The Major Tax Benefits That Come With Purchasing A Home

Oct 31 | 7 minutes read
The Major Tax Benefits That Come With Purchasing A Home

Save money by taking advantage of these tax breaks and credits

Are you considering purchasing a home? There are numerous benefits to purchasing 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 just the way you want it. But there are other advantages—financial advantages.

If you rented in the past, all of your money went to the landlord and none of it was tax deductible. That changes if you own a home.

Whether you buy a mobile home, a townhouse, a condominium, a cooperative apartment, or a single-family home, there are various tax incentives that 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.


Tax Deductions vs. Tax Credits

There are deductions and credits in the tax realm. 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. So, 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 home ownership come in the form of deductions. The following are the most prevalent deductions:


Deduction for Mortgage Interest

Mortgage interest on the first $750,000 ($375,000 if married filing separately) of mortgage debt is deductible. If you purchased your home before December 16, 2017, the existing limit of $1 million ($500,000 if married filing separately) applies.

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. You are eligible for a deduction if you actually paid the lender for these discount points.

If you refinanced your loan or obtained a home equity line of credit (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. So, 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 show how much you spent in mortgage interest and mortgage points. You can claim the deduction on Schedule A of Form 1040 or 1040-SR using that information.

Private Mortgage Insurance (PMI) is a mortgage 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 home.

According to the IRS, you can deduct PMI payments as home mortgage interest. The insurance must be in conjunction with a home issued after 2006. You are entitled for the entire deduction if your AGI is less than $100,000 ($50,000 if married filing separately). The deduction is phased out above specified levels. You can't take the deduction if your AGI is more than $109,000 ($54,500 if married filing separately).


SALT (State and Local Tax) Deduction

If 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. The previously unlimited deduction was capped to $10,000 per year in combined property taxes and either state income taxes or sales taxes under the Tax Cuts and Jobs Act (TCJA). If you are single or married filing jointly, the cap is $10,000; if you are married filing separately, the cap is $5,000.

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. Include 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.

If you choose to deduct state and local sales taxes rather than income taxes (you cannot deduct both), you can do so using either your actual expenses or the optional sales tax tables provided in Schedule A. (Form 1040).


Exclusion for Home Sales

Because of the home sale exclusion, you may not have to pay taxes on the majority of the profit you generate when you sell your home.

You won't have to pay taxes on the first $250,000 in profit if you owned and lived in the home for at least 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. However, 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 home early due to a divorce, job shift, or whatever else, you may be able to meet part of the residency requirement.

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 home 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 2021 and 2022 is 10% to 37%.

If you held the home for more than a year, long-term capital gains tax rates apply. Depending on your filing status and income, the rate is 0%, 15%, or 20%.


Tax Breaks

If you were awarded a qualifying mortgage credit certificate (MCC) by a state or local governmental entity or agency as part of a qualified mortgage credit certificate programme, you may be entitled for a mortgage credit.


Which expenses am I allowed to itemize?

Schedule A Form 1040 is where you itemize your deductions. Home mortgage interest, home equity loan or home equity line of credit (HELOC) interest, mortgage points, private mortgage insurance (PMI), and 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 should itemize their tax deductions?

You have the option of taking the standard deduction or itemize 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 2021 standard deduction amounts?

The standard deduction for single and married filing separately taxpayers is $12,550 in 2021, $18,800 for heads of household, and $25,100 for married filing jointly filers and surviving spouses.


What are the 2022 standard deduction amounts?

The standard deduction for single and married filing separately taxpayers is $12,950 in 2022, $19,400 for heads of household, and $25,900 for married filing jointly filers and surviving spouses.


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. Don't fall into the trap of believing that paying interest is advantageous since it lowers your taxes. Paying off your home as soon as possible is by far the finest 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 home for a long time. Of course, consult with your financial counsellor about the best approach to pay down your debt.

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