How Does Owning a Home Impact Taxes?
By RealtyCrunch Inc•April, 26th 2020
Buying a home will most likely be the most expensive and important purchase you make in your life. This is why the IRS has provided several tax breaks to encourage home ownership!
Some of the tax deductions occur the year that you purchase your home, others can be deducted each year and others when and if you eventually sell your home.
Home expenses that are tax deductible the year you purchase your home:
- Property tax deduction: the IRS allows you to offset your taxable income by up to $10,000 ($5,000 if married filing separately) in deductible property taxes, state and local income taxes, and sales taxes that you pay
- Points: if you paid points to the lender as part of a new loan or refinancing, you’ll be able to deduct them from your taxable income
Ongoing expenses that may be tax deductible:
- Mortgage interest deduction: while filing for taxes, your lender will send you an IRS Form 1098 outlining the amount of interest you paid in the previous year. If you paid interest on up to $750,000 of principle AND you itemize your deductions, then mortgage interested is tax deductible.
- Property taxes: which fall under the SALT (State and Local Taxes) are tax deductible if you don't itemize deductions. If your property is an investment property, they are not tax deductible because they already offset the taxable rental income, and thus would be counted twice.
- Private mortgage insurance (PMI): if you took out a loan in 2007 or later, you might be able to deduct the PMI payments.
- Energy Tax Credit: while most improvements are not deductible until sale, certain energy efficient improvements will result in up to a $2,000 tax credit, offsetting the amount you owe in taxes. Examples of what qualify include solar panels and solar powered water heaters. For more detail on the energy tax credit and filing form 5695 on the IRS website.
When you go to sell your home:
- Improvements: While most repairs are not tax deductible, capital expenditures that improve the value of the home will increase the tax basis of the house at sale. For example, if your home cost $250,000 and you put $50,000 into improvements, when you go to calculate profits, it will be as if you spent $300,000 on your home. If you sell your home for $700,000, you would have $400,000 in profit. In the past it was important to track all of the receipts for improvements to prove each of the deductions that reduced your tax bill. The below changes to capital gains taxation make it less critical to track receipts on improvements, but just in case you're going to own your home for decades, it's a good idea to keep them.
- Capital gains: if you lived in your home for at least two out of the five years, you don’t have to pay taxes on the first $250,000 of profits as a single filer, $500,000 if married. So in the example above, if you're a single filer, you'd take the $400,000-$250,000=$150,000 as the taxable capital gains on your home. If you are married however, there would still be no taxable capital gains because the $400,000 is less than the $500,000 allowable amount.