During tax season there is an active search for more deductions in order to reduce your tax liability. Unfortunately the ability to take deductions is largely reduced once the tax year is closed out. For this reason savvy consumers begin their quest for lower taxes early in the year, giving them the highest deductions when the next tax season rolls around.
Owning a home can provide a number of tax benefits, which encourage home ownership. As the government seeks to find more ways to tax individuals and businesses, many deductions come and go, but so far, the tax benefits for home ownership have largely been left alone. However, since the tax laws change every year, it is best to meet with a tax advisor or accountant to review the tax benefits as they may change.
Currently the following benefits can reduce your taxable income each year, along with the benefits at the time of the home purchase and sale. Generally you must itemize your taxes in order to obtain the deductions.
Tax Benefits When You Purchase a Home
- Points paid at closing
- Portion of this year’s property taxes paid on or before December 31
- Property insurance payments
- Mortgage interest paid
When you buy (or Refinance) a home you generally have the option of buying points. This option will reduce the interest rate, but increase your closing costs. The IRS considers points a form of interest because it “buys down the rate.” As a result, points become tax deductible. If you plan to stay in the home for several years, the lower rate can more than offset upfront costs.
Taxes are prorated from the time you purchase the home until the end of the year. If you establish an escrow account the payment is generally made in the fall and the lender will collect enough at closing to cover this expense. The property taxes paid for the year are tax deductible.
Property insurance is typically paid a year in advance and then monthly payments are made to an escrow account so there will be enough in the account to pay for the next year when the bill comes due. This advance payment is tax deductible. The deduction is for the amount paid to the insurance company, not the amount paid to the escrow account.
Mortgage interest is deductible up to a loan amount of $1 million dollars. Interest charged above $1 million is no longer deductible. This deduction can be significant because it will reduce your taxable income. If you have an interest rate of 4% then for every $100,000 in loan you receive a $4,000 deduction. A $1 million dollar mortgage will result in a tax deduction of $40,000. That can make a huge impact on your taxable income.
Tax Benefits Obtained Every Year of Home Ownership
- Mortgage Interest on both primary and vacation homes
- Property Taxes that are paid on or before December 31st of the tax year
- Property Insurance Payments
- Private Mortgage Insurance
- Some Home Improvements
- Some Interest on a Second Mortgage or Equity Line of Credit
Private Mortgage Insurance is set to expire in 2014, but has been extended several times. This deduction is only available for incomes below $109,000 for couples and $54,500 for single filers. Therefore most physicians will not qualify. Mortgage insurance is often found on homes purchased with less than 20% down. If you meet the IRS guidelines this monthly charge is tax deductible.
Home improvements that are completed for medical reasons may be 100% deductible. Also home improvements that meet energy efficiency guidelines qualify for tax credits. This is significant because it directly reduces your tax obligation dollar for dollar. This means if you owe $4,000 in taxes and receive $500 in tax credits, you will only owe $3,500 in taxes. If you are owed a refund, the refund will increase dollar for dollar. Energy improvements are varied and can include appliances, HVAC systems, windows, doors and many other energy efficient projects. There are a lot of parameters to meet the qualifications so getting the details before making any purchases will ensure compliance with the rules.
Interest on second mortgages and equity lines of credit have the same $1 million dollar cumulative loan cap as the first mortgage. There are also some restrictions on how the money is used. If you are using the funds to improve your home, the interest will qualify. If you are paying for a vacation or paying of debt, it might qualify.
Tax Benefits When You Sell Your Home
- No Capital Gains Tax
- Moving Expense Credits
The capital gains tax exemption is available on the first $250,000 for singles and $500,000 for married couples filing jointly. The only restriction is you must have lived in your home as a primary residence for two of the last five years. This provides tax free income. If you rent the home out during any of this time, there may be add backs to the initial cost before determining capital gains.
Moving expense deductions and credits are available in some cases. Your new job must be 50 miles or more, further from your home than your current job. You must also work full time at least 39 weeks to qualify. If you qualify then you may deduct all moving expenses. Unfortunately your first job out of school does not qualify for the deduction.
For more details about the tax deductions, visit www.irs.gov. Your tax advisor or accountant are also great sources of information. This will help you maximize your deductions and reduce your tax liability when you own a home.