THE BASIS POINT

Real Estate Tax Tips For 2005 Filing

 

We know tax season can be a confusing time, so we hope the topics below will come in handy right now, and will also give you some things to think about as you fine tune your tax strategy for next year.

Tax Formula for Primary Residence
The following example explains mortgage interest and property tax deductions on your primary residence. Let’s say you paid $625,000 for a San Francisco home and have a $500,000 mortgage at 6%. This means your annual property taxes are about $7150 and annual mortgage interest is $30,000. The sum of these figures is the amount you can deduct from your gross income. So if you earn $125,000 per year, instead of paying taxes on $125,000, your taxable income becomes $87,850 (minus any other deductions you’re taking). To figure out actual tax savings, multiply the $37,150 in deductions by your tax bracket, which in this case would be roughly 33%. This means an estimated annual tax savings of $12,259.

Tax Formula for Investment Property
Step one for determining rental property tax status is to subtract total property expenses (which include mortgage interest, property tax, and all expenses associated with managing and improving that property) from total property income. Step two is to subtract depreciation. If the resulting number is negative, you can deduct this loss if your adjusted gross income is less than $150,000.* Depreciation is calculated on the value of the home itself, not the land it sits on, since land does not depreciate. Nationwide, home-to-land value proportions are roughly in the 65%/35% range. In the Bay Area, land tends to be worth more, so home-to-land proportions are more like 50%/50%. So if you owned the $625,000 home mentioned above as a rental, you could depreciate roughly $312,500 over about 29 years (about $10,775 per year). To calculate your potential deduction, you start with total rental income, subtract all expenses as noted above, then subtract $10,775 in depreciation.

*If it’s greater than $150,000, your deductible amount accrues for the years you own the investment property, and is used to offset capital gains when you sell. So the benefit is the same if your AGI is more than $150,000, but benefits are deferred. Consult a tax professional on all tax issues.

Tax Formulas For Selling Your Home
When selling your primary residence, you calculate capital (or taxable) gains by subtracting purchase price, selling cost, and cost of home improvements from sale price. If you’re married and owned your home for at least two years, you’re exempt from paying taxes on capital gains up to $500,000 (the exemption is $250,000 for a single person). If you sell your primary home within 1-12 months of buying, you’re taxed at short-term capital gains rates of about 35% federal plus about 9.3% state (CA). So if your capital gains were $50,000, you’d pay about $22,150 in taxes. If you sell your home within 12-24 months of buying, you’re taxed at long-term capital gains rates of about 15% federal and 9.3% state (CA). If you had a $50,000 gain during this period, you’d pay about $12,150 in taxes. Capital gains also increase your income, so your tax brackets may also be affected. Again, you should consult a tax professional regarding your specific situation.

Tax Deductibility Cap on HELOCs
When using a home equity line of credit (HELOC) as a 2nd mortgage, be aware that tax deductibility is limited to $100,000. So if your 2nd is or will be more than $100,000,
you generally won’t get to deduct interest paid on loan balances above that cap (besides a couple of exceptions).

Deducting Mortgage Closing Costs
Almost every home loan transaction has the same closing cost line items: appraisal, underwriting, title insurance, escrow services, etc. Not all of these fees are deductible. Traditionally, only lender origination fees or mortgage broker fees (points) are deductible. But the savvy loan agent can “convert” certain standard fees to an origination fee so that you can get some extra tax benefit from your next loan transaction.

So as you plan for your next property transaction and finalize your 2005 taxes, we hope these briefs are useful to you. They’re not designed not to be recommendations, but rather basic guidelines using estimated figures and hypothetical scenarios. As always, you should consult a tax professional to see if any items discussed here apply to your specific situation.

 

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