So you’ve taken the plunge and bought a new home, capitalizing on today’s low interest rates and attractive home prices. Your new house or condo will undoubtedly bring you and your family much happiness in the years ahead – especially when it comes time to pay your taxes.
As the April 15 federal and state tax deadline rapidly approaches, homeowners shouldn’t forget the many tax benefits that are available to them. The good news is that you can deduct many home-related expenses, and the savings on your taxes can easily add up to thousands or even tens of thousands of dollars.
Filing your tax return may become a little more complicated. Instead of filling out the simple IRS form 1040EZ you’ll need to file the 1040 long form and Schedule A, on which you will list all your deductable homeownership expenses. But the extra time will pay off in valuable savings.
Because the tax rules for homeowners are more complicated, I recommend you consult with a tax professional before deciding what you can and cannot deduct. But in general, you can figure on a number of significant tax breaks associated with homeownership, including:
- Mortgage interest. The biggest tax break is reflected in the house payment you make each month since, for most homeowners, the bulk of that check goes toward interest. In most cases, the interest homeowners pay is deductible. This may mean a reduced tax bill overall and a bigger refund.
- Property taxes. As a homeowner, you are entitled to deduct payments of real estate tax on your property if you claimed itemized deductions on your tax return. The IRS allows you to deduct real estate taxes on your primary residence and any other homes you own. There are no limits on the dollar amount of real estate taxes you can deduct.
- Loan deductions. When homeowners borrow against the equity of their home to finance other investments, the interest they pay on the new loan is also tax deductible, within IRS guidelines. Generally, equity debts of $100,000 or less are fully deductible.
- Vacation homes. Tax breaks aren’t just limited to your primary residence. If you’re fortunate enough to have a vacation home, you can the mortgage interest on that property is fully deductible, too, within IRS guidelines. You can even rent out your second property for a short period of time and still take advantage of the deduction. But be careful – renting it out too much could turn it into a rental property with different tax rules.
- Homeowner exemptions. Depending on where you live, certain real estate property tax exemptions apply. In California, there’s a $7,000 exemption from property tax assessed value for owner-occupied homes, for example. Homeowners should check with local tax consultants to see if they, or their home, are eligible for any additional exemptions.
- Improvements on your residence: While you generally cannot deduct improvements to your home on your taxes, such items can lower your tax bite down the road. Improvements such as a family room addition, a kitchen makeover, or a pool increase the “basis” of your home – i.e., the purchase price plus improvements. When you go to sell, the higher your basis is, the less you will have to pay in capital gains taxes if you pay at all.
- Tax-free profits. The government allows homeowners to keep tax-free profits from the sale of a home that has been their primary residence for at least two years. Single taxpayers don’t owe taxes on the first $250,000 of profit from the sale of a principal residence, while married homeowners get $500,000 when filing jointly.
These tax savings can add up quickly. On a $500,000, 30-year mortgage loan at 5 percent, for example, a homeowner would end up paying nearly $25,000 in the first year in interest alone. At a 33 percent federal and state income tax rate, the mortgage interest deduction alone would save more than $8,200 in that tax year! But again, tax laws are complicated and everyone’s tax situation is different. Consult your tax professional to see how the rules apply to your situation.