If you are the buyer, focus on the left-hand column of the closing statement. You'll need to look at both the front and back sides of the statement to get the full story. You may also receive an attached supplemental schedule with further details. Sellers will find what they need to know in the right-hand column. Again, remember to look at both the front and back sides of the closing statement.

OK. On to the specifics.

Buyer's Side of the Deal

As the buyer, your first task is to establish your tax basis (cost) in the new property, for future gain/loss purposes. This equals the contract sales price (from the first line on the closing statement), plus or minus the adjustments explained below.

For example, say your closing statement shows a contract sales price of $253,000 (the agreed-upon price for the house). That number is the starting point for calculating tax basis.

A few lines below the contract sales price, you will see the total amount of settlement charges owed by the buyer (you). Let's assume they add up to $9,000. Included in this figure, you will find some current deductions (good), some outlays that affect your basis (OK), and some nondeductible expenditures (bad).

Now flip over the closing statement and peruse the left-hand column on the back side. It details all the expenses making up the aforementioned $9,000. Here's the tax treatment of the most commonly encountered items.

1. $1,800 loan origination fee. Usually this is 1% of the loan amount. Deduct it as additional mortgage interest on Schedule A of your 1040. The origination fee will also appear as "points" on you annual mortgage interest and taxes statement (Form 1098) sent by the lender. If you just deduct the Form 1098 amount, no further action is required.

2. $3,600 in mortgage interest points paid to obtain a lower interest rate. Second verse, same as the first. Deduct this as additional mortgage interest on Schedule A too. Once again, this number should be included as points on Form 1098. (In this example, a total of $5,400 worth of points should appear on Form 1098 and be written off on Schedule A.)

3. $200 for other costs related to obtaining the loan (appraisal fee, credit report, lender's inspection fee, etc.). Sadly, this is a nondeductible personal expense. While tax law allows an itemized deduction for "qualified residence interest," there's no tax law provision allowing a deduction for out-of-pocket costs of obtaining a personal residence mortgage. Arguably, the cost of the appraisal can be included in the basis of the home, because the buyer might pay this charge even in an all-cash deal.

4. $250 prepaid interest from the closing date to the 1st of the next month. Deduct this as mortgage interest on Schedule A. This number will be "buried" in the mortgage interest write-off reported on your Form 1098. If you just deduct the Form 1098 amount, no further action is required.

5. $700 for hazard insurance (homeowner's coverage) premiums. Unfortunately, this is a nondeductible personal expense.

6. $1,200 for "reserves deposited with the lender." This amount goes to fund your escrow account. It will usually include several month's worth of (1) premiums for hazard insurance; (2) premiums for private mortgage insurance, if any (also called PMI); and (3) property taxes. None of this is deductible at the time of closing, nor does it add to the basis of your home. However, when property taxes are actually paid out of your escrow account, you get a deduction on Schedule A. The amount paid out of escrow will also appear on Form 1098. Once again, if you simply deduct the Form 1098 amount, no further action is required, unless you have an adjustment because part of the tax bill is paid by the seller (see item 11 below).

7. $800 for "title charges," including the settlement fee, title search and examination, document preparation, buyer's share (if any) of title insurance cost, tax certificate, etc. Add the total amount of these charges to the basis of your home, as they are part and parcel of the cost of buying the property.

8. $100 for "government recording and transfer charges," including recording fees and city, county, and state transfer taxes or stamps. Again, these are part of the cost of buying the home and should be added to your basis.

9. $350 for "additional settlement charges," such as a survey of the property, pest inspection, etc. Again, the total of these costs should be added to your basis. However, if all or part of the money in the category goes to the homeowner's association, that amount is a nondeductible personal expense. Another item that may appear here is the cost of a home warranty contract. This is also nondeductible.

10. If the seller paid some of the mortgage points on your behalf, tax law says you can deduct these currently-believe it or not! However, you must then reduce the basis of your home by an equal amount. (This compensates for letting you claim a deduction for something you didn't pay for.) Any "seller-paid points" will show up as a seller settlement charge on the back of the closing statement in the right-hand column.

11. Now go back to the front side of the closing statement and check out the section in the left-hand column called "adjustments for items unpaid by seller." Generally, the only thing here is unpaid property taxes assessed for periods before you became the owner. In most parts of the country, property taxes are due well after the end of the 12-month assessment period to which they relate-meaning you'll eventually be billed for some taxes actually owed by the seller. Therefore, you are entitled to a credit from the seller in computing how much you owe at closing. This credit appears as an "adjustment for items unpaid by seller," which ensures that the seller pays at closing for his or her proper share of the tax bill you will be receiving after the sale. How does this affect your tax return? Take the property taxes number reported to you on Form 1098 (from the lender) and reduce it by the "adjustment." Then deduct the net figure on Schedule A. (You can only write off the net, because that's what actually comes out of your hide; the seller pays for, and therefore gets to write off, the rest.)

12. You will see some other numbers floating around in the left-hand column on the front side of the closing statement, under the section called "amounts paid by or in behalf of borrower." These figures simply detail how the contract price and your share of the settlement charges are being financed (part by your earnest money deposit, part by your mortgage loan, part by credits from the seller for unpaid taxes, and the rest by your downpayment). These amounts usually have no bearing on your tax situation.

The preceding explanations work most of the time. However, there are four notable exceptions.

Exception #1: Generally, the seller pays all real estate commissions. In the somewhat unusual case that you pay some, the amount will appear at the top of the back side of the closing statement in the left-hand column. Include the number in the basis of the home.

Exception #2: The up-front deduction for mortgage points is limited to the amount you pay at closing plus any earnest money deposit paid before closing. Any excess must be amortized over the life of the loan. (In other words, you cannot currently deduct points that are paid for out of the loan proceeds.) However, you are allowed to deduct seller-paid points regardless of how much (or how little) cash you plunk down before and at closing.

Exception #3: If the home is not your primary residence, you must amortize the points rather than deduct them currently. Also, you get no tax benefit for seller-paid points (that break applies only to your main house).

Exception #4: If the home will be used as a rental property, the tax treatment of the following items will differ: (1) you must amortize mortgage points over the life of the loan rather than deduct them currently, (2) you can amortize the cost of obtaining the mortgage over the life of the loan, (3) you can amortize the cost of a home warranty contract over the term of coverage, (4) you can claim current deductions for hazard insurance premiums and homeowner's association fees, and (5) you get no tax benefit from any seller-paid points.

Seller's Gain or Loss on Sale

OK. Enough about the buyer's side of the transaction. If you are the seller, your first concern is figuring your tax gain or loss. This equals the difference between the net sales proceeds and the property's tax basis. Tax basis equals your cost reduced by any depreciation deductions for business or rental use and further reduced by any prior home sale profits "rolled over" into the current residence (under the old tax-free gain rollover rules).

To arrive at the net sales proceeds number, take the contract sales price (at the top of the right-hand column on the front page of the closing statement). In our ongoing example, this figure is $253,000. Then find your share of the settlement charges. This number appears a bit farther down in the right-hand column. The seller's settlement charges generally include 100% of the commissions paid to both the buyer's and seller's realtors, all or part of the title insurance premium, and various other fees and charges as stipulated in the sales contract. For instance, you may agree to pay some mortgage points for the buyer as an incentive to close the deal (see item 10 above). You may also agree to pay for an inspection of the property by an engineer, a termite inspection, a radon test, a survey of the property, a homeowner's warranty, and so forth. The amount for each specific item is detailed on the back side of the closing statement in the right-hand column. Let's assume your share of the settlement charges totals $21,000. Your net sales proceeds are therefore $232,000 ($253,000-$21,000). Subtract from this amount your tax basis in the property. If the difference is a positive number, you have a taxable gain. Hopefully, you can shelter the whole gain under the current-law $250,000/$500,000 gain exclusion rules. (Discussed in the December 1998 and September 1999 issues.) Remember: just because the rather generous gain exclusion rules get you off the hook with the feds does not necessarily mean you can escape the clutches of your state tax collector. If you have a loss, it's nondeductible until further notice. Congress has stubbornly refused to allow any federal tax break for people unlucky enough to lose money when selling a home.

Exception #1: If the house has been used exclusively as a rental property for over one year, you can fully deduct a loss on sale. However if you sell for a gain, it will probably be taxed at two rates. Gain up to the cumulative amount of depreciation deductions claimed over the years is taxed at a maximum rate of 25%. Any remaining profit qualifies for the 20% maximum rate on long-term capital gains.

Exception #2: If all or part of the house has not been used as your primary residence for at least two years out of the five-year period ending on the sale date, you may be disqualified from the gain exclusion privilege. Or you may qualify for a reduced gain exclusion. (Discussed in the December 1998 issure.)

Seller's Deduction for Unpaid Taxes

The closing statement will generally include only one item that you, the seller, can actually claim as a current deduction. That's the amount of unpaid property taxes allocable to the period before the closing date. This figure appears under the "adjustments for items unpaid by seller" in the right-hand column on the front side. In effect, you pay this amount at closing by giving an offsetting credit to the buyer (see item 11 under the buyer's side analysis). You are therefore entitled to claim the corresponding writeoff on Schedule A.