Ten Tax Laws You Gotta Know

This filing season, the biggest beneficiaries of new tax laws are homeowners.

Unfortunately for some, any joy about a new tax break is tempered by the fact that it was created because they were having trouble paying their mortgages.

On a more positive note, another new law now allows some homeowners to deduct a common insurance cost.

A similar good news/bad news theme runs through other 2007 tax legislation.

A last-minute compromise on Capitol Hill granted millions of taxpayers a reprieve from the costly alternative minimum tax. But at the same time, the law means millions might have to wait to submit their returns and get any refunds.

And while one law made it easier for some to give to their favorite charities, another will have some philanthropic filers scrambling to find receipts.

Here's a look at 2007's new tax laws, combined with some provisions carried over from 2006, that could affect your current tax bill. For your 2008 tax planning purposes, we also take a peak at a couple of laws that took effect Jan. 1.

New tax laws

Several tax code changes will affect 2007 returns, but in many cases they are designed for very specific taxpayer circumstances. A few carryover provisions will offer some tax savings, especially for energy-conscious taxpayers. And a couple of law changes passed last year took effect Jan. 1 and could affect your 2008 tax planning.

1. Mortgage debt forgiven

2. Deductible mortgage insurance

3. AMT relief, delay

4. Donation documentation

5. Older philanthropist options

6. 'Enron' retirement catch-up

7. Home energy savings

8. Fuel-efficient autos

9. Popular deductions reappear

10. 2008 tax changes

1. Forgiven home debt nontaxable

The year 2007 was dominated by housing woes. Many individuals who took out adjustable-rate mortgages to buy homes discovered that those loan terms, a changing economy and slumping housing market combined into a perfect homeownership storm.

Many individuals lost their houses to foreclosure; others were able to renegotiate more manageable payment terms. But in both cases, many of those homeowners soon discovered that they also owed unexpected taxes related to their real estate transactions.

Tax laws consider debt that a lender forgives as taxable income. In a homeowner's case, for example, if the bank reworks a loan so that the principal is less and writes off that excess, the amount is taxable cancellation of debt income. The same is true in certain situations where a mortgage lender forecloses on a home and sells it for less than the owner's loan principal. For example, if a bank forecloses when the borrower owes $400,000 on a home and then sells the property for $310,000 in full satisfaction of the debt, the borrower will usually owe tax on $90,000.

Although the taxability of debt forgiveness amounts has long been on the tax books, it came as a huge surprise to many homeowners.

"People who didn't have the money to meet their mortgage payments have found that they owe income taxes on tens of thousands of dollars," says Mark Luscombe, principal federal tax analyst with CCH, a tax software and publishing company in Riverwoods, Ill. "It seems like the tax system is kicking them when they're down."

Apparently, politicians thought so, too. Under the Mortgage Debt Forgiveness Act of 2007, some homeowners granted forgiveness of mortgage debt won't have to pay taxes on that amount. But there are some restrictions:

1. There is a limit on the forgiven debt: up to $2 million or $1 million for a married person filing a separate return.
2. The tax break also has a time limit. It only applies to mortgage debt discharged by a lender in 2007, 2008 or 2009.
3. The loan also must have been taken out to buy or build a primary residence, not a second or vacation home. If debt is forgiven on those additional properties, the owner will owe cancellation of debt income as usual.

2. Writing off private mortgage insurance

When a homebuyer does not make at least a 20 percent down payment, lenders usually require private mortgage insurance, or PMI. For some loans taken out in 2007, PMI payments are now deductible.

"I don't think there's any question that it's a good idea," says Don Hodson, an enrolled agent with the Financial Enhancement Group in Anderson, Ind. However, Hodson has some concerns about the implementation of this tax break.

"Many people really don't know what PMI stands for or even what it is," he says. "You're actually being asked to purchase an insurance contract to guarantee the balance due. That required cost is actually a cost associated with the purchase and now it can be deducted just like home mortgage interest."

Kathy Harrison-Suits, an enrolled agent with Summit Capital Advisers in Tacoma, Wa., shares Hodson's PMI deduction concerns.

"This is a real area of concern for people," says Harrison-Suits. "Most people don't know what PMI is and my fear is that they're going to assume, 'I pay insurance on my house for my mortgage' and think they are eligible."

In fact, Harrison-Suits has already had some clients call about this tax break, thinking that their homeowner hazard insurance premiums qualify.

And even taxpayers who understand PMI and make such payments might not be able to use this tax break.

"Treasury gives with the right hand and takes away with left," says Hodson, pointing to the deduction's many restrictions.

It is phased out for taxpayers with adjusted gross incomes exceeding $100,000 ($50,000, if married filing separately). "It's reduced by 10 percent of every $1,000 over that $100,000 base. So if you have $110,000 income, you can't claim it," says Hodson.

The deduction also applies only to PMI policies issued in 2007, 2008, 2009 or 2010. Originally, the tax break was only for 2007 PMI payments, but it was expanded for the three additional years by the Mortgage Debt Forgiveness Act.

And the mortgage for which the insurance payments are made must be to buy or build a first or second home. If the PMI is in connection with a home equity loan, the funds must be use improve the property for the premiums to be deducted.

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