.

Example: In 1996, Harry was 60 years old and lived in a rental apartment. When the apartment building went co-op, he bought his apartment on December 1, 1999. Harry then went to live with his daughter on April 14, 2001 because he became ill. On July 10, 2003, he sold his co-op while still living with his daughter. Harry can exclude gain on the sale of his co-op because he met the ownership and use tests. His 5-year period runs from July 11, 1998, to July 10, 2003, the date he sold the co-op. Even though, he only owned the co-op from December 1, 1999 to July 10, 2003--over two years, he lived in the apartment from July 11, 1997 (the beginning of the five-year period) to April 14, 2001 (over two years).

Special Situations. There are a number of special situations that may result in exceptions to the general rules.

Individuals with Disabilities. There is an exception to the 2-out-of-5-year use test if you become physically or mentally unable to care for yourself at any time during the 5-year period. You qualify for this exception to the use test if, during the 5-year period before the sale of your home:

• You become physically or mentally unable to care for yourself, and
• You owned and lived in your home as a main home for a total of at least one year during the 5-year period before the sale of your home.

Under this exception, you are considered to live in your home during any time that you live in a facility (including a nursing home) that is licensed by a state or political subdivision to care for persons in your condition.

If you meet this exception to the use test, you still have to meet the 2-out-of-5-year ownership test to claim the exclusion.

Gain postponed on sale of previous home. For the ownership and use tests, you may be able to add the time you owned and lived in a previous home to the time you lived in the home on which you wish to exclude gain. You can do this if you postponed all or part of the gain on the sale of the previous home because of buying the home on which you wish to exclude gain.

Tip: Also, if buying the previous home enabled you to postpone all or part of the gain on the sale of a home you owned earlier, you can also include the time you owned and lived in that earlier home.

Previous home destroyed or condemned. For the ownership and use test, you add the time you owned and lived in a previous home that was destroyed or condemned to the time you owned and lived in the home on which you wish to exclude gain. This rule applies if any part of the basis of the home you sold depended on the basis of the destroyed or condemned home. Otherwise, you must have owned and lived in the same home for 2 of the 5 years before the sale to qualify for the exclusion.

Members of the uniformed services or Foreign Service, employees of the intelligence community, or employees or volunteers of the Peace Corps. You can choose to have the 5-year test period for ownership and use suspended during any period you or your spouse serve on qualified official extended duty (defined later) as a member of the uniformed services or Foreign Service of the United States, or as an employee of the intelligence community.

You can choose to have the 5-year test period for ownership and use suspended during any period you or your spouse serve outside the United States either as an employee of the Peace Corps on qualified official extended duty (defined later) or as an enrolled volunteer or volunteer leader of the Peace Corps. This means that you may be able to meet the 2-year use test even if, because of your service, you did not actually live in your home for at least the required 2 years during the 5-year period ending on the date of sale.

Note: The period of suspension cannot last more than 10 years. Together, the 10-year suspension period and the 5-year test period can be as long as, but no more than, 15 years. You cannot suspend the 5-year period for more than one property at a time. You can revoke your choice to suspend the 5-year period at any time.

Married Persons

If you and your spouse file a joint return for the year of sale, you can exclude gain (up to $500,000) if either spouse meets the ownership and use tests.

Example: Mary sells her home in June of this year and marries John later in the year. She meets the ownership and use tests, but John does not. Emily can exclude up to $250,000 of gain on a separate or joint return for this year.

Example: Now assume that John also sells a home. He meets the ownership and use tests on his home. Mary and John can each exclude $250,000 of gain.

Death of spouse before sale. If your spouse died before the date of sale, you are considered to have owned and used the property as your main home during any period of time when your spouse owned and used it as a main home.

Home transferred from spouse. If your home was transferred to you by your spouse (or former spouse if the transfer was incident to divorce), you are considered to have owned it during any period of time when your spouse owned it.

Use of home after divorce. You are considered to have used property as your main home during any period when you owned it and your spouse or former spouse is allowed to use it under a divorce or separation instrument. Such use is added to your own use before or after divorce.

Special Exceptions Affecting Exclusions

Home destroyed or condemned. If your home is destroyed or condemned after May 6, 1997, any gain (e.g., due to insurance proceeds) qualifies for the exclusion.

Expatriates. You cannot claim the exclusion if the expatriate tax applies to you because you have renounced their citizenship and one of the primary purposes was to avoid U.S. taxes.

More Than One Home Sold During the Two-Year Period. You cannot exclude gain on the sale of your home if, during the two-year period ending on the date of the sale, you sold another home at a gain and are excluding all or part of that gain. If you cannot exclude the gain, you must include it in your income.

However, you can claim a reduced exclusion if you sold the home due to a change in health or place of employment or experienced unforeseen circumstances such as natural disasters, death, or unemployment (eligible unemployment compensation). When counting the number of sales during a two-year period, do not count sales before May 7, 1997.

The $250,000 (or $500,000) exclusion is reduced according to a formula whose numerator is the number of days of qualified ownership or use (or between sales of the homes) and the denominator is 730 days (for 2 years). If married filing jointly, duplicate the same calculation for your spouse's ownership and use (or days between sales).

Example: You owned and used your main home for 400 days before selling it at a $150,000 gain following your move to a new job location. Your exclusion is $136,986, that is, 400/730 x $250,000.

Change in Place of Employment. You may qualify for a reduced exclusion if the primary reason for the sale of your main home is a change in the location of employment of a qualified individual.

Health. You may qualify for a reduced exclusion if the sale of your main home is because of health if your primary reason for the sale is to obtain, provide, or facilitate the diagnosis, cure, mitigation, or treatment of disease, illness, or injury of a qualified individual, or to obtain or provide medical or personal care for a qualified individual suffering from a disease, illness, or injury.

Unforeseen Circumstances. You may qualify for a reduced exclusion if the sale of your main home is because of an unforeseen circumstance if your primary reason for the sale is the occurrence of an event that you could not reasonably have anticipated before buying and occupying that home. You are not considered to have an unforeseen circumstance if the primary reason you sold your home was that you preferred to get a different home or because your finances improved.

Home used in business. So long as the business use takes place in the same dwelling unit as your main home, the exclusion is not affected by business use, with this exception: You cannot exclude the part of your gain that is equal to any depreciation allowed or allowable for the business use of your home after May 6, 1997. The 2 out of 5 year use-as-the-main-home test is not applied to deny exclusion for gain allocable to business use in the same dwelling unit, except for allowable depreciation.

Example: You bought a home in 1997 and used it throughout 3/4 as your residence and 1/4 as your home office. On December 30, 2002 you sold it. The gain qualifies for exclusion except that you cannot exclude the part of your gain that is equal to any depreciation allowed or allowable for the business use of your home after May 6, 1997.

Recapture of Federal Subsidy

If you financed your home under a federally subsidized program (loans from tax-exempt qualified mortgage bonds or loans with mortgage credit certificates), you may have to recapture all or part of the benefit you received from that program when you sell or otherwise dispose of your home. You recapture the benefit by increasing your federal income tax for the year of the sale. You may have to pay this recapture tax even if you can exclude your gain from income under the rules discussed earlier; that exclusion does not affect the recapture tax.

Glossary

Adjusted basis: This is your basis in the property increased or decreased by certain amounts. See Adjusted Basis, earlier in this Guide, for a list of items that increase or decrease your basis in the property.

Amount realized: This is the selling price of your old home minus your selling expenses.

Basis: Your basis in the property is determined by how you got it. If you bought or built the property, your basis is what it cost you. If you got the property in some other way, your basis will be determined differently. See Cost as Basis and Basis Other Than Cost earlier in this Guide for more information.

Date of sale: If you received a Form 1099-S, Proceeds From Real Estate Transactions, the date should be shown in box 1. If you did not receive this form, the date of sale is the earlier of (a) the date title transferred or (b) the date the economic burdens and benefits of ownership shifted to the buyer. In most cases, these dates are the same.

Fair market value: Fair market value is the price at which property would change hands between a willing buyer and a willing seller, neither having to buy or sell, and both having reasonable knowledge of the relevant facts. Sales of similar property, on or about the same date, may be helpful in figuring the fair market value of the property.

Fixing-up expenses: These are costs you pay for decorating or repairing your home to make it easier to sell. You may be able to deduct fixing-up expenses from the amount realized on the sale of your old home.

Gain: Your gain on the sale of your home is the amount realized minus the adjusted basis of the home you sold.

Improvements: These add to the value of your home, prolong the life of the property, or allow the property to be used for new purposes. The cost of improvements increases your basis in the property.

Main home: This is the home you live in most of the time. It can be a house, houseboat, cooperative apartment, condominium, etc.

Repairs: These maintain your property in good condition. They differ from Improvements in that they do not add much to the value or life of the property and their cost does not increase your basis in the property.

Seller-financed mortgage: This is a mortgage from the buyer of your home. The buyer makes mortgage payments to you.

Selling expenses: Selling expenses include items such as sales commissions, and advertising and legal fees you pay to sell your home. Selling expenses also usually include loan charges you pay on the buyer's behalf as an aid in selling your home, such as loan placement fees or "points."

Settlement fees (or closing costs): These are amounts paid in purchasing your property in addition to the contract price. Some of these amounts are added to the basis of the property and some are deductible as itemized deductions. Certain amounts are neither deductible nor added to the basis of the property. See Settlement fees or closing costs under Basis, earlier in this Guide, for more details.

There are two primary deductions for homeowners: real estate taxes and home mortgage interest. This Financial Guide explains which expenses you can and cannot deduct as a homeowner, and explains useful aspects of the real estate tax deduction. The mortgage interest deduction is discussed in a separate Financial Guide.

Note: Click here for the discussion of mortgage interest deductions.

Preliminary Note: Nondeductible Items

If you took out a mortgage to finance the purchase of your home, you are probably making monthly house payments. This house payment may include various costs of owning a home. The only costs you can deduct are real estate taxes actually paid to the taxing authority and interest that qualifies as home mortgage interest.

Here are some nondeductible items that may be included in your house payment.

• Fire or homeowner's insurance premiums.
• FHA mortgage insurance premiums.
• Any amount applied to reduce the principal of the mortgage.

Note: Members of the clergy or of the uniformed services who receive a nontaxable housing allowance can still deduct real estate taxes and home mortgage interest. They need not reduce their deductions by the nontaxable allowance.

What Is Meant by "Real Estate Taxes"?

Most state and local governments charge an annual tax on the value of real property. This is called a real estate tax. You can deduct the tax if it is based on the assessed value of the real property and the taxing authority charges a uniform rate on all property in its jurisdiction. The tax must be for the welfare of the general public and not be a payment for a special privilege or service you receive.

Deductible Taxes

You can deduct real estate taxes imposed on you. You must have paid them either at settlement or closing or to a taxing authority (either directly or through an escrow account) during the year. If you own a cooperative apartment, special rules apply to the deduction, which is generally available to you.

Purchase or Sale of Realty: How the Deduction Is Divided Up

Real estate taxes are generally divided so that you and the seller each pay taxes for the part of the property tax year you owned the home. Your share of these taxes is fully deductible, as long as you itemize your deductions.

For tax purposes, the seller is treated as paying the property taxes up to, but not including, the date of sale. You (the buyer) are treated as paying the taxes beginning with the date of sale. This applies regardless of the lien dates under local law. Generally, this information is included on the settlement statement you get at closing.

Tip: You and the seller each are considered to have paid your own share of the taxes, even if one or the other paid the entire amount. You can each deduct your own share, if you itemize deductions, for the year the property is sold.

Delinquent taxes. Delinquent taxes are unpaid taxes imposed on the seller for an earlier tax year. If you agree to pay delinquent taxes when you buy your home, you cannot deduct them. You treat them as part of the cost of your home.

Caution: Many monthly house payments include an amount placed in escrow (put in the care of a third party) for real estate taxes. You may not be able to deduct the total you pay into the escrow account. You can deduct only the real estate taxes that the lender actually paid from escrow to the taxing authority. Your real estate tax bill will show this amount.

Refund or rebate of real estate taxes. If you receive a refund or rebate of real estate taxes this year for amounts you paid this year, you must reduce your real estate tax deduction by the amount refunded to you. If the refund or rebate was for real estate taxes paid for a prior year, you may have to include some or all of the refund in your income.

Items Not Considered Real Estate Taxes

The following items are not deductible as real estate taxes.

Charges for services. An itemized charge for services to specific property or people is not a tax, even if the charge is paid to the taxing authority. You cannot deduct the charge as a real estate tax if it is:

1. A unit fee for the delivery of a service (such as a $5 fee charged for every 1,000 gallons of water you use),
2. A periodic charge for a residential service (such as a $20 per month or $240 annual fee charged for trash collection), or
3. A flat fee charged for a single service provided by your local government (such as a $30 charge for mowing your lawn because it had grown higher than permitted under a local ordinance).

You must look at your real estate tax bill to decide if any nondeductible itemized charges, such as those just listed, are included in the bill. If your taxing authority (or lender) does not furnish you a copy of your real estate tax bill, ask for it.

Assessments for local benefits. You cannot deduct amounts you pay for local benefits that tend to increase the value of your property. Local benefits include the construction of streets, sidewalks, or water and sewer systems. You must add these amounts to the basis of your property.

You can, however, deduct assessments (or taxes) for local benefits if they are for maintenance, repair, or interest charges related to those benefits. An example is a charge to repair an existing sidewalk and any interest included in that charge.

If only a part of the assessment is for maintenance, repair, or interest charges, you must be able to show the amount of that part to claim the deduction. If you cannot show what part of the assessment is for maintenance, repair, or interest charges, you cannot deduct any of it.

An assessment for a local benefit may be listed as an item in your real estate tax bill. If so, use the rules in this section to find how much of it, if any, you can deduct.

Transfer taxes (or stamp taxes). You cannot deduct transfer taxes and similar taxes and charges on the sale of a personal home. If you are the buyer and you pay them, include them in the cost basis of the property. If you are the seller and you pay them, they are expenses of the sale and reduce the amount realized on the sale.

Homeowners association assessments. You cannot deduct these assessments because the homeowners association imposes them rather than a state or local government.

Special Rules for Cooperatives

If you own a cooperative apartment, some special rules apply to you, though you generally receive the same tax treatment as other homeowners. As an owner of a cooperative apartment, you own shares of stock in a corporation that owns or leases housing facilities. You can deduct your share of the corporation's deductible real estate taxes if the cooperative housing corporation meets certain conditions.