Uncover the important information about how homeownership affects your tax burden, from mortgage points to PMI. My husband and I sat in our empty new living room for hours after closing on our first house and stared at the walls. He was the first to say anything, saying, “I thought it was painted.”
Over the next 15 years, we learned a lot about that old house. While we were prepared for parts of the work, we discovered others, such as the necessity to paint the walls, as we went. One of the unexpected changes was the requirement to make certain revisions to our tax filings.
The paperwork you fill out when you buy a house is just the beginning. We rapidly realized that first-time homebuyers face years of mortgage and insurance paperwork. Then there are the taxes, of course. To assist you in sorting through that mountain of paperwork and ensure you save as much money as possible, we studied the tax advantages of purchasing.
Six Tax Benefits for New Homeowners
1. You can deduct the interest you pay on your mortgage.
The most well-known tax advantage for homeowners is the mortgage interest deduction. With a few exceptions, including the following major ones, you can deduct all of the interest you pay on your house mortgage.
- Your mortgage cannot exceed $1 million.
- Your home must be collateral for your mortgage (unsecured loans do not qualify).
- Your mortgage must be on an eligible home, which might be your primary or secondary residence (vacation homes also count).
If you’re married and file a joint tax return, don’t assume you have to own your property together to claim the interest. The home can be owned by you, your spouse, or jointly for the deduction. The deduction is the same in either case.
And don’t stress about keeping track of how much interest versus principal you pay each month. Your lender should send you a Form 1098 at the end of the year detailing the amount of interest you paid over the year.
2. You may be able to deduct points.
Points are simply prepaid interest that you pay at closing to improve the rate on your mortgage. The more points you pay, the better the offer.
You can deduct points in the year you pay them if you meet specific criteria. Points must be paid on a loan secured by your primary residence, which must be used to purchase or build your residence.
3. Depending on the year and your income level, you may be able to deduct PMI.
PMI, or private mortgage insurance, protects the bank in the case of a default. First-time homebuyers may be compelled to pay PMI as a condition of their mortgage, especially if they cannot afford a sizable down payment.
PMI is not normally deductible in most years, however the particular restrictions change on a yearly basis. In 2016, if your household income was less than $109 000, you could claim a tax deduction for the cost of PMI for both your principal home and any vacation residences. Check to determine if the PMI deduction is available while you prepare your taxes.
4. Real estate taxes are deductible.
State or municipal governments levy real estate taxes based on the value of your property. The cost of your real estate taxes will be factored into your mortgage and placed in an escrow account by most banks or other lenders.
You cannot deduct payments placed into escrow, but you can deduct sums paid to meet taxes (this amount will appear on a form 1098 issued by your lender at the end of the year).
If you do not escrow for real estate taxes, you will deduct the amount you pay directly to the tax authority.
Not to mention the taxes you paid at settlement. You can deduct taxes if you refund the seller for taxes previously paid for the year.
Those sums will not appear on form 1098; instead, you must check your settlement sheet for the totals.
5. Your other tax deductions may matter more.
To qualify for these tax breaks, you must itemize your deductions on your tax return.
Most taxpayers will notice a significant change: in many situations, you will be switching from a Form 1040-EZ to a Form 1040 to include expenses on Schedule A.
Schedule A is where you would disclose charitable gifts, medical costs, unreimbursed job expenses, and interest, points, and taxes.
For itemizing deductions to make financial sense, you need higher total deductions than the standard deduction (which is $6,300 for individuals and $12,600 for married couples in 2015). Unless they are homeowners, most taxpayers do not reach such figures.
In particular, the house mortgage interest deduction tends to push most homeowners above the standard deduction level, increasing the value of additional deductions (such as medical expenditures) that may otherwise go unclaimed.
6. You’ll get capital gains tax relief down the road.
I know you just bought your house, but face it: resale value was a factor in your decision. In addition, unlike other investments, where you are taxed on the entire amount of any gain, you can deduct portion of the gain attributable to your property when you sell it.
Current legislation allows you to defer paying tax on up to $250,000 in gain ($500,000 if married filing jointly) if you own and live in the property for two of the last five years (those years do not have to be consecutive).
Gains in excess of that amount are taxed at capital gains rates, normally lower than ordinary income tax rates.
Learn more: What You Need to Know About Buying a Home This Winter