Last Updated on November 30, 2022 by Luke Feldbrugge
The tax benefits of owning a home can be a tipping point for you if you are on the edge of deciding to begin hunting for a new home. If you are a first time home buyer, some of these deductions and tax credits will surprise you. If you are a long-time homeowner, you know that a new home mortgage can help you with your tax burden for years. And if you’re a seller, there’s something in the tax laws for you too. Here we cover two main tax benefits of owning a home: tax credits and tax deductions.
As you are looking at the tax benefits of buying a house, it’s important to distinguish between tax credits and tax deductions. Both are good, but one is better. Here’s the math on that
- Tax Credit is more valuable because it reduces the amount of tax you might pay, or increases your return, dollar-for-dollar. A tax credit of, say $1,000, reduces your taxes by $1,000. That’s pretty straightforward.
- Tax Deduction reduces your adjusted income, so it only reduces a percentage of the tax you will owe. A tax deduction of $1,000 reduces your taxable income by $1,000, but you probably only pay 28% of that in taxes. That means you get a reduction of $280 on your tax credits. So deductions only take away a percentage of your owed taxes.
Home Mortgage Interest Deduction
When people talk about the tax benefits of owning a home, they are typically referring to the ability to deduct the interest payments on your mortgage loan from your taxes. Typically the home mortgage interest tax deduction is the biggest and most important deduction for new homeowners. When you deduct the interest you pay each year on your mortgage loan, it can amount to a lot of money you can take off the top of your earned income. It can amount to thousands of dollars, and depending on the cost of your house, tens of thousands of dollars.
The home mortgage interest tax deduction for buying a house does, however, have its limits. Currently you can only deduct the interest on the first $750,000 of your mortgage debt, so if your mortgage is more than that, you can’t deduct the rest of it.
The interest on your mortgage payments is also typically front-loaded. That means you are paying more interest on your loan in the first few years that you have it, and it tapers off as you get closer to the end of your payments. Consequently, your deductions on year one of your mortgage are going to be substantially larger in year one than they will be in year 15.
If you refinance your mortgage, either to reduce your interest rate or to cash out some of your equity, that new loan’s interest also qualifies for a tax deduction.
Every year, your mortgage company will send you a Form 1098 to tell you how much interest you’ve paid that year, and you will want to keep that form when you file your taxes.
Do the Math
When you are thinking about tax benefits of owning a home, remember to do the math. This is where a tax professional can help. The choice you have in front of you is to do a standard deduction or to itemize your deductions, meaning you can subtract your mortgage interest paid. But you can’t do both.
Your standard deduction for 2022 is $12,950 for a single filer and $25, 900 for joint filers. You can figure out how much your deduction will be using a mortgage interest deduction calculator.
Property Tax Deduction
Digging further into the tax benefits of owning a home, in addition to deducting your interest paid, there is also a property tax deduction. This allows you to deduct the local property taxes you paid on your property for the year. Currently there is a $10,000 cap on these deductions, but the average annual property tax paid in the U.S. is $2,100. Unless you are in an area where property taxes are very high, you should be able to stay below that cap.
You can see where the itemized deductions add up. Let’s say you are a single filer who just bought a house last year and paid $10,000 in mortgage interest and another $3,000 in property taxes. You’ve just exceeded your $12,950 standard deduction, so it may make sense to itemize.
If you are a first time home buyer, you might run into a situation at the closing where the seller has prepaid the property taxes and you are going to reimburse them. That reimbursement is also eligible for a deduction, so make sure you keep a copy of the settlement sheet.
Are Mortgage Points Tax Deductible?
When you close on your house, typically you can also deduct any points you paid when you got the mortgage. Mortgage points are payments you make to get the loan or get it with a reduced interest rate. One point is one percent of the total home loan amount. Two points are two percent. You get the picture.
If you pay these points up front, or pay them all during the first year of ownership, you can typically deduct them. That can add up fast. If, however, you roll them into the mortgage and pay them over time, they may not add up to much in terms of a yearly deduction. Information about your points paid will be on your 1098 form from your mortgage company.
Private Mortgage Insurance (PMI)
Another ongoing expense that comes from getting a mortgage is the requirement for private mortgage insurance. Unless you put a minimum of 20% down payment on your new home, your lender is going to require PMI, and the monthly payment can typically range between $100-$300. Generally speaking, you will be paying it for the first few years of owning your home, and it can add up. This deduction is for any mortgage or refinance after 2007. Congress almost eliminated this deduction recently, so no one is sure how long this will last.
If you’ve been keeping score, itemization is looking increasingly positive for your tax return on the first year of your mortgage. Generally, you can deduct:
- Interest payments
- Property taxes
That can add up to more than your standardized deduction, but please do the math and work with a licensed tax professional if you need assistance.
Home Office Deduction
We know what you’re thinking: you work from home now so your home office tax deductible? We’re afraid not. The home office deduction is reserved for those people who are actually self-employed. So if you receive a W2 from an employer, you can’t deduct office space in your home or the office equipment you need to do your jobs (computers, printers, wifi).
If you do have an eligible home office space in your new home, there are two ways to calculate your deduction: the easy way and the hard way.
- The easy way is to multiply the square feet of your office space by $5 and deduct that (maximum is 300 square feet or $1,500)
- The hard way is to calculate what percentage of your home is being used for your home office. Then you can deduct a portion of things like real estate taxes, mortgage interest, utilities, insurance, depreciation, maintenance, and repairs.
Energy Efficiency Upgrades
Remember what we said about tax credits? These are the dollar-for-dollar tax reductions, and they are available for energy efficient home improvements to your house. There’s a lot of attention on alternative energy upgrades such as solar panels, geothermal heating, fuel cells, wind power, but the list of energy efficient upgrades that qualify is pretty long.
- Energy efficient windows, doors, skylights
- Certain roofing materials
- Water heaters
- Biomass stoves
- Advanced air circulation systems
- Furnaces and boilers
Of course not every water heater, furnace or roof is going to qualify, so it’s best to check with the manufacturer before you try to deduct any items you think might qualify.
It’s important to remember that tax credits are not deductions, so you can use these even if you don’t itemize.
Mortgage Interest Tax Credit Certificate
A mortgage credit certificate is for homebuyers who are at low to moderate income levels. These tax breaks for first time home buyers are designed to make home ownership more widely available. The mortgage credit certificate program converts a portion of the home buyer’s mortgage interest directly into a tax credit (up to $2,000) instead of using it as a tax deduction.
Capital Gains Exclusion, Selling Your Home
Most of the tax advice out there is for buyers, but there are tax advantages for sellers too. Primarily, the capital gains you make when you sell your own home are tax free. That means that if you buy your house at one price, say $300,000, and sell it at a higher price of $450,000, your capital gains would be $150,000. That’s all tax free (unless you sell your home within the first year of ownership). This, however, only works for your primary residence and not a second home.
The limits for tax-free capital gains are $250,000 if you are single, and $500,000 for a married couple.
Save Money When You Close With Homes for Heroes
Homes for Heroes can’t help you with your taxes, but our team can help you:
- Find the home of your dreams
- Sell your current home
- Refinance your mortgage
- Get a new mortgage
- Do a home inspection
- Do the title work
When you work with our local team of dedicated real estate and mortgage professionals to close on a house, we thank you with a Hero Rewards check that averages $3,000 after closing.
IMPORTANT: Homes for Heroes does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.