Tax Benefits of Owning A Home

One of the great benefits of buying a house is the tax advantages extended to homeowners by the United States government. 

Under our tax laws, homeowners do not pay income taxes on the sale of a house if they have lived in it as their personal residence for at least 2 out of the last 5 years (some restrictions apply and always talk to an accountant for specific tax questions). Also, the interest portion of mortgage payments is tax-deductible.

With a few tax breaks, whether you buy a mobile home, townhouse, condominium, cooperative apartment, or single-family home, you can save money at tax time.

The only downside is that taxes will be more complicated. Now you can’t just plug your W-2 information into a 1040EZ form and finish your taxes in 10 minutes. If you itemize, you’ll be able to save money. You might save a lot of money if you do it.

Tax Credits vs. Tax Deductions

There are deductions and credits in the tax world. A credit is money taken off your tax bill. Credits are like coupons. The amount of your tax due will decrease by $1,000 if you get a $1,000 tax credit. Your tax liability is reduced when you take a tax deduction from your adjusted gross income (AGI).

The amount of the claimed deduction reduces your tax liability by 24%, if you’re in a 24% tax bracket. You can expect your tax liability to drop by $240 ($1,000 * 24%) if you claim a $1,000 deduction.

Tax Deductions for Homeowners

The tax benefits from owning a home come mainly in the form of deductions. Here are some of the most common deductions:

Mortgage Interest Deduction

Home mortgage interest can be deducted on the first $750,000 ($375,000 if married filing separately) of mortgage debt. If you purchased your home before Dec. 16, 2017, you can claim the previous limit of $1 million ($500,000 if you’re married and filing separately).

Your lender will send you IRS Form 1098 in January after the end of the tax year, detailing the amount of interest you paid in the previous year.

If you paid interest as part of your closing, be sure to include it. Interest for the partial first month of your mortgage will be included in your closing costs. Your settlement statement will detail it. If you are uncertain, ask your lender. You should add it to your total mortgage interest if it isn’t included on your 1098.

Mortgage Points Deduction

Your lender may have charged you mortgage points for a new loan or refinance. You can lower your interest rate by 0.25% for every point that you buy, which costs 1% of the total loan. Each point equals $3,000 if you paid $300,000 for your home ($300,000 × 1%). If, for instance, the interest rate is 4%, that one point would reduce the rate to 3.75%. You can deduct discount points as long as you actually paid the lender for them.

Over the life of the loan, you receive a deduction for points if you refinance or take out a home equity line of credit (HELOC). The points are built into each mortgage payment. The amount can be deducted from each payment made. The deductible amount would be $60 if $5 of your monthly payment was for points, and you made a year’s worth of payments. 

You will receive Form 1098 from your lender detailing how much interest and points you paid for your mortgage. On Schedule A of Form 1040 or 1040-SR, you can claim the deduction based on this information.

Private Mortgage Insurance (PMI)

A conventional loan requires borrowers with less than 20% down to pay private mortgage insurance (PMI). For each $100,000 borrowed, PMI costs $30 to $70 per month. If you stop making mortgage payments, PMI protects the lender (not you). PMI payments may be able to be deducted from your income, depending on when you purchased your home.

If you paid PMI on your home mortgage, you may claim the amount as interest on your home mortgage. PMI must have been paid on a home mortgage issued after 2006. 

For married couples filing separately, the deduction is fully available if your AGI is less than $100,000. If your AGI exceeds $100,000, the deduction phases out. You cannot take the deduction if your AGI exceeds $109,000 ($54,500 if married filing separately).

State and Local Tax (SALT) Deduction

When you itemize your federal return, you can deduct certain taxes paid to state and local governments. As a result of the Tax Cuts and Jobs Act (TCJA), the previously unlimited property tax and state income tax deduction has been capped at $10,000 per year. If you’re married and filing jointly, you’re allowed $10,000, but if you’re married and filing separately, you’re only allowed $5,000.

You’ll find the amount of your property taxes on your 1098 form if you pay them through a lender escrow account. If you pay directly to your municipality, your records will be in the form of a check or automatic transfer. Include any prepaid real estate taxes that you paid to the seller (you can find them on your settlement sheet). 

In the year following the tax year, your employer should send you a W-2 form, on which is the state and local income tax withheld from your paychecks. You can use your actual expenses or the optional sales tax tables in Schedule A (Form 1040) to deduct state and local sales taxes instead of income taxes (you can’t deduct both).

Home Sale Exclusion

There’s a good chance you won’t be taxed on most of the profit you make when you sell your home, because of the home sale exclusion.

You will not owe taxes on the first $250,000 of profit (i.e., capital gain) if you owned the home and lived in it for at least two of the five years before the sale.

The amount doubles if you file jointly with your spouse. The owner of the home must also meet the residency requirement (i.e., have lived in the residence for the past two years). If you sold your home early because of a divorce, job change, or something else, you might be able to meet part of the residency requirement.

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

  • If you owned the home for less than a year, you will be subject to short-term capital gains tax rates. Ordinary-income tax rates for 2021 and 2022 are 10% to 37%.
  • If you owned your home for more than a year, you will pay long-term capital gains tax rates. Rates vary by filing status and income, but are typically 0%, 15%, or 20%.

Tax Credits

Under a qualified mortgage credit certificate program, you might be eligible for a mortgage credit if you were issued a qualified mortgage credit certificate (MCC). If you wish to make energy-efficient improvements to your home, you can also check out energy.gov to see whether your state offers tax credits, rebates, and other incentives.

Which expenses can I itemize?

Schedule A of Form 1040 allows you to itemize your deductions. 

A homeowner can generally 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 taxes (SALT). Furthermore, charitable contributions, casualty and theft losses, some gambling losses, unreimbursed medical and dental expenses, and long-term care premiums may be deductible.

Who should itemize deductions?

Either the standard deduction or itemized deductions are available. If you can itemize more expenses than the standard deduction, then you should itemize. A mortgage interest, mortgage point, and SALT deduction must also be itemized.

What are the standard deduction amounts for 2022?

Under the 2022 standard deduction, tax filers filing separately and jointly will each have a standard deduction of $12,950, heads of household will have a standard deduction of $19,400 and jointly filed taxpayers and their surviving spouses will have a standard deduction of $25,900.

Final Words

If you are in the 24% tax bracket, you will still pay nearly 75% of your mortgage interest without any deductions. Do not think that paying interest is beneficial because it reduces your taxes. 

By far, the best financial move is to pay off your home as quickly as possible. If you intend to live in the house for a long time, you shouldn’t be penalized for paying off your mortgage early. Your financial planner can help you determine the most advantageous method of paying down your debt.

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