Posted: Monday, January 26, 2004

WASHINGTON (AP) Energized by the lowest mortgage interest rates in more than 40 years, home sales and refinanced loans moved at a record pace last year. The bustling mortgage activity means more taxpayers must master the complex rules that help homeowners win big tax advantages.

''It's tax-favored in a number of different ways,'' said Bernard Kent, a personal financial services partner at PricewaterhouseCoopers.

The benefits of home ownership stem from tax deductions for home expenses like mortgage interest and real estate taxes. When the total of those costs and other deductible items amounts to more than the standard deduction, it can mean a big tax bonus for homeowners.

If taxpayers find their deductions exceed the standard amount, they should itemize them on Schedule A. The standard deduction for 2003 is $4,750 for single people and $9,500 for married couples.

In most cases, the biggest tax advantage of home ownership is the mortgage interest deduction. Taxpayers can also deduct some of the many costs of buying, owning and selling a home. Vacation homes, home equity loans and home-based businesses come with their own sets of complex rules:

- Home buying. Buying a home means taxpayers can start to capitalize on mortgage interest and real estate tax deductions. The closing statement prepared for the purchase includes most of the information new homeowners need. Many of the costs paid at closing aren't deductible, including fees for an appraisal, notary services and preparation of the mortgage note or deed.

The points, or fees a bank or lender charges a borrower, might be immediately deductible. The points must meet certain requirements, and they must not be charged in place of the fees and taxes typically due at closing.

Some taxpayers might qualify for a tax credit that covers a portion of mortgage interest. Low-income taxpayers should contact their state or local government to find out if they qualify and secure a ''mortgage credit certificate'' before obtaining a mortgage.

- Home Owning. Homeowners can expect to get a statement from their lenders showing deductible interest paid during the year. That interest represents the biggest benefit available to most homeowners.

What many don't know is that other mortgage costs can also be deducted, including late payment charges and early payment penalties. Interest paid in advance is not immediately deductible.

Real estate or property taxes paid during the year are also deductible. Charges for city services such as water and garbage pickup do not count as deductible taxes, nor do homeowner dues.

- Home selling. Individuals selling their homes can keep up to $250,000 of capital gains tax-free if they owned and lived in the home as their principal residence for two of the five years before the sale. That amount is doubled to $500,000 for married couples.

Some fees paid when purchasing the house can be recouped by adding them to the basis the starting point for figuring gain or loss when selling the home.

Any long-term gain exceeding the tax-exempt limits would be taxed at a maximum rate of 20 percent if the house was sold before May 6, 2003. Lawmakers lowered the top capital gains rate to 15 percent as of May 6, 2003.

- Refinancing. Homeowners who refinanced their mortgages to take advantage of lower interest rates should keep in mind that their tax advantage might shrink along with their monthly payment.

Unlike many home buyers, homeowners who refinanced their home loans cannot immediately deduct points paid. The points must be spread over the life of the loan. For example, if a homeowner paid $2,000 in points on a 15-year refinancing mortgage (180 payments), the homeowner could deduct $11.11 per month or a total of $133.33 for the 12 payments made during a year.

If a portion of the refinanced mortgage is used to pay for home improvements, the homeowner may generally deduct the points associated with the home improvement that year, spreading out the remainder over the life of the loan.

- Other loans. The interest on up to $100,000 of equity loans secured by a taxpayer's primary home are deductible in most cases. That includes home equity loans used for personal consumption, such as a new car, college costs and even credit card debt. But taxpayers with income above $139,500 may face limits on their itemized deductions, including their mortgage or home equity interest.

Mortgage interest on a vacation home is generally deductible, but the situation gets more complicated if the home is rented out more than 14 days during the year.

Taxpayers then need to look closely at the rules for vacation property and rental property.

An entrepreneur or telecommuter may be able to deduct the costs of a home office if a portion of the home is used regularly and exclusively for business. The expenses typically include a portion of rent, depreciation, repairs and utilities. The rules are complicated, and a separate form must be filed to claim home office deductions.

On the Web:

Internal Revenue Service - http://www.irs.gov

Publication 523 Selling Your Home - http://www.irs.gov/pub/irs-pdf/p523.pdf

Publication 530 Tax Information for First-Time Homeowners - http://www.irs.gov/pub/irs-pdf/p530.pdf

Publication 587 Business Use of Your Home - http://www.irs.gov/pub/irs-pdf/p587.pdf

Publication 936 Home Mortgage Interest Deduction - http://www.irs.gov/pub/irs-pdf/p936.pdf

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