Assessed Value vs. Market Value: What’s the Difference?
Homes don’t come with sticker prices set in stone. Rather they are moving targets – that’s what makes buying and selling real estate so fun! (Or frustrating, depending on your perspective.) And, as a buyer or seller, you will likely hear two “prices” thrown about: assessed value and market value. So what’s the difference?
While assessed value and market value may seem similar, these numbers can be different – typically assessed value is lower – and they’re used in distinct ways as well. So, let’s clear up any confusion so you can wield these terms to your advantage.
What is Market Value?
The technical definition of market value is “the most probable price that a given property will bring in an open market transaction.” Or, in plain English, “It’s the price that a buyer is willing to pay for a home, and that a seller is willing to accept.”
Real estate agents are trained to pinpoint a home’s market value, which is done by looking at a variety of characteristics, including the following:
• External characteristics: Curb appeal, exterior condition of the home, lot size, home style, availability of public utilities.
• Internal characteristics: Size and number of rooms, construction and appliance quality and condition, heating systems, and energy efficiency.
• Comps or comparables: What similar homes in the same area have sold for recently.
• Supply and demand: The number of buyers and the number of sellers in your area.
• Location: How desirable is the neighborhood? Are the schools good? Is the crime rate low?
A home’s market value often is a good starting point for all kinds of things. For one, listing agents use market value to help sellers come up with a fair asking price for their home. And, since buyers shouldn’t just trust what sellers say their place is worth, their own agent can also estimate the home’s market value and come up with a different price that they think their clients should offer. No number is right or wrong; the ultimate deciding force is what price a buyer and seller are willing to shake hands on to close the deal.
What is Assessed Value?
When trying to understand the assessed value of a property, you must know who is doing the assessing and why the property is being assessed.
Municipalities, mostly counties, employ an assessor to place a value on a home in order to levy property taxes on it. To arrive at a value, the assessor (similar to a real estate agent) looks at what similar properties are selling for, the value of any recent improvements, any income you may be making from, say, renting out a room in the property, and other factors – like the replacement cost of the property if, God forbid, it burns down in a fire (which sounds dark, but assessors are thorough professionals who consider every possibility).
In the end, the assessor comes up with a value of your home. Then, he multiplies that number by an “assessment rate,” a uniform percentage that each tax jurisdiction sets that is typically 80% to 90%. So if, say, the market value of your home is $400,000 and your local assessment rate is 80%, then the assessed value of your home is $320,000.
That $320,000 is then used by your local government to calculate your property taxes. The higher your home’s assessed value, the more you’ll pay in taxes. You can check with your local tax assessor for a more exact figure for your home, or search by state, county, and ZIP code on publicrecords.netronline.com.
What Assessed and Market Values Mean to You?
While a home’s market value can rise and fall precipitously based on local conditions, assessed values are typically more immune to fluctuations. (Some states prohibit the assessed value from rising more than 3% a year even if market value increases.)
But the bottom line is, don’t get bent out of shape if you hear your assessed value isn’t as high as you’d hoped. Assessed value is used mostly for property tax purposes. Home buyers and sellers, on the other hand, look more to market value instead.
However, assessed value can come up when you buy or sell a home because this number, unlike the more subjective market value, is public knowledge contained in property records. So, rising assessed values bode well when home sellers try to justify their sale price to a buyer: “Hey, the assessed value is $310,000, and I’m only asking $320,000.” Likewise, buyers can use assessed value to justify a lower price: “Hey, the assessed value is $260,000, and you’re asking for $300,000. What gives?”
But the thing to remember with both assessed and market value is that at the end of the day, the price of a home is all in the eye of the beholder. The only number that matters is what a buyer and seller can agree sounds right, so don’t take any number you see too seriously.
What has your experience been with market value vs assessed value when selling or buying your home? Sound off on the Patrick Parker Realty Facebook Page or on our Twitter or LinkedIn feeds. And don’t forget to subscribe to our monthly HOME ADVICEtm email newsletter for articles like this delivered straight to your inbox. You may unsubscribe at any time.
6 Bad Habits to Avoid If You Hope to Sell Your Home in 2017
Everyone has a few flaws. But if you plan to sell your New Jersey home in 2017, these foibles can literally cost you—we’re talking tens of thousands of dollars. What’s more, many homeowners may not even be aware that certain actions can hurt their odds of selling their home (that is, until it sits on the market with no takers).
To help clue you in, here’s a list of regrettable blunders to kick to the curb starting now, even if you plan to put your home on the market next year:
Bad Habit No. 1: Overimproving your home
Dying to install new kitchen cabinets or retile your master bath? Home sellers often assume any upgrades they make to their home will pay them back in full once they sell, but that’s rarely the case. On average you will recoup just about 64% of the money you spend on renovations once you sell—and certain improvements can actually work against you if they’re unusual or undesirable in your market.
For instance, as much as you may be dying for a bidet in your bathroom, many others may not. Likewise, even if you consider a new swimming pool a plus, many homeowners don’t want the hassle of maintaining it (or the dangers if they have young kids).
Do this instead: Check out blog post on Home Improvements that offer the Biggest Return on Investment to see which upgrades provide the best value – and ask your Agent for advice on which amenities are hot (or not) on the Jersey Shore.
Bad Habit No. 2: Renovating without permits
We know it’s a pain to apply for permits before you knock down that wall or add a deck, but this corner-cutting will come back and bite you when you decide to sell. Without proper permits, buyers may worry whether the work done on your place is up to code—and as a result refrain from making an offer.
Do this instead: Don’t be a scofflaw; pull necessary permits. Usually, building permits are required for any renovation that involves opening/building walls, electrical, and plumbing changes.
Bad Habit No. 3: Limiting showing hours
Sure, no one wants to leave their home at dinnertime. But buyers are busy juggling work, family, and looking for a new home. If you limit showings to a few hours on weekends, you might miss a potential sale.
Do this instead: Stay flexible and cooperate with buyer’s agents who want to show your house, even if it’s inconvenient.
Plus, limiting showing times gives buyers the impression that the you may be a “difficult” seller. That can turn them off even more.
Bad Habit No. 4. Overlooking curb appeal
Even if you lavish tons of attention on prepping the inside of your home for buyers, it’s easy to overlook the outside. But keep in mind, your curb appeal is the very first impression buyers have of your home, so it pays to put some elbow grease into prettying up the exterior, too.
Do this instead: Make sure your paint job is pristine and your lawn is tidy and mowed. Also replace dead shrubs, prune trees, put out some potted plants, mulch garden beds, and freshen mailboxes.
Bad Habit No. 5: Relying heavily on open houses
Open houses were a great way to sell a house in, like, 1975. These days, the vast majority of houses are sold through the Internet.
Do this instead: While you can and should hold open houses, don’t depend on them too much. Look for Agents who mine for buyers by using the Internet and Social Media.
Bad Habit No. 6: Not following your Agent’s advice
Sure, you no doubt know more about your home than anyone else. But your Real Estate Agent knows more about how to sell it. And your Agent may make some suggestions you might not like to hear, like that you need a new paint job or that the asking price you had in mind needs to be lowered a bit. It’s tempting to take offense or just ignore this advice, but if you do, you could risk seeing your house sit on the market and grow stale.
Do this instead: Listen to your Agent. That doesn’t mean blindly following all advice. But when it comes to pricing, consider the comps your agent presents, not your gut feeling or wishful thinking. Agents buy and sell hundreds of houses in their career; you’ll probably buy and sell a handful in your lifetime. You’re paying for their experience, so follow their advice.
Want advice about selling your home? Contact us today for a free consultation or visit us on Facebook, Twitter, or LinkedIn. And don’t forget to subscribe to our monthly HOME ADVICE™ email newsletter for articles and tips like these delivered straight to your inbox.
6 Mortgage Terms to Know
Buying a house is an exciting and busy time. Once you’re pre-approved for a mortgage, you can start looking at homes in your price range. Whether you’re a first-time homebuyer or have been there before, it’s easy to feel overwhelmed. Not only will you have to find a home inspector and a real estate lawyer, you’ll also need to choose a mortgage lender. A mortgage represents a serious amount of money, so it’s important to fully understand it.
Before diving into these key mortgage terms we think it is important to briefly describe the difference between a Mortgage Broker and a Mortgage Lender. A Mortgage Broker is an intermediary who brings mortgage borrowers and mortgage lenders together, but does not use its own funds to originate mortgages. A mortgage broker gathers paperwork from a borrower, and passes that paperwork along to a mortgage lender for underwriting and approval.
Here are 6 mortgage terms to know as a homebuyer:
1. Amortization Period
Do you aspire to be mortgage-free? Well, you’ll want to know your amortization period. Your amortization period is the period of time over which your mortgage will be fully paid off. Generally, a standard amortization period on high-ratio mortgages (a down payment between 5% and 19.99%) is 25 years. On conventional mortgages (a down payment 20% or greater), 30 year amortization periods are still available. By shortening your amortization period you’ll pay less interest over the life of your mortgage, but your mortgage payments will be higher. A few years ago homeowners could choose an amortization period as long as 40 years, but that has recently been reduced by the federal government in an effort to avoid a housing bubble.
Even though you may of have purchased your home for $550,000, it doesn’t necessarily mean your lender agrees with its value. Most mortgage lenders will require an appraisal to determine your property’s value. You shouldn’t confuse market value and appraised value, as they aren’t always the same. It’s important to not get caught up in a bidding war and pay a lot more than the appraisal value, as you’ll have to come up with the extra money if the appraisal comes in a lot less. Homebuyers cover the cost of appraisals, although some lenders may be willing to foot the bill.
RELATED: Market Value vs. Appraised Value
3. Home Insurance
Protects your home in most cases from fire and other named perils. Insurance is paid by monthly premiums. Most lenders require you’re fully insured before they’ll approve your mortgage.
Lenders don’t simply offer you a mortgage out of the goodness of their heart. The interest on a loan like a mortgage covers the cost of borrowing. When you start paying your mortgage, you’ll notice your interest payments are quite high, but as you get closer to paying it off your interest payments will get smaller. That’s because as you pay down your principal, your interest payments become less and less.
Nobody wants to pay only the interest on their mortgage. A portion of each mortgage payments goes towards principal and interest. Most closed mortgages come with prepayments privileges. When you make lump sum payments, it’s applied against principal. This can help you shave years off your mortgage and save thousands in interest.
RELATED: Will I Qualify For A Mortgage?
Not to be confused with the amortization period, a mortgage term is the length of your current mortgage agreement. Although a mortgage term can be as short as six months or as long as 10 years, most homebuyers choose the stability of a five-year fixed rate mortgage term. Once your mortgage term expires, you can repay your balance in full or renew your mortgage with the same or another mortgage lender.
Best Practices for Paying Off Your Mortgage
It’s simple to pay off a mortgage earlier. But should you? It’s a complicated question.
Let’s discuss why…
For many people, their mortgage carries an interest rate that’s lower than they could average in retirement or investment accounts. And that means the “extra” money you could throw at a mortgage might actually earn you a lot more elsewhere.
With a low mortgage interest rate, homeowners are “so much better off putting that money in a Roth IRA,” says Jill Gianola, CFP professional, author of “The Young Couple’s Guide to Growing Rich Together.”
Other financial pros agree. And if you have extra money and an employer that offers matching retirement contributions, that option might give you a higher return for your money than paying off a low-rate mortgage, says Eric Tyson, author of “Personal Finance for Dummies.”
Then there’s the college aid factor. If you’re applying for need-based aid for your kids, that home equity could count against you with some colleges, he says, because some institutions view equity as money in the bank.
If, after those caveats, you want to pay off your mortgage early, here are 4 ways to make it happen:
1. Pay an extra 1/12th every month
Divide your monthly principal and interest by 12 and add that amount to your monthly payment. End result: 13 payments a year.
IMPORTANT NOTE: Before you make anything beyond the regular payment, phone your mortgage servicer and find out exactly what you need to do so that your extra payments will be correctly applied to your loan.
Let them know you want to pay “more aggressively,” and ask the best ways to do that.
Some servicers may require a note with the extra money or directions on the notation line of the check.
And to confirm, if you’re putting extra money toward your loan, always check the next statement to make sure it’s been properly applied.
2. Refinance with a shorter-term mortgage
Want to make sure your mortgage is paid in 15 years? Refinance to a 15-year mortgage.
15-year mortgages often carry interest rates a quarter of a percentage point to three-quarters of a percentage point lower than their 30-year counterparts.
But this option is not quick or free. You must qualify for a new mortgage – which means paperwork, a credit check, and, likely, a home appraisal. Plus closing costs.
So do your research about refinance costs before jumping in… even with a lower interest rate, that quicker payoff means higher monthly payments. And this method is a lot less flexible. If you decide that you don’t have the extra money one month to put toward the mortgage, you’re locked in anyway.
Ultimately, unless the new interest rate is lower than the old rate, there’s no point in refinancing. Without a lower rate, you’ll get all the same benefits (and none of the extra costs) by just increasing your payment a sufficient amount.
3. Make an extra mortgage payment every year
12 months, 13 payments. There are a couple of ways to pull off this tactic. You can save up throughout the year and make an extra payment. Or, for those who get paid biweekly, harness part or all of those “extra” or “third” checks.
Get a bonus? A tax refund? An unexpected windfall? However it ends up in your hands, you can funnel some or all of your newfound money toward your mortgage.
The upside: You’re paying extra only when you’re flush. And those additional payments toward the principal will cut the total interest on your loan.
The downside: It’s irregular, so it’s hard to predict the mortgage payoff date. If you throw too much at the mortgage, you won’t have money for other needs.
So yes, whether you should pay off your mortgage early it’s a complicated question. But it does not mean without the proper research you can’t come to an answer.
Have you used any of the above methods to start paying your mortgage off early? What is working for you?
And don’t forget to subscribe to the monthly Patrick Parker Realty email newsletter for articles like these delivered straight to your inbox!
8 Home Remodeling Projects That Add Value to Your Home
These home improvements provide the most bang for your buck
How much will this improvement add to the value of my home?
Much of the time, the answer is not as much value as it costs to actually make the improvement. But some home renovations provide more return on investment than others. Here are seven midrange projects that provide the most bang for your buck, according to Remodeling magazine’s Cost vs. Value report.
First let’s just take a brief look at Renovations that bring the greatest percentage return on investment, then we’ll explore each in greater detail. Then, After we take a greater look at these home improvements; we’ll include a list of those projects the return the least percentage return on investment.
Renovations that bring the greatest percentage return on investment:
1. Entry door replacement: 101.8 percent
2. Wood deck addition: 87.4 percent
3. Attic bedroom: 88.5 percent
4. Garage door replacement: 83.7 percent
5. Minor kitchen remodel: 82.7 percent
6. Window Replacement: 78.7 percent
7. Siding Replacement: 82.5 percent
8. Basement Remodel: 77.6 percent
1. Entry Door Replacement
Just as they did last year, Realtors® identified a steel entry door replacement as the project expected to return the most money, with an estimated 101.8 percent of costs recouped upon resale (compared to an estimated 96.6 percent recoup last year). The steel entry door replacement is consistently the least expensive project in the annual Cost vs. Value Report, costing little more than $1,200 on average and was the only project on this year’s list to recoup more than 100 percent of its cost at resale on a national level.
2. Wood deck addition
Homeowners who add a wooden deck, which costs an average of $9,539 nationwide, recoup an average of 87.4 percent of the project’s cost when they sell the home, according to the report. Keep in mind that municipalities typically require a permit to build a deck.
3. Attic bedroom
Renovations within the existing envelope of your home – those that don’t require you to build an addition or expand the roof and foundation – often return more value than building extra rooms onto your home, and they’re much cheaper. Converting an attic into a bedroom ranked third of the 35 improvements in the report, returning an average of 88.5 percent of the amount spent.
4. Garage door replacement
The curb value of your house depends on one thing: the buyer’s first impression. If you want to know how to increase the value of a home, think about how you would feel walking up to the sidewalk as you approach a house you might buy. The first thing you would notice is the exterior of the house. Picture the difference between a modern, orderly, attractive exterior and a house with gutters falling off and a pile of old tires in the driveway. If you want to increase the resale value of your house, you need to grab the buyer at first glance with a clean, neat, beautiful exterior. Homeowners who maintain their house’s exterior can expect a yearly home value increase. The sweat equity that you put in will increase home value.
If your garage door needs replacing to add to the very important factor of curb side appeal, you’ll earn an 83.7 percent of the project’s cost when selling.
5. Minor kitchen remodel
Updated kitchens still bring a significant payoff, especially at resale time: A minor kitchen remodel adds an average of 82.7 percent of the project’s cost back to the home’s value. Kitchens are important, Aaron says, because would-be buyers often overestimate how much they cost to update. The average cost of a minor kitchen remodel – new cabinet doors, appliances, countertops, sink, faucet, paint and hardware – was $18,856 nationwide, according to the report.
6. Window replacement
Perhaps it’s time increase the energy efficiency of your windows. Swapping existing 3-by-5-foot, double-hung windows with insulated wood replacement windows costs an average of $10,926, and returns an average of 79.3 percent of the amount spent, according to the report. Insulated vinyl replacement windows cost about $1,000 less and return an average of 78.7 percent of the amount spent.
7. Siding replacement
The national average to replace 1,250 square feet of existing siding with new vinyl siding, including all trim, is $11,475, according to the report. On average, the project will return 82.5 percent of the amount you spent to the value to your home.
8. Basement remodel
A basement remodel isn’t cheap: Finishing the lower level of a house to include an entertaining area and a full bathroom costs an average of $62,834 nationwide. You can expect to recoup an average of 77.6 percent of the project’s cost when you sell the home, according to the report.
Note these renovations that yield the smallest return on investment:
- Home office remodel: 48.9 percent
- Sunroom addition: 51.7 percent
- Bathroom addition: 60.1 percent
- Backup power generation: 67.5 percent
- Master suite addition: 67.5 percent
6 Things Preventing Your Home Sale
Nothing’s more frustrating for a seller than having your home sit on the market. And sit … and sit … and sit.
Maybe buyers are touring your house but not making offers. Or maybe buyers aren’t visiting your home at all. Either way, you’re starting to feel like the last kid to be picked in dodgeball.
But as the last kid picked in dodgeball knows, there is always hope for a comeback. The reason a home sits on the market longer than expected often boils down to a few easy-to-fix issues. Here are six of the big ones that might stop you from selling a home.
1. You’ve priced it too high
No matter what you feel your home should be worth, the hard truth is, it’s worth only what people are willing to pay. Research what the comps — or comparable homes in your area — are going for and listen to buyer feedback. If people are consistently telling you that price is an issue, it’s time to pay attention.
RELATED: This Importance of Proper Pricing
Trust your real estate agent to inform you about a fair price for the current market. If you’re dead set on getting your ideal asking price, take an honest look at whether you need to make upgrades to your home or wait for a market uptick.
2. No one knows it’s for sale
Simply sticking a “For Sale” sign in the lawn won’t cut it. Today’s buyers do the majority of their home searching online, which means you need to get your home listed on major real estate.
FREE DOWNLOAD: Getting Your Home Sold! Your 25-Point Marketing Plan
You’ll also want to make sure your online listing includes plenty of high-quality, well-staged photos.
3. It’s got glaring issues
It could be a big issue (such as a failing roof or wonky foundation), or it could be a small but obnoxious issue that buyers just can’t get past (your beloved wall-to-wall pink carpeting, let’s say). Either way, the fact that your home isn’t selling means buyers are consistently finding something wrong with it. Ask potential buyers for feedback after you conduct showings; their answers may help clue you in to the problem.
Some buyers are willing to accept a lower price or a closing credit for a home with a sticking-point issue, but others are turned off from the start and figure it’s not worth the hassle of fixing it themselves or trying to negotiate a concession.
RELATED: About the Negotiation Process
4. It doesn’t show well
Make sure there is nothing stopping buyers from falling in love with your home during showings.
Open blinds and curtains to let in the natural light and put lamps in especially dim areas. Remove any bulky furniture that may make rooms hard to navigate. And take care of small items you’ve been putting off, like fixing sticky drawer pulls or a leaky faucet. A number of small updates such as these could be turning off buyers.
5. Buyers can’t picture themselves living there
Buyers are more likely to make an offer on your house if they can picture their own daily life there.
Clean and remove clutter and get rid of personal items such as family photos along the stairway and your kids’ artwork on the fridge.
RELATED: Home De-Cluttering Plan
If your home is currently empty or near-empty, or your furnishings aren’t to most buyers’ tastes, you may want to consider hiring someone to professionally stage your rooms.
RELATED: All About Home Staging
6. You’ve neglected the curb appeal
More than one buyer has pulled up to a house whose listing they liked, taken one look at the exterior, and driven away. It doesn’t matter how gorgeous your home is on the inside; if buyers aren’t willing to step in the door, then you’ve immediately lost them.
RELATED: The Importance of Curb Appeal
A few simple fixes can make your curb appeal irresistible. Weed and mulch the flower beds, trim the hedges, clear the walkways, and repaint any flaking siding. Consider adding some homey touches such as a wreath on the door or a bench on the porch. You don’t need to overspend on landscaping; just focus on making your home look presentable and welcoming.
What challenges have you faced when selling your home? Sound off in Comments, on Facebook or Twitter and don’t forget to subscribe to the monthly Patrick Parker Realty eNewsletter for articles, tips and guides like this one delivered straight to your inbox. And if you have any questions about getting started with the home selling process, a Patrick Parker Realty Agent is here to help! Contact Us today!
From the Patrick Parker Realty Tax Season Blog Series:
Tax Advantages of Buying Your First Home
Tax breaks ease the cost of mortgage
Buying a home is when you begin building equity in an investment instead of paying rent. And Uncle Sam is there to help ease the pain of high mortgage payments. The tax deductions now available to you as a homeowner will reduce your tax bill substantially.
If you have been claiming the standard deduction up until now, the extra write-offs from owning a home almost certainly will make you an itemizer. Suddenly, the state taxes you pay and your charitable donations will earn you tax-saving deductions, too.
So make sure you know about all these breaks covered here that may now be available to you:
• Mortgage interest
• Real estate taxes
• Private Mortgage Insurance premiums
• Penalty-free IRA payouts for first-time buyers
• Home improvements
• Energy credits
• Tax-free profit on sale
• Home equity loans
• Adjusting your withholding
For most people, the biggest tax break from owning a home comes from deducting mortgage interest. You can deduct interest on up to $1 million of debt used to acquire or improve your home.
Your lender will send you Form 1098 in January listing the mortgage interest you paid during the previous year. That is the amount you deduct on Schedule A. Be sure the 1098 includes any interest you paid from the date you closed on the home to the end of that month. This amount is listed on your settlement sheet for the home purchase. You can deduct it even if the lender does not include it on the 1098. If you are in the 25 percent tax bracket, deducting the interest basically means Uncle Sam is paying 25 percent of it for you.
When you buy a house, you may have to pay “points” to the lender in order to get your mortgage. This charge is usually expressed as a percentage of the loan amount. If the loan is secured by your home and the amount of points you pay is typical for your area, the points are deductible as interest as long as the cash you paid at closing via your down payment equals the points.
For example, if you paid two points (2%) on a $300,000 mortgage—$6,000—you can deduct the points as long as you put at least $6,000 of your own cash into the deal. And believe it or not, you get to deduct the points even if you convinced the seller to pay them for you as part of the deal. The deductible amount should be shown on your 1098 form.
Real estate taxes
You can deduct the local property taxes you pay each year, too. The amount may be shown on a form you receive from your lender, if you pay your taxes through an escrow account. If you pay them directly to the municipality, though, check your records or your checkbook registry. In the year you purchased your residence, you probably reimbursed the seller for real estate taxes he or she had prepaid for time you actually owned the home.
If so, that amount will be shown on your settlement sheet. Include this amount in your real estate tax deduction. Note that you can’t deduct payments into your escrow account as real estate taxes. Your deposits are simply money put aside to cover future tax payments. You can deduct only the actual real estate tax amounts paid out of the account during the year.
Private Mortgage Insurance Premiums (PMI)
Buyers who make a down payment of less than 20 percent of a home’s cost usually get stuck paying premiums for Private Mortgage Insurance, which is an extra fee that protects the lender if the borrower fails to repay the loan. For mortgages issued in 2007 or after, home buyers can deduct PMI premiums.
This write-off phases out as adjusted gross income increases above $50,000 on married filing separate returns and above $100,000 on all other returns. (If you’re paying PMI on a mortgage issued before 2007, you’re out of luck on this one.) The PMI write-off is set to expired at the end of 2014, although Congress may extend it into future years.
Penalty-free IRA payouts for first-time buyers
As a further incentive to homebuyers, the normal 10 percent penalty for pre-age 59½ withdrawals from traditional IRAs does not apply to first-time home buyers who break into their IRAs to come up with the down payment. This exception to the 10 percent penalty does not apply to withdrawals from 401(k) plans.
At any age you can withdraw up to $10,000 penalty-free from your IRA to help buy or build a first home for yourself, your spouse, your kids, your grandchildren or even your parents. However, the $10,000 limit is a lifetime cap, not an annual one. (If you are married, you and your spouse each have access to $10,000 of IRA money penalty-free.) To qualify, the money must be used to buy or build a first home within 120 days of the time it’s withdrawn.
But get this: You don’t really have to be a first-time homebuyer to qualify. You’re considered a first-timer as long as you haven’t owned a home for two years. Sounds great, but there’s a serious downside. Although the 10 percent penalty is waived, the money would still be taxed in your top bracket (except to the extent it was attributable to nondeductible contributions). That means as much as 40 percent or more of the $10,000 could go to federal and state tax collectors rather than toward a down payment. So you should tap your IRA for a down payment only if it is absolutely necessary.
There’s a Roth IRA corollary to this rule, too. The way the rules work make the Roth IRA a great way to save for a first home. First of all, you can always withdraw your contributions to a Roth IRA tax-free (and usually penalty-free) at any time for any purpose. And once the account has been open for at least five years, you can also withdraw up to $10,000 of earnings for a qualifying first home purchase without any tax or penalty.
Save receipts and records for all improvements you make to your home, such as landscaping, storm windows, fences, a new energy-efficient furnace and any additions.
You can’t deduct these expenses now, but when you sell your home the cost of the improvements is added to the purchase price of your home to determine the cost basis in your home for tax purposes. Although most home-sale profit is now tax-free, it’s possible for the IRS to demand part of your profit when you sell. Keeping track of your basis will help limit the potential tax bill.
Some energy-saving home improvements to your principal residence can earn you an additional tax break in the form of an energy tax credit worth up to $500. A tax credit is more valuable than a tax deduction because a credit reduces your tax bill dollar-for-dollar.
You can get a credit for up to 10 percent of the cost of qualifying energy-efficient skylights, outside doors and windows, insulation systems, and roofs, as well as qualifying central air conditioners, heat pumps, furnaces, water heaters, and water boilers.
There is a completely separate credit equal to 30 percent of the cost of more expensive and exotic energy-efficient equipment, including qualifying solar-powered generators and water heaters. In most cases there is no dollar cap on this credit.
Tax-free profit on sale
Another major benefit of owning a home is that the tax law allows you to shelter a large amount of profit from tax if certain conditions are met. If you are single and you owned and lived in the house for at least two of the five years before the sale, then up to $250,000 of profit is tax-free. If you’re married and file a joint return, up to $500,000 of the profit is tax-free if one spouse (or both) owned the house as a primary home for two of the five years before the sale, and both spouses lived there for two of the five years before the sale.
Thus, in most cases, taxpayers don’t owe any tax on the home-sale profit. (If you sell for a loss, you cannot take a deduction for the loss.)
You can use this exclusion more than once. In fact, you can use it every time you sell a primary home, as long as you owned and lived in it for two of the five years leading up to the sale and have not used the exclusion for another home in the last two years. If your profit exceeds the $250,000/$500,000 limit, the excess is reported as a capital gain on Schedule D.
In certain cases, you can treat part or all of your profit as tax-free even if you don’t pass the two-out-of-five-year tests. A partial exclusion is available if you sell your home “early” because of a change of employment, a change of health, or because of other unforeseen circumstances, such as a divorce or multiple births from a single pregnancy.
A partial exclusion means you get part of the $250,000/$500,000 exclusion. If you qualify under one of the exceptions and have lived in the house for one of the five years before the sale, for example, you can exclude up to $125,000 of profit if you’re single or $250,000 if you’re married—50 percent of the exclusion of those who meet the two-out-of-five-year test.
Home equity loans
When you build up enough equity in your home, you may want to borrow against it to finance an addition, buy a car or help pay your child’s college tuition. As a general rule you can deduct interest on up to $100,000 of home-equity debt as mortgage interest, no matter how you use the money.
Adjusting your withholding
If your new home will increase the size of your mortgage interest deduction or make you an itemizer for the first time, you don’t have to wait until you file your tax return to see the savings. You can start collecting the savings right away by adjusting your federal income tax withholding at work, which will boost your take-home pay. Get a W-4 form and its instructions from your employer or go to www.irs.gov.
Keep in mind that this is general information designed to help you put these valuable deductions on your radar. Patrick Parker Realty Agents and Realtors are not certified accountants. Please be sure to check with your tax adviser to see if you qualify for a particular credit or deduction.
The Patrick Parker Realty Tax Season Blog Series will cover many topics as they relate to real estate and increasing your income tax refund. Such topics will include Home Ownership Tax Breaks, Hidden Tax Deductions, Deductions on Mortgage Interest, Reporting on the Sale of Your Home, Home Purchase Tax Credits and more. In addition, our Blog Series will explore Tax Incentives as they relate to major transitions and lifestyles; Marriage, Birth, Divorce, Death of Spouse, Health Insurance, Caretaking of Dependents, Business Owners, Commuters and more.
Check in to The Patrick Parker Realty Blog each Tuesday, Thursday and Saturday through Tax Day for new posts. You can also follow The Patrick Parker Realty Tax Season Blog Series on Facebook and Twitter using #taxseasonblog.
For more information about paying taxes on the sale or purchase of your home or any other questions you have about this article please speak with your tax professional or visit www.irs.gov.
From the Patrick Parker Realty Tax Season Blog Series
Tax Terms Glossary
Confused by tax terms and lingo? Get plain-English definitions that make tax return terminology less, well, taxing.
An employer-sponsored retirement savings plan through which employees divert part of their salary to a tax-deferred investment account. Salary put in the plan is not taxed until it is later withdrawn, presumably in retirement. Employers often match part or all of the employee’s deposits. Penalties usually apply to withdrawals before age 55, although most plans allow employees to borrow limited amounts tax- and penalty-free from their accounts. See also Roth 401(k).
For most business property, except real estate, the law allows you to depreciate the cost at a rate faster than would be allowed under straight-line depreciation (see definition below.) For example, automobiles and computers are assumed to have a five-year life for tax purposes. With straight-line depreciation you would be permitted to write off 20 percent of the cost each year; the accelerated method generally lets you deduct 20 percent of the business cost the first year, 32 percent the second, 19.2 percent the third, 11.52 percent in years four and five, and the remaining 5.8 percent in the sixth year. It takes six years to fully depreciate the property, thanks to the “midyear” convention, which basically assumes that business assets are put into service in the middle of the year.
This is the technical term that Congress uses for what most of us call home mortgage debt, on which the interest is deductible. To qualify, the debt must be used to buy, build or improve your principal residence or second home and must be secured by the property. The interest paid on up to $1 million of acquisition indebtedness is deductible if you itemize deductions.
The level of involvement that real estate owners must meet to qualify to deduct up to $25,000 of passive losses from rental real estate. Failure to pass this test could make such losses nondeductible under passive-loss rules. (see passive loss rules below.)
Additional child tax credit
You may qualify for this credit if the regular child credit more than wipes out your tax liability. This additional credit can trigger a refund check from the IRS even if you don’t owe any tax.
Your basis in property is the starting point for determining whether you have a gain or loss when you sell it. (This is sometimes referred to as cost basis, tax basis or simply, basis.) The basis generally starts out as what you pay for the property, although special rules apply to assets you inherit or receive as a gift. The basis can be adjusted while you own property. When you buy rental property, for example, the basis begins at what you pay for the place, including certain buying expenses, and it is adjusted upward by the cost of permanent improvements. The basis is reduced by the amount of any depreciation you are allowed to deduct while you own the property. You use your adjusted basis to figure the gain or loss on the sale.
Adjusted Gross Income (AGI)
This is your income from all taxable sources, minus certain adjustments, and is the key to determining your eligibility for certain tax benefits and the phase-out of your eligibility for others. Adjusted Gross Income is also the amount from which deductions (the standard deduction or itemized deductions) and personal and dependent exemptions are deducted to arrive at the amount of taxable income that will actually be taxed. The adjustments—sometimes called above-the-line deductions because you can claim them whether or not you itemize deductions—include (among other things) deductible contributions to Individual Retirement Accounts (IRAs), SIMPLE and Keogh plans, contributions to Health Savings Accounts (HSAs), job-related moving expenses, any penalty paid on early withdrawal of savings, the deduction for 50 percent of the self-employment tax paid by self-employed taxpayers, alimony payments, up to $2,500 of interest on higher education loans and certain qualifying college costs.
This credit effectively refunds to you part of what you pay to adopt a qualifying child. An eligible child is generally one under age 18 or one who is physically or mentally incapable of caring for him or herself. If you adopt a special-needs child, you may be eligible for a credit that exceeds your actual costs. The right to the credit phases out as AGI rises.
See Taxpayer advocate.
Qualifying payments to an ex-spouse that can be deducted as adjustments to income whether or not you itemize. The recipient must include the payments in his or her taxable income.
Alternative Minimum Tax (AMT)
A special tax designed primarily to prevent the wealthy from using so many legal tax breaks that their regular tax bill is reduced to little or nothing. In recent years, it has hit more and more taxpayers who live in high-tax states, have many children or exercise incentive stock options and will increasingly hit taxpayers who do not consider themselves rich. The AMT ignores certain tax benefits allowed by the regular rules and applies special rates—26 percent and 28 percent—to a larger amount of income than is hit by the regular tax.
A revised tax return, filed on Form 1040X, to correct an error on a return filed during the previous three years. An amended return can result in owing extra tax or getting a refund, depending on the mistake you correct.
As if you didn’t know, this is a review of your tax return by the IRS, during which you are asked to prove that you have correctly reported your income and deductions. Most audits are done by mail and involve specific issues, not the entire return.
Automobile, business use
The cost of driving your car on business can be deducted as a business or employee expense. You can deduct actual costs or use the standardized mileage rate published by the IRS, plus what you spend for parking and tolls while driving on business.
Automobile, donating to charity
Strict rules control your charitable deduction of a donated vehicle. In most cases, your deduction is limited to the amount the charity gets for the car when it sells it. The charity should give you this information within 30 days of the sale. Without it, the maximum deduction you’ll be able to claim for the vehicle donation is $500.
Automobile, driving for charity
The cost of using your car while doing charitable work is deductible. You can deduct 14 cents per mile you drove while performing services for a charity. You can also deduct what you pay for parking and tolls.
Bargain sale to charity
Selling property to a charity for less than the property’s actually worth. Depending on the circumstances, this could result in a tax deduction or extra taxable income.
See Adjusted basis.
If you make an interest-free or bargain-rate loan to a friend or relative, you may be required to include in your taxable income some of the interest the IRS believes you should have charged.
A person is considered legally blind for purposes of qualifying for a larger standard deduction if:
• He or she is totally blind.
• He or she can’t see above 20/200 in the better eye with glasses or contact lenses.
• His or her field of vision is 20 degrees or less.
The amount over face value that you pay to buy a bond paying higher than current market rates. With taxable bonds, a portion of the premium can be deducted each year that you own the securities.
Burden of proof
The responsibility of the taxpayer to prove that his or her tax return is accurate, rather than the IRS having to provide convincing evidence that it is inaccurate. Although Congress has shifted the burden of proof to the IRS in certain tax disputes, don’t throw away your records. The change will have no effect on the vast majority of taxpayers. The burden shifts only if a case gets to court—which happens very rarely—and then only if the taxpayer has complied with all record-keeping requirements and has cooperated with IRS requests for information. In almost all cases, the burden of proof remains on your shoulders.
Generally, when a debt is cancelled or forgiven, the borrower who benefits is considered to have received taxable income equal to the amount of the cancelled debt. There are exceptions. For example, some student loans contain agreements that debt will be forgiven if the borrower works for a certain period of time in a certain profession. And, up to $2 million of debt forgiven on a mortgage on a principal residence – in a foreclosure, for example, or short sale — can also be tax-free but only until Dec 31, 2014. Also, forgiven debt is not taxable to the extent the borrower is insolvent (that is, whose liabilities exceed his or her assets) or when the debt is waived by a bankruptcy court. Other provisions grant tax-free treatment for cancelled debts in specific circumstances.
The cost of a permanent improvement to property. Such expenses, such as adding central air conditioning or an addition to your home, increase the property’s adjusted tax basis.
The profit from the sale of such property as stocks, mutual-fund shares and real estate. Gains from the sale of assets owned for 12 months or less are “short-term capital gains” and are taxed in your top tax bracket, just like salary. For most assets owned more than 12 months, profits are considered “long-term capital gains” and are taxed at 0, 15, or 20 percent. Taxpayers who otherwise fall in the 10 percent or 15 percent bracket get an even better deal. Their rate on long-term gains is 0% percent for 2008 through 2014. The special rates for long-term gains do not, however, apply to all gains from investment real estate. To the extent that gain results from depreciation (depreciation deductions reduce your basis in the property and therefore increase gain dollar for dollar upon sale), a 25 percent maximum rate applies (unless you are in the 10 percent or 15 percent bracket, in which case that rate applies) to this “recaptured” depreciation. Also, long term-gains from the sale of collectibles are taxed at a maximum rate of 28 percent.
The loss from the sale of assets such as stocks, bonds, mutual funds and real estate. Such losses are first used to offset capital gains and then up to $3,000 of excess losses can be deducted against other income, such as your salary. Long- and short-term losses (distinguished by whether the property was held for more than one year or a shorter period of time) are first used to offset gains of a similar nature. Any excess first offsets the other kind of gain, then other types of income.
Capital losses can be used to offset capital gains, and up to $3,000 of any net capital loss can be deducted against other income, such as your salary or bank account interest. Net capital losses not currently deductible because of the $3,000 limit can be carried over to future years.
Damage that results from a sudden or unusual event.
A gift of cash or property to a qualified charity for which a tax deduction is allowed. You must have either a receipt or a bank record (such as a cancelled check) to back up any donation of cash, regardless of the amount. Donations of $250 or more must have an acknowledgement from the charity.
Generally, your deduction for donations to charity in one year cannot exceed 50% of your adjusted gross income for that year (30% in the case of donations of appreciated assets and contributions to private foundations). You can carry over any excess for the following five tax years. The carryover expires, however, should you pass away before it is used up. Your heirs cannot claim it.
See Standard mileage rate.
This credit is $1,000 for each child under age 17 you claim as a dependent on your return. The right to this credit is phased out as adjusted gross income rises.
Child- and dependent-care credit
Not to be confused with the child credit, this one offsets part of the cost of paying for care for a child under the age of 13 or disabled dependent while you work. The credit—which ranges from 20 percent to 35 percent depending on your income—can be applied to as much as $3,000 of qualifying expenses if you pay for the care of one qualifying child, or up to $6,000 if you pay for the care of two or more.
Payments made under a divorce or separation agreement for the support of a child. The payments are neither deductible by the person who pays them, nor considered taxable income to the person who receives the money.
The American Opportunity credit can be worth up to $2,500 for each qualifying student and is available for the first four years of vocational school or college. The Lifetime Learning credit can be worth up to $2,000 per year for additional schooling. You can claim an American Opportunity credit for qualifying expenses of each qualifying student (including yourself, your spouse or your dependent child). For example, having three children in college at the same time could earn you $7,500 worth of credits. However, only one Lifetime Learning credit can be claimed each year, for a maximum credit of $2,000 per tax return. The right to claim the American Opportunity credit disappears as adjusted gross income rises from $80,000 to $90,000 for a single taxpayer ($160,000 to $180,000 on a joint return). The right to claim the Lifetime Learning credit disappears as adjusted gross income rises from $50,000 to $60,000 for a single taxpayer ($100,000 to $120,000 on a joint return).
College expense deduction
For 2014 and earlier years, qualifying taxpayers can deduct up to $4,000 of college expenses if their adjusted gross income is under $65,000 on a single return or $130,000 on a joint return. This break is available whether or not you itemize deductions, but is not available on the return of a student who is claimed as a dependent on his or her parent’s return. . A write-off of up to $2,000 will be allowed for qualifying taxpayers whose AGI falls between $65,000 and $80,000 on a single return, and between $130,000 and $160,000 on a joint return. You cannot claim the deduction in the same year you claim an American Opportunity or Lifetime Learning credit for the same student. But because the income phase-out range for this deduction is higher than for the Lifetime Learning credit, some taxpayers whose income is too high to benefit from the Lifetime Learning credit will benefit from this write-off.
Pay received by members of the U.S. Armed Forces and support personnel in combat zones, including peace-keeping efforts. Military pay received by enlisted personnel serving in combat or designated peace-keeping efforts is tax-free. Officer pay is tax-free up to the maximum pay for enlisted personnel (plus imminent danger/ hostile fire pay), an amount that increases each year. Although tax-free, combat pay may now be counted as compensation when determining whether the taxpayer can contribute to an IRA or Roth IRA.
If you donated an easement to a conservation group or a state or local government to restrict development of your property, you can deduct the resulting decline-in- value of your property.
A concept of tax law that taxes income at the time you could have received it, even if you don’t actually have it. A paycheck you could pick up in December is considered constructively received and taxed in that year, even if don’t get and cash the check until the following January. Also, interest paid on a savings account is considered constructively received and taxable in the year it is credited to your account, whether or not you withdraw the money.
See Personal interest.
Coverdell education savings account
A Coverdell ESA allows you to put up to $2,000 a year in a special account that will be used to pay a student’s school bills. There’s no deduction for contributions but if the money is used to pay qualifying expenses, withdrawals, including accumulated income, are tax-free. The $2,000 cap is the limit on how much can be set aside for any student in one year, regardless of how many people contribute. In addition to being used for college expenses, ESA funds can also be spent for primary and high school bills. Even the cost of a computer is a qualifying expense.
See Coverdell education savings account.
Credit for qualified retirement savings contributions
See Retirement credit.
If you receive a settlement in a damage suit that includes money for future medical expenses, the amount is not taxable. But you can’t deduct those future medical expenses covered by the amount of the award allocated to medical care as an itemized deduction. Enter medical expenses that exceed the award in Deductions and Credits under Medical.
Write-offs you are permitted to subtract from your gross income to calculate your taxable income. All taxpayers may claim a standard deduction, which is determined by the IRS. If your qualifying expenses exceed your standard deduction, you may claim the higher amount by itemizing your deductions. Although no records are needed to back up your right to the standard deduction, you must maintain records of qualifying expenditures if you itemize. For higher income taxpayers, the amount of their otherwise allowable itemized deductions will be reduced when adjusted gross income (AGI) exceeds a threshold amount. The reduction and threshold amounts can vary each year.
Someone you support and for whom you can claim a dependency exemption on your tax return. For each dependent you claim, the exemption knocks a standard amount off your taxable income. Other tax breaks (such as the child tax credit) may also be available for dependents.
A deduction to reflect the gradual loss of value of business property as it wears out. The law assigns a tax life to various types of property, and your basis in such property is deducted over that period of time. See also Accelerated Depreciation.
A method to move funds from one Individual Retirement Account (IRA) or Keogh plan to another. You can also use this method to move money from a company retirement plan such as a 401(k) to an IRA. With a direct transfer, you order one sponsor to transfer the money directly to your new IRA; you do not take possession of the funds. There is no limit on the number of times you can move your money via direct transfer. However, if you take possession of the funds and personally deposit them in the new IRA, the switch is considered a rollover. You can use the rollover method only once each year for each IRA account you own. The direct transfer method must be used to move funds from a company retirement plan to an IRA, or else 20 percent of the money withdrawn from the company plan will be withheld for the IRS, even if no taxes are due.
Compensation, such as salary, commissions and tips, you receive for your personal services. This is distinguished from “unearned” income such as interest, dividends and capital gains.
Earned income credit
If your adjusted gross income is below a certain amount, you may be able to claim the earned income credit, which might wipe out your income tax bill and even result in a refund of any leftover credit. The exact credit amount depends on your income level, as well as how many qualifying children you have.
Interest on college loans can be deducted as an adjustment to income, so you get a benefit even if you claim the standard deduction rather than itemizing deductions on your return. To qualify for the write off, the debt had to be incurred to pay higher education expenses for you, your spouse or your dependent. Up to $2,500 of such interest can be deducted, but this tax-saver — like so many others — is phased out at higher income levels.
Education savings account
See Coverdell education savings account.
This deduction is allowed for kindergarten through 12th grade teachers for what they spend for classroom supplies. This is an “adjustment to income,” which means you get this benefit even if you claim the standard deduction rather than itemizing.
Elderly or disabled credit
This credit is for low-income taxpayers age 65 or older at the end of the year, or those who are retired on permanent and total disability. Relatively few taxpayers qualify for this credit.
The fastest way to get your tax return (or a request for an extension of time to file) to the IRS (and state revenue office).
Residential Energy Efficient Property Credit: This tax credit helps taxpayers pay for qualified residential alternative energy equipment, such as solar hot water heaters, solar electricity equipment and wind turbines. The credit, which runs through 2016, is 30 percent of the cost of qualified property. There is no cap on the amount of credit available, except for fuel cell property. Generally, you may include labor costs when figuring the credit and you can carry forward any unused portions of this credit. Qualifying equipment must have been installed on or in connection with your home located in the United States; fuel cell property qualifies only when installed on or in connection with your main home located in the United States.
A tax preparer who, by virtue of passing a tough IRS test or prior IRS work experience, can represent clients at IRS audits and appeals.
For 2014 the exemption amount for estates is $5,340,000, with a maximum estate tax of 40%.
If you have income that’s not subject to withholding, such as investment or self-employment income, you may have to make quarterly payments of the estimated amount needed to cover your expected tax liability for the year.
Excess Social Security tax withheld
If you hold more than one job during the year—either at the same time or successively—too much Social Security could be withheld from your pay. This is because each employer is required to withhold the tax, but no taxpayer has to pay the full tax on more than the annual limits. If wages from two jobs pushes you over the limit, too much tax will be withheld. You get a credit for the excess when you file your tax return for the year.
You can claim a personal exemption for yourself. On joint returns a personal exemption is claimed for each spouse. You also get an exemption for each dependent you claim on your return. Each exemption reduces taxable income by a standard amount, which is partially phased out at higher income levels.
Also known as the Section 179 deduction, expensing lets you treat a certain amount of the expenditures that normally would be depreciated over a number of years as current business expenses to be deducted immediately.
See Scholarships and fellowships.
The Federal Insurance Contribution Act tax that pays for Social Security and Medicare is usually split 50/50 between employers and employees.
Your status determines the size of your standard deduction and the tax-rates that apply to your income. For tax purposes, you are considered single, married filing jointly, married filing separately, head of household or qualifying widow or widower.
First-time homebuyer credit
See Homebuyer credit.
Flexible spending account
See Reimbursement account.
See Cancelled debt.
To prevent people from avoiding the estate tax by giving their property away, the law imposes a gift tax. You can give up to $14,000 yearly to each of as many people you want without worrying about this tax. Any part of the credit used to offset taxable gifts will not be available to reduce the estate tax. When the gift tax is owed, it is owed by the giver, not the recipient.
All of your income from taxable sources, before subtracting any adjustments, deductions or exemptions.
Head of household
A filing status with lower tax rates for unmarried or some married persons considered unmarried (for purposes of this filing status) who pay more than half the cost of maintaining a home, generally, for themselves and a qualifying person, for more than half the tax year.
Health Savings Account (HSA)
HSAs allow Americans under age 65 to make tax-deductible contributions to a special account tied to a high-deductible health insurance policy. Earnings inside the HSA are tax-deferred (just like in an IRA). To be eligible to contribute to an HSA, you must have a qualified high-deductible insurance policy. Money from the HSA can be used tax- and penalty-free to pay the insurance policy deductible, co-payments and any other qualifying expenses. Money left in the account at the end of a year can be rolled over to the next year. Nonqualifying withdrawals of earnings before age 65 are taxed and a 10 percent penalty is imposed. After you reach age 65, contributions to the HSA must cease and non-qualifying withdrawals are taxed but not penalized.
Special anti-discrimination rules can limit retirement plan contributions for highly-paid individuals, defined as anyone making more than $115,000 in 2014 or anyone who is a 5% owner of a company which offers the retirement plan in question. If lower-paid employees do not contribute to a 401(k) plan in sufficient numbers, for example, higher-paid employees can have part of their contributions returned at year-end, meaning it will be treated as taxable compensation.
One requirement for deducting business losses is that you show you are trying to make a profit. The law presumes you’re in business for profit if you report a taxable profit for three years out of any five-year period (or two out of seven years if you’re into breeding, showing or racing horses). Otherwise, your activity is assumed to be a hobby, unless you can prove otherwise. The distinction is important because if the expenses of a hobby exceed the income, the difference is considered a personal expense, not a tax-deductible loss.
The period of time you own an asset for purposes of determining whether profit or loss on its sale is a short- or long-term capital gain or loss. Sales of assets owned one year or less produce short-term results. The sale of assets owned more than 12 months produces long-term results. The holding period begins on the day after you purchase an asset and ends on the day you sell it. If you buy on January 4, for example, your holding period begins January 5. If you sell the following January 4, you have owned the asset for exactly one year, and are stuck with short-term treatment. To be eligible for the gentler long-term tax treatment, you’d need to hold on until January 5, so that you have owned the asset for more than one year. See Capital gain.
This credit is available if you close on the purchase of a U.S. principal residence between April 9, 2008 and April 30, 2010. (If a home is under contract on April 30, the deadline to close is extended to June 30, 2010.) The maximum credit for 2008 purchases is the lesser of $7,500 or 10% of the home purchase price; the maximum credit for purchases in 2009 and 2010 is the lesser of $8,000 or 10% of the purchase price (the credit amount is halved for a buyer who uses married filing separate status). Maximum credits are allowed to individuals who did not own a U.S. principal residence within the three-year period ending on the purchase date. For purchases after November 6, 2009, a reduced credit equal to the lesser of $6,500 or 10% of the purchase price is allowed to an individual who owned the same U.S. principal residence for a period of five consecutive years during the eight-year period ending on the purchase date (the credit amount is halved for a buyer who uses married filing separate status). The credit is phased out at higher income levels (stricter phase-out ranges apply to purchases on or before November 6, 2009). For purchases after that date, the credit is only allowed if the price of the new principal residence doesn’t exceed $800,000. Credits for 2008 purchases generally must be paid back over 15 years, starting in 2010. Credits for 2009 and 2010 purchases generally won’t have to be paid back. Credits for 2009 purchases can be claimed on 2008 returns, and credits for 2010 purchases can be claimed on 2009 returns. The credit is fully refundable, which means it can be used to offset the buyer’s regular tax and alternative minimum tax liabilities with any leftover credit amount refunded to the buyer in cash. Certain liberalized rules apply to military service members.
Home equity loans
Debt secured by your principal residence or second home—such as a second mortgage or home equity line of credit—that is not used to buy, build or substantially improve the property. Although interest on most personal loans is not deductible, interest on up to $100,000 of home equity debt is an exception.
Home office expenses
If you use part of your home regularly and exclusively as the principal place of your business or the place you meet with clients, patients or customers, you can qualify to deduct certain expenses that are otherwise nondeductible personal expenses. Examples include a portion of your utilities, homeowner’s insurance premiums and depreciation (if you own your home) or part of your rent (if you are a renter).
Home sale profit
Profit of up to $250,000 ($500,000 for married taxpayers filing jointly) is tax-free, if you owned and lived in the home for two of the five years leading up to the sale. This break can be used repeated times, but not more than once in any two year period. A surviving spouse is considered married (and eligible for a $500,000 exclusion) if a home is sold within two years of the death of his or her spouse.
Hope credit (now the American Opportunity credit)
See College credits.
If someone works in your home—as a child care provider, for example, or housekeeper or gardener—as your employee (rather than as an independent contractor or an employee of a service company), you may be responsible for paying Social Security and Medicare taxes for the employee. This requirement is triggered in 2014 if you pay the employee $1,900 or more during the year. This is also sometimes called the “nanny tax.” (If you pay an employee $1,000 or more in any calendar quarter, you must pay federal unemployment tax.)
The cost of prescription drugs imported from Canada or any other foreign country is not deductible.
Interest you are considered to have earned—and therefore owe tax on—if you make a below-market-rate loan. The term is also used to refer to the interest income you must report on taxable zero-coupon bonds. Although the bonds pay no interest until maturity, you must report and pay tax on the interest as it accrues.
Incentive stock option
An option that allows an employee to purchase stock of the employer below current market price. For regular income tax purposes, the “spread” or “bargain element”—the difference between the price paid and market value of the stock—is not taxed when the option is exercised. Rather, it is taxed when the stock is sold. For alternative minimum tax purposes, however, the spread is taxed in the year the option is exercised.
To prevent inflation from eroding certain tax benefits—including standard deductions and exemption amounts and the beginning and end of each tax bracket—they are automatically adjusted annually for increases in the consumer price index.
Individual 401(k) plan
The 401(k) rules allow a self-employed person with no employees (other than his or her spouse) to use a 401(k) plan to sock away—and deduct—far more for his or her retirement than in the past. For 2014, self-employed individuals can contribute up to $52,000 to a solo 401(k). Those 50 and older can shelter up to an additional $5,500 by making extra “catch-up” contribution.
Individual retirement account (IRA)
A reference to an IRA without the moniker “Roth” in front of it is a reference to a traditional IRA, a tax-favored account designed to encourage saving for retirement. If your income is below a certain level or you are not covered by a retirement plan at work, deposits into a traditional IRA can be deducted. The maximum annual contribution for 2014—deductible or not—is $5,500 or 100 percent of the compensation earned during the year, whichever is less. Those who are age 50 or older at the end of the year can add an extra $1,000 “catch-up” contribution, bringing their annual limit to $6,500 for 2010. Also, spouses can contribute part of his other compensation to an IRA for a non-working spouse. The tax on all earnings inside the IRA is postponed until you withdraw the funds. In most cases there is a penalty for withdrawing funds before you reach age 59 1/2. The right to deduct contributions phases out at higher income levels for those covered by a retirement plan at work. See also Roth IRA.
Individual retirement arrangement
See Individual retirement account (IRA).
IRA payouts for first-time homebuyers
As a general rule, withdrawals from traditional IRA before age 59½ are hit with a 10% tax penalty. But the penalty is waived on up to $10,000 withdrawn to buy a first home for yourself, a child or grandchild, or your parents or grandparents.
IRA withdrawals for education
The typical 10% penalty for early (pre-age 59½) withdrawal from traditional IRAs is waived if the distributions is used to pay higher education expenses for yourself, your spouse, or a dependent. However, the payout is taxed.
Tax rules designed to protect married taxpayers who file joint returns from being held responsible for taxes due to erroneous actions by their spouses—such as failing to report income or claiming unsubstantiated deductions. Basically, if you can show that you didn’t know and didn’t have reason to know about error that resulted in the underpayment of tax on the joint return, you can be relieved of responsibility for that underpayment. You have two years from the time the IRS begins trying to collect the underpayment to petition for innocent spouse relief.
With an installment sale you agree to have the purchaser pay you over a number of years, and you report the profit on the sale as you receive the money instead of all at once in the year of the sale.
Interest paid on loans used for investment purposes, such as to buy stock on margin. You can deduct this interest on Schedule A if you itemize, up to the amount of investment income (not including capital gains or dividends that qualify for the 0, 15, or 20 percent rates) you report.
The costs of looking for a new job in your same line of work are deductible. Qualifying expenses include the cost of want-ads, employment agency fees, printing and mailing resumes, and travel expenses such as transportation, lodging and 50% of food if your job hunting takes you away from home overnight.
The cost of education that maintains or improves skills you use on the job, or that is required to maintain your job is deductible Education that qualifies you for a new trade or business, such as law school, is not eligible for this deduction, but may be eligible for the American Opportunity or Lifetime Learning tax credit.
See Moving expenses.
Jury duty pay repaid to employer
Jury fees you are required to turn over to your employer—in exchange for your salary continuing while you do your civic duty—are deductible. This will offset the jury fee income you are required to report if the money only passes through your hands.
Also known as an H.R. 10 plan, this is a retirement plan for the self-employed. As much as 20 percent of your net earnings from self-employment income (up to $52,000 for 2014) can be deposited in a defined contribution Keogh. Contributions are tax deductible. There is no tax on the earnings until the money is withdrawn, and there are restrictions on tapping the account before age 59½.
A reference to the Social Security cards needed by any child you claim as a dependent on your tax return. The nine-digit identifying number shown on the card must be reported on the tax return of the parent who claims the child as a dependent. What if a child is born late in the year and you haven’t received a Social Security number by the time you’re ready to file? The IRS says you must delay filing, even if it means getting an extension to file past the April 15 deadline. If you claim a dependent and fail to include the number, the exemption will be rejected and your tax bill hiked accordingly.
The tax—at the parents’ higher tax rate—imposed on unearned income of children who are under age 19 at the end of the year and dependent students who are under age 24. For 2014, the kiddie tax can only apply to the child’s unearned income in excess of $2,000.
Lifetime learning credit
See College credits.
The tax-free exchange of similar assets, such as real estate for real estate. The tax on profit accrued in the first property is deferred until the subsequent property is sold.
A partnership investment—in real estate and oil and gas, for example—that passes on both profits and losses to investors. By definition, limited partnerships are passive investments, subject to the passive-loss rules.
“Listed property” is the term used for depreciable assets that Congress has put on a special list for special scrutiny by the IRS. Basically, this includes things Congress worries you might use for personal as well as business purposes—a car, computer, cellular telephone, boat, airplane and photographic and video equipment. (If a computer or photographic or video equipment is used exclusively at your regular place of business, however, it is not considered listed property.) There are special restrictions on the depreciation of listed property if business use does not exceed 50 percent.
Long-term care insurance premium
Premiums paid for long-term care insurance can be deducted as a medical expense. The maximum annual deduction is based on your age.
Long-term gain or loss
See Capital gain or Capital loss.
The payment within one year of the full amount of your interest in a pension or profit-sharing plan. To qualify as a lump-sum distribution—and for favorable tax treatment—other requirements must be met.
Luxury car rules
The restrictions that limit annual depreciation deductions for business automobiles that cost more than a certain amount.
See Investment interest
Marginal tax rate
The share of each extra dollar of income that will go to the IRS. It’s not necessarily the same as the rate in your top tax bracket because in many cases rising income squeezes the value of tax breaks, so that the extra income is effectively taxed more harshly than advertised. Knowing your marginal rate tells you how much of each additional dollar you make will go to the IRS and how much you’ll save for every dollar of deductions you claim.
The tax law provision that generally allows any amount of property to go from one spouse to the other—via lifetime gifts or bequests—free of federal gift or estate taxes.
The difference between what you pay for a bond and its higher face value. The tax treatment varies depending on whether the bond is taxable or tax-free and whether you redeem it at maturity or sell it before that time.
Master limited partnerships (MLP)
Similar to regular limited partnerships, but MLP shares are traded on the major exchanges, making for a much more liquid investment. Although limited-partnership losses are considered passive, income from an MLP is considered investment income rather than passive income. That means passive losses can’t be used to shelter MLP income.
The test used to determine whether you are involved enough in a business to avoid the passive-loss rules. To be considered a material participant, you must be involved on a “regular, continuous and substantial basis.” One way to pass the test is to participate in the business for more than 500 hours during the year.
The portion of the combined Social Security and Medicare tax—1.45 percent for employees and 2.9 percent for self-employed taxpayers—that pays for Medicare. Although the part of the tax that pays for Social Security stops at $117,000 in 2014, the Medicare portion of the tax applies to all wages and self-employment income, no matter how high.
The rule that treats certain kinds of depreciable property, including real estate, as though it were placed in service in the middle of the month it was first used.
In general, business property is depreciated under a midyear rule that allows half a year’s depreciation for the first year, whether you buy property in January or December. However, if you buy more than 40 percent of the business property you put into service for the year during the fourth quarter, the midquarter convention takes over. With it, you depreciate each piece of property as though it were placed into service in the middle of the calendar quarter in which it was purchased. You claim just six weeks’ worth of depreciation for property put in service during the final quarter, for example.
See Standard mileage rate.
A term often used to refer to deductible interest paid on debt that qualifies as acquisition indebtedness or home equity debt. Interest on up to $1 million of debt used to buy or build your principal residence or second home can be deducted. In addition, interest on up to $100,000 of borrowing via a home equity loan or line of credit can be deducted, regardless of how you use the money.
Some of the costs of moving in connection with taking a new job are deductible. To qualify for the deduction, the new job must be at least 50 miles farther from your old home than your old job was. Deductible expenses include the cost of moving your household goods, as well as travel and lodging expenses for you and your family. If you moved to take your first job, the 50-mile test applies to the distance between your old home and your new job. You can take this deduction even if you claim the standard deduction rather than itemizing deductions on your return.
An agreement under which two or more taxpayers, who together provide more than half the support for someone else, agree that one supporting person will claim the supported person as a dependent, and the other supporting persons will not.
See Household employee.
Net Unrealized Appreciation (NUA)
NUA comes into play if you take a total payout from a company retirement plan that includes appreciated employer securities. Rather than make a tax-free rollover of the entire amount to an IRA, you can roll the stock into a taxable account and owe tax only on the stock’s value when you acquired the shares. The Net Unrealized Appreciation that accrued while the stock was inside the plan will not be taxed until you ultimately sell the stock. At that point, the profit can qualify for special long-term capital gain treatment. If you rolled the stock into an IRA, all appreciation would be taxed as ordinary income when withdrawn, at your top tax rate.
Nonbusiness bad debt
A bad debt not connected with your trade or business. An uncollectible loan to a friend or a deposit to a contractor who becomes insolvent are examples. You must be able to show that you tried to collect the debt. When those efforts are unsuccessful, a nonbusiness bad debt is deductible as a short-term capital loss in the year the debt becomes entirely worthless.
The full fair-market value of most assets that you donate to charity can be deducted if you have owned the asset for more than a year. The deduction for assets owned one year or less is limited to your tax basis, which is generally what you paid for the property. If you give property with a total value of more than $500, you’ll need to file Form 8283 and give details about the assets, including a description of them and their individual values. If their value is more than $5,000, you generally will need to attach an appraisal, unless you give listed securities. Note that if you donate used clothing or household items such as furniture, appliances, linens, or electronics, you can’t deduct the value of the items unless they are in excellent or good condition.
Nonqualified stock options
Options to purchase company stock that are granted to employees as compensation but do not meet restrictions necessary to qualify as incentive stock options. (See Incentive stock options.) There is no tax consequence when the options are granted but when employees exercise the options to purchase stock, the “spread” or “bargain element”—the difference between purchase price and the stock’s value—is taxed as additional compensation.
Out-of-pocket charitable contributions
Expenses you incur while working for a charity – from the cost of driving your car (generally 14 cents per mile) to the cost of stamps for a fundraiser—can be deducted as a charitable contribution.
Original Issue Discount (OID)
The amount by which the face value of a bond exceeds its issue price. Part of the discount on taxable bonds must be reported as taxable interest income each year that you own the securities.
Passive activities are investments in which you do not materially participate. Losses from such investments can be used only to offset income from similarly passive investments. Passive losses generally can’t be deducted against other kinds of income, such as salary or income from interest, dividends or capital gains. Generally, all real estate and limited-partnership investments are considered passive activities, but there is an exception for real estate professionals and a limited exception for rental real estate in which non-professionals actively participate. Losses you can’t use because you have no passive income to offset can be carried over to future years.
Basically, this is interest that doesn’t qualify as mortgage, business, student loan or investment interest. Included is interest you pay on credit cards, car loans, life insurance loans and any other personal borrowing not secured by your home. Personal interest cannot be deducted.
Plug-In Electric Drive Motor Vehicle Credit
Internal Revenue Code Section 30D provides a credit for Qualified Plug-in Electric Drive Motor Vehicles including passenger vehicles and light trucks. For vehicles acquired after 12/31/2009, the credit is equal to $2,500 plus, for a vehicle which draws propulsion energy from a battery with at least 5 kilowatt hours of capacity, $417, plus an additional $417 for each kilowatt hour of battery capacity in excess of 5 kilowatt hours. The total amount of the credit allowed for a vehicle is limited to $7,500.
The credit begins to phase out for a manufacturer’s vehicles when at least 200,000 qualifying vehicles manufactured by that manufacturer have been sold for use in the United States (determined on a cumulative basis for sales after December 31, 2009). For additional information see Notice 2009-89.
In connection with getting a home mortgage, each point is equal to 1 percent of the mortgage amount. Points paid on a mortgage to buy or improve your principal residence are generally fully-deductible in the year you pay them. You get to deduct the points even if you convince the seller to pay them for you, as long as you paid enough cash at closing—as a down payment, for example—to cover the points. Points paid to refinance the mortgage on a principal home or to buy any other property must be deducted over the life of the loan.
Tax breaks allowed under the regular income tax but not under the Alternative Minimum Tax, including the deduction of state and local taxes and interest on home equity loans. One that is becoming more and more important to more and more taxpayers is the “spread” between the exercise price and the value of stock purchased with incentive stock options. Although that amount is not taxed under the regular tax, it is a preference item subject to tax if you’re hit by the AMT.
Prizes and awards
The value of a prize or award is generally taxable, so if you hit the lotto, Uncle Sam is a winner, too. One exception is that certain noncash employee awards—the proverbial gold watch, for example—can be tax-free.
Withdrawals from a company retirement plan which are subject to a 10 percent penalty (in most cases) if you’re under age 55 in the year you leave the job or from a traditional IRA if you’re under age 59½.
See Real estate taxes.
An employee benefit plan—such as a pension or profit-sharing plan—that meets IRS requirements designed to protect employees’ interests.
Real estate taxes
Real estate taxes you pay are deductible. You can deduct the state and local property taxes you paid on any number of personal residences or other real property you own.
Recapture of depreciation
When you depreciate investment real estate, your tax basis declines. To the extent that profit when you sell is due to the reduced basis (rather than appreciation), the law recaptures part of the depreciation tax break by taxing that part of your profit up to 25 percent, rather than the regular top 15 percent rate for long-term capital gains.
A fringe benefit, sometimes called a flexible spending account or salary reduction plan that allows an employee to divert some of his or her salary to a special account that is used to reimburse the employee for medical or child care expenses. Funds channeled through the account escape federal income and Social Security taxes and state income taxes as well.
Retirement saver’s credit
This credit is worth as much as 50 percent of up to $2,000 contributed to an IRA, 401(k) or other retirement plan, for a maximum credit amount of $1,000 ($2,000 if filing jointly). The credit is designed to encourage lower-income workers to save for their retirement. The credit is phased out as income rises. Taxpayers under age 18 and those claimed as dependents on their parents’ returns are not eligible, regardless of their income.
The tax-free transfer of funds from one individual retirement account (IRA) to another or from a company plan to an IRA. If you take possession of the funds, the money must be deposited in the new IRA within 60 days. Beware that when the rollover method is used to move money from a company plan to an IRA, 20 percent of the amount will be withheld for the IRS, even though the rollover is tax-free if the money is in the IRA within 60 days. To avoid this automatic withholding, use the direct transfer method to move money from a company plan to an IRA. See Direct transfer.
Employers are now allowed to add a Roth option to 401(k) plans to allow employees to invest after-tax money with the promise of tax-free withdrawals in retirement. With the regular 401(k), you invest pre-tax money but have to pay tax on all withdrawals in retirement. If your firm offers a matching contribution, it must go into the traditional 401(k), and you will be taxed on distributions from that part of the plan. The same dollar limits apply to Roth 401(k)s as to regular plans. The maximum employee contribution for 2014 is $17,500. Plus, you can make an extra $5,500 “catch-up” contribution if you are age 50 or older. You can choose to divert part of your pay to each kind of 401(k) account, but your combined contributions can’t exceed the preceding limits.
The back-loaded IRA is named after a chief supporter—the late Senator William Roth of Delaware. It’s called back-loaded because the tax benefits come at the end of the line. Contributions are not deductible, but all withdrawals are tax-free, as long as they come after you reach age 59½ and at least five years after January 1st of the year in which you opened up your first Roth account. Contribution limits are the same as for traditional IRAs: $5,500 in 2014, with an extra $1,000 catch-up contribution allowed for those age 50 and older. But there’s a catch: If your income is too high, you can’t contribute to a Roth IRA.
You can also roll over funds from a traditional IRA to a Roth IRA—so that all future earnings would be tax-free rather than simply tax-deferred. This is called a Roth IRA conversion. But to do so, you have to pay tax on the money you move from the old IRA to the Roth. Starting in 2010, there is no income restriction on Roth IRA conversions (for earlier years, Roth conversions are only allowed if AGI is $100,000 or less).
Named after the subchapter of the tax law that authorizes it, an S corporation generally pays no tax because profits and losses are passed on and taxed to the shareholders.
State and local general sales taxes you pay may be deductible if you itemize. But you must choose between deduction sales taxes or deducting city and state income taxes. If you live in a state that does not impose an income tax, claim the sales tax deduction. You don’t need to keep all your receipts, either. The IRS has a handy table with estimates based on your income, family size and where you live. You can add to the table amount sales taxes paid on cars, boats, aircraft and other big ticket items. Purchase of such items could lead some taxpayers in income-tax states to pay more sales tax than income tax. You can choose whichever deduction is most valuable to you.
See Retirement saver’s credit.
Salary reduction plan
See Reimbursement account.
Scholarships and fellowships
Scholarships and fellowships received by degree candidates to cover tuition, fees, books and supplies are generally tax-free. But amounts for room and board are taxable.
Section 179 deduction
The Self Employment Contributions Act tax that pays for Social Security and Medicare for self-employed individuals. For 2014, the self-employment tax rate is 15.3 percent on the first $117,000 of self-employment income and 2.9 percent on all amounts over $117,000.
Self-employed health insurance premiums
Premiums paid by a self-employed person for coverage for yourself, your spouse or dependents can be deductible, even if you don’t itemize deductions.
A Simplified Employee Pension (SEP) is a tax-favored retirement plan mainly for self-employed taxpayers. Contributions to the plan are tax deductible. The maximum contribution for 2014 is the smaller of 20% of net earnings from self-employment or $52,000. Contributions for the 2014 tax year are due by April 15, 2015, but you can extend the contribution deadline to October 15, 2015 if you extend the due date of your return.
The sale of borrowed stock, usually with the hope that the stock price will fall. If it does, the investor profits by repaying the loan with shares purchased at the lower price. If the stock price increases, the investor loses and has to repay the loan with shares that cost more than those sold. As far as the IRS is concerned, the transaction doesn’t count for tax purposes until the investor delivers stock to the lender to close the sale.
Short-term gains and losses
See Capital gain or Capital loss.
The Savings Incentive Match Plan for Employees (SIMPLE) is a retirement plan that can be offered by companies with 100 or fewer employees. A key consideration is that the employer generally must match employee contributions up to 3 percent or contribute 2 percent of pay for each employee, whether or not they contribute on their own. The rules are simpler than for other tax-qualified retirement plans. Congress hopes that this will encourage smaller employers to establish plans. For 2014, a self-employed person with no employees could open a SIMPLE and contribute up to $12,000 of self-employment earnings (plus a $2,500 catch-up contribution if he or she is age 50 or older by the end of the year).
Social Security Tax
See FICA and SECA.
Social Security Tax, excess withheld
If you hold more than one job during the year—either at the same time or successively—too much Social Security could be withheld from your pay. If this happens, you are entitled to a refund of the excess withholding.
Generally, to contribute to a traditional or Roth IRA, you must have earned income. But a working spouse can contribute up to $5,500 of his or her earned income to an IRA for a nonworking spouse in 2014. The limit is $6,500 if the account owner is age 50 or older by the end of the year.
A no-questions-asked write-off that reduces taxable income, the amount of which varies depending on your filing status. Taxpayers age 65 and older or blind get larger standard deductions. Unlike taxpayers who itemize deductions, you need no records to prove you deserve this deduction. Even if you somehow made it through the year without incurring any deductible expenses, you may still claim the full standard deduction. About two-thirds of all taxpayers use the standard deduction rather than itemize. Special rules can reduce the standard deduction for children who are claimed as dependents on their parents’ returns.
Standard deduction for a dependent
If you can claim a child as your dependent on your tax return, the child may not claim a personal exemption on his or her own tax return.
Standard mileage rate
The deductible amount you can claim for each mile you use your car for business, charitable, job-related moving or medical purposes without having to keep track of the actual cost. You can also deduct the actual cost of parking and tolls when driving for any of these purposes.
The basis of inherited property is stepped-up to its value on the date of death of the owner, or a slightly later date if chosen by the executor of a taxable estate. In other words, tax on any appreciation during his or her lifetime is forgiven. The heir uses the higher basis to figure his or her gain when the property is ultimately sold. If the value of property declined while it was owned by the decedent, the basis is stepped-down to date of death value.
Student loan interest deduction
You can deduct a portion of the interest you pay on student loans used to pay for college or other post-high school education expenses for yourself, your spouse or your dependents. This tax break is phased out as income rises. You can claim this write-off whether or not you itemize deductions.
This can mean different things. It can refer to income that is taxable (such as wages, interest and dividends) rather than tax-exempt (such as the interest on municipal bonds). On tax returns, “taxable income” is your income after subtracting all adjustments, deductions and exemptions—that is, the amount on which your tax bill is computed.
Each tax bracket encompasses a certain amount of income to be taxed at a set rate. The rates now run from 10 percent to 35 percent. You are said to be in the 25 percent bracket if your highest dollar of income falls in that bracket. Even if you’re in the 25 percent bracket, part of your income is taxed at the 10 percent rate and some at 15 percent. Some of your income—such as the amounts protected by your personal and any dependent exemptions and your standard or itemized deductions—is not taxed at all.
Interest paid on bonds issued by states or municipalities that is tax-free for federal income tax purposes. Although you must report this income on your return, it is not taxed. Note that some interest that is exempt from the regular tax is taxed by the Alternative Minimum Tax.
All sorts of income can potentially be tax-free, including: Auto rebates; child-support payments; combat pay; damages in lawsuits for physical injury; disability payments, if you paid the premiums for the policy; dividends on a life insurance policy, up to the total of premiums paid; Education Savings Account withdrawals used for qualifying expenses; gifts; Health Savings Account withdrawals used for qualifying payments; inheritances; life insurance proceeds; municipal bond interest; policy officer survivor payments; profits from the sale of a home, up to $250,000 if you’re single or $500,000 if you’re married; qualified Roth IRA and Roth 401(k) withdrawals; scholarships and fellowship grants; Social Security benefits (between 15 percent and 100 percent are tax-free); veterans benefits; and workers’ compensation.
The official inside the IRS who is charged with helping individuals resolve their problems with the IRS, as well as identifying changes in IRS procedures that could make the agency more taxpayer-friendly. This official oversees IRS Problem Resolution Officers (PRO) around the country. You should go to a PRO, or ultimately the Advocate, if you are getting the run-around – or worse – from regular IRS channels.
Tax preference item
See Preference item.
See Economic stimulus payment.
This special tax-computation method for lump-sum distributions from pension and profit-sharing plans is available, but only to taxpayers born before January 2, 1936. If you qualify, it could save you a substantial amount.
Ten-year forward averaging
See Ten-year averaging.
See College credits.
Qualifying taxpayers can deduct a portion of college expenses if their adjusted gross income is under certain limits. This break is available whether or not you itemize deductions, but is not available to students who are claimed as dependents on their parents’ return. It is available to their parents, though, if they pay the tuition. You cannot claim the deduction in the same year you claim an American Opportunity or Lifetime Learning credit for the same student. But because the income phase-out ranges for this deduction are higher than for the Lifetime Learning credit, some taxpayers whose income is too high to claim the Lifetime Learning credit will benefit from this write-off.
Income from investments, such as interest, dividends and capital gains. See Earned income.
The penalty is the IRS’s not-so-subtle reminder that taxes are due as income is earned, not just on April 15 of the following year. Basically, it works like interest on a loan, with the penalty rate applied to the amount of estimated tax due, but unpaid by each of four payment dates during the year. The penalty rate is set by the IRS and can change each quarter. There are several exceptions to the penalty. See Estimated tax.
Special tax rules apply if you rent out a vacation home, and the rules differ depending on how much you use the home personally. While all rental income is to be reported, the deductibility of expenses can be limited if you engage in “too much” personal use—generally defined as using the home for more than 14 days during the year or more than 10 percent of the number of days it is rented for fair market rent.
Benefits in a company retirement plan that are yours to keep if you leave the job. Your own contributions, to a 401(k), say, are immediately 100 percent vested. But employer contributions on your behalf can be vested gradually over a period of time, as a way to encourage you to stay with the employer. If you quit a job when just 50 percent of your benefits are vested, for example, you would forfeit half of the amount the employer has set aside for you.
You can ask the Social Security Administration to withhold taxes from your Social Security benefits. This could make sense if withholding allows you to avoid making quarterly estimated tax payments. To request voluntary withholding, file form W-4V with Social Security. You can also ask a retirement plan sponsor to withhold from payouts from IRA distributions.
The level of earnings to which the full Social Security tax applies. For 2014, the full 15.30 percent tax (the combined rate paid by employers and employees) applies to the first $117,000 of wages or self-employment income, and the 2.9 percent Medicare portion applies to all income over that level. (Employees pay part of the tax—5.65 percent up to the wage base limit and 1.45 percent after that—and their employers pay the other half. Self-employed taxpayers have to pay both halves.)
The sale of stocks, bonds or mutual fund shares for a loss when, within 30 days before or after that sale, you buy the same or substantially identical securities. The law forbids the deduction of the loss.
The amount held back from your wages each payday to pay your income and Social Security taxes for the year. The amount withheld is based on the size of your salary and the W-4 form you file with your employer.
If a stock you own becomes completely worthless during the year, you can claim a capital loss as though you sold the stock for $0 on December 31 of the year the stock became worthless.
Keep in mind that this is general information designed to help you put these valuable deductions on your radar. Patrick Parker Realty Agents and Realtors are not certified accountants. Please be sure to check with your tax adviser to see if you qualify for a particular credit or deduction.
Check back in with the Patrick Parker Realty Blog each Tuesday, Thursday and Saturday for more Tax Season Blog Series’ Posts and sign up for the monthly Patrick Parker Realty eNewsletter to have updates delivered to your inbox.
The Blog Series will cover many topics such as How do I qualify for a home seller break?, How do I qualify for a home buyer break?, Do I have to report the home sale on my return?, What is the gain on the sale of my home?, What Are Home Renovation Tax Credits?, Deducting Mortgage Interest, Taking the First-Time Homebuyer Credit, How to Avoid Taxes on Canceled Mortgage Debt, Tax Incentives as they relate to Life’s biggest transitions, such as Marriage, the Birth of a Baby, Divorce, or the death of a Spouse and much more. New posts in this Blog Series will be published twice weekly.
For more information about paying taxes on the sale or purchase of your home or any other questions you have about this article please speak with your tax professional or visit www.irs.gov.
Escrow and Your Role as Home Seller
Here’s why escrow takes weeks, and what you’ll be called upon to do as the seller during this time.
What happens during that mysterious time period known as “escrow,” between signing the purchase contract and closing on a house? As the home seller, you won’t have to do much during this time except sit back and wait — with some important exceptions that we’ll discuss here.
What Is Escrow?
Escrow begins when both you and the buyer have signed the agreement governing the sale of your home and chosen an escrow or title agent to act as intermediary in making the deal happen. At that point, many people will spring into action:
- The escrow agent, title agent, or lawyer will start ordering or preparing title reports, preparing the property deed, and more
- The buyer’s lender will begin in-depth review and processing of the loan and order a professional appraisal of your home
- The buyer will (depending on what contingencies were in your contract) arrange for pest and general inspections and homeowners’ insurance, plus work on meeting any other contingencies.
Your most important tasks will include making your home available when needed for inspections and appraisals, preparing various forms and statements (such as disclosures if you haven’t already done so, and any other forms required locally, such as a smoke detector certificate), and meeting any other contingencies you agreed to in your contract, within the promised time frame (for example, getting copies of permits for work you did on your kitchen).
More generally, you’ll need to be available and responsive when issues arise. For example, if the title search turns up a lien on your property placed by a contractor who claims you didn’t pay the bill, you’ll need to pay up or otherwise deal with this to clear the property’s title. Or if the inspection finds that your house doesn’t have enough smoke detectors, and providing these is the seller’s obligation in your area, you’ll have to buy and put in additional ones.
In any case, plan on staying in close touch with your real estate and escrow agents during this time, to make sure you stay on track. Below are more specific tips on issues that might arise during the escrow period.
Getting Past the Appraisal
Even if you’ve found a buyer willing to purchase your house for a price you’re willing to sell for, it’s not only the buyer who must agree. Except in the rare cases when a buyer is paying cash for your home, it’s likely that the buyer’s mortgage lender will require that the property be appraised — that is, that a professional, selected by the lender, will come to the property and look around, then put a dollar figure on its value.
It used to be that appraisals were little more than formalities. But no longer, with lenders edgy after losing money to defaulting homeowners and getting stuck with properties worth less than the mortgages held against them.
Dealing With the Inspection Contingency
One of the biggest hurdles to clear is the inspection contingency. Hopefully your own advance inspection of the property has ruled out major problems that can’t be fixed. But even if you did your own inspection, your house is practically guaranteed to have a few defects — whether loose tiles, a missing cover plate on an electrical outlet, or a major crack in the foundation.
Your contract probably gives the buyer a certain number of days (such as three) within which to “approve” or “disapprove” of the report. The buyer now has an opportunity to say, “Forget it,” and end the deal. More likely, however, the buyer will negotiate over the needed repairs. You can either agree to the buyer’s requests for a reduced price, offer to pay for repairs outright, suggest minor changes to the buyer’s request or insist on a second opinion from a contractor you trust, or refuse some requests and see how the buyer responds. Assuming the buyer truly wants your house, you should be able to reach a compromise. Be aware that if you playing hardball in these negotiations, you may cause the deal to collapse.
Dealing With the Title Contingency
If any clouds on your house title are discovered, you’ll need to deal with them quickly. This can sometimes mean coming up with some immediate cash. For example, if there’s a lien on your house for unpaid child support, it’s probably not going to be removed until you pay the child support or get a statement proving that it’s no longer owed.
Preparing for the Final Walk-Through
Another often overlooked contingency that’s probably in your contract is the final walk-through. As one of the last steps during the days or hours before the closing, the walk-through allows the buyer and buyer’s agent to visit your house and make sure that you’ve left it in the agreed-upon physical condition.
You’ll need to have moved out of the house (unless otherwise agreed), made any negotiated repairs, left behind all fixtures and other agreed-upon property, moved out all of your own things, and left the place clean. If you fail to meet one of your obligations, the buyer can use this as an excuse to delay the closing, bring up new repair or price requests (possibly getting a last-minute credit in escrow to make sure you take care of matters), or even cancel the sale. Take careful note of the final walk-through date, and make plans to have your house empty and spotless before that time.
Market Value vs. Appraised Value
The interesting thing about homes is that their real value has almost nothing to do with what they are bought and sold for. Well, this is an exaggeration, but when you think of it, buying or selling a home can be as deceptive as Jack buying some magic beans.
This is the price that the people looking at your home are willing to pay for it. If just about everyone coming by your home says that they are willing to pay $200,000, then the market value of your home is $200,000. There isn’t a whole lot you can do to change that. The tricky thing about market value is that it can take into account factors that are completely out of the seller’s control.
For instance, an elderly couple walks into a new home and instantly it reminds them of the home they first lived in. Nostalgia in this case could make the home worth thousands more, simply for that reason. Or, maybe the husband is a little nervous and feels that the home is haunted. This may seem like a joke, but you would be surprised to find out just how often someone claims that ‘getting bad vibes’ from a home is a reason not to buy it. In this case however, no matter what the price, that customers is not going to buy the home.
The appraised value is basically what the bank thinks your home is worth. This can include everything from what neighborhood you live in, to how many fixtures you have in your kitchen. The appraised value tends to be unbiased, because the bank is not looking to bargain with you. They need an accurate assessment.
It is very rare that the appraised value of a home is the same as the market value. Why is this? Essentially the appraised value of your home is determined in order to justify the rate of the mortgage loan. This price is based on historical data and previous sales comparisons. That means sales of similar homes in the past six months. You may encounter some problems if there is a large gap between the appraised value of the home and purchase price being offered.
For instance if a buyer decides that they absolutely must have a home and they are willing to pay for it, they mat be in for shock when they discover what the down payment is. If the purchase price is much higher they bank may determine that the apprised value of the home is not enough to cover the requested mortgage they will often raise the down payment. This situation may not emotionally deter the buyer, but, coming up with an extra 2 or 3% of the purchase can translate into thousands of dollars. And as we all know coming up with cold hard cash like that can be a real problem.
Therefore, be aware of what similar appraised vales of home in your area are. This will lessen the shock of the purchase. Also, if you can afford the initial down payment you will end up paying less for the home in the long run, providing the bank gives you the mortgage rate that you wish. In this housing market that is quite possible.
Perception vs. Reality in Realty
The really big issue at hand here is perception vs. reality. As mentioned before, sometimes buyers will just ‘fall in love’ with a home. They will be willing to go to great lengths to get that home. However, banks don’t care if you ‘love’ the house or not, they are unbiased and they will appraise the home at what they think is its value.
Fundamentally lenders, not buyers, perform appraisals. There has to be the feeling that the buyer is making a solid investment. This makes sense because of the massive mature of most mortgages the home is the collateral with which you borrow money to buy the same home.
In addition, appraised value is based on historical data and comparisons with similar homes that have sold over the past six months. This is not carved in stone. If the market is fluctuating wildly, other factors may enter the picture, so keep aware at all times.
In the past six months, for instance, the average sale price of a home in the United States has gone up a solid $20,000. It is this kind of data that the lender will look at when they are making the appraisal.
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Of course if there are multiple bidders this raises flags that for whatever reason the home may be worth more. This is the only instance, in the face of overwhelming interest, where the lender may take into account peoples emotions.
When the appraisal comes in way under the market value the seller has some decisions to make, and the buyer should be aware of what their tactics are. Often they will present a counter-offer that is not based on the appraised value. This will almost automatically eliminate many buyers that cannot afford that initial down payment.
As a buyer this could go either way. It could means that you cannot afford the home, which means you should take it as a lesson and start looking elsewhere. If you can afford it, it means that there will be fewer buyers contributing to an increase in the price of the home. This will not only save you money, but if you can afford the initial down payment it means you will save money over the long term.
Make sure that before, or during the bidding process you have done your own research and you know what home appraisals in the area have gone for in the past.
Lowest Common Denominator
Sometimes, the market value of the home will be lower than the appraised value. No matter what the situation the lender will base the mortgage on whichever one is lower. It’s how they cover their bases and make sure the market stays stable. In the case that the appraised value of the home is lower, lets say that it is 5%, the lender will use the difference between the two to calculate the down payment. So make sure you have at least 10% set aside for this contingency.
One last thing… Assessed Value
It is important to know the assessed value of your home for a couple other reasons. Let’s say you have gone through the bidding process and you have managed to come up with the necessary down payment. The assessed value of your home will also be crucial when you re sell the home (if you do) there are no guarantees that the appraised value of your home will increase and this could have as much to do with the national economy, your neighbors and a host of other factors.
The assessed value of your home will also affect how much you pay annually in taxes. The municipal government uses these value statistics to determine how much tax they collect from you. So if you are astounded that the appraised value of your home was so high, know that over the course of time, the money you saved on a down payment could in fact.
Patrick Parker Realty experts can offer additional insights and information on how market value differs from appraised value and how this plays into how Mortgage Lenders and Brokers determine what your home is worth. For more information contact us today!
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