Buying a House Without a Realtor: Smart Idea or Big Headache?
Buying a house can affect many aspects of your life, including your tax bill. That’s because investing in a home doesn’t just mean taking on a new mortgage payment. Your purchase could also provide tax benefits starting in the tax year you acquired the property.
This guide can also help you see some of the tax breaks you may be entitled to. Read on to learn more.
In this article
- How you’ll get a tax break for buying a house
- What isn’t tax-deductible when you buy a house?
- The bottom line
How you’ll get a tax break for buying a house
Potential tax savings can come in the form of deductions that reduce taxable income or tax credits that could reduce your tax liability on a dollar-for-dollar basis.
A $1,000 deduction could, for example, reduce your taxable income from $40,000 to $39,000, and you’d save money by avoiding taxes on $1,000 of income. A $1,000 tax credit, on the other hand, could take a $5,000 tax bill down to $4,000, so it may offer greater savings.
Most tax breaks for homeowners are tax deductions, but some tax credits may soon be available to specific home buyers. When you’re figuring out how to file taxes, you’ll want to claim both the credits and deductions your home entitles you to in order to get the most savings.
Here are some ways homeownership could help you reduce your tax bill.
Mortgage interest is the interest you pay on your home loan. When you make a monthly mortgage payment, some of the money is allocated to paying down your principal balance while the rest covers the interest accrued on your loan.
The specific amount of interest you pay typically changes each month. Yet the interest on your loan is tax-deductible with mortgages up to $750,000 for married joint filers (or up to $1 million if you borrowed before December 16, 2017). For married separate filers, interest is deductible on up to $375,000 in debt. However, it’s important to note that you can only claim this savings if you itemize. That means you deduct for specific expenses rather than claiming the standard deduction.
For 2021, the standard deduction is $25,100 for married joint filers and $12,550 for single taxpayers or married separate filers. Unless the total value of your itemized deductions exceeds that amount, you will save more by claiming the standard deduction — which would mean you couldn’t deduct your mortgage interest.
Mortgage insurance premiums
Borrowers may be required to pay mortgage insurance premiums (MIPs) if they don’t make a large enough down payment on their home.
The rules for when private mortgage insurance is required vary depending on the lender and loan type. With most conventional loans, borrowers have to pay mortgage insurance if they make less than a 20% down payment. This is required even with many of the best mortgage lenders because it protects against lender losses in case of foreclosure.
MIPs are tax-deductible for many homeowners, at least through 2021. The deduction was set to expire in 2020, but it was extended for this tax year by the Consolidated Appropriations Act of 2021.
For married couples filing jointly with an adjusted gross income above $100,000 or married filing separately with incomes above $50,000, deductibility of MIPs begins to phase out. You can no longer claim this deduction if your joint income exceeds $109,900 or $54,400 for married separate filers.
Real estate taxes
Many U.S. cities and towns charge local property taxes or real estate taxes. If you pay these taxes, you might be able to deduct the amount from your federal taxable income. This is true for primary and secondary homes, although special rules apply if you rent out your properties.
As with mortgage interest, you must itemize in order to deduct real estate taxes. And joint filers are subject to a combined $10,000 deduction for all state and local taxes (or $5,000 for married separate filers). That includes real estate taxes, as well as state income or sales tax.
Mortgage points may be paid when you close on your home loan. They reduce the value of interest. For example, one point may cost 1.00% of the loan amount and reduce your interest rate by 0.25%.
Points are considered prepaid interest, and you can deduct the full amount of points only if you meet certain criteria. Your home loan must be $750,000 or under (or $375,000 or less for married separate filers), and all of the following requirements must be met:
- The loan must have been used to purchase your principal residence.
- Paying points must be a common, established business practice in the area where you borrowed.
- You didn’t pay more points than customarily charged.
- You report income in the year you receive it and deduct expenses in the year you paid them.
- You didn’t pay points in place of other charges usually listed separately on mortgage settlement statements, such as appraisal or inspection fees.
- Your points are based on a percentage of the loan balance.
- Your settlement statement clearly shows the points charged.
- You itemize on your taxes in the year you paid the points.
You also have the option to spread out the points over the life of the loan and deduct them over time. This could be a good choice if you don’t itemize your deductions in the year you pay points, but you itemize in future years.
Profits from home sale
When you sell assets at a profit, you are subject to taxes on the gains. This is true even if the asset you sell is your home. But there are special rules for how gains on a primary residence are treated.
Specifically, you can exclude up to $250,000 in gains as an individual (or up to $500,000 for married joint filers), provided you meet both an ownership and use test. These tests require that:
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- You owned the home for at least two of the past five years
- You used the home as your main home for at least two of the past five years
These tests can be met using two different two-year periods, and the key is aggregate time — you don’t necessarily have to live in the house for two straight years to qualify.
If you sell your home after at least two years of ownership, you will also be taxed at the long-term capital gains tax rate, which is typically lower than your standard rate. But if you sell before two years are up, you would be taxed at the short-term rate, which is your standard income tax rate.
Home office expenses
It is possible to claim a home office deduction if you have a part of your home that is set up exclusively for business purposes.
However, this deduction can only be claimed if you’re self-employed, not an employee of another company. And the office space must also be your principal place of your business, which means you mostly work from the office at home.
The deduction can be calculated using a simplified calculation, which allows you to deduct up to $5 per square foot of your home used for business purposes, up to a maximum of 300 square feet. Or the regular method of calculating the deduction is based on what percent of your home is devoted to business use. You can deduct a percentage of most home expenses based on a percentage of the home used for business purposes if you use the regular method.
Home energy tax credit
Qualifying energy-efficient improvements could also entitle a homeowner to tax credits, at least during the 2021 tax year. For example, equipment tax credits are valued at up to 10% of the cost of certain improvements up to a maximum of $500. This includes air source heat pumps and biomass stoves, among other energy-efficient items.
The IRS has comprehensive details about residential energy property costs that can entitle taxpayers to credits. It also includes specifications that energy-efficient products must meet in order for homeowners to become eligible for tax credits.
What isn’t tax-deductible when you buy a house?
While many expenses related to homeownership are tax-deductible, some aren’t. Non-deductible expenses include:
- Mortgage principal payments
- Moving costs (in most cases, though exceptions can apply for active-duty military and other special cases)
- Homeowners association fees for non-rental property
- Utility bills, such as water, cable, sewer, and electric
- Homeowners insurance for non-rental property
- Furniture and household items
Are closing costs tax-deductible?
You can deduct home mortgage interest and some real estate taxes that are part of your closing costs. But most costs, including transfer taxes, appraisal expenses, and loan origination fees, are not tax-deductible.
Do you get a tax break for buying a house?
Homeowners could potentially get several tax breaks, which could help make a home more affordable if you’re looking into how to get a loan. Depending on whether you itemize or if the home is your primary residence, you may be entitled to the following tax benefits:
- A deduction on mortgage interest paid on loans up to $750,000
- A deduction of mortgage insurance premiums paid
- A deduction for points paid when obtaining your home loan
- A deduction for up to $10,000 in real estate taxes
- Favorable tax treatment on profits from home sales, including the ability to exclude up to $500,000 in gains (for married joint filers) or $250,000 in gains for married separate filers
- A deduction for home office expenses
- Tax credits for certain energy-efficient improvements
Specific criteria must be met to claim many of these deductions and credits, so it’s best to check with a tax professional.
Should homeowners itemize deductions or take the standard deduction on their income tax return?
Homeowners may want to itemize deductions on their taxes because itemizing is necessary to claim deductions for certain expenses such as mortgage interest, mortgage points, mortgage insurance premiums, and real estate taxes.
However, itemizing makes sense only if the combined value of all itemized deductions exceeds the standard deduction. The standard deduction in 2021 is $25,100 for married joint filers and $12,550 for single taxpayers or married separate filers.
Can you get a tax deduction for a home equity loan?
It is possible to claim a deduction for interest paid on home equity loans only if the borrowed money is used to buy, build, or substantially improve the taxpayer’s primary residence or qualifying second home that is used to secure the loan.
Can first-time homebuyers get a tax credit?
Under current tax law, there are no special tax credits for first-time homebuyers. President Joseph Biden has proposed a $15,000 credit for qualifying first-time homebuyers, and several Democratic representatives drafted a bill that would provide one.
The legislation proposes a refundable credit, so taxpayers would be entitled to it even if their tax bill was below $15,000. It would be worth up to 10% of the home’s purchase price for homes valued at 110% or below the median purchase price in the local area. Families could be eligible if they hadn’t owned or purchased a home within three years of the purchase and if their incomes didn’t exceed 160% of the median income in their area.
It is unclear if the legislation will pass.
The bottom line
There are a number of tax incentives for homeowners built into the federal income tax system, including tax breaks for energy-efficient home improvements. Taxpayers might also get favorable capital gains tax treatments if they profit on their home and may be able to deduct property taxes as part of their local and state tax deduction. And, of course, a home mortgage interest deduction could also help some homeowners reduce their taxable income.
The specific tax credits you might be eligible for as a homeowner will depend on whether you claim itemized deductions and if your home is your primary residence. If you want to know exactly how your home will affect your tax refund — and whether itemizing makes sense or a particular write-off is available to you — your best option is to talk with a tax professional.
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