In better times, homes were widely seen as a Fort Knox of family wealth. Today, many are in a swamp of disappearing value. In either case, tax provisions relating to homes can dramatically affect the bottom line—and are worth unhurriedly working through.
Mortgage insurance. In a new break, begun for 2007 and scheduled to last at least through 2010, homeowners may now be able to deduct mortgage insurance premiums on new or refinanced mortgages. The deduction is taken on the 1040's Schedule A along with mortgage interest, but in most cases it phases out between $100,000 and $109,000 of adjusted gross income.
Canceled debt. Troubled homeowners unable to keep up their mortgage payments may no longer get slapped by the tax code if part of their home debt is forgiven during a foreclosure or a modification of the loan's terms. In the past, the amount of the canceled debt could be considered taxable income to the homeowner. Now that's no longer generally the case. This break was enacted late in the year, so it may not show up in some tax manuals and instructions.
But it's not without limit. Debt incurred though a home equity loan and not used to upgrade the house is still generally taxable income if it is forgiven.
No loss. Bad news continues for homeowners with a home that's fallen in value below its cost. They cannot generally deduct a loss when selling. A profit? That's taxable as a capital gain, though couples may qualify to exclude up to $500,000 of gain, and singles up to $250,000.
Spousal sale. New relief has been granted to recently widowed spouses who sell the family home—but the break begins with 2008 transactions. The law now allows them two years in which to sell the home and, if certain conditions are met, exclude up to $500,000 of profit from tax.
Previously they only had a year in which to do that, after which the maximum tax exclusion was the same $250,000 that singles get.
Old standbys. No matter how your home's value is doing, itemized deductions of mortgage interest and property tax can still be big tax savers.
Also generally deductible is interest on a home equity loan of up to $100,000, no matter what the money was used for. That's a big deal since interest is not ordinarily deductible on other types of consumer borrowing, such as on credit cards or auto loans.
Mortgage interest may also be deductible on a second home, which could be a boat or recreational vehicle with sleeping, cooking, and toilet areas. One limit: Total mortgage debt to buy, construct, or improve your homes is, with a few grandfathered exceptions, limited to $1 million, with up to $100,000 of home equity debt on top of that.