December 29, 2010

Expensive Houses Have Little Impact on Alternative Minimum Tax (AMT)

I saw someone recently make a claim along the lines that someone buying an expensive house is basically forced to pay AMT or the Alternative Minimum Tax.    I've seen this kind of statement before.   I wasn't sure how much impact expensive housing would have on AMT so I decided to find out.

AMT is pretty complex and I don't think most people really understand how it works.   I only have a basic understanding of it myself.   I decided to work through an example of a relatively high income household with an expensive home.   Below I figure the regular tax and the AMT and see how an expensive home impacts AMT.

Here's the example situation : Lets say you make $200,000 a year and are married with no kids.   Your ONLY deductions are your mortgage interest, your property tax and your state income tax.   You live in San Francsico and own a tiny house that cost $800,000.  Your mortgage interest is $40,000, your property taxes are $12,000 and your state income tax is $10,000.   You also have two exemptions for you and your spouse for $7,300 total.  

Figuring your taxes normally :
Income = $200,000
Itemized deductions = $62,000
Exemptions = $7,300
Taxable income = $130,700
Normal TAX = $25,038

Now lets figure your AMT.   This is more complex.  To figure AMT you use   Form 6251  and Instructions for Form 6251

Start with form 6251.

Line 1 is the taxable income without exemptions from form 1040 line 41, which is $138,000
Line 2 doesn't apply
Line 3 $22,000 for the state and property taxes
Line 4 the mortgage interest deduction is $0 in this case because the mortgage is entirely eligible mortgage interest used to buy the house.
Line 5 doesn't apply
Line 6 maybe around $400
Lines 7-28 don't apply
Line 29 alternate minimum taxable income is sum of lines 1-28 = $159,600

Line 1 in form 6251 is your income less the deductions.   Then you add back some deductions and other things.   For example in line #3 we add back the state and property taxes of $22,000.     Line #4 would add back any mortgage interest on things that are not eligible like a HELOC used to buy a car.    But in this case the mortgage is an eligible mortgage on a primary residence so it does not add back the mortgage interest.  However the AMT does not remove your state and local taxes from your income to figure the alternate minimum taxable income.  So AMT does not consider local or state taxes as deductible.

The interest on the mortgage is not taxable by AMT but the property tax bill for the house is taxed by AMT.

Line 30 is $70,950
Line 31 is 29 minus 30 = $88,650
Line 32 26% of line 31 = $23,049
Line 33 is $0
Line 34 tentative minimum tax is $23,049
Line 35 normal tax from 1040 line 44 $25,038
Line 36 AMT line 34 - 35, if zero or less = 0.   So the AMT is ZERO

Line 30 is the exemption which in this case is $70,950 since its a married couple.   The exemption is subtracted from the alternate minimum taxable income to get us line 31.   The tax rate is then figured by multiplying 26% times the figure in line #31.   In lines 35 we insert the normal tax rate figured above.   Line 36 subtracts the normal tax from the AMT.  In this case that would be less than zero.  In other words the normal tax rate is more than the AMT rate so the AMT tax is ZERO.  If on the other hand the AMT tax rate was higher than the normal rate you'd add the difference and effectively pay the AMT rate.  

Follow all that?  I did say it was complex.   If you don't follow the details of how I calculated the AMT then thats OK.

So this family has a high income $200,000 and a very high cost home worth $800,000 that they spend $40,000 in interest and $12,000 in property taxes on.    Yet they do NOT owe AMT tax.

The interest they pay on their eligible home mortgage does not hurt them for AMT taxes.   However the property tax they pay does hurt them.

One key to this is if the mortgage interest is eligible or not.   An eligible mortgage is defined as :
"An eligible mortgage is a mortgage whos proceeds were used to buy, build or substantially improve your main home or a second home that is a qualified dwelling.  A mortgage whos proceeds were used to refinance another mortgage is not an eligible mortgage."

That bit about using proceeds to refinance another mortgage kinda sounds like refinanced loans don't count.  However what they mean is that you can't pay off a mortgage on some other property and have it count.  If you refinance a mortgage it is eligible if you simply refinanced an existing eligible mortgage.   If you take cash out and didn't use the money to improve the house then that portion is not eligible.  The IRS clarified this point that refinanced mortgages are eligible.

Bottom Line:    High mortgage costs should not contribute into pushing you into AMT.   High property or state taxes can make a difference for AMT.  Generally expensive housing alone is not going to 'force' people into AMT.

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