When you planned to buy your home, you probably did not think ahead about your taxes. The good news is that buying a house helps you with your taxes. Buying a new home offers a few advantages to renting.
The federal government offers numerous personal tax deductions on homeownership but no credits. What’s the difference?
MORTGAGE INTEREST DEDUCTION
If homeowners itemize deductions, they may be able to deduct interest on their home mortgage. Taxpayers who don’t own their homes are not eligible to deduct interest on any debt they have incurred for the purchase of goods or services.
This important tax break was eliminated by the Tax Cuts and Jobs Act. The deduction was only available for interest paid on debts up to $1,000,000 incurred to buy or substantially rehabilitate a house. Homeowners could also deduct interest on up to $100,000 in home equity debt. This applies regardless of how the funds were used. The TCJA restricted the deduction to interest on mortgage debt up to $750,000 incurred after December 14, 2017. This was to help buy or improve a home.
According to the OTA, the mortgage interest deduction will cost $25.1 billion in fiscal 2019. The OTA had estimated that the mortgage interest deduction cost $74.5 billion in fiscal 2018, prior to the TCJA being enacted. Due to other provisions in the TCJA, OTA estimated that the cost of the mortgage interest deduction would have been $74.5 billion in fiscal year 2018. This was in part due to fewer taxpayers itemizing their deductions. The lower limit on deductible mortgage interests also contributed to this drop in cost. According to Urban-Brookings Tax Policy Center, only 8% of tax units benefited in 2018 from the deduction, compared to 20% in 2017.
PROPERTY TAX DEDUCTION
If homeowners itemize deductions, they may be able to reduce their taxable income by deducting the property taxes that they pay on their homes. This deduction effectively transfers federal funds to jurisdictions that impose property taxes (mostly local, but some state governments), which allows them to increase property tax revenue at lower costs to their constituents. According to the OTA, this deduction saved homeowners millions of dollars in income tax over fiscal year 2019. Because there were fewer homeowners who itemized, and because the TCJA placed a $10,000 limit on the amount of state and local taxes taxpayers could deduct, the cost of this deduction was lower.
PROFITS FROM HOME SALES
Capital gains tax is generally payable by taxpayers who sell assets. If homeowners meet certain criteria, they may be able to exclude capital gains from their taxable income of up to $250,000 (or $500,000 for joint filers), if they have not claimed the capital gains exclusion in the past two years. According to the OTA, homeowners could save $43.6 billion on income tax by using the exclusion provision in fiscal 2019.
Tax Deduction: A tax deduction applies to a reduction in your adjusted gross income (AGI). You use your AGI to find the amount of tax you owe to the government, called your tax liability.
Tax Credit: A tax credit works like a store coupon. You subtract that amount from your final tax bill, also called your tax liability. If you owe $1,000 in taxes, but qualify for a $500 credit, you only need to pay the government $500.
Yes, you still pay property taxes, but on your personal income taxes you gain up to seven tax breaks. Those include:
1. The interest you pay on your mortgage is deductible. With mortgages in excess of $750,000, the Internal Revenue Service (IRS) lets you deduct the loan interest. You can accrue a pretty sizable tax deduction this way. You can also deduct interest on a HELOC as long as you use it for home improvements. The Tax Cuts and Jobs Act of 2017 sets limits for these deductions. When you use tax preparation software, such as TurboTax or H&R Block, or QuickBooks, the software prompts you for this information, so you can’t miss this terrific deduction.
2. You can deduct your property taxes up to $10,000. This gets combined with the deduction for local and state income taxes. You do not get to combine or deduct foreign property taxes. Check your IRS Form 1098 if you paid through an escrow service or your receipt if you paid through your municipality.
3. Another deduction lets you earn money back on the paid loan points on your mortgage or refinanced mortgage. You must have paid for the points to claim this. This is fractional and it uses an IRS formula.
4. Mortgages taken out after 2007 can take a deduction on the Private Mortgage Insurance (PMI). If you put less than 20 percent down on your home’s mortgage, you will probably have to obtain PMI. Married couples with an adjusted gross income of $100,000 or less can take this deduction. Single people earning up to $50,000 can take this, too.
5. Make energy-efficient upgrades to your home and you get to take another deduction. Through 2021 you can claim solar energy tax deductions whether you upgrade your electric or water heating appliances or install equipment to generate solar energy to power your home. Your deduction ranges between 22 and 30 percent of the cost of the equipment.
6. You can also deduct expenses for supplementary aids to facilitate living in your home as you age. Senior citizens who install grab bars in their bathroom, for example, or a lift so their wheelchair or scooter can reach the second floor of their home can deduct those expenses. Wheelchair ramps are another common expense that qualifies for this deduction.
7. Your home office nets you another deduction. (By now you probably owe pretty little in taxes. Heck, the government might have to pay you.) You deduct $5 per square foot, up to 300 square feet of your home for office space. The maximum deduction equals $1,500. You do not have to run a business from home to have a home office. If you do run a business from home and you’re self-employed, then you will pay business tax. If you run a larger company from home, use business tax services to prepare your taxes.
Of course, you have to file form 1040 to claim all of these wonderful deductions. It proves worth it though, since you save thousands on your taxes. That sums up how your homeownership pays you back annually at tax time.