Tax Benefits of Owning a Home

Owning a home requires you to have a clear picture of your finances. Not only do you need to know what to budget each month for various expenses, but you also have to be aware of tax savings. From deducting mortgage interest to claiming energy tax credits, there are multiple ways to get money back on your tax return. 

This article will cover the leading tax benefits of owning a home and the eligibility requirements that come with them. Use this guide to maximize deductions so you can save.

If you aren’t sure whether you qualify for certain deductions or credits, talk to a tax specialist. They can crunch the numbers for you.

Mortgage Interest Deduction

A mortgage interest deduction allows you to deduct what you paid in mortgage interest on your taxes. You cannot deduct the whole mortgage, but you can deduct the percentage that is interest. There are a few criteria that limit when you can use this tax deduction. 

• You must itemize your taxes when filing. Anyone who opts for the standard deduction cannot at their home’s interest as a line item.
• You can only deduct the interest paid on the first $750,000 of your loan for mortgages procured after December 2017. If your loan is less than this amount, the cap should not affect you.  
• The tax deduction can apply to a primary home or a second home. It also applies to all types of homes (condos, mobile homes, houseboats, etc.) 

To claim the mortgage interest deduction, ask your lender for a copy of Form 1098. All lenders should send this form out by the end of January, so you can expect to receive it by early February. This will state exactly how much you paid in interest, which is the amount you can deduct. 

For example, if you have a $1,500 per month mortgage payment, $200 might go toward the principal and $1,300 might go toward the interest during the first year. This means you will pay $15,600 in mortgage interest based on the amortization schedule, which is what you can deduct.

By 2035, you might pay $400 toward the principal and $1,100 toward the mortgage interest, bringing your annual interest costs to $13,200. The less mortgage interest you pay over time, the less your deduction will be.

Property Tax Deduction

Most Americans pay taxes to different entities. Along with filing their federal income tax, they also need to pay state and local taxes (SALT) on various assets. The property tax deduction allows you to write off the state and local taxes that you paid on your property when you are filing your federal taxes. These tax deductions apply to both the annual property taxes you paid and any taxes you paid when closing on your home. 

There are some limits to this tax deduction. You will once again need to list out itemized deductions to claim this benefit instead of doing the standard filing option. There is also a $10,000 cap on SALT deductions. 

Deductions on property taxes benefit homeowners who live in states with high tax rates. To get the most from this deduction, make sure you gather your financial documents to prove you paid your state and local taxes and deserve the tax benefits as a result. If you don’t have a copy of your property tax records, reach out to your local municipality for tax documents. Your mortgage lender might also have this information if they handle your property tax payments. 

Knowing how much you pay in property taxes is important for understanding your monthly payments and where your money goes. You should also look into homestead exemptions which can help reduce your property tax burden.

Capital Gains Tax Exclusion

One of the most common questions that homeowners have when they sell their homes is whether they have to pay capital gains taxes. However, it’s possible to take advantage of the capital gains tax exclusion to reduce (or even eliminate) your overall bill. 

The capital gains tax exclusion applies to the first $250,000 in profits for single filers or $500,000 for married couples filing jointly. This only applies to primary residences, which means you must have lived in the home for two of the past five years. 

Here are a few examples of the capital gains tax exclusion so you can see how it works:

• A homeowner bought a house for $300,000 and sold it for $500,000. Their capital gains are $200,000 which falls below the $250,000 threshold. They don’t have to worry about paying this tax. 
• The second homeowner bought a house for $200,000 and sold it for $500,000. Their capital gains are $300,000 and they take advantage of the $250,000 exclusion. The capital gains tax only applies to the remaining $50,000. 
• The third homeowner bought a house for $200,000 and sold it for $500,000. They paid a six percent commission to their real estate agents, totaling $30,000. This commission is also deductible, so the capital gains tax only applies to $20,000 once the $250,000 exclusion is applied.  

Knowing what you can deduct from your capital gains bill can have a big impact on the taxes you pay. You might pay far less than you think once it’s time to file or eliminate your capital gains tax bill entirely. 

Home Office Deduction

Self-employed individuals who have a dedicated space in their homes for work can reduce their tax bill with a home office deduction. This deduction is based on the square footage of the workspace compared to the rest of the home. If you are a W-2 employee you likely cannot claim this deduction. 

Here are a few ways to determine how much of your space qualifies and what you can deduct: 

• Only measure your dedicated workspace. This is an office or room that is used regularly and exclusively for work. 
• Measure the square footage of the room and compare it to the rest of the house. For example, a 12 x 10 room is 120 square feet. If you have a 1,800-square-foot house, the office makes up 6.6%. 
• Identify all possible deductions, including utilities, maintenance, and property taxes, which can be prorated for the home office.

If you are looking for a simpler way to calculate your deduction, use the IRS rule of thumb for $5 per square foot. If your workspace is 120 square feet, then your deduction would be $600. The maximum space you can deduct according to the IRS is 300 square feet or $1,500. 

Home office tax benefits are meant for spaces that are the primary place of business for self-employed individuals. They can also be used if they are where the bulk of your administrative or management activities occur. For example, if you have a landscaping business but use a home office for bookkeeping and marketing, you could still qualify.

Energy-Efficient Home Improvement Credits

You can also take advantage of tax credits as you consider what improvements and repairs you need for your home. You can receive up to $3,200 annually in federal tax credits if you make energy-efficient upgrades that improve how your home is run. For example, installing solar panels, replacing old windows with energy-efficient ones, and adding insulation can all count toward these credits.

These credits are based on a percentage of what you spend, with a cap of 30%. For example, if you spend $10,000 on solar panels for your roof, you could receive a tax credit of $3,000 for your efforts. Energy Star has a list of items that count toward these credits and the IRS also has guidelines you can review. 

This is a good time to discuss the difference between tax credits and tax deductions. Tax credits reduce your overall tax burden. Tax credits reduce the amount you owe in taxes, while deductions reduce your taxable income.

Too often, people think deductions reduce what you pay when they really reduce what you are taxed on. You will still save on tax deductions, but usually not as much as tax credits. You can apply both tax credits and deductions when you file to maximize savings.   

One thing to note is that tax credits are subject to change. Different legislative priorities and bills could increase or decrease available credits. Check which credits apply to you before starting an efficiency project to make sure you are covered.

Tax Deduction for Points Paid

If you are in the process of buying a home, pay attention if your lender offers any points to lower your interest rate. You may be able to reap tax benefits and interest savings by choosing this option. Points are prepaid interest on the home and typically cost 1% of the loan’s value. For example, if you are taking out a $300,000 loan, a point would cost $3,000. 

Mortgage points are optional and require a higher upfront cost. However, some people feel like the savings are worth it. Instead of paying interest over time, some buyers want to invest in points to reduce their overall costs. Your Realtor or financial advisor can help you understand whether buying points is worth it and what the break-even point would be for the investment. 

Another perk of buying points is that they are tax deductible. The IRS allows you to deduct the full amount of the points for the year you pay them. Once again, this only applies if you opt for itemized deductions. This is a one-time tax deduction, which means it only applies to the year you bought the points. You cannot continue to deduct them in the same way you deduct your interest.  

If you are not buying a new home, there is still a chance you can choose to purchase points and apply them to your tax deductions. Homeowners who are refinancing often purchase points to receive lower interest rates. If you start the refinance process this year, keep any points you purchase in mind. 

This deduction mostly applies to primary residences and might not apply to vacation or second homes.

Private Mortgage Insurance (PMI) Deduction

Private mortgage insurance (PMI) is often required for loans that are greater than 80% of the home’s value. For example, if you buy a $300,000 house and require a $250,000 loan, you will need to pay PMI. Once you reach 20% ownership, your lender will stop charging PMI on top of your loan. PMI is usually 0.5% to 2% of the original loan amount per year. Using the $250,000 example, PMI could range from $1,250 to $5,000 per year, or $104 to $416 per month. 

Unfortunately, the tax deduction for PMI expired after 2021, which means you cannot use your PMI to reduce your taxable income. However, this deduction is subject to periodic renewal by Congress, so homeowners should check for updates. While there isn’t any present legislation to bring back the PMI deduction, it could come up in the future. 

For now, the best way to save money is to pay down your mortgage loan until the PMI is canceled.

Rental Income Tax Benefits (For Landlords)

Don’t forget to check your tax benefits if you rent out part of your property or have a separate investment property that you collect rental income from. While you will need to pay taxes on your profits from renting out your space, there are plenty of deductions to reduce your tax bill. Here are a few expenses you can add to your itemized deductions. 

• Mortgage interest: just like your primary residence, you can deduct your mortgage interest on your investment property or second home. 
• Operating expenses: track the cost of doing business to manage your rental. This includes advertising costs, property management fees, and insurance costs. 
• Repairs: document any money you spend on repairs when looking for tax deductions for your rental home. 
• Depreciation: wear and tear is a natural part of owning a rental property. The IRS allows you to deduct depreciation on your taxes. 
• Professional service fees: these can range from legal fees to pest control costs. Whenever you hire an expert for your business, document the costs.  

Because there are so many deductions available, you need to keep detailed records of all costs and income associated with your rental property. You don’t want to over or underpay on taxes because of poor bookkeeping.

Take Advantage of the Tax Benefits of Owning a Home

Homeownership comes with several unexpected bills and expenses, but it also provides tax benefits that can reduce your annual costs. If you have always filed the standard way, consider switching your tax process to list itemized deductions. You might be able to save more now that you are a homeowner. Once you add your mortgage interest deduction, property tax deduction, and other credits, you might save more than you realize.

To maximize your tax benefits, stay organized throughout the year. Know what you paid in taxes, interest, and utilities. Keep up with other costs and home improvement expenses. You can also work with a tax professional to walk you through your options. They can help you better understand your tax bill.

If you are preparing to become a homeowner, talk to your real estate agent about your taxes. They can answer any questions you have and help you prepare for potential costs. Experienced agents should be able to speak confidently about real estate taxes and other fees you can expect.

To find a Realtor, try FastExpert. You can choose from hundreds of leading agents in your state or region. Find a real estate professional who is a good fit for your needs. They can make buying, selling, and even paying taxes easier.