As a homeowner, you can benefit from tax breaks that make your home more affordable, shaving down your IRS bill each year. It is a benefit I like to remind you about because, let’s face it, there’s not too much brightness around filing your taxes.
Read over the list below to review what could pertain to your situation. No matter what, please remember to always consult with your tax advisor.
Tax Deduction vs. Tax Credit
Man, you guys, this article is taking me back to law school. Federal Income Taxation, with AJ Bellia, was a class I crushed because the entire tax code is a like a treasure hunt to keep as much of your money as possible. Let’s do a quick refresher on federal tax deductions and credits.
DISCLAIMER: This article is informational and should not be taken as tax or legal advice. Please consult licensed professionals for how the tax code applies to your personal situation.
Tax Deductions
A tax deduction allows you to exclude the deduction amount from taxable income. E.g. if you spend $1000 and it is tax deductible, you won’t pay any income taxes on that $1000. So if you are in the 22% tax bracket, you could save the $220 you would have paid in taxes.
You can either take the standard deduction or itemize your deductions. The standard deduction allows you to take a set amount for your deduction, regardless of any individual deductions for which you may qualify. Itemized deductions allow you to report all the individual deductions for which you qualify and take the sum of those as your deduction. Itemizing is much more work but may make sense for you, depending on your personal tax situation.
For the 2018 tax year and beyond, Congress shook up the tax code a little bit by changing the standard deduction…by almost double. For example, for single filers, the standard deduction went from $6,350 to $12,000; married couples filing jointly went from $12,700 to $24,000. As a result, many tax payers benefit more from the standard deduction than from itemizing. That being said, you should still have your tax preparer or software review whether itemizing would benefit you more than the standard deduction.
Tax Credits
Now, deductions are nice, but credits are better. A credit is a dollar for dollar reduction in your taxes. So if you qualify for a $500 tax credit, your tax bill is reduced by $500. Right. off. the. top. Excellent!
Double bonus on credits is that you can usually take them regardless of whether you itemize or take the standard deduction.
Mortgage Interest Deduction
Interest paid on home loans is deductible up to $750,000 for a principal residence plus a second home for single or married filing jointly ($375,000 each for married filing separately). You’ll need to itemize your income taxes in order to claim this. Don’t just fill out the 1040-EZ without doing the math first to see whether itemizing or the standard deduction will result in the lowest tax bill – or highest refund – for you.
Home Equity Loan Interest Deduction
A home equity loan allows you take a loan against the equity you have built in your home. Like a regular mortgage, you can deduct the interest paid on home equity loans or home equity lines of credit (HELOC). The big caveat here is you can only take this deduction if you used the borrowed funds to pay for a home improvement. Make that new kitchen work for you!
Discount Points Deduction
When you take out your mortgage or refinanced to a new mortgage, you often have the option to purchase discount points to lower your interest rate on the loan. The cost to purchase these discount points is deductible. Please note, “loan origination points” are different fees which are not deductible.
Mortgage Insurance (PMI) Deduction
PMI is insurance you pay for that protects your lender in the event you default on your mortgage. It is often seen in mortgages where the buyer is putting down a lower down payment. Your PMI payments can be deducted on your itemized tax return.
Property Tax Deduction
Property taxes on all real estate are deductible. When you buy a home, check the settlement sheet. If you reimbursed the seller for property taxes he or she prepaid for a period you actually owned the home include that amount in your property tax deduction. You can deduct up to $10,000 of property taxes if married filing jointly or $5,000 for single or married filing separate.
Investment/Rental Property Deduction
The cost of maintaining and marketing a rental property can be deducted from the income the property generates. These expenses include mortgage interest payments, insurance, utilities, maintenance, repairs, advertising costs and management fees, as well as the non-cash cost of depreciation.
Home Office Deduction
You can deduct the costs of a home office that you use exclusively as your principal place of business. The IRS allows you to take this deduction based on the percentage of square footage of your office space relative to your home. You are not required to have a room devoted to the office, just a space exclusively used for business.
Be careful with this one as it requires (1) regular and exclusive use and (2) must be the principal place of your business. So if you are working remotely for another company, you generally do not qualify for this deduction.
Tax-Free Rental Income Deduction
If you rent out your own home for 14 or fewer days during the year, the rental income is tax-free.
Residential Energy Property Credit
This credit allows homeowners to take up to $500 off their federal income tax for making certain improvements that increase the energy efficiency of their homes, such as water heaters, furnace, boiler, heat pump, windows or roofing. This credit will expire at the end of 2021.
Residential Energy Efficient Property Credit
Energy saving improvements such as adding solar panels, fuel cells or geothermal heat pumps may qualify for a tax credit. For improvements made between December 31, 2020 and January 1, 2022, the IRS allows you to claim up to 22% of the total cost paid, including installation. This credit is nonrefundable, but can be carried forward into later tax years.
Mortgage Tax Credit (MCC)
This program allows buyers to apply for a MCC at the time of purchase. Qualifying homeowners may take a tax credit equal to a percentage of the interest paid on their mortgage loans each year. This program’s goal is to make housing more affordable for low income buyers. Applicants must meet specific criteria and fall under the income limits.
Tax Deduction No-No’s
- Home insurance premiums
- Homeowner Association (HOA) fees
- Transfer taxes
- Cost of utilities
- Rent for living in the home prior to closing
- Costs for acquiring or refinancing a mortgage, such as origination points, appraisal fee or credit reporting fees
- Depreciation
Be sure you are taking advantage of all the homeowner tax breaks available to you. As always, I’m available for all your homeownership questions!
Photo by Nataliya Vaitkevich from Pexels
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