Tax Consequences of Home Ownership
Tax code has got various benefits to homeowners. The significant benefit is that the homeowners are not required to pay taxes on the rental income accrued from their own homes. Rental value from their homes is not counted as taxable income. It is an income that is not taxed (Das et al., 2017). The amount accrued from homeownership can only be compared to return on investments as in savings interest.
The homeowners deduct both property tax and mortgage interest payments, including other deductions such as federal income tax expenses. A whole income tax system includes taxation of all forms of income, and all costs related to the income are deducted. Hence, in a proper functioning tax system, property and mortgage interest taxes should be deducted. Though, the current tax system does not tax rental income received by homeowners. It makes the justification for deducting such a form of income unclear (“An Analysis of the Effect of the 2018 Tax Revisions on the Tax Benefit of Home Ownership”, 2018). Homeowners may also fail to include the limits of capital gain realized from a home sale. Hence, the benefits worthy to taxpayers in high-income tax brackets compared to those in lower brackets.
Many people would wish to buy homes and stop paying rent at some point in life. It is only possible to buy a home when an individual can do so. Those who find themselves in a position to buy a home as an investment enjoy parts of the returns. Included as part of the returns, is the opportunity to live in the homes rent-free. Comparing to other forms of investments, the return from homeownership is what economics refers to as imputed rent, which is excluded from income tax. Buying a home is an investment, part of the returns being the opportunity to live in the home rent-free. On the other hand, landlords have to account for the rental income they receive, and the tenants may not be in a position to deduct the rent they pay. The homeowner may act both a renter and a landlord even though the tax code treats them the same way, ignoring the simultaneous role of the landlords.
For homeowners who attempt to itemize the deductions, in the process, reduce their taxable income through deduction of the home mortgage interest paid. The taxpayers who are not in a position to own their homes or purchase one cannot remove the interest on debts used in the purchase of services and goods.
The homeowners who itemize various deductions can decrease their taxable income through property taxes deduction on their homes. It is federal funds transfer to different jurisdictions imposing property taxes locally, offering an opportunity to increase tax revenue at low cost. The deduction has significantly saved homeowners. Moreover, there are still chances of that cost going down shortly.
Every taxpayer who makes a sale on an asset is liable to pay capital gains tax on the proceeds made on that sale. However, the homeowners have a limit set for them on the sale of their assets in they meet specific criteria. The homes must have been maintained as their homes for some time (Das et al., 2017). They may also have not claimed capital gains exclusion from the sale of the homes within the few previous years. Exclusions and deductions available for the homeowners are preferable to high tax brackets compared to low brackets. All these depend on how long an individual has lived in a homestead before the sale, as well as the profit accrued from the sale. The law has been made in such a way that when an individual’s capabilities fall within a given bracket, then they may find some form of relief or fall within a tax-free bracket.
There are tests an individual must meet for the proceeds from the sale of the main home to be tax-free. These include ownership, use, and timing. When it comes to owning, the individual must have owned the home for at least two years before the sale. The years do not have to be continuous or be immediate. For anyone who has lived in the house at one point for two years before deciding to sell the house qualifies. In terms of use, then the individual must have used the homestead as a primary home within two years in a bracket of five years before deciding to sell the house. For timing as part of qualifications, then the individual must not have deducted gain o the sale of another asset or home within five years before the sale date.
The homeowners must make a joint return filing. One of them must meet the ownership requirement. That is having owned the home for a period not less than two years before the date of sale. However, there are exceptional circumstances. When an individual does not meet all the requirements, there are some rules or criteria that may allow them to claim part of full exclusion on tax (Marjavaara & Lundholm, 2014). If a person acquires a homestead as part of a divorce settlement, the person can claim it was owned by either the spouse for a period of at least two years among the five years duration within the period of sale. In order to meet the set requirements, one can claim that they were temporarily unavailable in the home, even if the premises had been rented out to someone or used for commercial purposes.
If either of the spouses is granted access and use of the homestead as part of the divorce settlement or even separation agreement, the absent spouse who does not reside in the homestead can still count the days the other spouse uses the home. It is used when the spouse still owns part of the home as up to when it is sold. If one of the spouses dies, the surviving spouse can count the day the deceased live in the home before death. It applies only to the situation where the surviving spouse did not remarry.
There are certain cases where individuals can qualify for reduced exclusions. The individual could treat part of his proceeds as tax-free even if they did not pass the two within five years period test. It is available when an individual sells there house before the years required elapses as a result of changes in employment work stations, health effects, and other unknown situations like divorce or pregnancy. If an individual wants to move to a better house or the conditions do not favor their current status, then the law will not hold them to stay where they are even if they do not meet the requirements (Marjavaara & Lundholm, 2014). The law has also provided for their provision where they will receive a reduction on the exclusion as per the provisions of the law. The tax law has dramatically enabled proper control and consideration in the homeownership industry. The possible money laundering schemes that would have come through the purchase of multiple homes and sale have been avoided. It has been possible through the control of sales of homes as per now an individual can purchase the homes but have difficulty in selling them and pumping the illegal money back to the economy (Diachok, 2019). It a regulation that helps the government to reduce tax avoidance through sales of homes.
It is upon an individual to turn down the government’s offer and avoid the exclusion. It is a rare occurrence for a person to pay taxes on
home in order to keep or preserve exclusion for a home that they intent to sell within the next few years. The exclusion can be used more than once on many occasions in an individual’s lifetime (Kim & Norton, 2017). The exclusion can be used more than once after every two years. It is not easy for people to preserve exclusions for future use in selling other homes if at all they intend to or own one more extra home. At all costs profits are always minimized by finding out on how to reduce taxes imposed on the income accrued from the sales.
Every person who sells a home must report on the returns and declare the true profits realized from the sell. It is a requirement of the law for this to be done. If an individual fails to meet the criteria set then they have to pay the full amount of taxes as required by the law. The proceeds of real estates must be fully declared by those in the business. To avoid not filling and returning a form an individual must give some form of assurance (Nicodano & Regis, 2015). The assurance involved includes declaring an intention to sell a house that a person has been residing in for the past few years not less than two.
On figuring a gain during the sale of a house, it realized when the house is sold more than its cost value either to contract it or to purchase it. One has to adjust the gains for tax purposes that is if they made any improvements to the home or the lands (Nicodano & Regis, 2015). It is good to note that capital improvements add value to a home hence the tax value or gain goes up. However, the improvement costs are also taken into consideration. Expenses on routine maintenance and repairs are never excluded. The expenses are added to initial costs to boost the adjusted basis. Other factors deducted are the depreciation, claimed energy credits and casualty losses that reduce the tax bills (“An Analysis of the Effect of the 2018 Tax Revisions on the Tax Benefit of Home Ownership”, 2018).
If the house was purchased from someone else then the price plus the development costs are what is included. It applies when the house was not built from the start. If the home is inherited then the original cost has to be used. Any fees or charges paid must be deducted before tax calculation or determination of tax ability (Kourdoumpalou, 2017). The adjustment of a home is the cost adjusted for tax reasons through improvements and deductions taken.
The energy conservation subsidies are not included on gross income. These apply when an individual builds a home for the first time. When the home is inherited the consideration will be based on the fair market value at the time the other spouse died. The treatment basis is similar to that of the deceased where the property was inherited from.
Sometimes back a person could have put off paying taxes on gain made from sale of homes. It was possible because, of using the proceeds from the sale to purchase another house. The process was known as the rolling over rule referring to a gain accrued from one home to another. However, the current laws in place have tried to discourage such acts and home owners are now advised to try to avoid such acts. Postponement also affects the adjusted basis ability of selling another new home. The taxes on the previous sales were not omitted in the process but just transferred to other future dates (Kourdoumpalou, 2017). Nowadays the postponement is not possible as the law prohibits such acts.
It is upon an individual to pick the year where to declare the taxes on the sale of a home. There is no specific regulation or law that dictates the year returns should be declared. Purchasing an expensive residence can no longer be used as an excuse to not paying taxes in gain on sale of a home.
In conclusion part of the profit from subsequent sale of a home cannot be ineligible for home sale exclusion on taxes. It is even after the owner meets the minimum two year ownership and stay test. The homeownership and sale tax consequences takes into consideration of the available laws. It is these laws that lead to the consequences that tax have on homeownership criteria’s. The tax laws have ensured proper government regulations and policy control of real estate transactions. The homes have been able to be controlled in terms of structure architecture by the government because of the determination of quality during sale. The mortgage loans have also assisted on the financial strength of various individuals towards purchase homes. The taxing system should also cater for both the taxpayers in the higher bracket as well as those in the lower bracket.
References
An Analysis of the Effect of the 2018 Tax Revisions on the Tax Benefit of Home Ownership. (2018), 18(7). https://doi.org/10.33423/jaf.v18i7.467
Das, P., Boudreaux, D., & Rao, S. (2017). Do the Federal Income Tax Deductions for Home Ownership Benefit the Less Advantage and Average American Family?. Accounting And Finance Research, 6(4), 265. https://doi.org/10.5430/afr.v6n4p265
Kim, H., & Norton, E. (2017). How Home Health Agencies’ Ownership Affects Practice Patterns. Fiscal Studies, 38(3), 469-493. https://doi.org/10.1111/j.1475-5890.2017.12136
Kourdoumpalou, S. (2017). Detecting tax evasion when tax and accounting earnings match. Corporate Ownership And Control, 14(2), 289-295. https://doi.org/10.22495/cocv14i2c2p1
Marjavaara, R., & Lundholm, E. (2014). Does Second-Home Ownership Trigger Migration in Later Life?. Population, Space And Place, 22(3), 228-240. https://doi.org/10.1002/psp.1880
Diachok, O. (2019). XIII International Scientific Conference “History of Trade, Taxes and Duties”. History Of Trade, Taxes And Duties, (1-2). https://doi.org/10.32836/2309-7205-2019-1-2-19-20-13
Nicodano, G., & Regis, L. (2015). Taxes, Ownership and Capital Structure. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.2682570