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March 27, 2012 at 09:19 AM
Continuing with the theme of how I employ tax planning in my advisory practice (part of AdvisorOne’s Special Report, 22 Days of Tax Planning Advice for 2012), in this post we’ll examine the tax issues to remember when a client buys a home.
As we all know, housing prices have experienced a severe decline over the past four years. Even so, according to the Case-Shiller index, they are still above the 2000 level. In some portions of the country, mainly the areas which experienced the greatest run-up, prices have fallen more sharply. All this presents a great opportunity for those with the courage and financial resources to step up to the purchase window. In this post, we’ll examine some of the tax consequences of becoming an owner of rental real estate.
Basis
A person’s tax basis is essentially the net cost of an investment asset. In real estate, it includes the amount you pay for it in cash, in debt obligation, in other property or in services. In addition, if you paid sales tax on the property, it may be added to your basis if you did not deduct state and local general sales taxes as an itemized deduction on Schedule A (Form 1040).
A few other additions to basis include: freight charges to obtain the property and installation and testing charges. Also, if the previous owner owed real estate taxes, and you paid them and were not reimbursed, these taxes are added to your basis. However, if this is the case you cannot receive a deduction on the taxes you paid. Other fees that are added to basis include: abstract fees, charges for installing utility services, legal fees, recording fees, surveys, transfer taxes, title insurance and any amounts the seller owes that you agree to pay, such as back taxes or interest, recording or mortgage fees, charges for improvements or repairs, and sales commissions.
The following are settlement fees and closing costs you cannot include in your basis in the property. They include: fire insurance premiums, rent or other charges relating to occupancy of the property before closing, charges connected with getting or refinancing a loan such as: points (discount points, loan origination fees), mortgage insurance premiums, loan assumption fees, cost of a credit report, and fees for an appraisal required by a lender.
Basis is important for a number of reasons, most notably that when you dispose of the property, you will subtract the adjusted basis from the net sales proceeds to determine the amount subject to taxation.
