Tax Reform Act Alert: The Tax Cuts & Jobs Act of 2017 has dramatically changed the tax treatment of real estate taxes and mortgage interest. Please review my overview of the new Tax Act here.
One of my favorite Seinfeld episodes is the one where Kramer tries to explain to Jerry how tax write-offs work. “It’s all a write-off!” exclaims Kramer who, not surprisingly, had no idea what he was talking about. I’ve embedded the Youtube video below.
With the April 15 tax deadline quickly approaching, let’s talk about some of the taxes, deductions, and “write-offs” arising out of a Massachusetts residential real estate purchase and sale. (Disclaimer: I am neither a CPA nor tax attorney, so consult your own tax professional for specific questions).
Real Estate Property Taxes
Every Massachusetts municipality levies a real estate property tax on residential property. Indeed, the real estate tax is the primary revenue producer for most towns with a limited commercial tax base. The real estate tax rate is set by the local board of assessors and is keyed to the assessed value of your land and home, which is often less than the true market value.
Real estate taxes are generally tax deductible if you itemize your deductions on IRS Form 1040, Schedule A. At closing, the closing attorney will ensure that all real estate taxes are paid up and allocated between buyer and seller as of the closing date. If the end of the fiscal quarter is approaching, most lenders will require that the buyer pay the upcoming real estate tax bill in advance.
Most lenders these days require an escrow account for the payment of real estate taxes, and the mortgage company will actually send the payment to the assessor. However, the homeowner should check the actual property tax bill to calculate the exact amount of real estate taxes paid for the year.
Rich’s Advice: It’s very important to keep a copy of your HUD-1 Settlement Statement on file (and for your tax preparer). Also, get a copy of your loan amortization schedule for reasons I’ll discuss later.
Mortgage Interest Tax Deduction
The mortgage interest tax deduction is typically the largest tax deduction taken by a typical homeowner. The deduction applies to interest paid on a qualifying mortgage for both a principal residence and a second home. It also applies to home equity lines and second mortgages subject to some limitation, discussed below.
If you paid any points for getting a mortgage, they may also be tax deductible, either the year paid or over the life of the loan. This applies to both purchase loans and refinances. (Check your HUD-1 Settlement Statement). The same is true for PMI — mortgage insurance premiums. They remain tax deductible for 2012 and 2013 thanks to the Fiscal Cliff Bill.
Cash out refinances and equity lines have some special rules. If you use the money for a car, a vacation, college tuition, etc., then you can deduct your interest on loan amounts up to $100,000. If you borrow more than $100,000, the interest on the excess is not deductible. However, if you use the money to make improvements on your home, then the money is treated for tax purposes as though it’s part of your home mortgage … so you can deduct all the interest, along with your mortgage interest, as long as the total amount you’ve borrowed doesn’t exceed $1 million plus $100,000.
Consult IRS Publication 936 for more information on the mortgage interest deduction.
Rich’s Advice: At closing, I advise new buyers to speak to their accountant about whether they should recalculate their W-4 withholdings in light of their new mortgage and corresponding tax deductions. This is where that loan amortization schedule comes in very handy. New buyers often have substantially more tax deductions than before becoming homeowners, and thus, they can adjust their withholdings so they can keep more of their take home pay every week, instead of giving Uncle Sam an interest free loan!
Massachusetts Property Transfer Tax
Sometimes called deed stamps, transfer tax or excise tax, Massachusetts home sellers must pay a tax on selling their property. For every Massachusetts county except Barnstable and the Islands, the tax is $4.56 per thousand of the purchase price on the deed. So for a $500,000 sale, that’s a whopping $2,280 tax bill. There is considerable debate among tax professionals as to whether this tax is deductible on your federal and state return. It’s best to consult your tax preparer.
Capital Gains On Sale
If you sell your home for more than you paid for it, you have a capital gain, and in theory you have to pay capital gains tax. However, in most cases, you don’t have to pay taxes on the first $500,000 of capital gain on a home (or $250,000 if you’re married and filing separately). To get this special treatment, you have to have owned the home and lived in it as your primary residence for two years out of the last five years prior to the sale. Even if you didn’t own and live in the home for two full years, you might still be able to exclude some or all of your capital gain; you just won’t be eligible for the full $500,000 exception.
Other Closing Costs
Unfortunately, most of the typical real estate closing costs are not tax deductible. This includes lender origination fees, credit report, flood certification, homeowner’s insurance, appraisals, attorney fees, title abstract, title insurance, county recording fees, and real estate commissions.
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Richard D. Vetstein, Esq. is an experienced Massachusetts real estate attorney who helps people buy, sell and finance residential real estate. If you need assistance, please contact him at 508-620-5352 or at [email protected].
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