The Retirement Corporation of America

Your Home—Your Tax Shelter

YOUR HOME MAY very well be your castle, and second only to your retirement savings plans, it probably is the very best tax shelter you have. Just to sum up, the tax benefits of home ownership are three-fold:

1. Tax deduction of mortgage interest. The mortgage interest is deductible on up to $1 million used to buy, build or improve your primary home, plus a second home. Furthermore, you can deduct interest on another $100,000 borrowed against the equity in your home, no matter what you use the money for. Years ago, Congress stripped the deductibility of interest on every other kind of loan. Only the interest on your mortgage remains a tax deduction.

2. Tax deduction of real estate taxes. You can deduct from your federal income taxes all the property taxes you paid on all the property you own.

3. Tax break when you sell your home. You can now sell your home and pocket a capital gain of up to $500,000, tax-free. The only restrictions are that you must have personally lived in the home for at least two of the past five years. On the other hand, you can use that $500,000 tax break once every other year. The old law required you to pay capital gains taxes on the sale of a home unless you:

- Bought a home of equal or greater value.

- Were at least 55, in which case you got a one-time-only break in which the first $125,000 of capital gains were tax-free.

Making maximum use of the mortgage interest deduction. Since real-estate related interest is tax deductible and the interest on other types of loans is not, you want to use that deductibility to your best advantage. All things being equal, when you need money badly for some worthy, long-term purpose, turn first to the built-up equity in your home. You should consider a home-equity loan first for:

•  Paying for major home improvements.

•  Covering the cost of big medical bills.

•  Covering any shortfall in the money saved to send kids to college.

Tax deductibility is a splendid thing to have and the interest rate on a home equity loan will be low compared to the rate on virtually any other form of consumer borrowing. Furthermore, you usually have a very long time to pay off the loan, so the monthly payments will be comparatively reasonable. Just keep this in mind:

•  The collateral for a home equity loan or second mortgage is your home. If you cannot pay it back, you will lose your home.

•  It is generally poor financial practice to borrow long-term to finance short-term expenses. It might sound like a great idea to finance your next car with a home equity loan. The interest rate is favorable and tax-deductible to boot. Because the loan is a long-term loan, the monthly payments are pretty reasonable. But in three years, you will want another car and finance that with another home equity loan with the first loan only partially paid down. Three years later, you might do it again.

Using long-term debt to finance short-term expenses can get you into financial trouble as easily as anything you can think of. Sure, you can pay off all of your home equity debt when you sell the home but you may want to spend the proceeds of the home sale on other things. If you use home mortgage debt wisely, it's a powerful tax-sheltering tool. Abuse it, and all the tax-sheltering features in the world won't keep you out of trouble.

Making maximum use of the tax-free sale of your home.
Allowing the first $500,000 of the gain on the sale of your home to be tax-free creates a blockbuster tax shelter.