Consider purchasing a property. There are numerous advantages to purchasing one. You can design it to your liking, install a professional home entertainment system, or customize the walk-in closet to accommodate all of your belongings to your exact specifications. However, there are additional financial rewards.
If you leased in the past, you did not receive a tax deduction for any of the money you paid to your landlord. This is different for homeowners.
Whether you purchase a mobile home, townhouse, condominium, co-op apartment, or single-family home, a number of tax incentives can help you save money during tax season.
The only disadvantage is that your taxes will get more complex. No longer can you plug your W-2 information into the 1040EZ form and do your taxes in 10 minutes. You enter the delightful realm of itemizing upon becoming a homeowner. Obviously, the trouble is worth it when you consider the money you could save.
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Tax Credits vs. Tax Deductions
In the world of taxes, there are deductions and credits. Credits indicate a reduction in your tax liability. Consider their coupons. A $1,000 tax credit will reduce your tax liability by $1,000. A tax deduction lowers your adjusted gross income (AGI), hence reducing your tax bill.
For example, if you are in the 24% tax rate, 24% of the total claimed deduction will reduce your tax payment. Therefore, claiming a $1,000 deduction will reduce your tax burden by $240 ($1,000 24%).
Tax Deductions for Homeowners
The majority of the beneficial tax treatment associated with property ownership comes in the form of deductions. Here are some of the most typical deductions:
Mortgage Interest Deduction
Mortgage interest can be deducted on the first $750,000 (or $375,000 if filing separately) of mortgage debt. If you purchased your house before December 16, 2017, the previous limit of $1 million ($500,000 if filing separately) applies.
In January, following the end of the tax year, your lender will issue you Internal Revenue Service (IRS) Form 1098, which details the interest you paid during the preceding tax year. Include any interest you paid as part of your closing costs. The interest for the partial first month of your mortgage will be included in your closing costs. It is included on the settlement sheet. Request that your lender or mortgage broker explain this to you. Add this to your total mortgage interest when filing your taxes if it is not mentioned on your 1098.
Mortgage Points Deduction
As part of a new loan or refinancing, you may have paid mortgage points to your lender. Each point you purchase typically costs 1% of the total loan amount and reduces your interest rate by 0.25 percentage points. For instance, if you purchased a home for $300,000, one point would equal $3,000 ($300,000 1%). And, with a 4% interest rate, this one point would reduce the rate to 3.75 percent for the duration of the loan. As long as you truly paid for these discount points, you are eligible for a deduction.
If you refinanced your loan or obtained a home equity line of credit (HELOC), you earn a point deduction over the life of the loan. Each time a mortgage payment is made, a little portion of the points are added to the debt. You may deduct this amount for each month that payments were made. Therefore, if $5 of each payment was for points and you made 12 payments, your deductible would be $60.
Your lender will issue you Form 1098, which will show the mortgage interest and mortgage points you paid. You can claim the deduction on Schedule A of Form 1040 or 1040-SR using this information.
Private Mortgage Insurance (PMI)
Lenders charge private mortgage insurance (PMI) on traditional loans with a down payment of less than 20%.
PMI typically costs $30 to $70 for $100,000 borrowed per month. Similar to other types of mortgage insurance, PMI protects the lender (not you) in the event that you default on your mortgage payments. Depending on your income and the date on which you purchased your house, you may be entitled to deduct your PMI payments.
According to the IRS, PMI premium payments can be treated as mortgage interest. The insurance must be associated with mortgage debt issued after 2006. If your AGI is less than $100,000 ($50,000 if filing separately), you qualify for the maximum deduction. Over certain thresholds, the deduction is gradually eliminated. If your AGI exceeds $109,00 (or $54,500 if filing separately), you cannot claim the deduction.
State and Local Tax (SALT) Deduction
The state and local tax (SALT) deduction allow you to deduct certain taxes paid to state and local governments if you itemize deductions on your federal return. The Tax Cuts and Jobs Act (TCJA) reduced the previously unlimited deduction for property taxes and state income or sales taxes to $10,000 per year. The cap of $10,000 applies whether you are single or married filing jointly, however, it is reduced to $5,000 if you are married filing separately.
If you paid your property taxes using an escrow account, the amount will be listed on your 1098 form.
Alternatively, if you pay your municipality directly, you will have personal records in the form of a check or automatic transfer. Include any payments made to the seller for prepayments of real estate taxes (you can find them on your settlement sheet).
State and local income taxes deducted from your paycheck are reflected on your W-2 form, which your employer(s) should deliver to you by the end of January following the tax year. If you choose to deduct state and local sales taxes instead of income taxes (you cannot deduct both), you can use either your actual expenses or the Schedule A sales tax figures.
Home Sale Exclusion
Due to the home sale exclusion, it’s likely that you won’t have to pay taxes on the majority of the profit you generate from selling your property.
If you’ve owned and lived in the home for at least two of the preceding five years, the first $250,000 in profit is tax-free (i.e., capital gain). The amount doubles to $500,000 if you file jointly with your spouse. Nevertheless, at least one spouse must satisfy the ownership criterion, and both must satisfy the residency requirement (i.e., lived in the home for two out of the previous five years).
You may be able to satisfy a portion of the residency requirement if you had to sell your house early due to a divorce, a job transfer, or another circumstance.
If the gain on the sale of your principal residence exceeds the exclusion, you must report the whole gain on Form 8949: Sales and Other Dispositions of Capital Assets.
Depending on how long you owned the property, any capital gains will be taxed at either the short-term or long-term rate:
If you held the residence for less than a year, short-term capital gains tax rates apply. These profits are subject to your ordinary income tax rate, which for 2021 and 2022 ranges from 10% to 37%.
If you held the residence for more than a year, long-term capital gains tax rates apply. Depending on filing status and income, the tax rate is 0%, 15%, or 20%.
Tax Credits
You may be eligible for a mortgage credit if a state or local government unit or agency awarded you a qualifying mortgage credit certificate (MCC) under a qualified mortgage credit certificate program.
Additionally, visit energy.gov to determine if your state offers tax credits, rebates, or other incentives for energy-efficient home upgrades.
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