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Discover the key tax benefits of homeownership, including deductions for mortgage interest, property taxes, and more. Explore how buying a home can optimize your tax savings.
Are you looking to make the most of your tax return this year? Whether you're a homeowner, a frequent traveler, or simply someone who wants to maximize savings, understanding the various deductions and credits available to you is key. In this blog, we'll delve into some of the top tax advantages that come with buying a home, exploring how you can save money by taking advantage of these benefits. So, let's dive in and uncover the potential savings awaiting you!
When you rent a home, all your finances flow directly to the landlord without any potential for tax deductions. However, the scenario shifts when you become a homeowner. Various tax breaks become available, regardless of whether you purchase a townhouse, condominium, cooperative apartment, or a single-family home.
Despite the benefits, transitioning to homeownership may complicate the process of preparing your tax return. It's no longer as simple as inputting your W-2 details into Form 1040. Instead, you'll likely need to itemize your deductions. While this may add complexity, it presents an opportunity to potentially save money on your taxes.
Distinguishing between tax deductions and tax credits is crucial, as they operate differently, with tax credits generally being more advantageous.
Tax credits directly lower your tax bill. For instance, if you claim a $1,000 tax credit, your IRS tax liability decreases by $1,000. On the other hand, tax deductions lower your adjusted gross income (AGI), subsequently reducing the amount of taxes owed. For instance, if you're in the 24% tax bracket and claim a deduction, your tax liability decreases by 24% of the total deduction amount.
💡 TIP: For the 2024 tax year, the standard deduction has increased to $29,200 for couples filing jointly and $14,600 for single filers. This marks a rise from $27,700 for couples and $13,850 for singles in 2023.
It's important to assess your potential deductions quickly to determine if opting for the standard deduction would yield greater savings. Remember, you can't simultaneously claim the standard deduction and itemize; you must choose one method over the other.
The majority of the tax advantages associated with homeownership are delivered through deductions, which are categorized as itemized deductions and recorded on Schedule A of either Form 1040 or 1040-SR. However, to benefit from these deductions, you'll need to waive your eligibility for the standard deduction corresponding to your filing status. It's essential that the sum of these itemized deductions exceeds the standard deduction allocated to you in order to justify itemizing your deductions.
Homeowners can deduct mortgage interest on up to $750,000 of their mortgage debt, or $375,000 for those married and filing separately. However, if the home was purchased before December 16, 2017, a more lenient limit of $1 million, or $500,000 for married couples filing separately, applies.
Important: You're eligible to deduct mortgage interest on a second home as long as the mortgage meets the same criteria for deductible interest as your primary residence. However, different regulations come into play if you decide to rent out the second home.
In January following the end of the tax year, your lender will furnish you with IRS Form 1098, which outlines the interest amount paid. Additionally, if you recently purchased your home, ensure to incorporate any interest paid as part of your closing costs. Lenders typically include interest for the partial first month of your mortgage in these closing expenses, which can be located on the settlement sheet. If this amount is not reflected on your Form 1098, you can include it in your total mortgage interest when preparing your taxes.
If you've paid mortgage points to your lender during a new loan or refinancing process, each point typically represents 1% of the total loan amount and reduces your interest rate by 0.25%. For instance, if you paid $300,000 for your home, one point would amount to $3,000. This single point would decrease the interest rate from 4% to 3.75% for the entire loan term.
You're eligible for a tax deduction if you've indeed provided the lender with funds for these discount points.
NOTE: Similar to the mortgage interest deduction, discount points are deductible on the initial $750,000 of debt.
If you've refinanced your loan or obtained a home equity line of credit (HELOC), you're eligible to claim a deduction for points over the duration of the loan. A portion of the points is incrementally included in each mortgage payment, and you can deduct this amount for every month that you make payments. For example, if $5 of your payment was allocated for points, your deductible amount would be $60 for a year's worth of payments.
Your lender will provide you with Form 1098, outlining your mortgage interest and points paid. Utilizing this information, you can claim the deduction on Schedule A of either Form 1040 or 1040-SR.
Lenders commonly impose private mortgage insurance (PMI) on borrowers who provide less than a 20% down payment for a conventional loan. Typically, PMI expenses range from $30 to $70 per month for every $100,000 borrowed. It serves to safeguard the lender, not the borrower, in the event of payment default.
Depending on your income and the timing of your home purchase, you may qualify to deduct your PMI payments. However, it's important to note that mortgage insurance premiums ceased to be deductible starting from 2023.
The state and local tax (SALT) deduction enables you to claim specific taxes paid to state and local governments. There's a $10,000 limit for both single filers and those married filing jointly, which decreases to $5,000 for married individuals filing separately. This cap encompasses the combined total deduction for state income tax, local income tax, and property taxes.
If you pay your property taxes via a lender escrow account, you'll find the amount on your 1098 form. Otherwise, you can refer to your personal records, such as checks or automatic transfers, if you directly pay taxes to your municipality. Additionally, ensure to account for payments made to the seller for any prepaid real estate taxes, which can be located on your settlement sheet.
In most cases, selling your home won't incur taxes on the majority of the profit, thanks to the home sale exclusion. This provision dictates that you won't be taxed on the initial $250,000 of profit if you've both owned and lived in the home for a minimum of two out of the last five years prior to the sale.
For married couples filing jointly, this exclusion doubles to $500,000. To qualify, at least one spouse must meet the ownership requirement, while both spouses must meet the residency requirement.
Certain situations, such as a divorce, job change, or other circumstances impacting your ability to maintain the home, may allow you to fulfill part of the residency requirement, even if you had to sell the home earlier than anticipated.
💡 TIP: If you experience a taxable gain exceeding the exclusion upon selling your primary residence, you must document the gain on Form 8949, titled "Sales and Other Dispositions of Capital Assets."
Depending on the duration of your ownership, gains from selling your home are subject to either short-term or long-term capital gains tax rates. If you owned the home for one year or less, short-term capital gains tax rates are applicable. These gains are taxed at your ordinary income tax rate, which typically ranges from 10% to 37%, depending on your annual income.
Conversely, if you held the home for more than a year, long-term capital gains tax rates apply. These rates are either 0%, 15%, or 20%, contingent upon your filing status and income level.
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You could qualify for a mortgage credit if you received a qualified mortgage credit certificate from a state or local governmental unit or agency through an approved mortgage credit certificate program.
Explore energy.gov to determine if your state provides tax credits, rebates, or other incentives for making energy-efficient enhancements to your home.
Homeowners typically have the opportunity to deduct various expenses, including home mortgage interest, interest on home equity loans or lines of credit (HELOCs), mortgage points, and state and local tax (SALT) deductions. Additionally, if you choose to itemize your deductions on Schedule A of Form 1040, you may be eligible to claim deductions for charitable donations, casualty and theft losses, certain gambling losses, unreimbursed medical and dental expenses, and premiums for long-term care insurance.
Every taxpayer can choose between taking the standard deduction or itemizing their deductions. It's advisable to perform a simple calculation of your total itemized deductions to determine if claiming the standard deduction would be more financially advantageous for you.
In 2023, the standard deduction stood at $13,850 for single individuals or married couples filing separately. It rose to $20,800 for heads of household and $27,700 for married couples filing jointly.
For the 2024 tax year, the standard deduction has increased to $14,600 for single individuals or married couples filing separately. It's now $21,900 for heads of household and $29,200 for married couples filing jointly.
Avoid assuming that paying interest is advantageous solely because it lowers your tax burden. In numerous scenarios, prioritizing the early repayment of your home can prove to be the most financially prudent decision.
Being audited is comparable to being struck by lightning. You don't want to practice pole vaulting in a thunderstorm just because it's unlikely. Making sure your books are accurate and your taxes are filed on time is one of the best ways to keep your head down during tax season. Check out Vincere's take on tax season!
This post is just for informational purposes and is not meant to be legal, business, or tax advice. Regarding the matters discussed in this post, each individual should consult his or her own attorney, business advisor, or tax advisor. Vincere accepts no responsibility for actions taken in reliance on the information contained in this document.
For business tax planning articles, our tax resources provides valuable insights into how you can reduce your tax liability now, and in the future.
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