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Unbiased Financial Information Provided by Financial Finesse

Buying a home isn't just a good long-term investment; it's also a great way to trim your annual tax bill. The tax savings you get through ownership can actually help you pay the mortgage. And when you sell your property, you're allowed to keep a big profit without paying tax on it. Take a look at how homeownership helps the average taxpayer.

How Does Buying Beat Renting?

Melissa is single with no dependents and earns $52,000 a year. As a renter, she doesn't itemize deductions. Melissa eventually purchases a home and ends up paying $12,000 in mortgage interest and $1,000 in property taxes each year. Now when she files her taxes she itemizes deductions, which means she not only gets to deduct home-related expenses, but things like state income taxes as well.

 

Melissa the RenterMelissa the Homeowner
Annual income $52,000 Annual income $52,000  
Single exemption -$3,950 Single exemption -$3,950  
Standard deduction $-6,200 Deductions -$12,000 mortgage interest
      -$1,000 property tax
      -$1,500 state income tax
Taxable income $41,850 Taxable income $33,550  
Tax due $6,318.75 Tax due $4,578.75  

* 2014 tax schedule

 

Homeownership reduces Melissa's federal income tax bill by nearly 30 percent! And she may be able to get it even lower by deducting applicable charitable contributions and tax preparation expenses. Melissa may want to revise her W-4 form with her employer to have less tax deducted each pay period (For more information, see Publication 919, How Do I Adjust My Withholding, or use the IRS Tax Withholding Calculator).

What's Deductible for Buyers?

Under current IRS rules, you can deduct the following on your federal income tax return if you itemize deductions:

 

  • Mortgage interest for a first and second home to a maximum of $1 million in mortgage debt.
  • Points associated with a home purchase mortgage or home improvement loan for your primary residence. You may also deduct points on a second home, but only over the life of the loan.
  • Interest on a home improvement loan that's used to make capital improvements, which increase the value of your home or add to its life span. A new roof, a deck, built-in appliances, new wiring, insulation, or a swimming pool are examples capital improvements.
  • Interest on home equity loans of up to $100,000. (See IRS Publication 936, Home Mortgage Interest Deduction, for more information about limitations.)
  • Property taxes (but not escrow money held for taxes).

 

If you're a low-income first-time homeowner, you may be eligible for the mortgage credit certificate (MCC) program. Under the MCC, a percentage of mortgage interest paid can be taken as a tax credit (as opposed to a deduction), which reduces your tax bill dollar for dollar. The balance of the mortgage interest is deductible if you itemize. State legislatures establish household income and home purchase price limits. You apply for the MCC through your lender.

What Are the Tax Benefits for Sellers?

Many of the costs of selling your home, such as real estate broker commissions, title insurance, legal fees, inspection fees, and repair costs to make the home more salable (if they were incurred within 90 days of the sale), are deductible.

Married taxpayers who file jointly may exclude up to $500,000 of capital gain from the sale of their principal residence provided they lived in the home for two of the last five years. Single taxpayers and married taxpayers who file separately may exclude up to $250,000. The balance of the capital gain is subject to long-term capital gains tax rates (See IRS Publication 523, Selling Your Home, for more information).

What About Changes in Tax Laws?

Recent tax legislation will affect the tax benefits of homeownership in several ways:

 

  • As income tax rates decrease the relative value of real estate deductions are diminished.
  • As standard deductions increase annually, the number of people who benefit from itemizing is reduced.
  • More taxpayers are becoming subject to the alternative minimum tax (AMT). Under AMT, tax savings provided through certain exemptions and deductions (such as the property taxes) are eliminated. You must calculate your taxes the regular way and the AMT way and pay the larger amount.

 

For more information about the tax benefits of homeownership, see IRS Publication 530, Tax Information for First-Time Homeowners and Publication 936, Home Mortgage Interest Deduction, or speak with a tax professional.