Are you considering buying a home? It has many tax advantages. You can customize your walk-in closet to hold everything you have, just the way you want it, or you can install a professional home theater system. The benefits of owning a home go far beyond decoration. Financially, there are other advantages as well.
Homeowners are able to deduct their mortgage interest if they own their home. Renters can’t deduct their mortgage interest.
Many tax breaks are available for purchasing mobile homes, townhouses, condominiums, cooperative apartments, or single-family homes.
You’ll have to get more complicated on your taxes. The days of plugging your W-2 into the 1040EZ form and finishing your taxes in 10 minutes are over. As a homeowner, you’ll be forced to itemize. When you see how much money you can save, it’s worth the hassle.
What You Need To Know
- It is possible that buying a home is one of the biggest and most expensive purchases you will ever make.
- To make homeownership more affordable, the Internal Revenue Service (IRS) offers several tax breaks.
- Private mortgage insurance (PMI) and mortgage interest are common tax deductions.
- A deduction can only be claimed if you itemize your taxes (and not take the standard deduction).
- Investing in energy-efficient windows and solar panels can qualify homeowners for tax credits.1
Deductions vs. credits
If you receive a $1,000 tax credit, your tax bill will be reduced by $1,000. Think of it like a coupon. If you get a $1,000 tax credit, your tax bill will be reduced by $1,000. Tax deductions reduce your adjusted gross income (AGI), which reduces your tax liability.
Your tax liability will drop by $240 if you claim a $1,000 deduction if you fall into the 24% tax bracket. Therefore, if you claim a $1,000 deduction, your tax liability will drop by $200 ($1,000 × 24%).
Deductions for homeowners
The most common deductions that come with owning a home are as follows:
Interest Deduction on Mortgages
Mortgage interest can be deducted on the first $750,000 of mortgage debt ($375,000 if married filing separately). The old limit of $1 million applies to home purchases made before Dec. 16, 2017.2
In order to deduct home mortgage interest, you must itemize deductions on Schedule A of Form 1040 or 1040-SR, and your mortgage is secured by a home in which you own an interest. If your second home meets the same requirements as your primary home for deductible interest, you can deduct mortgage interest.
Your lender will send you a Form 1098, which details your interest paid in the previous year, in January, after the end of the tax year.4 Include any closing interest you paid as well. As part of your closing, the lender will include the interest for your first month of mortgage. You can find it on your settlement sheet. Ask your lender or mortgage broker to point out this to you. Your mortgage interest should be added to your total income when you do your taxes if it’s not included on your 1098.
Reduction of mortgage points
You may have paid mortgage points to your lender as part of a new loan or refinancing. Each point costs 1% of the total loan and lowers your interest rate by 0.25%. If you spent $300,000 on your home, you would pay $3,000 for each point. With a 4% interest rate, for example, that one point would lower your rate by 3.75% throughout the loan. It’s possible to deduct these discount points as long as you gave the lender money to buy them.
The first $750,00 in debt is exempt from discount points, just like the mortgage interest deduction.
Over the life of your mortgage, you receive a deduction for points if you refinanced your loan or took out a home equity line of credit (HELOC). A small percentage of the points are built into the loan every time you make a payment. A deductible amount for each month that you make payments can be deducted. For example, if $5 of your payment was for points, and you made a year’s worth of payments, you would be liable for $60.
It is necessary to know the amount of mortgage interest and points you paid so that you can claim the deduction on Schedule A of your 1040 or 1040-SR.56 Your lender will provide you with Form 1098, detailing how much you paid in mortgage interest and mortgage points.
Insurers who provide private mortgage insurance (PMI)
In order to qualify for a conventional loan, borrowers need to pay private mortgage insurance (PMI). PMI usually costs $30 to $70 a month for every $100,000 borrowed. If you stop making payments, PMI protects your lender (not you). You may be able to deduct PMI payments depending on your income and when you purchased your home.
Premiums for mortgage insurance are no longer deductible.
Prior to 2022, the PMI deduction expired and was renewed several times. The PMI deduction expired in 2017 but was renewed in 2019. As a result of the Consolidated Appropriations Act (CAA) of 2021, the deduction was available for 2020 and extended through 2021. Taxpayers can no longer deduct mortgage insurance premiums for 2022 returns, and the IRS has let the deduction expire.
Deduction for state and local taxes (SALT)
When you itemize your federal return, you can deduct certain taxes paid to state and local governments under the state and local tax (SALT) deduction. You can deduct up to $10,000 if you’re a single or a married couple filing jointly, and $5,000 if you’re married and filing separately.10 The deduction limit covers the combined total of state, local, sales, and property taxes.
When filing your taxes, you are not allowed to deduct mortgage interest, mortgage points, and SALT unless you itemize your deductions.
Your 1098 form will include your property tax payment amount if you pay your property taxes through an escrow account with your lender.4 If you pay directly to your municipality, you will receive a check or automatic transfer as personal records. Include your payments for any prepaid real estate taxes that you paid to the seller (you can find them on your settlement sheet).
By the end of January following the tax year, your employer(s) should provide you with your W-2 form, showing the state and local income taxes withheld from your paycheck. You can use your actual expenses or the optional sales tax tables in Schedule A (Form 1040) if you elect to deduct state and local sales taxes instead of income taxes.
Exclusion from home sales
With the home sale exclusion, you might not have to pay taxes on most of the profit you make when you sell your house.
It’s not taxable to sell a home if you live in it for at least two out of the five years before it’s sold. If you’re married filing jointly, the amount doubles to $500,000 before taxes. Both spouses must meet the residency requirement (i.e., lived in the home for two out of the last five years) as well as the ownership requirement. In the event that you sell your home early due to divorce, job change, or another reason, you might be able to meet part of the residency requirement.
Report the entire gain on Form 8949: Sales and Other Dispositions of Capital Assets16 if your taxable gain on the sale of your main home exceeds the exclusion.
Any gains on your home are taxed at either the short-term or long-term capital gains rate, depending on when you owned it:
- Tax rates on short-term capital gains are 10% to 37% for 2022 and 2023, respectively.17 18 These gains are taxed at your ordinary income tax rate.
- Depending on your filing status and income, you’ll owe 0%, 15%, or 20% capital gains taxes if you’ve owned the home for over a year.
The tax credit system
If a qualified mortgage credit certificate (MCC) has been issued by a local or state government agency under a qualified mortgage credit certificate program, you may be eligible for a mortgage credit. Find out whether your state offers tax credits, rebates, and other incentives for energy-efficient home improvements on energy.gov.
What expenses can I itemize?
The Schedule A of Form 1040 allows you to itemize your deductions. It is generally possible to deduct interest on a home mortgage, interest on a home equity loan, points on a mortgage, private mortgage insurance (PMI), state and local taxes (SALT). In addition, charitable donations, casualty and theft losses, gambling losses, unreimbursed medical and dental expenses, and long-term care premiums may be deducted.
Is it a good idea to itemize deductions for everyone?
Deductions can be itemized or the standard deduction. If you can itemize expenses that are more valuable than the standard deduction, itemizing makes financial sense. In addition, you must itemize in order to claim mortgage interest, mortgage points, and SALT deductions.
2022 Standard Deduction Amounts: What Are They?
In 2022, the standard deduction is $12,950 for singles and married filing separately, $19,400 for heads of household, and $25,900 for married filing jointly and surviving spouses.17
In 2023, what are the standard deduction amounts?
The standard deduction for married filers filing separately in 2023 is $13,850, for heads of household it is $20,800, and for married filers filing jointly it is $27,700.
Let’s keep this in perspective: If you’re in the 24% tax bracket, you still pay nearly 75% of your mortgage interest without deduction. In spite of the fact that paying interest reduces your taxes, paying off your home as quickly as possible is, by far, the best financial move. Those who plan to live in their home for a long time don’t have to pay a prepayment penalty. Consult your financial planner regarding the best method for paying off your debt.