Since the financial crisis, the idea of homeownership is certainly much more controversial. Let’s face it, it may not necessarily be an easy path to riches.
Despite all this, one thing remains true: There is a plethora of lucrative homeowner tax deductions available. And the rules are generally favorable in terms of eligibility.
For example, the definition of a home includes not just a typical single-family residence but also a town house, condo, mobile home, cooperative apartment and even a house boat.
The main criteria is that the “home” must allow for a place to sleep, cook and to do the other things for living. In fact, you can even get homeowner tax deductions for those so-called tiny homes that have become popular over the past few years!
Granted, there is some additional paperwork. For many of the deductions, you will need to file a Schedule A form. But the time it takes to deal with this — whether with a professional tax preparer or online software from H&R Block (HRB) or Intuit’s (INTU) TurboTax — will certainly be worth the trouble.
So then, what are some of the homeowner tax deductions available? Here’s a look at seven.
Homeowner Tax Deductions #1 — Mortgage Interest
Among homeowner tax deductions, the break for mortgage interest is the most common. This deduction is available for your principal residence and even a second home.
But there are some important rules to keep in mind. For example, the mortgage must be secured by the home — and yes, you must have an ownership interest in the property, be the primary borrower and make the payments. Simply helping someone else with payments, say one of your children, isn’t enough.
There is also a limit on the amount for the interest deduction. In other words, the combined mortgages cannot be more than $1 million (or $500,000 if you are married and file separately).
However, the use of the home can have an impact on the deduction. To this end, if you borrow against a rental property to buy a home, then the interest is not deductible (either for the home or rental). Or, if you rent out a second home, you don’t get a deduction unless you use it for more than 14 days or more than 10% of the days you rented it for (whichever is longer,) otherwise the home is considered a rental.
OK then, what if you take out home equity debt? There’s good news here: You can deduct up to $100,000 (or $50,000 if you are married and file separately). It also doesn’t matter what you use the money for. But there may be a limit if the total debt on the home exceeds the fair market value.
As for a refinancing, you will be able to maintain the deduction from the old loan but any excess amount will be treated as a home equity loan, subject to the $100,000/$50,000 limit. But if there is a prepayment penalty, you can deduct this as home mortgage interest so long as the payment wasn’t for some type of service.
Finally, you can also deduct private mortgage insurance, or PMI. Private mortgage insurance is not the same thing as homeowner’s insurance, which protects against property loss. PMI is often a condition for those home buyers who make modest down payments (essentially, the insurance is for the potential of a foreclosure). But the deduction is phased out for those taxpayers with adjusted gross income (AGI) of over $100,000 (or $50,000 for those who are married and file separately).
Homeowner Tax Deductions #2 — Points
For a home mortgage, you will likely pay points (which may also be referred to as origination fees or premium charges). Each point is equal to 1% of the loan amount.
You may be able to deduct all the points during the year you make the loan so long as:
- The money is used to buy or build a main home.
- The loan is secured by the main home and the points are expressed as a percentage of the amount.
- The payment of points is an established business practice in your community and are not more than generally charged.
- The points are not be for separate items like property taxes.
- Money borrowed from your lender or mortgage broker is not used to pay for the points.
If you do not meet those criteria — or if the loan is a refinancing or for a second home — then the points are deducted in equal amounts over the life of the loan. Suppose the point on your property come to $1,000. For a 30-year loan, you will be able to deduct $33 each year. However, for loans over $250,000, there is a cap on deductible points according to the life of the loan.
Also, if the mortgage amount is over $1 million or you have home equity debt over $100,000, then you will not be able to deduct the full amount of the points.
Homeowner Tax Deductions #3 — First-Time Home Buyers
If you are making a first-time home purchase, then check out the mortgage credit certificate (MCC) program. It allows for getting a tax credit for up to 20% of the interest payments made, up to a maximum of $2,000. Note that tax credits are different than tax deductions,
To get this benefit, you need to apply with your state or local government to get the MCC.
Oh, and there’s another interesting thing you can do: You may use as much as $10,000 from an IRA for qualified acquisition expenses without paying a penalty. In fact, if you’re the spouse, parent, child or grandchild of the first-time home buyer, you can also withdraw the same amount, without penalty, to help your relative pay for the home.
Homeowner Tax Deductions #4 — Property Taxes
Another big tax break is property taxes, which you can deduct during the year you pay them. You can even get this for foreign property.
Additionally, if you purchased a new house, you can deduct any of the property taxes you paid for the seller. The amount will be on the closing statement.
But there are some restrictions with the deduction for property taxes: Specifically, you cannot include any charges for local improvements or services (such as the construction of a sidewalk or trash collection).
Homeowner Tax Deductions #5 — Selling a Home
When you sell a home for a profit, you will have a capital gain. It’s no different than if you sold stock, bonds or mutual funds. In other words, if you sell your home a year after the purchase — which is common for most people — then you will be eligible for the lower capital gains tax rate, which is a maximum of 20%. But if there is a loss on the transaction, there is no tax deduction allowed.
The capital gain on the sale of a home is the difference between the amount realized (which is the what the seller pays minus closing costs and commissions) and the cost basis. Interestingly enough, it’s the cost basis that people often overlook. The reason is that you can include any improvement that you have made to the home like adding a new room, a swimming pool, air conditioning system and so on. (Homeowners must maintain records of such things just in case there is an audit). These things lower the reported gain. However, there are certain items that you must subtract, such as casualty losses and energy tax credits.
Then again, the good news is that the chances are pretty good that you will not have to pay any capital gains tax. The reason: The tax law provides for a nifty exclusion. When selling a home, there is no tax on capital gains up to $250,000 (the amount is $500,000 for those couples who file joint returns). In order to avoid the capital gain tax, during the five years before the sale, you must have owned the home for at least two years and also lived in it for two years (keep in mind that both of these do not have to happen at the same time).
However, even if you cannot meet these criteria, you still may get some of the benefit if there are health issues, job relocation or unforeseen circumstances like divorce or death.
Homeowner Tax Deductions #6 — Debt Cancellation
If you are in the unfortunate situation where you need to get debt forgiveness from your lender, then you have essentially received income.
But Congress has realized this usually adds unduly to to a person’s burdens so there are some helpful rules to alleviate things.
For those who have a foreclosure, short sale or some type of debt restructuring on “Qualified Principal Residence Indebtedness,” there is no taxable income recognized up to a loan amount of $2 million or $1 million if married filing separately.
The home must also be a principal residence.
Homeowner Tax Deductions #7 — Energy Efficiency
Going green can provide some nice cost savings. But there are also tax breaks, too. Some of the things you can get credit for include insulation as well as more energy-efficient heaters, windows, doors and air conditioners.
But, the tax credit is still kind of miserly. For energy-efficient expenditures, the maximum is for $500. Also, you can get no more than $200 for windows.
Tom Taulli is an Enrolled Agent (the highest designation for the IRS) and the founder of BizDeductor, which offers services and apps to help save a bundle on taxes. He is also the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.