Save money by taking advantage of these tax breaks and credits.
Are you considering purchasing a home? There are numerous benefits to buying one. You can decorate it to your liking, install a professional home entertainment system, or even design the walk-in closet to contain everything you own how you want it. But there are other advantages—financial advantages.
It changes if you own a property.
Whether you buy a mobile home, a townhouse, a condominium, a cooperative apartment, or a single-family home, various tax incentives can save you money at tax time.
The only disadvantage is that your taxes will get more complex. The days of plugging your W-2 information into the 1040EZ form and finishing your taxes in 10 minutes are long gone. You enter the delightful realm of itemizing as a homeowner. Of course, it’s worth the effort when you consider how much money you could save.
KEY LESSONS
A home may be the most expensive and significant purchase you will ever make.
The Federal Revenue Service (IRS) offers several tax benefits to help make homeownership more affordable.
There are many typical tax deductibles, such as mortgage points, interest, and private mortgage insurance.
To claim deductions, you must itemize your taxes.
Tax credits are offered to qualifying first-time homebuyers and homeowners who make energy-saving upgrades (e.g., solar panels and energy-efficient windows).
Tax Deductions vs. Tax Credits
There are deductions and credits in the world of taxes. Credits are sums of money deducted from your tax bill. Consider them to be coupons. If you receive a $1,000 tax credit, your tax liability will be reduced by $1,000. A tax deduction lowers your adjusted gross income (AGI), lowering your tax liability.
If you are in the 24% tax bracket, for example, your tax burden will be reduced by 24% of the total claimed deduction. Hence, if you get a $1,000 deduction, your tax liability will be reduced by $240 ($1,000 24%).
Tax Breaks for Homeowners
The majority of the tax benefits associated with property ownership come in the form of deductions. The following are the most prevalent deductions:
If you purchased your property before December 16, 2017, the existing deduction limit of $1 million ($500,000 if married filing separately) applies.
To deduct Home mortgage interest you must itemize these deductions on a Schedule A Form 1040 or 1040-SR and the mortgage is a secured loan on a residence you own.
Your lender will issue you Internal Revenue Service (IRS) Form 1098 in January, following the end of the tax year, showing the amount of interest you paid the previous year.
Include any interest you paid as part of your closing costs. Lenders will include interest for the first partial month of your mortgage as part of the closing costs. It is listed on the settlement sheet. Request that your lender or mortgage broker point this out to you. If it isn’t on your 1098, add it to your total mortgage interest when filing your taxes.
Deduction for Mortgage Points
As part of a new loan or refinancing, you may have paid mortgage points to your lender. Each point purchased typically costs 1% of the total loan and reduces your interest rate by 0.25%. If you purchased $300,000 for your home, each point would be worth $3,000 ($300,000 1%). With a 4% interest rate, for example, one point would reduce the rate to 3.75% over the life of the loan. Eligibility for a deduction is available if you actually paid the lender for these discount points.
Discount points, like mortgage interest, are deductible on the first $750,000 of debt.
If you refinanced your loan or obtained a home equity line of credit loan,(HELOC), you are eligible for a point deduction throughout the term of the loan. A modest fraction of the points is added into the loan with each mortgage payment. You can deduct that amount for each month in which you paid. Hence, if you paid $5 for points and made a year’s worth of payments, your deductible would be $60.
Your lender will issue you Form 1098, which will explain how much you spent in mortgage interest and points. You can claim the deduction on the Schedule A of Form 1040 or 1040-SR using that information.
Private Mortgage Insurance (PMI) is a fee charged by lenders to borrowers who put down less than 20% on a conventional loan.
For each $100,000 borrowed, PMI typically costs $30 to $70 per month. PMI, like other types of mortgage insurance, protects the lender (rather than you) if you fail to make mortgage payments. You may be eligible to deduct your PMI payments depending on your income and when you purchased your house.
Mortgage insurance premiums are no longer deductible.
Prior to 2022, the PMI deduction expired and was repeatedly renewed. The PMI deduction ended in 2017. However, it was reinstated in 2019 and applied retroactively to the 2018 tax year. The deduction began in 2020 and was extended until 2021 by the Consolidated Appropriations Act (CAA). The IRS has allowed the deduction to expire for 2022 returns, meaning taxpayers can no longer deduct mortgage insurance premiums.
Deduction for State and Local Taxes (SALT)
When you itemize on your federal return, you can deduct some taxes paid to state and local governments using the state and local tax (SALT) deduction. When you are single or married filing jointly, the cap is $10,000; if you are married filing separately, the cap is $5,000.
The deduction limit applies to the total deduction of state, local, sales, and property taxes.
To receive the mortgage interest deduction, mortgage points deduction, and SALT deduction, you must itemize your deductions. If you use the standard deduction on your tax return, you cannot claim these deductions.
You’ll find the amount on your 1098 form if you pay your property taxes through a lender escrow account.
If you pay directly to your municipality, you will have personal records in the form of a check or automatic transfer. Including any payments, you made to the seller for prepaid real estate taxes (you can find them on your settlement sheet).
State and local income taxes deducted from your paycheck are reported on your W-2 form, which your employer(s) must send by the end of the tax year.
When you choose to deduct state and local sales taxes rather than income taxes (you cannot deduct both), you can do so by using your actual expenses or optional sales tax tables provided in Schedule A. (Form 1040).
House Sale Exemption
Because of the home sale exclusion, you may not have to pay taxes on most of the profit you generate when you sell your home.
You don’t have to pay taxes on your first $250,000 in profit, when you are the owner and live in the house for two of the five years before the sale (i.e., capital gain). If you’re married and filing jointly, the amount doubles to $500,000. Nonetheless, both couples must meet the residency criterion and at least one spouse must meet the ownership requirement (i.e., lived in the home for two out of the previous five years).
If you had to sell your house early due to a divorce, job shift, or whatever else, you may be able to meet part of the residency requirement.
If your taxable gain on the sale of your primary residence exceeds the exclusion amount, report the entire gain on Form 8949: Sales and Other Dispositions of Capital Assets.
Any gains will be taxed at either the short-term or long-term capital gains rate, depending on how long you owned the home:
If you held the residence for less than a year, you are subject to short-term capital gains tax rates. These profits are taxed at your regular income tax rate, which for 2022 and 2023 is 10% to 37%.
If you held the residence for over a year, long-term capital gains tax rates apply. Depending on your income and filing status, the rate is 0%, 15%, or 20%.
Tax Breaks
If you were awarded a qualifying mortgage credit certificate by state or local governmental entity or agency as part of a qualified mortgage credit certificate program, you may be entitled for a mortgage credit.
Additionally, visit energy.gov to see if your state offers tax credits, rebates, or other incentives for making energy-efficient home upgrades.
Which Costs Am I Allowed to Itemize?
Schedule A Form 1040 is where you itemize your deductions.
State and local tax (SALT) deductions are generally allowable deductions for homeowners. Charitable contributions, accident and theft losses, some gambling losses, unreimbursed medical and dental expenses, and long-term care premiums may also be deductible.
Who Is Required to Itemize Deductions?
You have the option of taking the standard deduction or itemizing your deductions. If the value of the costs you can itemize exceeds the standard deduction, itemizing makes financial sense. You must also itemize to deduct mortgage interest, mortgage points, and SALT.
What Are the 2023 Standard Deduction Amounts?
Standard deductions for a single or married filing separately taxpayers in 2023 is $13,850, $20,800 is for heads of household, and $27,700 is for married filing jointly filers.
In conclusion
Keep the following in mind: Without any deductions, you’re still paying roughly 75% of your mortgage interest if you’re in the 24% tax bracket. When you Pay off your mortgage as soon as possible is by far the smartest financial decision. There is no penalty for paying off your mortgage early, so pay as much as you can if you intend to stay in the house for a long period. Of course, consult with your financial counselor about the best approach to pay down your debt.