Home, deductible home

Barry Salzberg

ALTHOUGH MOST PEOPLE don’t think of it that way, they are probably living in a real estate tax shelter. Whether you build a home or buy one already standing, certain tax benefits will automatically come your way.

Mortgage interest and property taxes are, of course, deductible. Closing costs, such as points paid to obtain permanent mortgage financing, are deductible if the amount is in lieu of interest payments on a residence.

But if you are in the market for a new home, there are greater advantages in buying a building side and becoming your own general contractor. You will still use a builder, so by acting as the contractor, you will merely be obtaining your own construction loan to pay for all the building materials.

As the general contractor, you will be allowed a tax deduction for the amount of interest incurred on any loans used to finance the construction. You also will be allowed a deduction for the sales tax paid on construction materials, provided the amount is separately stated and paid by you to the seller of the materials. If you had bought an existing home, these costs would not be deductible.

Assume that you purchased land for $50,000 and named yourself as the general contractor for the construction of your home. Also, assume that you obtained $200,000 of financing at 14 percent to build the home. If the house takes five months to build, assuming the costs are prorated at 20 percent ($40,000) each month, then the total interest cost will be approximately $7,000. If 60 percent of the financing was used to buy materials and the sales tax rate was 5 percent, the total sales tax cost would be nearly $6,000.

Thus, by constructing your own home for $257,000 ($200,000 for the loan, $7,000 in interest and $50,000 for the land) you would be able to deduct the $7,000 in interest and $6,000 in sales tax. If you are in the 50 percent tax bracket, this would amount to net tax savings of $6,500. Had you purchased a home at the same price, none of this tax or interest would be deductible.

If you want an apartment rather than a house, you might consider buying a cooperative or condominium apartment. Either way, you generally will receive tax benefits similar to those of other home buyers.

In a co-op, you own shares of stock in a corporation that owns or leases housing facilities. As a shareholder, you are entitled to occupy a housing unit in a building controlled by the corporation.

As a result of co-op ownership, you will incur monthly mortgage payments and monthly maintenance fees. The tax law will allow you to deduct both the interest you pay on the mortgage and the portion of your montly maintenance fee that is your share of the corporation’s mortgage interest and real estate tax. To obtain this latter deduction, you must be a “tenant shareholder” (basically, only individuals qualify) and the co-op must qualify as a “cooperative housing corporation.”

To qualify as a CHC, the co-op must meet several tests. One is that it derives at least 80 percent of its gross income from tenant shareholders.

Most co-ops have difficulty in meeting the 80 percent test. In a recent private ruling, the Internal Revenue Service confirmed its position that payments for an apartment used by a doctor, dentist, lawyer or other professional acting in the form of a corporation are not to be considered in satisfying the 80 percent requirement.

The co-op must meet another test: Each Stockholder must have the right to occupy a housing unit for dwelling purposes. The IRS in a recent ruling concluded that the apartment need not be presently suitable for dwelling purposes. The stockholder must merely have the right to alter the apartment so that it might be made suitable for dwelling purposes.

WHEN A CO-OP is used for business purposes or is sublet to derive rental income, the owner will be entitled to deduct all or a major portion of the montly maintenance fee. If an individual uses the co-op for business or investment purposes and the co-op qualifies as a CHC, he will also be entitled to a deduction for depreciation.

If you buy a condominium apartment, you will own outright a dwelling unit in a multi-unit structure. You will also own a share of the common elements of the structure such as the land, lobbies, elevators, and parking and garage areas.

As with the purchase of a house, you may deduct your mortgage interest payment. You may also deduct your share of any annual dues you pay to an owners’ association that comprises real estate taxes on your interest in the land and on the parts of the building owned in common. In addition, you may deduct taxes directly assessed on your apartment unit and on any separate interest you own–a parking space, for example, or a storage area.

If your use your apartment for business purposes or sublet it to derive rental income, you may obtain a deduction for depreciation. And, as with a co-op, your entire monthly maintenance fee would be deductible.

Direct real estate ownership, in the forms described above, has become increasingly popular. As a form of tax shelter, if offers not only significant tax benefits but also substantial economic advantages.

COPYRIGHT 1985 U.S. Chamber of Commerce

COPYRIGHT 2004 Gale Group

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