Top Tax Advantages of Buying a Home

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Top Tax Advantages of Buying a Home

Are you considering purchasing a home? There are several benefits to purchasing one. You may decorate it to your liking, add a professional home entertainment system, or even design the walk-in closet to contain everything you own just the way you want it. But there are other advantages—financial advantages.

If you leased in the past, all of your money went to the landlord and none of it was tax deductible. That changes if you own a property.

Whether you purchase a mobile home, a townhouse, a condominium, a cooperative apartment, or a single-family home, there are various tax incentives that may save you money at tax time.

The only disadvantage is that your taxes will get more complex. The days of plugging your W-2 information into the 1040EZ form and doing your taxes in 10 minutes are long gone. You join the delightful realm of itemizing as a homeowner. Of course, it’s worth the effort when you consider how much money you may save.

Key Takeaways

  • Purchasing a house may be the most costly and significant investment you will ever make.
  • The Internal Revenue Service (IRS) offers a number of tax benefits to help make homeownership more affordable.
  • Mortgage interest, mortgage points, and private mortgage insurance are all common tax deductions (PMI).
  • You must itemize your taxes in order to claim the deductions (and not take the standard deduction).
  • Tax credits are offered to qualifying first-time homebuyers and homeowners who make energy-saving upgrades (e.g., solar panels and energy-efficient windows).

Tax Credits vs. Tax Deductions

There are deductions and credits in the realm of taxes. Credits are sums of money deducted from your tax bill. Consider them coupons. If you get a $1,000 tax credit, your tax liability will be reduced by $1,000. A tax deduction lowers your adjusted gross income (AGI), lowering your tax burden.

If you are in the 24% tax bracket, for example, your tax burden will be reduced by 24% of the entire claimed deduction. So, if you get a $1,000 deduction, your tax burden will be reduced by $240 ($1,000 24%).

Tax Deductions for Homeowners

The majority of the tax benefits associated with property ownership come in the form of deductions. The following are the most prevalent deductions:

Mortgage Interest Deduction

Mortgage interest on the first $750,000 ($375,000 if married filing separately) of mortgage debt is deductible. If you purchased your property before December 16, 2017, the existing maximum of $1 million ($500,000 if married filing separately) applies.

Residence mortgage interest cannot be deducted unless you itemize deductions on Schedule A Form 1040 or 1040-SR and the mortgage is a secured loan on a home in which you have an ownership interest. You may deduct mortgage interest on a second property as long as it meets the same deductible interest rules as your main dwelling.

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Your lender will issue you Internal Revenue Service (IRS) Form 1098 in January, after the end of the tax year, showing the amount of interest you paid the previous year. Include any interest you paid as part of your closing costs. Lenders will add interest for the first half month of your mortgage as part of the closing costs. It is included on the settlement sheet. Request that your lender or mortgage broker point this out to you. If it isn’t on your 1098, add it to your total mortgage interest when filing your taxes.

Mortgage Points Deduction

As part of a new loan or refinancing, you may have paid mortgage points to your lender. Each point purchased typically costs 1% of the total loan and reduces your interest rate by 0.25%. If you purchased $300,000 for your property, each point would be worth $3,000 ($300,000 1%). With a 4% interest rate, for example, one point would reduce the rate to 3.75% over the life of the loan. You are eligible for a deduction if you really paid the lender for these discount points.

Discount points, like mortgage interest, are deductible on the first $750,000 of debt.

If you refinanced your loan or obtained a home equity line of credit (HELOC), you are eligible for a point reduction throughout the term of the loan. A modest fraction of the points is added into the loan with each mortgage payment. You may deduct that amount for each month in which you paid. So, if you paid $5 for points and made a year’s worth of payments, your deductible would be $60.

Your lender will issue you Form 1098, which will explain how much you spent in mortgage interest and points. You may claim the deduction on Schedule A of Form 1040 or 1040-SR using that information.

Private Mortgage Insurance (PMI)

Borrowers who put down less than 20% on a traditional loan are charged private mortgage insurance (PMI). For each $100,000 financed, PMI typically costs $30 to $70 per month. PMI, like other kinds of mortgage insurance, protects the lender (rather than you) if you fail to make mortgage payments. You may be eligible to deduct your PMI payments depending on your income and when you purchased your house.

According to the IRS, you can deduct PMI payments as home mortgage interest. The insurance must be in connection with a mortgage issued after 2006. You are eligible for the full deduction if your AGI is less than $100,000 ($50,000 if married filing separately). The deduction is phased out above those levels. You can’t take the deduction if your AGI is more than $109,000 ($54,500 if married filing separately).

State and Local Tax (SALT) Deduction

The state and local tax (SALT) deduction lets you deduct certain taxes paid to state and local governments, provided that you itemize on your federal return. The Tax Cuts and Jobs Act (TCJA) capped the previously unlimited deduction at $10,000 per year in combined property taxes and either state income taxes or sales taxes. The $10,000 cap applies whether you are single or married filing jointly and drops to $5,000 if you’re married filing separately.

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You must itemize your deductions to claim the mortgage interest deduction, mortgage points deduction, and SALT deduction. You can’t claim these deductions if you take the standard deduction when filing your tax return.

If you payyour property taxes through a lender escrow account, you’ll find the amount on your 1098 form. Alternatively, you will have personal records in the form of a check or automatic transfer if you pay directly to your municipality. Be sure to include payments that you made to the seller for any prepaid real estate taxes (you can find themon your settlement sheet) (you can find themon your settlement sheet).

State and local income taxes withheld from your paycheck appear on your W-2 form, which your employer(s) should send by the end of January following the tax year. If you elect to deduct state and local sales taxes instead of income taxes (you can’t deduct both), you can use your actual expenses or the optional sales tax tables found in Schedule A (Form 1040). (Form 1040).

Home Sale Exclusion

Chances are you won’t have to pay taxes on most of the profit that you might make when you sell your home, thanks to the home sale exclusion.

If you’ve owned and lived in the home for at least two of the five years before the sale, you won’t pay taxes on the first $250,000 of profit (i.e., capital gain) (i.e., capital gain).The number doubles to $500,000 if you’re married filing jointly. However, at least one spouse must meet the ownership requirement, and both spouses must meet the residency requirement (i.e., lived in the home for two out of the previous five years) (i.e., lived in the home for two out of the previous five years).You might be able to meet part of the residency requirement if you had to sell your home early due to a divorce, job change, or something else.

If you have a taxable gain on the sale of your main home that’s greater than the exclusion, report the entire gain on Form 8949: Sales and Other Dispositions of Capital Assets.

Depending on how long you owned the home, any gains will be taxed at either the short-term or long-term capital gains rate:

  • If you held the residence for less than a year, you are subject to short-term capital gains tax rates. These profits are taxed at your regular income tax rate, which for 2021 and 2022 is 10% to 37%.
  • If you held the residence for more than a year, long-term capital gains tax rates apply. Depending on your filing status and income, the rate is 0%, 15%, or 20%.
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Tax Credits

You might be eligible for a mortgage credit if you were issued a qualified mortgage credit certificate (MCC) by a state or local governmental unit or agency under a qualified mortgage credit certificate program. Also, check to find out whether your state offers tax credits, rebates, and other incentives for energy-efficient improvements to your home.

Which expenses can I itemize?

You itemize your deductions on Schedule A Form 1040. Homeowners cangenerally deduct home mortgage interest, home equity loan or home equity line of credit (HELOC) interest, mortgage points, private mortgage insurance (PMI), and state and local tax (SALT) deductions. You also may be able to deduct charitable donations, casualty and theft losses, some gambling losses, unreimbursed medical and dental expenses, and long-term care premiums.

Who should itemize deductions?

You can either take the standard deduction or itemize your deductions. If the value of expenses that you can itemize is greater than the standard deduction, then it makes financial sense to itemize. Also, you must itemize to claim the mortgage interest, mortgage points, and SALT deductions.

What are the standard deduction amounts for 2021?

For 2021, the standard deduction is $12,550 for single and married filing separately taxpayers, $18,800 for heads of household, and $25,100 for married filing jointly filers and surviving spouses.

What are the standard deduction amounts for 2022?

The standard deduction for single and married filing separately taxpayers is $12,950 in 2022, $19,400 for heads of household, and $25,900 for married filing jointly filers and surviving spouses.

The Bottom Line

To put this in context, if you’re in the 24% tax bracket, you’re still paying over 75% of your mortgage interest even if you don’t take any deductions. Don’t fall into the trap of believing that paying interest is advantageous since it lowers your taxes. Paying off your mortgage as soon as possible is by far the smartest financial decision. There is no penalty for paying off your mortgage early, so pay as much as you can if you intend to stay in the house for a long period. Of course, consult with your financial counselor about the best approach to pay down your debt.

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