It’s that time of year again. Holiday music plays ad nauseum in retail stores. Holiday lights get strung up, and everyone is asking everyone else what they’re doing for New Year’s Eve.
For home buyers who are hoping to find a new place in time to register their children for the Spring semester, it’s a tense, busy time. There are decisions you must make, even if you’d rather not, and boxes to be packed, instead of wrapped.
One of the most important decision is whether or not you’re going to close on your new home by December 31st, or wait until January 2nd. Although a mere two days apart, closing on New Year’s Eve or the first business day of January could have an impact on your finances. It’s wise to think ahead about this choice, and choose carefully.
How should you know when to close? The answer starts with federal income tax deductions.
The federal government allows you to deduct the mortgage interest you pay from your federal income taxes. For some people, that allows them to deduct more than the standard deduction everyone is entitled to. But when you purchase a home, you’re also allowed to deduct any origination points (a point is one percent of the loan amount) you pay for your new loan.
If you’re closing at the end of this year, you may choose to pay an additional point or two (which is deductible), and lower your interest rate. This is especially helpful if you’re moving into a home you’re going to be in for at least 7 to 10 years or longer. You’;ll get to increase your deductions, and will save thousands of dollars over the life of the loan by having the lower interest rate.
Another way to boost your deductions is to prepay your first month’s interest at the closing. If your mortgage costs you $1,500 per month, almost all of the first payment will be interest and, therefore, deductible. By planning carefully, you’ll be able to maximize your deductions for this year.
However, if you’re a first-time buyer, and not currently itemizing your deductions, it may make more sense to push all of these expenses and future deductions into the new year. If the amount of mortgage interest you’ll pay on your new home will allow you to benefit from itemizing, you should consider taking all of the home-buying deductions you can in the new year.
If you don’t currently itemize, and you don’t expect that you’ll do so with your new home purchase, it doesn’t really matter when you close. Pick the date that is easiest for you.
Here’s another wrinkle. If you’re selling a home at the same time you’re buying, and you expect to spend less on your new purchase than you receive from your sale, you may want to wait until the new year to close on your sale. That’s because President Clinton promised a significant capital gains relief to home sellers. Essentially, he promised that sellers could exclude the first $500,000 of capital gains each time they sell their home. Although no one expects tax relief at this level, if something is done in 1997, it will likely be made retroactive to January 1st. (Although no specific promises were made, there’s talk about sellers being able to deduct losses as well.)
Although you may need a bridge loan to cover the gap between your purchase on December 31st and your sale on January 2nd, you may find it ultimately worthwhile. As always, check with your tax advisor for more details.