And a ruling by the IRS in late 2002 could put more dollars in homeowners' pockets when they must sell before they qualify for the full tax break. The Treasury has defined the unforeseen circumstances that often force homeowners to sell and under which they now can get some tax relief. They include:
Death,
Divorce or legal separation,
Job loss that qualifies for unemployment compensation,
Employment changes that make it difficult for the homeowner to meet mortgage and basic living expenses, and
Multiple births from the same pregnancy.
A partial exclusion can be claimed if the sale was prompted by residential damage from a natural or man-made disaster or the property was "involuntarily converted," for example, taken by a local government under eminent domain law.
What's not deductibleWhile many tax breaks are available to a homeowner, don't get too carried away. There are still a few things for which you have to bear the full cost.
One such expense is insurance. If you pay private mortgage insurance because you weren't able to come up with a large enough down payment, that's a cost you can't write off at tax time. Neither can you deduct your property insurance premiums, even though the coverage generally is required as part of the home loan and is included as a portion of your monthly payment.
Other nondeductible residential expenses include homeowner association dues, any additional principal payments you make, depreciation of your home, general closing costs and local assessments to increase the value of your neighborhood, such as construction of new sidewalks or utility connections.
What about all those repairs that seem to crop up the day after you move in? Surely they're tax deductible. Sorry. While they'll make your house much more comfortable, you're on your own here, too.
But hold onto the receipts. In today's hot real estate market, some homeowners may find their property will appreciate beyond the $250,000 ($500,000 for married couples) amount the IRS will let you keep tax free when you sell. If that happens, the records of property improvements could help you establish a higher basis for your house and reduce your taxable profit.
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-- Updated: Dec. 6, 2006