Last week, in response to a reader's question, I explained how to determine the annual deduction for mortgage interest and property taxes when itemizing on an income tax return.
But the person who asked the question is a first-time homeowner. I think now the answer should have been expanded to include the one-time deductions available upon purchase of a new home.
Each transaction is different, of course, and you should examine the closing statement carefully to be sure you don't miss any bets. But there are some general rules that will help you pick out the right items.
If you paid points to sweeten the interest rate as an inducement to the bank or mortgage company to grant the mortgage, the total amount of the points qualifies as interest in the year paid.
(The seller of the house cannot deduct any points he was required to pay. But that amount can be added to the cost basis to reduce the gain on the sale.)
Usually some adjustment of interest and taxes between buyer and seller is required at the time of closing. You have to figure out what actually happened to know who gets what as far as income tax is concerned.
For example, if the seller already had made the mortgage payment for the month and the closing statement shows that you (the buyer) repaid to the seller the amount of prepaid interest applicable to the period after the closing, that amount should be included in your interest deduction.
On the other hand, if you close early in the month, the seller may not have made the payment for the month yet. If the seller is paying off the mortgage balance, this will not affect you.
But if you're assuming his mortgage and the seller pays you his pro rata share of the interest for the days up to the closing date, you should subtract the amount of his payment to you from the total interest the bank says you paid for the year.
The same principle applies to property taxes. If you pay to the seller your pro rata share of prepaid taxes, you get to deduct that amount on your tax return. But you must substract any unpaid property tax money advanced to you for the number of days the seller had occupancy (or title) before you closed on the property.
A lump sum payment into the escrow account required at closing by your mortgage bank is not deductible even if it is to cover anticipated tax payments. As explained last week, you may only claim property taxes actually paid on your behalf by the bank (plus or minus the closing statement adjustments explained above).
Premiums for property insurance on your residence are not deductible at any time. Legal fees and other closing costs should be added to your cost basis, so they will reduce any capital gain at the time of sale.
This explanation, together with last week's column, should now provide a more complete answer to the reader who asked the question and to anyone else who bought a home in 1980.
Question: Can I deduct as a medical expense the cost of a program to help me stop smoking?
Answer: Well, officially the IRS says this does not qualify, since it is intended for the improvement of your general health rather than as treatment for a specific health problem.
But this is a grey area, and in my opinion it depends on the individual circumstances. If you decided on your own that quitting would be a good idea, then it might be difficult to justify the deduction.
But if you signed up for the program on the advice of your physician, particularly if you were showing symptoms of an incipient problem like emphysema, then I would consider it a valid medical deduction.
In this case, you can deduct not only the fee for the program itself but also your transportation costs (at 9 cents a mile if you use your car).
If the deduction is disallowed later as a result of an audit, you will be required to pay only the extra tax (plus interest from the due date of the return). There would certainly be no action for tax fraud.