There are multiple reasons why it’s a great time to buy a home: Interest rates are at a record low, home prices are attractive and, accordingly, overall affordability is at an all-time high. But there are other advantages that first-time home buyers often overlook: the tax benefits of home ownership. These benefits can save hundreds or even thousands of dollars every year. The biggest tax breaks come from mortgage interest, home equity interest, property taxes and points:
For most homeowners, a large percentage of their monthly mortgage payment goes toward interest. All this interest is deductible, unless your mortgage loan is more than $1 million. For mortgages that exceed $1 million, the Internal Revenue Service will limit your interest deduction. Interest tax deductions don’t end with your first mortgage. If you pull out extra cash through refinancing, or if you secure a home equity loan that interest is also deductible. Generally, equity debts of $100,000 or less are fully deductible. In addition, if you purchase a vacation home, that mortgage interest is fully deductible. Plus, the vacation property doesn’t have to be strictly a house. It can be a boat or RV, as long as it has cooking, sleeping and bathroom facilities. You can even rent out your second property for part of the year and still take full advantage of the mortgage interest deduction as long as you also spend some time there.
Another major tax deduction is property taxes. Most monthly mortgage payments include property taxes, which are placed into an escrow account for payment twice a year. As the homeowner, these taxes can be deducted on your tax return every year. If it’s your first tax year in the house, review the settlement statement you got at closing to find the tax payment information. When the property was transferred from the seller to you, the year’s tax payments were divided so that each of you paid the taxes for that portion of the tax year during which you owned the home. Your share of these taxes is fully deductible.
If you paid points to get a better rate on your mortgage loan, the cost of these points is also deductible. The IRS lets you deduct points in the year you paid them if the loan is to purchase or build your primary home and the points were within the usual range. A homeowner who pays points on a refinanced loan is also eligible for this tax break, but in most cases the points must be deducted over the life of the loan. But if the refinancing frees up cash that you use to improve your house, you can fully deduct points on that money in the year you paid the points. The same rule applies to home equity loans or lines of credit. When the loan money is used for work on the house securing the loan, the points are deductible in the year the loan is taken out. Points paid on a loan secured by a second home or vacation residence, regardless of how the cash is used, must be amortized over the life of the loan.
When you Sell
When you decide to move up to a bigger home, you’ll be able to avoid some taxes on the profit you make. Years ago, a homeowner had to use the sale proceeds to buy another house. But in 1997, the law was changed so that up to $250,000 in sales gain ($500,000 for married joint filers) is tax?free as long as you owned the property for two years. If you sell before meeting the ownership and residency requirements, you owe tax on any profit. The IRS provides some tax relief if the sale is due to a change in your health, employment or unforeseen circumstances. A partial exclusion can be claimed if the sale was prompted by residential damage from a natural or man?made disaster or the property was “involuntarily converted,” for example, taken by a local government under the eminent domain law. Second home sales can provide some tax benefits, but not as much as they did in the past, as a result of a law that took effect in 2008. Previously, you could move into your vacation property, live in the home as your primary residence for two years and then sell and pocket up to $250,000 or $500,000 profit tax?free. Now, you’ll owe tax on part of the sale money based on how long the house was used as a second residence.
Consult a Qualified Tax Advisor
Remember, these are only general guidelines, to help get you started. To take full advantage of the tax advantages of owning a home, consult a qualified tax advisor.