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10 Can’t-Miss Tax Breaks For Home Owners
Home ownership has its fair share of costs. But you can also reap significant tax breaks on buying a home. This easy guide gives you a list of 10 BIG tax breaks for homeowners.
To get some of these tax breaks, you may need to itemize the deduction in your IRS tax return.
The easy and convenient way to find out your tax-deductible home expenses is by signing up to file a free return with e-file.com. Based on your answers to the tax questions, the software reports any home tax deductions you qualify for on your return.
The Tax Benefits that you can get as a Homeowner broadly fall into the following three categories (click the link for details):
A. Tax Breaks on Buying your home-
- Mortgage Interest Deduction
- First Time Home Owner Benefit (Penalty-Free IRA withdrawals)
- Mortgage Interest Tax Credit for Low-Income Group
B. Tax Breaks on Home Related Expenses and Improvements-
- Local and State Property Taxes Deduction
- Energy Efficient Home Improvements
- Medical Home Improvements
- Home Office Deduction (Only for Business use of Home)
- Rent expenses (Only where you have rented your Home)
- Mortgage Insurance Premium
C. Tax Breaks on Selling your home-
Do check the Conclusion on the important decisions you need to take regarding these tax breaks and for filing the returns as the homeowner.
Let’s dive into the details and see how much tax savings they can put in your pocket:
Paying interest on your mortgage loan? There is a major tax benefit for this.
You can get a tax deduction for the interest that you pay on UP TO $750,000 of mortgage debt used to PURCHASE or IMPROVE YOUR HOME. This limit is applicable if you are married and filing jointly (if you are single, the limit is reduced to half i.e. $375,000).
This cap is applicable on Home Purchases made after December 14, 2017 (courtesy Tax Cuts and Jobs Act 2017).
This benefit is available on the mortgage loan for your Main home (where you ordinarily live most of the time) and anyone second home.
Interest on Home Equity Loans and Lines of Credit (HELOC) can also be deducted ONLY if the borrowed funds are used to Buy, Build, or Substantially Improve the home.
Law Before December 14, 2017- The law was more generous before this. If you had purchased the home before December 14, 2017, the deduction is allowed on interest payments on up to $1 million of mortgage debt (if single $500,000).
You should receive Form 1098 from your mortgage lender (usually sent out in January) stating how much interest you paid for the year.
To claim this benefit, you need to itemize this deduction in your return. You need to fill the details in Schedule A of Form 1040 return.
If you chose to itemize, you cannot take the benefit of the standard deduction. So this is an important decision which you should take by comparing the benefit under standard deduction vs itemized deductions.
Uncle Sam sweetens the deal for first time home buyers. You may feel the need to dig into your IRA funds for the down payment on your house.
In such cases, you can withdraw your IRA funds up to $10,000 for your home purchase. This withdrawal is exempt from the 10% penalty that is usually charged on IRA withdrawals before the retirement age.
The first time home buyer as per IRS is one who does not own a home in the last 2 years before purchase. So, it is not really meant literally.
The funds can be used to buy, build or rebuild a first home. It need to be used within 120 days of withdrawal.
If you’re married, both you and your spouse can withdraw $10,000 each from separate IRAs without paying the penalty.
However, you’re still required to pay tax on the amount you withdraw.
You can claim State and Local property taxes commonly called as “SALT” taxes up to $10,000 as a deduction as a married couple filing jointly (Limit is $5,000 for individual filing separately).
Amount over $10,000 is not deductible.
This is the maximum cap for all the state, local and property taxes collectively.
This cap does limit the benefit for tax-payers in states with high property taxes e.g. New Jersey, New York, etc.
Before the implementation of TCJA in 2017, there was no upper cap to these taxes. You could deduct all such taxes paid on the house property, without any limits.
Again, this deduction needs to be itemized and claimed in Schedule A of Form 1040.
GOING GREEN and using renewable energy……..Uncle Sam rewards you with a TAX CREDIT for that.
You can claim a tax credit for Home Improvements which use renewable sources of energy like:
- Solar Panels
- Solar Powered Hot Water Heaters (at least 50% of water heating should be from solar power)
- Wind Turbines
- Geothermal Heat Pumps
- Fuel Cells (Must Generate at least 0.5KW and electricity generation efficiency greater than 30%)
The available benefit is 30% of Total Cost of the Installation of Equipment. You can include any labor costs allocable to the onsite preparation, assembly, or original installation of the equipment. Your cost for piping or wiring to interconnect such property to the home also qualifies.
Note that a TAX CREDIT is far better than a Tax Deduction. Tax credits directly reduce the amount of tax you owe, thereby directly reducing your tax liability. Tax Deductions reduces the income subject to tax and therefore the benefit depends on the effective tax rate at which your income is subject to tax.
The Energy Efficiency tax credit is a “non-refundable” credit. This means you cannot get the credit as a refund, when the eligible amount exceeds your tax liability. e.g Let’s say, you owe $2000 in federal taxes this year and the energy tax credit calculation comes to $2500. In such case, the tax credit you get is limited to $2000 i.e. to the extent of tax liability and $500 ($2500-$2000) is not eligible for refund.
Important Note- You must HURRY to get the maximum out of this credit. This is because it’s a limited time benefit which is getting reduced every year through 2021. Using solar energy cannot only get you a tax credit, but also help you get decent savings on your power bill.
If you need to install special equipment at home due to medical reasons, you can get a tax deduction for such expenditures.
Some examples of home improvements for medical reasons include Building ramps, Widening Doorways, Installing Support Bars in bathrooms, Installing a Lift, Altered cabinets etc.. Maintenance costs for the operation and upkeep of these upgrades are also deductible as medical expenses if the upgrade itself is medically necessary. However, improvements that simply make your home more elderly-friendly aren’t deductible if they’re not medically necessary.
An important caveat applies for improvements that lead to a permanent increase in the value of the home. Such benefit is restricted to the extent the Cost of Improvements EXCEEDS the increase in the Value of the Property.
Again, you need to itemize these deductions in your return. Since this is a medical deduction, you’ll only be able to deduct the amount in excess of 7.5% of your adjusted gross income. (Note: The 7.5% floor will increase to 10% beginning with 2019 returns)
Lower-income homeowners, who have issued a qualified Mortgage Credit Certificate (MCC) from a state or local government can take benefit of Mortgage Interest Tax Credit. The MCC is used to subsidize the purchase of a primary home.
The credit amount ranges from 10% to 50% of mortgage interest paid during the year. The exact percentage is listed on the MCC issued to you. The MCC tax credit remains in place for the life of the mortgage, so long as the home remains your principal residence.
The credit is capped at $2,000 irrespective of the credit rate. However, you can carry forward the unused portion of the credit to the next three years or until used, whichever comes first.
Using your Home as an Office? Great! You can get a tax break here.
Some important caveats– This benefit is available if you use your home as a Principal Place of Business and work from home on a Regular Basis (not just occasionally). Also, a DEDICATED area must be used EXCLUSIVELY for business purpose.
Now the tough part is the calculation of this benefit, as there are a few technicalities involved.
You can calculate this benefit, by two methods:
Simplified Method– This is a really simple method as the name suggests. You just measure the square foot area dedicated for your home office and multiply it by a prescribed rate i.e. which is $5. However, the maximum square foot area you can claim for your home office is restricted to 300 sq.feet which caps the deduction at $1500 ($5 x 300 sq.feet).
Regular Method (Actual Expenses)- If you feel the simplified method does not give you a fair deal, you can opt for the Regular method. Here you have to claim the actual expenses on home office which can be broken into two:
- Direct Expenses – Expenses directly incurred in your home office area. For e.g. cost of painting or repairs of the home office area
- Indirect Expenses – Expenses on the overall cost of keeping and running a home. This needs to be claimed proportionately by dividing the AREA USED for your HOME OFFICE BY TOTAL HOME AREA. This ration is called Business Percentage. For e.g if you pay $2000 for your utilities, the total home area is 3000 sq. feet and home office sq.feet is 700, then the deduction available is $2000 x 700/3000= $467
If you are using the Indirect Method, you also need to maintain appropriate records as proof. Note that the Tax Law has different provisions if you are using your Home for Day-Care Business. You can refer this IRS guide for further details.
Planning to SELL your house?
You may be able to book capital gains on your home sale without any tax liability.
Profits on sale of a home are TAX FREE up to $500,000 if married and filing jointly (if you are single filer, the limit $250,000).
There are some strings attached to this benefit.
You need to satisfy three key conditions:
- Either You or Your Spouse (if filing jointly) must have OWNED the home for at least 2 years in the last 5 years leading up to the sale
- Home should have been your Primary Residence (applicable for Both in case filing jointly) for any 2 years in the last 5 years. The 2 years need not be continuous.
- You must NOT have claimed capitals gains tax benefit on another home sale in last 2 years before this sale.
If you realize a profit in excess of the tax-free amount or you fail to qualify, the income on the sale of your home is reported on Schedule D as a capital gain.
Planning to rent out a part of your home say a room or the basement?
While you’ll have to pay tax on your rental income, you also become eligible to deduct expenses for the rental space.
You can deduct expenses like insurance, repair and maintenance costs, estate taxes, utilities etc. Depreciation on the part of your house used for rental purposes, and on any furniture or equipment in the rented space may also be deducted. Again, common expenses need to be claimed in proportion to the rental space.
This is not an itemzied deduction. You need to subtract these expenses from your rental income in Form E.
The itemized deduction for mortgage insurance premiums expired on December 31, 2017.
But, there is HOPE. Reason: This benefit expires every year and Congress has had a track record of extending it. There is already a bill in Congress proposing its extension.
So there is a possibility of the tax break being revived.
However, if you are looking to file the IRS return now, no need to worry about it. You can file an amended return in case there is a positive update on this.
So you can see a number of tax breaks that homeowners can claim. However, it is important to note that you can get the deductions if you claim it correctly in your IRS returns. You need to itemize these deductions for mortgage interest, property taxes, medical expenses, etc. Once you itemize, you are not eligible to claim the standard deduction which is $24,000 for married and joint filers ($12,000 if single).
So the following are important decisions you need to take:
- Taking Standard Deduction or Itemizing
- Filing Single or Jointly
While itemizing can be a tedious exercise, the tax savings can justify effort especially in cases where it significantly above the standard deduction.
When you prepare your return on eFile.com, it will calculate which is better for you and which gives you the most tax advantages, the Standard Deduction OR Itemized Deductions.
The easiest way to determine if any of your home expenses are tax-deductible is to start a free tax return on efile.com.
- IRS Publication 530- Tax information for Home Owners
- IRS Publication 587- Business Use of Your Home
- IRS Publication 523- Selling your Home
- IRS Publication 52- Residential Rental Property
The information in these tax publications is for your knowledge and reference; you are not expected to have any detailed tax information when you prepare your tax return online with tax software like efile.com. The tax software does most of the hard work for you.