Tips for Homeowners to Ease the Tax Bite

Tips for Homeowners to Ease the Tax Bite

In addition to deducting interest payments, homeowners can use these strategies to reduce their taxes

By: Anya Martin

March 4th, 2015

The Wall Street Journal

Jumbo borrowers enjoying low, low interest rates may have a bitter pill to swallow come tax time: The IRS limits the deduction on interest payments for loan amounts over $1 million.

Happily, homeowners have other ways to soften the tax bill, accountants say. Here is some advice from four CPAs:

Rule of two. The $1 million restriction applies to debt acquired to buy, build or improve a home, as well as an additional $100,000 of home-equity loan or line of credit debt. But deductions can be applied to up to two homes (or a boat or any structure that has plumbing and a bathroom).

Borrowers will come out ahead by first deducting interest payments on the loan with the highest interest rate—which is often the second home, says Jeffrey Schragg, tax partner at the McLean, Va., office of global accounting firm BDO USA.

Back to nature. Got a scenic lookout on your property or a wetlands that attracts a variety of birds? A homeowner can take a conservation easement and donate that land to a nonprofit that will manage its preservation. The homeowner can then take an itemized deduction of the appraised land value as a charitable contribution, Mr. Schragg says. He has seen this deduction used mostly for second homes, which are more likely to be in locations of natural beauty, he adds.

“It doesn’t have to be open to the public, it just has to be preserved and it can’t be developed,” Mr. Schragg says. “Sometimes if it’s a large piece of property, the owner will do it in increments over several years.”

Conserve energy. If a home remodel includes energy-efficient products or a solar-energy system, a portion of the cost may be eligible for a residential energy credit, says Mary Canning, dean emeritus of Golden Gate University’s School of Taxation and Accounting in San Francisco. Some federal credits expire with the 2014 tax year and have varying caps, such as $200 for energy-efficient windows and $500 for insulation. Some high-cost upgrades have credits that can go up to 30% of the cost, including installation of solar panels, solar hot-water systems, a geothermal heat pump and small residential wind systems. These credits expire in 2016.

‘Whatever is claimed must be substantiated with documentation — canceled checks, credit-card receipts, bank statements’

In California, eco-friendly upgrades of existing energy systems are growing in popularity for both people who plan to sell while home prices are up and those who plan to stay, Ms. Canning says. “People are more and more looking at this being the place where they are going to retire and putting in solar,” she adds.

Home-office homework. The home-office deduction is a notorious potential red flag for an IRS audit. But for people who genuinely do work from home, it can be a lucrative deduction, says Eric L. Green, a partner with Stamford, Conn.-based law firm Green and Sklarz, which specializes in tax matters. Eligible for deduction: office space, as well as a share of certain expenses that apply to the entire home, such as mortgage interest, utilities, property taxes, insurance and even landscaping and snow removal, he adds.

To survive an audit, the area designated as office must be used exclusively for work, with a few exceptions, such as an in-home day-care service. And the space should be a reasonable proportion, Mr. Green says. “If someone is claiming 42% of their home as a home office, stuff like that is an audit trigger,” he says.

Keep receipts. When a home is sold, the seller doesn’t have to pay federal taxes on the first $250,000 if filing single or the first $500,000 if filing jointly of the capital gains. To lower the potential tax hit, certain home-related expenses can be subtracted from the profit, including money paid for upgrades, closing costs, property taxes and transfer taxes from the initial purchase, says Robert Winton, a partner with White Plains, N.Y.-based accounting form Citrin-Cooperman.

Still, whatever is claimed must be substantiated with documentation—canceled checks, credit-card receipts, bank statements, Mr. Winton says.

“If you are audited, you have to be able to show that you spent the money on the house, and that it was an improvement, not just maintaining the house,” he adds.