Tax Breaks for Homeowners
This article is for informational purposes only. If you're seeking tax advice please consult with a tax advisor.
When you decided to own a home as opposed to renting one, you were getting started on the road to creating an investment. To assist homeowners such as yourself with the strain caused by paying high mortgages, the US government has created numerous tax deductions specifically designed to lower the payments you’ll have to make during tax season. Now that you qualify for them, your next step should be to learn as much about them as possible.
We’re sure that up until recently, you’ve probably only been claiming standard deductions on your taxes. Now that you’re a homeowner, you’ll learn to itemize the extra tax write-offs you’ll be claiming. To add some even better news to the mix, all of the donations you make to various charities, along with the taxes you pay to your state, will provide you with even more tax deduction opportunities. Below, we’ve listed 10 tax breaks that you should know about now that you own a home. They are:
- Mortgage interest
- Property Taxes
- Mortgage Insurance
- Tax & Penalty-Free IRA
- Home improvements
- Energy credits
- Home Sale Profits
- Home equity loans
- Adjusting your withholding
One of the most common tax breaks available to homeowners is the deduction of interest paid on a mortgage. Huge tax breaks come in the form of deducting mortgage interest for most people. Interest incurred on up to $1 million of debt obtained by acquiring and/or improving a home can be deducted.
Around January, you should receive a form 1098 from your lender that lists all interest paid on your mortgage the prior year. This information will be used on Schedule A as your deduction amount. It’s important to make sure that any and all interest that was paid since the day you purchased the home until the last day of that exact month is listed on a form 1098. The amount should be printed on the settlement sheet. In the event you find that it’s not listed, it can still be deducted. The US government will pay 25% of the interest on your behalf if you're a part of the 25% tax bracket.
In order to obtain your mortgage when buying a house, lenders may require you to pay what is known as “points”. These “points” are typically a certain percent of the total loan. In order for the points to be considered deductible as interest, there are a few requirements that need to be met:
1. It's a secured loan by your home.
2. The points you are required to pay our common for your area.
3. The cash amount that was paid as a down payment was equal to the points.
Here’s an example:
For a $300,000 mortgage, you paid a total of 2 points (2%). If you contributed a minimum of $6000 (2% of $300,000 = $6000) towards the deal, the 2 points can be deducted.
*The points can be deducted in your taxes even in the event that the seller actually pays for them as a stipulation in the deal. Remember, this amount should be printed on your 1098 form.
Local property taxes can be deducted each year also. If you use an escrow account to pay your taxes, this amount may be listed on a form sent to you by your lender. You might find the amount listed in your checkbook registry or in your personal records if you pay your municipality directly. It’s possible that you might’ve reimbursed the seller for prepaid real estate taxes the year you purchased your home from them.
In this case, the amount you reimbursed them for will also be shown on your settlement sheet. You want to make sure to add this amount to get a deduction for real estate taxes. Keep in mind, escrow account payments cannot be deducted as real estate taxes. The deposit you made/make will be applied to future tax payments. Only the amount paid during the actual year can be deducted as real estate tax.
If a buyer makes a down payment for under 20% of the homes total cost, they usually incur premiums on their mortgage insurance. This is an extra charge used to protect the lender in the event the buyer can’t repay their loan. Buyers can now deduct these mortgage insurance premiums on all mortgages that were issued during or after 2007.
On tax returns listed as “Married - Filing Separate”, the deduction decreases more and more as the adjusted gross income rises above $50,000. The same thing happens on all other tax returns where the adjusted gross income rises above $100,000.
*This doesn’t apply to anyone who’s paying for mortgage insurance prior to 2007.
There is a penalty of 10% for individuals who make “pre-age” withdrawals from their IRAs. To encourage home buying, this penalty does not apply to first-time homeowners who make withdrawals from their IRAs to use as down payments. However, the penalty is still imposed on individuals who make withdrawals from their 401(k) plans.
You’re allowed to withdraw up to $10,000 from your IRA in order to purchase or build your first home for you and/or any of your loved ones at any age completely penalty free. The only downside is, the $10,000 limit is for your entire lifetime. It is not on an annual basis. Each spouse and a married couple can take advantage of the $10,000 limit for a total of $20,000 together. The only stipulation is that within 120 days after its withdrawal, the money must be used to buy or start construction on your first house.
Here’s a great tip that you don’t want to overlook:
To qualify as a “first-time buyer”, it doesn’t have to be your actual first time buying a home. As long as you haven’t owned a home within the span of 2 years, when you do purchase one, you are considered a first-time buyer all over again. Now even though that may sound great, it does still have its drawbacks. You should only use IRA money as an almost last resort because it’ll still be taxed in your tax bracket. What this means is that federal and state taxes could claim up to 40% or more of that $10,000 you needed for a down payment. That’s not good at all.
This makes a Roth IRA a better option when saving to purchase a first home. Any and all contributions made to a can be withdrawn not only penalty-free but tax-free as well anytime you like. The money can be used for any reason you deem necessary. After 5 years of an open Roth IRA account, up to $10,000 of additional earnings can be withdrawn as well penalty and tax-free for a home purchase.
It’s a good idea to make sure you keep all records along with receipts for any and every improvement made to the home. No matter how minor or major they are, they will come in handy later.
These expenses aren’t deductible at the current moment but will be included in the purchasing price when tax season comes around to determine the value of your home. Even though almost all profits made from home sales are currently tax-free, the IRS can still potentially request part of your profits once the home is sold. Keeping track of your calls basis will help reduce any possible tax bills.
If you make energy-saving home improvements, you may qualify for what is known as “energy tax credit”. The special tax credits can be worth up to $500. Says they actually reduce your tax bill dollar for dollar, these tax credits tend to be more valuable than a typical tax deduction.
Things such as energy-efficient skylights, central air conditioners, furnaces, exterior doors and windows, water heaters, boilers, and even insulation systems can allow you to qualify for energy tax credits up to 10% of their costs.
More expensive and efficient energy equipment such as solar powered generators can qualify you for even better energy tax credits worth up to 30% of their costs. Good news is there is no dollar limit on these credits.
The current tax law provides homeowners with another benefit of actually owning a home. In the event that certain requirements are met, a huge amount of profit can potentially be rendered tax-free. For example:
· Up to $250,000 can be considered tax-free for a person who is single and resided in the house for at least 2 of the 5 previous years before its sale.
· Up to $500,000 can be considered tax-free profit for individuals who are married and found a joint return. If the home was owned by one or both of the spouses, considered as a primary residence, and lived in for at least 2 of the 5 previous years prior to its sale by both spouses they will qualify for the tax-free profit.
For the most part, profit isn’t usually taxed. In the event, you take a loss on the sale, you can’t write the loss off as a deduction.
This tax exclusion can be used multiple times. As long as you meet all of the requirements and haven’t used the exclusion in the last 2 years on a different property, you’re good to go. Profits exceeding $250,000/$500,000 is reported as a capital gain on Schedule D form.
There are exceptions to the rule where even if you don’t reside in the house for 2 out of the 5 years prior to its sale, you can still qualify for the tax-free profit. If unforeseen circumstances such as having triplets or quadruplets, health conditions, employment situations, divorce, etc. cause you to sell your home early, you may qualify for what’s known as a partial exclusion.
In simple terms, a partial exclusion means that as opposed to you getting the full $250,000/$500,000 exclude her from taxes, only a part of it will be considered tax-free. If you meet one of the exceptions and have resided in the house for at least one of the 5 previous years prior to its sale, 50% of the profit will be tax-free. Partial exclusion for tax-free profit would be $125,000 for the qualifying single individual and $250,000 for the qualifying married couple.
After building up enough equity in your home, you can use it as collateral for borrowing additional money to use as you see fit. You can deduct the interest charged on a home equity debt as mortgage interest up to $100,000 regardless of how you plan to use the money.
A lot of Real Estate Investors will use this strategy as a way to build their portfolio. They use the equity in their own home to purchase another income producing property.
You can collect all of the savings immediately by making adjustments to your federal income tax withholdings at your place of employment. This is highly recommended for individuals who will become itemizers for the 1st time due to the size of their mortgage interest created by their home. The proper form (W–4) can be obtained from your employer and/or by visiting www.irs.gov.
This article is for informational purposes only. It should not be considered tax advice. If you're seeking tax advice please consult with a tax advisor.
Hi there! I'm Ryan Fitzgerald, a REALTOR in Raleigh-Durham, NC and the owner of Raleigh Realty. Chances are you and I share a similar passion, Real Estate! I also have a passion for building businesses, working out, inspiring others, technology, sports, and people. Connect with me on Facebook and Instagram!