Second in a series of articles
Our tax laws encourage homeownership in three major ways. When you file your annual federal income tax return, you can deduct the interest you pay on your mortgage, up to a limit. You can also deduct the real estate tax you pay to your state and local governments. And when you sell your home, in many cases you can avoid federal tax on a sizable portion of the profit, or capital gain.
The mortgage interest and real estate tax deductions apply both to principal homes and second homes that are used part of the year. The capital gains tax exclusion applies only to a principal residence. (Investment property also gets tax breaks, but this column will look at personal homes.)
There is, however, no definition of principal residence in the tax code. If you ask an Internal Revenue Service agent -- or your tax lawyer -- for a definition, he will advise you that "whether or not property is used by the taxpayer as his principal residence . . . depends on all the facts and circumstances in each case, including the good faith of the taxpayer."
What does that mean?
There have been few court cases in which "principal residence" has been defined, but in those cases, judges provide the same answer: We will investigate the facts of each case and make our decision based on those specific facts, case-by-case.
If you have lived in the same home for many years and consider it to be your only home, it will clearly be your principal residence. The key components that will guide and assist the courts and the IRS in deciding are:
Where do you pay your state or local income tax?
Where do you vote?
What is the address on your driver's license?