This article is accurate for returns filed through tax year 2017. Under the Tax Cuts and Jobs Act, some of the laws mentioned changed beginning in 2018. Learn more about the updated tax laws enacted under the Tax Cuts and Jobs Act here.
Purchasing a home is one of the biggest steps you can take in your financial life. In fact, for most people, a home is the single most expensive item they will ever purchase. Taking out a 30-year loan for hundreds of thousands of dollars is nothing to take lightly, but it does come with plenty of benefits. In addition to the pride and stability that comes with owning your own home, there are also a number of tax benefits.
Of course, obtaining tax benefits shouldn’t be your only motivation for buying a home, but seeing what there is to gain might motivate you to close a deal. Let’s walk through five ways you may be able to improve your tax return after becoming a homeowner.
1. Eligibility for Tax Credits
As a homeowner, you may be eligible for certain tax credits which will lower your overall tax obligation for the year. As is always the case when claiming a credit, you will want to confirm that you are actually eligible before filing your return. Two notable tax credits which you may want to consider are the nonbusiness energy property tax credit and the renewable energy tax credit. Each of these has to do with improvements you have made to your home in an effort to make the property more efficient overall.
For the residential energy efficient property credit, you will need to have added equipment to your property which produces energy using solar, wind, or geothermal methods. You can claim a credit for up to 30% of the cost of the system, including installation fees. However, the credit is capped at a maximum of $1,000 per kilowatt of capacity.
For the nonbusiness energy property tax credit, you will need to have made efficiency improvements to your property such as adding new insulation, replacing windows, or replacing systems like a furnace or water heater. There are specific qualifications to consider here, as the equipment you purchase and install needs to meet with standards in order to make you eligible for the credit. Here, you will find a credit limit of $500 in total, and the credits you claim accumulate against that limit from year to year.
2. Property Tax Deduction
One of the biggest tax breaks you can receive as a homeowner is the ability to deduct the property taxes you paid during the year. Unfortunately, this one is missed by some homeowners as they simply forget that they paid property taxes, which are typically rolled into your mortgage. If your property taxes are paid through your mortgage escrow account, be sure to retrieve the exact dollar amounts you paid before completing your tax return.
It should be noted that you are only going to benefit from this part of the tax code if you itemize your deductions. For those who simply claim the standard deduction, there is going to be no benefit realized from the payment of property taxes. So, when trying to decide whether or not to itemize your return, remember to include property taxes in those calculations.
Also, you should think about mortgage interest; this may be deductible as well if you itemize (note that there is a difference between the mortgage interest credit vs. deduction). It may still be better to claim the standard deduction in the end, but don’t forget to think about property tax when adding up your major expenses from the previous year.
3. Some Closing Costs
Are closing costs tax deductible? This is one of the most common questions asked by homebuyers, many of whom are looking for any way to save money after making such a large purchase. Unfortunately, the answer to whether or not you can deduct closing costs is a bit murky. What part of closing costs are tax deductible? Take a look at the list below.
- Sales taxes paid at closing
- Mortgage discount points, also called loan-origination fees
- Mortgage insurance premiums
- Some real estate taxes
- Mortgage interest paid at settlement
So, is closing cost tax deductible for a buyer? Well, there are a number of qualifications you must meet in order to benefit from deducting closing costs. First and foremost, you must be itemizing your return. If you are claiming the standard deduction, you will not be able to deduct any of your closing costs. There are other eligibility points to watch for as well, so it is wise to check with a tax professional if you want to go this route.
4. Home Office Deduction
If you work from home and you use part of your home exclusively for work purposes, you may be able to deduct some of your expenses thanks to the home office deduction. While it was once quite complicated to determine the value of this deduction, taxpayers can now use a simplified method which makes for a quick and easy calculation. By finding the square footage in use for your home office, and multiplying by a prescribed rate, a deductible amount can be determined
Before you file your taxes with this deduction included, it will be necessary to meet two requirements. First, you have to use this portion of your home regularly for business, and this part of the home must be exclusively dedicated to business use.
Additionally, your home must be your principal place of business. So, if you work in an office regularly, but work from home on occasion, you will not qualify for a home office deduction. Unlike the other items on our list, which are only available to homeowners, this deduction is available to both homeowners and renters.
5. Income Property Tax Implications
Those who own rental properties, or income properties, already know that it is common to lose money on such investments—especially in the short term. Purchasing a rental property is a decision which is made with long-term benefits in mind.
As such, you might be able to enjoy tax benefits in the near term, as you’ll likely be losing money that can be used as a deduction from your overall income. However, it is important to note that passive activity losses are limited, so you can’t report a large loss in order to offset all of your income for the year.
Key Tax Points for Home Sellers
Usually, you are going to think about the tax implications of buying and owning a home—but what about when you sell? There are some things to keep in mind on this front as well, especially in terms of the profits realized on the sale.
Many homeowners are surprised to learn that most, if not all, of the money they make when selling their home will be tax-free. For a single filer, up to $250,000 of profit on the sale of a primary residence is not subject to taxes. For someone who is married and filing a joint return, that amount doubles to $500,000. There are some basic qualifications for this tax protection, however, so be sure to check on your qualifications.
There are many great reasons for owning a home, even without taking taxes into consideration. You may be able to build equity if the value of your home climbs over time, you will not be at the mercy of a landlord, and you can make changes to the property as you see fit. When determining what home purchase expenses are tax deductible, it is important to consider your unique circumstances and check the qualifications carefully.