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10 essential tax questions for homeowners

Mortgage tax questionsAlbert Einstein once said, "The hardest thing in the world to understand is the income tax.” If you buy, sell, finance or own real estate, it gets even worse. Property and taxes go together like blood and leeches.


"For many homeowners, real estate taxes and mortgage interest are by far some of their biggest tax deductions," says Art Ford, a certified public accountant in Boston. "If I pay $1,500 a month in mortgage interest, that's an $18,000-a-year deduction."

So before you belly up to the nearest bar or start pulling your hair out, here are some commonly asked questions about taxes and homeownership. Knowing these answers will help keep your tax bill as low as possible.

No. 1: How much of my mortgage payment is tax deductible?

On a Schedule A (see pdf form at end of article), you can generally deduct the following:

  • Property taxes on first and second homes (if you itemize your deductions)

No. 2: I sold my home this year. Will I owe capital gains tax?

As long as the property was your principal residence for at least two of the last five years, you can exclude $250,000 of your profit ($500,000 for married couples) from your federal taxable income. If you profited less than the $250,000/$500,000 threshold, no extra form is required. You can do this as often as every two years.

If you made a higher profit or otherwise don't qualify for the exclusion (say, you sold after just one year), Ford says you'll generally owe up to 23.8% in federal taxes on your gains over and above the "excluded" amount. (Your actual rate will vary depending on your income.)

But when calculating your taxable gains, Ford suggests looking beyond what you originally paid for your home. You should also factor in anything that you spent on home improvements while you owned the property.

Say you and your spouse bought a place for $100,000 two decades ago, lived there as your primary residence and sold the home for $800,000. You'd ordinarily have to pay capital-gains taxes on $200,000 -- your $800,000 sale price minus your $100,000 purchase price minus the $500,000 exclusion for married couples.

However, if you spent $150,000 on upgrades, you can deduct that from your capital gain. In the example above, that would reduce your taxable profit from $200,000 to just $50,000.

That said, IRS Publication 523 (see pdf form at end of article) notes that you generally can't deduct repairs or maintenance, only "improvements" that are designed to increase your home's value. Unfortunately, the rules for what's a "repair" versus an "improvement" are pretty vague.


If you still have taxable profits on your home after factoring in all of the above, you'll report your gains on a Schedule D, Capital Gains and Losses (see pdf form at end of article). There are special rules for vacation homes. You may be able to exclude some or all of your gain.

Remember different states have different rules. Always consult with a tax professional if you need personal advice.

No. 3: I lost money on the sale of my home. Do I get to deduct the loss?


No. 4: Are my closing costs tax deductible?

You can claim a deduction for real estate taxes you paid as part of your mortgage closing costs. The same goes for prepaid interest. It will be included on the 1098 form (see pdf form at end of article) your lender sends you.

What about points?


No. 5: What happens with points on a refinance?



No. 6: Does a mortgage modification affect my taxes?


No. 7: Does a foreclosure, short sale or principal reduction affect my taxes?

Homeowners who lost their homes to either a foreclosure, short sale or had a bank "forgive" part of their mortgage principal used to have to pay income taxes on any money that their lender agreed to write off.

But the Mortgage Forgiveness Debt Relief Act of 2007 changed that for loans restructured between 2007 and 2014 for primary residences. For those tax years, you don't have to consider the discharge of mortgage debt as taxable income.

However, Congress has yet to extend this relief to loans restructured after Dec. 31, 2014. Additionally, the 2007 law doesn't cover investment properties and vacation homes, nor does it apply to forgiven home-equity loans.

Lastly, states have their own rules about taxes on forgiven mortgage debt, so check with a tax professional.

No. 8: Can I deduct prepayment penalties?


No. 9: What expenses am I NOT allowed to deduct from my income?


  • Hazard insurance
  • Homeowners association dues
  • Principal payments
  • General closing costs like appraisal fees or title insurance
  • Local assessments to improve your neighborhood

No. 10: Does the so-called "Obamacare" tax affect gains from property sales?

The 2010 "Obamacare" Affordable Care Act added an extra 3.8 percent tax on capital gains incurred by certain high-income taxpayers.

If you fall under the law's requirements, you'll have to pay 23.8 percent in federal income taxes on your home-sale profits over and above the $250,000/$500,000 exclusion rather than the 20 percent rate that you'd otherwise face.

However, this extra tax only applies to single or head-of-household filers who have a $200,000 adjusted gross income or married joint filers with a $250,000 adjusted gross income. And remember, the first $250,000 of a single taxpayer's profits ($500,000 for joint filers) is federally tax free.

Knowing what tax deductions are available to you can help minimize the tax man's bite come April 15. After all, the law says you have to pay taxes -- but there's no reason to leave Uncle Sam a tip.

Schedule A

IRS Publication 523

Schedule D Capital Gains and Losses

Form 1098

Gina Pogol was the original author of this article. (Image: ljdema/iStock)

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