Does owning real property carry any income tax benefits?
UPDATED: March 23, 2018
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Though there are many benefits to owning real property, whether or not there are tax benefits for any particular taxpayer depends on the taxpayer’s overall circumstances. Tax benefits for your primary residence are limited to Schedule A deductions and the occasional energy credits that have periodically been available over the last 6 years.
Owning real property enables you to deduct two types of interest -- the interest of a home mortgage (home equity indebtedness) plus a interest paid on a home equity loan (home equity indebtedness) -- from your stated income on your tax forms. However, you have to meet certain qualifications in order to receive an income tax deduction for interest on mortgage payments. Further, these qualifications are subject to total dollar amount limitations.
Qualifications for Income Tax Deductions
Acquisition indebtedness, home equity indebtedness, and qualified residence are three terms that you should become familiar with if you are seeking income tax breaks for owning real property:
1. "Acquisition indebtedness" refers to any type of loan debt incurred when acquiring, constructing or substantially improving a qualified residence. This is subject to a $750,000 ($375,000 married filing separately) aggregate loan amount limitation for the purchase of a first or second personal residence after December 15, 2017. (Homeowners prior to December 16, 2017 can deduct interest on debt up to $1,000,000.) Any debt over that $750,000 dollar limit does not qualify for the mortgage interest deduction.
2. "Home equity indebtedness" refers to debt secured by a qualified residence to the extent that the amount of the loan does not exceed the fair market value of that residence. The value of this debt is reduced by the amount of the acquisition debt (see above), and is subject to a $100,000 ($50,000 married filing separately) aggregate loan amount limitation. However, a home equity loan could also count as acquisition indebtedness if used to substantially improve a home and increase its value; therefore not all home equity loans are subject to the $100,000 aggregate loan limitation amount.
The law changed in late 2017. As stated above, homeowners could deduct the interest paid on a home equity loan or home equity line of credit (HELOC), regardless whether the loan was used for remodeling, repairs, or other personal uses, such as paying off credit cards. Under the Tax Cuts and Jobs Act of 2017, mortgage interest paid on equity debt for personal purposes is no longer deductible. However, if the interest on equity debt is used to substantially improve your main home and second home, it is still deductible, so long as the total of the mortgages does not exceed $750,000.
3. "Qualified residence" refers to your principal residence and one other residence that is not rented to others. A qualified residence is your primary house, condo, cooperative, mobile home, house trailer, or boat. For a second home, a residence is a house, condo, an apartment, or a mobile home not used on a transient basis.
How to Reap Benefits to Your Income Taxes
Deductions for mortgage interest, home equity interest and property taxes may be deducted using Schedule A if you have sufficient itemized deductions to use Schedule A. With today’s low interest rates and higher standard deductions many taxpayers are finding that they are unable to take advantage of Schedule A deductions. Their standard deduction ends up being higher. When a taxpayer can utilize the deductions, they are available for both their primary residence and one vacation residence or secondary family home. With electronic filing a Schedule A will automatically generate if the deductions can be utilized. If you file a paper return it must be attached to your 1040. Some states also offer similar deductions.
Foreign Persons and Income Tax Benefits
The rules for reaping benefits to income taxes are different for those without U.S. citizenship. Foreign investors in U.S. real estate must always ensure their investments remain in compliance with federal tax laws. There are also different forms that apply to foreign taxpayers, such as the Form 1042 (Annual Withholding Tax Return for U.S. Source Income of Foreign Persons), and the 1042-S (Foreign Persons U.S. Source Income Subject to Withholding). Hiring a real estate professional or a real estate attorney who specializes in issues of foreign persons in the U.S. real estate market will help ensure that you receive all of your entitled benefits.