Question

Your client Jon recently received a substantial inheritance from his deceased grandfather, who expressed in his will his desire that Jon invest at least 75% of the money in real estate (which is how Grandfather made his fortune). Jon is in the market for his first home. He plans to make a down payment of 20% of the home’s purchase price and finance the rest with a mortgage. Jon also wants to purchase some investment property in the form of residential rental real estate. Moreover, Jon is thinking about starting a real estate development company to convert a 120-acre parcel of raw land, on which he owns an option to buy, into residential building lots. 1. Outline briefly the major federal income tax benefits Jon may expect from owning and ultimately selling a personal residence. 2.In connection with Jon’s ownership of the residential rental real estate, explain briefly what tax deductions he might expect to be able to offset against the projected rental income from the property or properties, and where in the Internal Revenue Code he might find the authority for such deductions? 3.Assuming Jon exercises the option to buy the raw land, discuss briefly the factors involved in the question of whether he will be considered to be in the “trade or business” of real estate development and what this might mean for Jon in terms of the tax treatment of the income he receives on the lot sales. 4.Jon mentions to you that someone at his club told him that it is important that he qualifies as a “real estate professional” for tax purposes. What do you tell him when he asks if this is true and if so, why?

Answer 1

1. There are various facts with regard to tax benefits available to the consumer considering purchasing or selling home. It involves a huge investment and the government plays a vital role in encouraging the buyers of homes. Hence the buyer or seller of homes are provided with various monetary benefits in the form of tax benefits. However these tax benefits can be availed with certain conditions and restrictions.

In this case Jon wants to purchase his first home. He plans to make a down payment of 20% of homes purchase price and finance the rest with a mortgage. There are major tax benefits available in regard to interest expense by a house owner for purchasing home purchase with mortgage. Thus mortgage interest is deductable from the taxable income. But for availing this deduction they need to for go the standard deductionavailable to them , and itemize the deductions for availing benefits of deductions upto 750000 of mortgage debt from their income taxes.

Moreover for a homeowner property taxes paid are also deductable from taxable income.i.e., State and local level real-estate taxes but the maximum deduction allowed is 10000.

There are other expenses eligible for deduction example insurance, depreciation, repairs etc.

On selling the property which qualifies as your primary residence the benefits of deduction of capital gains upto 25000 in home appreciation can be done and thus upto this amount of gain therewill be no tax at the federal level. If the consumer is married and filling a joint return then upto 500000 can be excluded provided all other requirements are met. Homeowner can be eligible for this exclusion only when this home has been used at least 2 out of 5 years as the primary residence before the sale has been taken.

2.With respect to the residential rental real estate the owner can deduct mortgage interest and the state and local real estate taxes. More over operating expenses with respect to the rental properties are also deducted. Loan origination fees which is paid while financing the rental property is treated as a form of interest and hence qualifies for deduction.

Similarly any form of interest whether paid on unsecured loans for the property or interest payment on credit card used for property expenses are deductable from your taxable income.

Licensing fees and rental property taxes and occupancy taxes are made by the rental property owner however they are tax deductable. There are various common utilities that can be claimed for tax deduction by the consumer .