Once you're a homeowner, you may be eligible for several tax breaks. Use this guide to get a better sense of what those tax breaks are.
This article does not constitute tax advice. Please consult a tax advisor regarding your specific situation.
People buy homes for a lot of reasons: the pride of homeownership, gaining control over your housing costs, wealth creation through home equity.
What first-time homebuyers might not be thinking about is homeowner tax breaks, but those are a significant perk. That’s right: your humble abode can save you money when tax season rolls around.
Yes, homeowners may be eligible for several different tax breaks. To take advantage of the tax benefits of buying a home, though, you’ll need to itemize deductions on your tax returns.
Itemizing deductions simply means tallying up all your tax-deductible expenses for the year and using those to lower your taxable income. Things like charitable contributions, student loan interest, and yes, some homeownership expenses.
So if you make $100,000 per year and have $30,000 in tax-deductible expenses, your taxable income is only $70,000, giving you a lower tax bill (or a bigger refund).
But itemizing is not always wise.
Many people opt to take the standard deduction because it’s way easier and is a higher amount than if they itemized.
According to the Internal Revenue Service (IRS), the standard deduction for 2021 is $12,550 for single filers, a $150 increase from 2020. For couples who are married filing jointly, the standard deduction is $25,100, which is a $300 increase from 2020.
So if you’re married and don’t have $25,100 in tax-deductible costs for the year, it’s smarter to take the standard deduction.
But it’s always best to work with a tax advisor who can tell you which homeowner tax breaks you’re eligible for and the most strategic ways to file. After all, we’re not professional tax advisors and this doesn’t constitute tax advice.
Don’t assume your decision about whether to itemize or take the standard deduction will be the same year to year. Some years, your potential deductions may be larger than others. For instance, if you buy a home and you pay points to lower the interest rate, the points may be deductible.
Itemizing your taxes can get complex, so it’s smart to talk to a professional about your options, especially if you’ve made a large purchase or sale of an asset in the past year.
Here’s a brief overview of the most common tax advantages of homeownership.
This article does not constitute tax advice. Please consult a tax advisor regarding your specific situation.
You can deduct interest paid on a mortgage up to the first $750,000, or $375,000 if married and filing separately.
That means that if your mortgage is $750,000 or less, you can deduct all of the interest paid. If your mortgage is $800,000, you can deduct the interest paid on $750,000 of it. The interest on the remaining $50,000 would not be deductible.
You’ll receive a 1098 Form from your lender early in the calendar year indicating how much mortgage interest you paid in the past year, and you’ll need to submit that when you file your taxes.
The allowable mortgage amount was decreased from $1 million by the Tax Cuts and Jobs Act (TCJA) that went into effect in 2018. If you took out your mortgage before December 16, 2017, however, you can still deduct interest on a mortgage that is up to $1 million if you meet other guidelines.
If you have a second home you may also be able to deduct mortgage interest on it. Investment property interest may be deductible, but only to offset the income from the property. We discuss investment properties in more detail below.
Related reading: Second Home Mortgage Requirements: What to Know Before Buying That Dream Vacation Home
If you’ve taken out a home equity loan or home equity line of credit (HELOC), you may be able to deduct the interest paid on up to $750,000, but only if the loan was taken out to buy, build, or improve the property the loan is attached to.
However, if you took out a home equity loan or line of credit to buy a boat or go on vacation, that interest is not tax deductible.
If your situation is at all in a gray area, seek a licensed CPA’s advice before taking the deduction. You don’t want to end up in hot water with the IRS because you used a HELOC to add a hot tub to the home – pun intended.
You can deduct a total of $10,000 in local taxes, including state and local income, sales, and property taxes (this is known as the SALT deduction). Note that if you claim a large amount of sales tax, it may limit the amount of property tax you can deduct.
Many people pay discount points or origination points when they take out a mortgage, which means that they pay a certain amount of money upfront to reduce the interest rate on the loan. One “point” is the equivalent of 1% of the mortgage amount. If your loan amount is $300,000, one point would cost you $3,000.
Points are deductible in the year in which they are paid, for a primary residence, up to a mortgage amount of $750,000 if you meet nine rules described by the IRS.
If you paid mortgage points on a second home, you can deduct them as well, but the rules are different. Rather than deducting the full amount in the year you paid the points, you can deduct 1/30 of the discount points over the life of a 30-year mortgage.
If you are self-employed and work from home, you may be able to deduct home office expenses on your taxes as well. According to the IRS, “The taxpayer needs to use a portion of the home exclusively for conducting business on a regular basis and the home must be the taxpayer's principal place of business.” These include a portion of your rent or mortgage based on the square footage of the office space, as well as a portion of your utilities.
Remote workers who are full-time employees of a company cannot deduct home office expenses.
Rules affecting the tax benefits of homeownership change all the time, and it’s important to keep up with them. Failing to do so can either cost you money or cause you to make errors in your taxes — which can lead to penalties and charges from the IRS.
The deductibility of mortgage insurance is an example of how tax benefits change. If your down payment is less than 20% of the home’s purchase price, you will likely owe mortgage insurance.
Mortgage insurance payments were tax deductible through 2020, provided you didn’t exceed certain income limits, but they will not be deductible for the 2021 tax year unless the allowance is extended by Congress, says H&R Block.
Related reading: How Much Is Mortgage Insurance — And Is It Worth It?
It’s not just your principal residence that’s eligible for homeowner tax breaks. You may be able to take deductions on your rental and investment properties as well.
Before we get to the tax breaks, however, keep in mind that any rental income you collect must be reported on your income taxes.
Investment property owners also need to be aware of capital gains taxes. Capital gains taxes apply if you sell your property: you’ll be taxed on the difference between the sale price and your tax basis in the building.
Short-term capital gains apply if you sell a building less than a year after purchasing it; long-term capital gains apply if you’ve owned the building more than a year. In general, the rate on long-term capital gains is far less than the rate on short-term gains.
Nicole Rueth, a senior vice president at Fairway Independent Mortgage Corporation (Fairway owns Home.com), notes that “Investors can 1031 exchange a property to defer the capital gains” under some conditions.
Under a Section 1031 exchange (named after a section of the tax code), you can reinvest gains from the sale of an investment property into another investment property without having to pay any capital gains, provided you do so within 60 days and both properties are in the U.S. You cannot use the money to purchase a new primary residence without paying a capital gains tax.
According to the IRS, there are a number of deductions you may be able to take related to your rental or investment property:
These deductions are considered “ordinary and necessary expenses for managing, conserving and maintaining your rental property” by the IRS.
You cannot deduct expenses used to improve or enlarge the property. So if you want to add a swimming pool or another section of the house, those costs would not be deductible.
Investment property owners can also get tax breaks via depreciation and amortization of their property. Depreciation and amortization means that you can deduct a certain portion of your property costs (and capital investments, such as major appliances) according to specific schedules.
Deductions, capital gains, and depreciation and amortization are complex, and investors should consult tax professionals about how to file.
“Having an investment-knowledgeable CPA is critical to your investing success,” Rueth said.
Related reading: Investment Property Mortgage Rates: What Should You Expect to Pay?
Yes, homeowners can deduct mortgage interest paid on up to $750,000, as well as $10,000 in property taxes. To take advantage of these tax breaks, you’ll need to itemize your deductions rather than take the standard deduction. A tax professional can help you determine which is the right option for you.
Homeowners can also deduct interest paid on up to $750,000 of a home equity loan or home equity line of credit, but only if the loan was taken out to buy, build, or improve the property the loan is attached to.
The size of your homeowner tax breaks depends on the amount of your mortgage and your property tax rates. You can deduct interest paid on up to $750,000 on a mortgage, and up to $10,000 paid in property taxes.
You can also deduct points paid on a mortgage, if you purchased the home that year, it is your primary residence, and you meet nine rules described by the IRS. But how large your tax breaks are depend on the size of your home loan, how much you paid in property taxes, and how much you paid toward the points.
Deductible housing expenses include mortgage interest, property taxes, interest paid on a home equity loan or home equity line of credit, and points paid to lower the interest rate on a mortgage.
Taxes can get complex quickly, especially if you own multiple properties or have real estate investments. Working with a tax advisor will help you understand how much you owe, the homeowner tax breaks and tax credits available to you, and the best filing strategies.
This article does not constitute tax advice. Please consult a tax advisor regarding your specific situation.
