Q: We sold and purchased a home last year and I have a few tax questions:
How much of my real estate brokerage fees on the sale of my old home is deductible?
Can I deduct legal fees incurred when the sale of my old house fell through because of the lack of knowledge of my real estate agent on the first attempt?
Can I deduct the loan origination fee and the points I paid for the purchase of my new home?
R.F., Mukilteo
A: Some of the expenses you mentioned are tax deductible, while others merely reduce your cost basis in the home for purposes of calculating your taxable capital gain.
Tax deductions provide an immediate benefit, while reducing your cost basis only helps if and when you decide to sell your home and keep the cash.
A deduction is an expense that can be subtracted from your taxable income for the year. For example, if you earned $50,000 in 2003 and had $10,000 worth of deductions, your taxable income would be reduced to $40,000 – thereby reducing your income tax bill for the year.
Unlike ordinary income, which is taxed the year that it is earned, capital gains may stretch over many years. You don’t pay tax on a capital gain until you sell your home and realize the gain.
Now, let’s determine which of the costs in your example are tax deductions and which only affect your capital gains.
Points and any other loan fees based on the amount of the loan, such as a loan origination fee are fully tax deductible for purchase loans for the tax year in which they are incurred. So you deduct any loan fees you paid last year. But to make sure that the many readers who refinanced their homes last year are not confused, the tax deduction rules are different for refinances than purchases. Any loan fees paid to refinance the mortgage on your home must be amortized over the life of the loan. For example, if you paid one point ($2,000) for a $200,000 30-year fixed rate loan, you must amortize that fee over 30 years. That means you can deduct only 1/30th of the fee ($66.66) each year. Now if you pay the loan off early, as most people do by selling or refinancing again, you can deduct the remaining balance of the points and loan fees not yet amortized.
Real estate brokerage fees are not tax deductible, however they reduce your cost basis for purposes of calculating your capital gain when you sell a home. For example, if you paid $15,000 in real estate commissions to sell a $250,000 home, you add that figure to the amount of money you paid to buy the home in order to calculate your taxable gain (profit) when you sell your home. Under current tax law, you can exclude up to $250,000 in home sale profits ($500,000 for a married couple filing jointly) from capital gains tax, so for most people this is no longer an issue. But if you are fortunate enough to buy a home that increases more than $500,000 in value before you sell it, you can deduct costs such as real estate sales commissions from your taxable gain.
Legal fees and any other costs incurred in the sale of your home also reduce your cost basis for purposes of calculating your taxable capital gain, if any. So keep track of them when you sell.
Mail your real estate questions to Steve Tytler, The Herald, P.O. Box 930, Everett, WA 98206. Fax questions to Tytler at 425-339-3435, or e-mail him at economy@heraldnet.com.
