Before the first snowflakes of winter, homeowners should think about spring savings. Steps taken today could reduce the tax hit on April 15.
Most homeowners who itemize their taxes can deduct the interest paid on their first and second mortgages of up to $1.1 million in debt. That total reflects up to $1 million for home loans and another $100,000 for home-equity loans.
The deductions add up for homeowners with jumbo mortgages—those above $417,000 in most places and $625,500 in high-price areas. A hypothetical example looks at a couple in the 30% tax bracket who files jointly. Assuming their income is under $300,000, the $24,000 they paid toward mortgage interest could see a benefit of up to $7,200 in tax savings, according to Mary Canning, dean emeritus and professor at Golden Gate University’s Braden School of Taxation and Accounting in San Francisco.
Some homeowners don’t realize they can deduct the mortgage interest paid on second homes, Ms. Canning says. Some of her clients, many of whom are approaching retirement age, have paid off the mortgage on their primary home and are buying a vacation home in nearby scenic towns like Sonoma or Carmel, she adds. With the deduction, “they are finding it’s quite affordable as opposed to putting up children and their families in hotels for a vacation,” Ms. Canning says.
That second home can even be a boat, mobile home or any structure, as long as it has plumbing, such as toilets and showers. However, an empty lot being held to build a future retirement home doesn’t qualify.
One mistake Ms. Canning often sees: Homeowners who try to deduct mortgage interest on a second home that was purchased using a margin loan on their brokerage account. “Sometimes people are surprised that they cannot make the deduction,” she says. It isn’t allowed, however, because the loan “has to be secured against the home.”
Beyond mortgage interest, documenting other home-related expenses can help further reduce tax bills. For example, self-employed taxpayers and business owners can write off some expenses if part of their home qualifies as a home office, says Robert Winton, a partner at White Plains, N.Y.-based Citrin Cooperman & Co.
Qualified taxpayers with second homes can also rent out the property and deduct some of their expenses, Mr. Winton adds. Deductions can include “maintenance, insurance and property taxes,” he adds.
Because the IRS doesn’t require reporting of rental income for 14 days or less a year, some business owners rent their home to their business for a meeting or retreat and then deduct the rental fee as a business expense on their company’s tax return, says Robert Walsh, founder and president of Red Bank, N.J.-based Lighthouse Financial Advisors.
Homeowners can take a few steps now to prepare for tax time. Diagram and measure home office space and total square footage, take pictures and save utility, security and real-estate tax bills, Mr. Walsh says. “If you paint your home office, it’s a 100% expense to office,” he adds.
Those who rent a second home regularly may wish to set up a separate bank account for rental earnings and keep a calendar for days of personal use, Mr. Walsh says.
Of course, with interest rates so low, tax savings may not be the highest priority for many high-end home buyers. “For people who are buying a big home and have a $1.5 million mortgage and it’s your dream home, you don’t mind not [being able to deduct] all of that interest,” Mr. Walsh adds.
Here are a few more tips to consider when looking for tax savings. Be sure to consult a tax professional or financial adviser for more specifics.
• Income limits. The Internal Revenue Service limits and phases out Schedule A itemized deductions if the taxpayer’s adjusted gross income exceeds $250,000 for a single individual or $300,000 for a married couple, says Mr. Walsh. Common Schedule A deductions include mortgage interest, state and local income taxes, sales taxes, and medical expenses and charitable donations.
The so-called “Pease Limitation,” named after former Rep. Donald Pease, was enacted by Congress in 1990. During the Bush tax cuts, the limits went away, but they kicked back in for 2013.
• Equity means everything. That $100,000 home-equity loan doesn’t have to be used to improve the home.
• Status matters. Unmarried couples who file separate tax returns and own their own homes will each get up to $1.1 million. Conversely, married couples filing separate returns can only deduct mortgage interest on up to $500,000 of home debt.
This article was originally published October 29, 2014, in The Wall Street Journal
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