Top Tax Advantages of Buying a Home

Thinking of buying a home? There are plenty of perks in it. You can decorate it to suit your taste; you can put in a professional home theater system or perfectly customize the walk-in closet to hold everything you have in just the way you want it. But there are other benefits – financial benefits. If you rented in the past, all of your money went to the landlord. None of it came back to you as a tax deduction; but all of that is about to change. (For more information on buying a home, see: How To Buy Your First Home: A Step-By-Step Tutorial)

These tax breaks aren’t just available for the single family home in the nice subdivision, either. You could purchase a mobile home, townhouse, condominium, cooperative apartment and, yes, a single family home. As long as you’re entering into a mortgage contract, you’re eligible. 

The only downside is that your taxes are about to get more complicated. Gone are the days when you plug your W-2 information into the 1040EZ form and, 10 minutes later, your taxes are done. As a homeowner, you enter the wonderful world of itemizing. You will have your own treasure trove of stories about losing receipts and calling stores days before your taxes are due, just to shave a couple more dollars off your taxable income.

Yet it’s all worth the hassle when you see how much money you might save.

In the tax world, there are deductions and credits. Credits represent money taken off of your tax bill. Think of them as coupons. If you get a $500 tax credit, your tax due will go down $500. A tax deduction reduces your adjusted gross income, which in turn reduces your tax liability. Here’s how it works: If you’re in the 25% tax bracket your tax liability will be reduced by 25% of the total claimed deduction. So if you claim a $2,000 deduction you can expect your tax liability to drop by about $500. 

Most of the favorable tax treatment that comes from owning a home is in the form of deductions. Here are the most common deductions:

Mortgage Interest

Unless your case is that rarest of rare cases, you can probably deduct all of your home mortgage interest. There are some exceptions: for example, there is a $1 million yearly cap on the amount you can deduct, but chances are this won't apply. In many instances, you can even deduct late fees.

In January, after the end of the tax year, your lender will send you IRS Form 1098, detailing the amount of interest you paid in the previous year. Be sure to also include any interest you paid as part of your closing. Lenders will include interest for the partial first month of your mortgage as part of your closing. You can find it on the settlement sheet. Ask your lender or mortgage broker to point this out to you. If it’s not included on your 1098, add this to your total mortgage interest when doing your taxes. (See also Tax Deductions On Mortgage Interest.)

Real Estate Taxes

The money you pay in property taxes is deductible, too. If you pay your taxes through a lender escrow account, you’ll find the amount on your 1098 form. If you pay directly to your municipality, you will have personal records in the form of a check or automatic transfer.

If you reimbursed the seller for any real estate taxes they prepaid while you owned the home, include those payments as well. You can find them on your settlement sheet. 

Points

You may have paid points to the lender as part of a new loan or refinancing. Points are normally priced as a percentage of the total loan. If you paid $275,000 for your home, each point costs you 1% of your home, or $2,750. As long as you actually gave the lender money for these points, you get a deduction. 

If you refinanced your loan, or took out a home equity line of credit, you receive a deduction for points over the life of the loan. Each time you make a mortgage payment, a small percentage of the points is built into the loan. You can deduct that amount for each month you made payments. If $5 of the payment was for points, and you made a year’s worth of payments, your deductible amount is $60. (See also A Tax Primer For Homeowners.)

Private Mortgage Insurance (PMI)

If you took out a loan in 2007 or later, you might be able to deduct your private mortgage insurance payments. Lenders charge PMI to borrowers who put down less than 20%. If you’re single and your adjusted gross income is less than $50,000, you’re eligible for the deduction. Above $50,000, the deduction phases out. If you’re married, the threshold is $100,000. 

If You Sell Your Home

Chances are you won’t have to pay taxes on most of the profit you might make when you sell your home. If you’ve owned and lived in the home for at least two of the five years before the sale, you won’t pay taxes on the first $250,000 of profit. If you’re married, the number doubles to $500,000, but both spouses have to meet the residency requirement. You might even be able to meet part of the residency requirement if you had to sell your home early due to a divorce, job change, or something else. (Sellers may be interested in reading Dos And Don'ts Of Selling A House.)

Of course, it would be nice if all of these were tax credits, but they’re not. However, there are some tax credits available to you as a homeowner. For example, if you make improvements to the energy efficiency of your house – such as a geothermal heat pump or a solar energy system, you may qualify for a federal tax credit of 30% of the installation cost. Check energy.gov to find out whether your state also offers tax credits, rebates, and other incentives for energy-efficient improvements to your home. 

Let’s keep this in perspective. If you’re in the 25% tax bracket, you’re still paying 75% of your mortgage interest without any deductions. Don’t fall into the trap of thinking that paying interest is beneficial because it reduces your taxes. Paying off your home as quickly as possible is, by far, the best financial move. There’s no prepayment penalty for paying off your mortgage, so pay as much as you can if you plan to live in the home for a long time. Of course, talk to your financial planner about the most beneficial way to pay down your debt.