When you own a home, you get to enjoy some tax advantages that renters are not able to take advantage of. These tax advantages of owning a home, along with fulfilling the American dream are what causes many to buy their first home.
With rents around the country rising, the tax benefits of owning a home only become more magnified!
The exact tax benefits that you will get from owning your home will vary based on different factors, but suffice it to say that the average homeowner typically gets thousands of dollars in tax deductions related to ownership. The value of these deductions is considerable, and will be especially notable if you have always rented before. There are several common tax deductions that homeowners can claim:
Capital Gains Exclusion
The capital gains exclusion from selling your home is hands down the most substantial tax benefit an owner gets from ownership. When you sell your home – hopefully for more than you bought it for – you get to keep the profits up to $500,000 when you are married and $250,000 if single. When you consider that selling other investments, like stocks or bonds, is often taxed at around 15%, you can see why this is such a great benefit. You have the potential to walk away with up to half a million dollars without paying taxes.
The tax system is designed this way because these profits are usually used to buy another home. You take your tax-free money and invest it in more real estate – the smart move for you and the economy. The latest version of the capital gains exclusion was a tax advantage that was put into place in 1997.
In all the excitement of purchasing a home, many buyers forget about all of the home buying tax deductions come April in the next calendar year. There are lots of them too including mortgage interest, discount points, property taxes, pro-rated interest, mortgage insurance and a few others.
When you take out a mortgage, you can expect to pay a considerable amount of interest, depending on the price of your home and the rate of the mortgage. Much of this interest is paid up front on the loan, meaning that for the first years of home ownership, your monthly payments will be going towards interest – two-thirds of each payment, in many cases. Even if you get a fantastic rate on your mortgage, you are still borrowing hundreds of thousands of dollars, which results in a sizable interest payment. Fortunately, you can deduct this mortgage expense on your taxes.
The federal government allows you to deduct all of the interest on the mortgage up until you hit $1 million in interest or $500,000 if you are married and filing separately from your spouse. For most home buyers this means you will be able to deduct mortgage interest throughout the life of the loan.
If you were to take out a mortgage for $300,000 and you had a fixed-rate loan at 4% for 30 years, you would be paying around $11,000 over the first year towards interest. If you fall into the 25% tax bracket, you would be able to deduct approximately $2750 off your taxes. Being able to deduct an extra $2750 off of your yearly tax bill is something anyone can appreciate. In fact, that could be a couple of months rent in some areas depending on what type of property you are renting.
Wherever you buy your home, you can expect to pay some property taxes. The local school district, the county and the town or city itself may all need funds every year to provide services to the community where your home is located. Usually based off of the assessed value of the house, property taxes are an expense that every homeowner needs to plan for. They can be costly, especially in some regions of the country.
One bonus that comes from paying those taxes, though, is that you can deduct them from your yearly tax bill. You could easily wind up deducting $4,000 or $5,000 a year just from property taxes. Again, a deduction that everyone can appreciate. The amount you can deduct should be discussed with your accountant when preparing your yearly taxes.
When you got your loan for the house, you may have chosen to purchase discount points on the rate of the loan. A point is essentially 1 percent of the loan amount. So using the example of a $300,000 loan one point would equal 1% of $300,000 or $3000. There is a price for each point, but then you get the enjoy the benefit of having a lower interest rate on your home and the lower monthly payments that result from such an interest rate.
Typically you should pay points if you expect to be in a home for an extended period. Some buyers choose to do this, and some do not, but those that do may be able to deduct the cost of those points. A single point purchase could save you $500 or more off of your tax bill the first year after you buy your home.
When trying to decide whether it makes sense to pay points or not, you will want to take the difference in payment between paying points and not paying them. You then need to figure out how long it will take for a payback on that difference. If you are only planning on staying in the home a couple of years, then you would probably opt not to pay points. As the difference in payment would not be enough to offset the cost savings.
For most people, paying a 20% down payment on a new home is just not possible. Unless you make a considerable amount of money from your job, enjoy some inheritance or have help from your family, 20% is often too hefty an amount for most people to come up with. In fact, many people incorrectly assume a small down payment precludes a buyer from purchasing a home. This is certainly not the case. The cost of not having a 20% down payment, however, is that you have to take out mortgage insurance in most circumstances.
Fortunately, you should be able to deduct the cost of your mortgage insurance off of your tax bill, as long as you make less than $100,000 a year. If you make between $100,000 and $109,999, you may also be able to deduct a portion of your mortgage insurance payment. Most people who claim this deduction enjoy a sizable deduction amount, averaging around $1,000.
As of now, the mortgage insurance deduction has not been renewed by Congress for 2015. If it is not renewed, you will not be able to use this deduction. However, Congress typically waits to renew this particular deduction until the end of the year, so there is hope that it will be there when you file.
It is wise to save the receipts for all work done on your home that is considered an improvement. Things such as replacing old kitchen counter tops, replacing a heating system, putting in new windows and replacing a roof are great improvements. Keep in mind that not everything you do to your home is considered an improvement. A repair is not regarded as an improvement. While in the real sense of the word it is, the IRS does not treat repairs the same as improvements. So fixing a window is not the same as replacing one.
While you cannot deduct these improvements from your current year’s tax bill, when it comes time to sell, they can be added to the purchase price of your home. This will be used to figure the cost basis for tax purposes. As a homeowner it is important to understand what home improvements add value and which don’t. Many mistakenly believe that all home improvements add value which is not always true.
Home Equity Loans
One little-known tax break for owning a home is that you can deduct the interest on a home equity loan. When making some of the home improvements discussed you can take out an equity loan to do so. The interest generated from the loan can be deducted on your taxes up to $100,000 of mortgage debt.
Home Office Deduction
Another tax benefit of owning a home is the possibility of deducting a home office on your taxes. There are some requirements that you must meet explained in detail in the IRS guidelines including it’s a principal place of your business, or you are regularly using a space in your home for business. There is a high audit rate from those who claim the home office deduction so be sure to follow the laws to the T.
There are more than just tax benefits for owning a home. Over the long haul, a home is an investment. While owning a home each month you are building equity in the property every time you make a mortgage payment. Even though we have just come out of one of the toughest times for real estate in decades, historically it is a wealth builder. In fact, from a long-term perspective, it is one of the best investments you can hold. Lastly, the enjoyment one gets from having something tangible they own can’t be discounted. Many years of memories and happiness are made in the homes we live in. All these things make the American dream of home ownership alive and well.