I know Halloween is right around the corner, but I certainly don't want to scare you; tax season is approaching. And now is the best time to make sure that everything is in order to ensure you get as much of your hard earned income back from the government as you possible can. Of course I'm assuming that you only have as much deducted from each paycheck as you have to in order to cover your tax bill. If you're getting a hefty tax refund each year, Uncle Sam would like to thank you for the nice no-interest loan your giving him, but your money can work better for you. If you're like most Americans, you're not really sure how much you should be having deducted each year though. Luckily the good men and women at the IRS have setup a nice little site that allows you to calculate how much you should be having withheld. I encourage you to put it to use.

Now, to today's topic. Your home will most likely be the single biggest investment in your financial portfolio, except possibly a business. And it's really much more than that. I mean, it's our home. It's your place, your sanctuary from the world. Where your family will gather and friends will visit. For most of us, our homes represent all that we work for. And as a financial asset, from purchase to sale, it has a huge impact on your taxes. So let's take a look at some of the changes in the tax law regarding your home.

This is a great time to be a first time home buyer. I'm sure by now you've seen the ads: first time home buyers get up to $8,000 as a tax credit if they buy in 2008 or 2009. First, let's look at some of the terms here.

• First time home buyers: This sounds as if you have never owned a house before, but actually it means that you or your spouse haven't owned another house in the three years before you bought this one.
  
• up to $8,000: For 2009, you can claim the smaller of $8,000 or 10% of the purchase price of the home. And you have to split the credit with anyone else who is a purchaser. So if your spouse is on the contract, and filing separately, you share the credit.
  
• tax credit: This means different things depending on if you bought the house in 2008 or 2009. If you bought in 2008, the tax credit is actually a loan, repaid over 15 years. If you bought in 2009, it's only repaid if it ceases to be your principle residence within 36 months.

And that brings up something important. One criteria for this credit is that this home must be your principle residence. So buying a home to rent it out, or use for business, or give to your child, none of these will qualify you for the credit.

And the credit is phased out (reduced) when your modified adjusted gross income reaches $75,000, $150,000 for married filers, and is eliminated for single filers over $95,000 ($170,000 for married, filing jointly).

There are some other exemptions on who can take the credit: the house must be located in the U.S., nonresident aliens can't take the credit, you are given the house as a gift or inheritance, or if it's sold to you by a related party (i.e. parent, grandparent. corporation you own 50% of).

Still, it's a awfully good incentive to buy a home, especially with prices down as they are.

A little background first, so you will see why this is important:

The Treasury Department and their staff at the IRS define income as any increase in you wealth. They would no doubt love to tax you on the pennies you find in the street, but they don't because the cost of tracking that income exceeds any tax their likely to get. So, what about debt that your creditor has decided yo discharge, that is they've decided you don't have to pay after all? According to the IRS, if you no longer have to pay a debt, that translates as an increase in your wealth and you have to include that in your income.

For instance: you have racked up $10,000 in credit card bills, and instead of filing bankruptcy, you work out a deal with the creditor to pay off $6,000 and they will discharge the other $4,000. At the end of the tax year, you should get a form 1099-C, a Cancellation of Debt, that includes the $4,000 that you would then add into your gross income, and then pay taxes on. (Remember though, it's your responsibility to know if a debt should be included in income, whether they send out the 1099 or not!)

So that sucks, right? You just got out of a huge debt, now you have to pay taxes on it. And if that debt was a mortgage, the taxes could be crushing. With so many foreclosures over the last few years, this is a situation that could really hurt homeowners who are already in the terrible position of being foreclosed on!

The government recognizes that and as part of the Emergency Economic Stabilization Act of 2008, they suspended the discharge of indebtedness penalty. And the rules are pretty simple: if your home was foreclosed on between 2006 and 2013, any change in your position isn't recognized as income.

Perhaps an example: Gabriel buys a house for $200,000 in 2006, and then in 2008 loses his job which leads to the house being foreclosed, with $175,000 still outstanding. The fair market value of the house is $150,000. When the bank takes back the house, Gabriel is still liable for $25,000, the difference between the balance on the loan and the value of the house. But the bank knows Gabriel can't pay it, so they discharge the remaining $25,000. If this had happened in 2005, Gabriel would have to include this as income on his tax return. But since it's 2009, he attaches a Form 982 and correctly excludes that money from income. 

Simple, right?

As a general rule, the IRS has allowed you to exclude up to $250,000 of the gain you made selling your home as long as you met two criteria. You must have owned the house for at least two years, and you must have lived in the house as your main home for the prior two years. What if you don't meet those two rules? Then the gain you make on the sale has to be included in your gross income.For 2009 there's a new rule in place: Any gain from the sale or exchange of your main home is no longer excludable from income if allocatable to periods of nonqualified use. Generally, nonqualified use means any period after 2008 where neither you nor your spouse used the property as a main home.

Alright, what does this all mean? It's about trying to close loopholes in the use test. You have to have lived in the house you sold, as your main home, for two years. But what if you live there 300 days of the year and rent it out while your on vacation? What if you run a business from your home? So the IRS requires you to allocate the time you spend "living" in your home versus the time spent trying to earn money with your home. The income exclusion is an attempt to help out home owners, not business people, so they want you to show that the house you sold was your primary residence. If all you did was live there, then you can take the credit without issue. If you used the house to generate money, you have to allocate the time, just divide the time spent doing other things by the total time you've owned the house. That's the proportion you have to reduce your exclusion.

There are two exclusions to this rule:

1. If any portion of the 5-year period ending on the date of the sale or exchange that is after the last date you (or your spouse) use the property as a main home. In other words, as long as you've used the home as your principle residence in the 5 years before you sold;
2. Any period (not to exceed an aggregate period of 10 years) during which you or your spouse is serving on qualified official extended duty as a member of the uniformed services, as a member of the Foreign Service of the United States, as an employee of the intelligence community; an employee or volunteer in the Peace Corps and any other period of temporary absence (not to exceed an 2 years) due to change of employment, health conditions, or such other unforeseen circumstances as may be specified by the IRS.

And there we have the major changes in tax law affecting your home for the 2009 tax season. Overall, very beneficial for tax payers. As usual I want to state that I am not a CPA or tax professional and this page is provided for information only, not as tax advice. Everyone has different tax issues, and how these rule apply to you is something you need to discuss one-on-one with your tax adviser. Anything you think is incorrect or are interested in getting more information on, drop me a line. I look forward to hearing your comments.