There are many deductions that home buyers are allowed to take but navigating what your buyers can and cannot claim is daunting. Here is our basic guide that you can modify and send to your clients.
D.C. First-time bomebuyers
Taxpayers who have not recently owned a home in the District may be eligible for a one-time tax credit of up to $5,000 of the amount of the purchase price against federal income tax. The tax credit is reported on Form 8859, and the taxpayer must file Form 1040 to claim this credit.
The credit is available for home purchases after August 4, 1997 and before December 31, 2011. Download the DC First-Time Homebuyer Credit Tax Form 8859. The credit has not yet been renewed for 2012 and beyond.
Who May Claim the Credit?
- Home buyers who purchased a main home during the tax year in the District of Columbia and
- The home buyer (and spouse if married) did not own any other main home in the District of Columbia during the 1-year period ending on the date of purchase.
If the home buyer constructed the main home, they are treated as having purchased it on the date first occupied. The “main home” is the one your home buyer(s) live in most of the time. It can be a house, houseboat, house trailer, cooperative apartment, condominium, etc.
However, your home buyer may not claim the credit if any of the following apply:
- The house was acquired from certain related persons or by gift or inheritance. For details, see section 1400C(e)(2).
- Your home buyer’s modified adjusted gross income (see the instructions for line 2) is $90,000 or more if single, married filing separately, head of household, or qualifying widow(er); or $130,000 or more if married filing jointly.
- You previously claimed this credit for a different home.
The following provides a guide for your home buyer on what they can and cannot deduct from the closing costs at settlement. This is only a guide, for more information, please refer to the IRS Guide, Publication 530. Here are some of the costs that can be deducted:
- Real Estate Taxes – These taxes are usually divided so that the buyer and the seller each pay taxes for the part of the property tax year the buyer owned the home. If your home buyer itemizes their deductions, their share of these taxes is fully deductible.
- Mortgage Interest – The home buyer can deduct in each year only the interest that qualifies as home mortgage interest for that year. See information about “Points” below.
- Late Payment Charge – The buyer can deduct, as home mortgage interest, a late payment charge if it was not for a specific service in connection with their mortgage loan.
- Prepayment Penalty – If the home buyer pays off their home mortgage early, they may have to pay a penalty. They can deduct that penalty as home mortgage interest provided the penalty is not for a specific service performed or cost incurred in connection with the mortgage loan.
Here are the costs that cannot be deducted:
- Fire or homeowner’s insurance premiums.
- FHA mortgage insurance premiums.
- The amount applied to reduce the principal of the mortgage.
- Insurance, including fire and comprehensive coverage, and title and mortgage insurance.
- Wages paid for domestic help.
- The cost of utilities, such as gas, electricity or water.
- Homeowners association dues or assessments.
- Appraisal fees.
- Notary fees.
- Preparation costs for the mortgage note or deed of trust.
- Mortgage insurance premiums.
- VA funding fees.
- If the buyer agrees to pay delinquent taxes when the house is bought, the taxes cannot be deducted, they are treated as part of the cost of the home.
In general, home buyers can’t deduct prepaid home mortgage interest ahead of the year to which it relates. The most common form of prepaid interest is “points”. A point is a charge paid by the borrower to the lender when taking out a loan. One point equals one percent of the amount borrowed; for example, on a $100,000 loan, two points equals $2,000, but on a $500,000 loan, two points equals $10,000.
After the home mortgage interest deduction, the most important tax break for homeowners is the deduction for state and local taxes, including real estate taxes. Your home buyer’s real estate taxes are fully deductible, whether they are imposed by the state, county, city, township, or some other local government body.
Let your home buyer know that they can deduct taxes on all their real estate – the deduction is not limited to only two principal residences, like with the home mortgage interest deduction. Real estate taxes paid on all real estate they own for personal or family purposes is deductible on Line 6 of Schedule A, Itemized Deductions.
Who gets the deduction?
The person who owns the real estate and, therefore, owes the taxes is the person who takes the deduction, provided that he or she actually paid the amounts. Co-owners should divide the tax bill and the deduction according to the percentage of their ownership interest. If the home buyer pays taxes for someone else, on property that they do not own (i.e. an elderly parent), a tax deduction cannot be taken.
However, if you are divorced and your separation agreement or divorce decree requires you to pay real estate taxes on property owned jointly by you and your ex-spouse, the amount you pay on the ex-spouse’s portion may be deductible as alimony. More detailed rules apply to condos and co-ops.
For more information on what can and cannot be taken as a deduction, please refer to the IRS Guide, Publication 530.