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13 Tax Breaks for Homeowners and
Home Buyers
Owning (or buying) a home is expensive. But at least there are
some tax deductions, credits, and exclusions that can help you
recoup some of those costs.
By Rocky Mengle | June 22, 2020
Owning a home is part of the American Dream. Whether you fancy a log cabin in the
middle of nowhere, a suburban Cape Cod with a white picket fence, or a downtown
condo in the sky, there's just something special about trading in a lease for a deed. But
that transition can be difficult – and expensive. It's tough saving up enough cash for a
down payment and then keeping up with the mortgage payments — to say nothing of
the maintenance costs, which are now all on you!
Fortunately, Uncle Sam has a few tax tricks up his sleeve to help you buy a home, save
on home-related costs and sell your home tax-free. Some of them are complicated,
limited or come with hoops you have to jump through, but they can be well worth the
trouble if you qualify. So, without further ado, here are 13 tax breaks that can help you
buy a home and prosper as a homeowner.
Click on the link to access this article online: 13 Tax Breaks for Homeowners and Home
Buyers Page |11. USING RETIREMENT FUNDS FOR A DOWN PAYMENT
Before you can become a homeowner, you have to scrape up enough dough for a
down payment. If you have an IRA or a 401(k) account, you might be able to tap into
those funds to help you buy a home. Savers with a traditional IRA can withdraw up to
$10,000 from the account to buy, build or rebuild a first home without paying the 10%
early-withdrawal penalty — even if you're younger than age 59½. If you're married, both
you and your spouse can each withdraw $10,000 from separate IRAs without paying the
penalty. (To qualify as a first home, you and your spouse cannot have owned a home for
the past two years.) However, even though you escape the penalty, you're still required
to pay tax on the amount you withdraw.
With a Roth IRA, you can withdraw contributions at any time and for any reason without
facing a tax or penalty. The IRS has already taken its cut. You can also withdraw up to
$10,000 in earnings before age 59½ to help buy a first home without being hit with the
10% penalty for early withdrawals. (Your spouse can do the same.) If you've had the
account for five years, the earnings will be tax-free, too.
If you want to pull money out of a 401(k) account to put toward a down payment, you'll
have to borrow from the plan. You can typically take out a tax- and penalty-free loan
from your 401(k) plan for up to half of your balance, but not more than $50,000. Money
borrowed from a 401(k) usually must be paid back (with interest) within five years, but the
repayment period for loans used to purchase a main home can be extended. Be
warned, though, that you'll have to repay the loan before your next tax return is due if
you leave or lose your job. Otherwise, you'll have to pay taxes on the unpaid balance
and a 10% early-withdrawal penalty if you're not yet 55.
(Note that, under the CARES Act, people impacted by the coronavirus can borrow more
from their 401(k) plan — up to the lesser of $100,000 or 100% of the account balance —
until September 23, 2020. They are also given an additional year to repay existing 401(k)
loans due between March 27 and December 31, 2020.)
Click on the link to access this article online: 13 Tax Breaks for Homeowners and Home
Buyers Page |22. MORTGAGE POINTS DEDUCTION
You usually have to pay "points" to the lender when you take out a mortgage. In most
cases, the points you pay on a loan to buy, build or substantially improve your primary
residence are fully deductible in the year you pay them. There are some requirements
that must be satisfied — such as the loan must be secured by your main home — but you
generally don't have to wait to deduct points paid for a standard mortgage.
On the other hand, if you're buying a second home, you can't deduct the loan points in
the year you pay them. But you can still deduct them gradually over the life of the
loan. That means you can deduct 1/30th of the points each year if it's a 30-year
mortgage. That's $33 a year for each $1,000 of points you paid — not much, maybe, but
don't throw it away.
When you refinance, you also typically have to deduct any points you pay ratably over
the life of the new loan. However, in the year you pay off the loan — because you sell the
house or refinance again — you get to deduct all as-yet-undeducted points. There's one
exception to this sweet rule: If you refinance a second time with the same lender, you
add the points paid on the latest loan to the leftovers from the previous refinancing, then
deduct that amount gradually over the life of the new loan. A pain? Yes, but at least
you'll be compensated for the hassle.
There's one last catch, and it applies whether you're deducting points in the year you
paid them or over the life of the loan. You must itemize to claim the deduction. (Because
the standard deduction was nearly doubled by the 2017 tax reform law, most people
don't itemize.) Itemizers must report deductible points on line 8a or 8c of Schedule
A (Form 1040).
Click on the link to access this article online: 13 Tax Breaks for Homeowners and Home
Buyers Page |33. MORTGAGE INSURANCE PREMIUM DEDUCTION
Homeowners who pay private mortgage insurance on loans originated after 2006 can
deduct their premiums if they itemize. (PMI is usually charged if you put down less than
20% when you buy a home.) The deduction is phased out if your adjusted gross income
exceeds $100,000 and disappears if your AGI exceeds $109,000 ($50,000 and $54,500,
respectively, if you're married but file a separate return).
Look at Box 5 on the Form 1098 you receive from your lender for the amount of premiums
you paid during the year. Report the deductible amount on line 8d of Schedule A (Form
1040).
This deduction is set to expire after the 2020 tax year. (However, the deduction has
expired and then been extended several times in the past.)
4. MORTGAGE INTEREST DEDUCTION
For most people, the biggest tax break from owning a home comes from deducting
mortgage interest. If you itemize, you can deduct interest on up to $750,000 of debt
($375,000 if married filing separately) used to buy, build or substantially improve your
primary home or a single second home. (For pre-2018 mortgages, interest on up to $1
million of debt is deductible.) Improvements are "substantial" if they add value to the
home, extend the home's useful life or adapt the home for new uses. Basically, additions
and major renovations are "substantial," but basic repairs and maintenance are not.
Click on the link to access this article online: 13 Tax Breaks for Homeowners and Home
Buyers Page |4Your lender will send you a Form 1098 in January listing the mortgage interest you paid
during the previous year. That's the amount you deduct on line 8a or 8b of Schedule
A (Form 1040). If you just bought a home, make sure the 1098 includes any interest you
paid from the date you closed to the end of that month. This amount is listed on your
settlement sheet for the home purchase. You can deduct it even if the lender doesn't
include it on the Form 1098.
(Note that, before 2018, you could deduct interest on up to $100,000 of home-equity
loans or lines of credit even if you used the cash to pay for personal expenses, such as
paying off credit card debt or buying a car. After the 2017 tax reform law, that interest is
no longer deductible. The interest is only deductible now if the loan proceeds are used
to purchase, construct or improve your home.)
5. MORTGAGE INTEREST CREDIT
In addition to the mortgage interest deduction, there's also a mortgage interest
tax credit available to lower-income homeowners who were issued a qualified Mortgage
Credit Certificate (MCC) from a state or local government to subsidize the purchase of a
primary home. The credit amount ranges from 10% to 50% of mortgage interest paid
during the year. (The exact percentage is listed on the MCC issued to you.) The credit is
limited to $2,000 if the credit rate is higher than 20%. However, if your allowable credit is
reduced because of the limit, you can carry forward the unused portion of the credit to
the next three years or until used, whichever comes first.
To claim the credit, complete Form 8396 and attach it to your 1040. You also need to
report the credit amount on line 6 of Schedule 3 (Form 1040). Don't forget to check box
c and write "8396" on line 6, too.
There are a number of restrictions and special rules for this credit. For instance, no double
dipping is allowed. If you claim the mortgage interest credit, you have to reduce your
mortgage interest deduction on Schedule A by the credit amount. If you refinance your
original loan, you'll have to get a new MCC in order to claim the credit on the new loan—
and the credit amount on the new loan may change. Also, if you sell the home within
nine years, you may have to repay all or part of the benefit you received from the MCC
program.
Click on the link to access this article online: 13 Tax Breaks for Homeowners and Home
Buyers Page |56. PROPERTY TAX DEDUCTION
You get hit with all kinds of taxes — not just income taxes. As a homeowner, one of the
additional taxes you're going to have to get used to paying is your local real property
tax. The good news is that you might be able to deduct the state and local property taxes
you pay on your federal income tax return.
There are, however, a few wrinkles that can spoil this deduction. First, you have to itemize
in order to deduct real property taxes. If you do itemize, you can deduct them on line 5b
of Schedule A (Form 1040).
There's also a $10,000 limit ($5,000 if you're married but filing a separate return) on the
combined amount of state and local income, sales and property taxes you can
deduct. Anything over $10,000 is not deductible. That hits homeowners particularly hard
in states where income, sales and/or property taxes are on the high end.
7. HOME-OFFICE EXPENSE DEDUCTION
If you're self-employed and work at home, you might be able to deduct expenses for the
business use of your home. The home-office deduction is available for homeowners and
renters, and it doesn't matter what type of home you have — single family, townhouse,
apartment, condo, mobile home or even a boat. You can also claim the deduction if
you work in an outbuilding on your property, such as an unattached garage, studio, barn
or greenhouse.
Click on the link to access this article online: 13 Tax Breaks for Homeowners and Home
Buyers Page |6The key to the home-office deduction is to use part of your home regularly and
exclusively for your moneymaking endeavor. Pass that test and part of your utility bills,
insurance costs, general repairs and other home expenses can be deducted against
your business income. You can also write off part of your rent or, if you own your home,
depreciation (a noncash expense that can save you real money on your tax bill).
There are two ways to calculate the deduction. Under the "actual expense" method, you
essentially multiply the expenses of operating your home by the percentage of your
home devoted to business use. The problem with this method is that it can be a nightmare
pulling together all the records you'll need to calculate and substantiate the deduction.
If you use the "simplified" method, you deduct $5 for every square foot of space in your
home used for a qualified business purpose. For example, if you have a 300-square-foot
home office (the maximum size allowed for this method), your deduction is $1,500.
Employees who work remotely can't deduct the costs of maintaining a home office
anymore (that includes employees working from home during the coronavirus
pandemic). Before 2018, employees could claim home-office expenses as a
miscellaneous itemized deduction if the costs exceeded 2% of their adjusted gross
income. However, this deduction was eliminated by the 2017 tax reform act.
8. CREDITS FOR ENERGY-SAVING IMPROVEMENTS
To encourage the use of renewable energy sources, Uncle Sam will reward you with a
tax credit if you install certain energy-efficient equipment in your home. You'll save 30%
on new systems that use solar, wind, geothermal or fuel cell power to produce electricity,
heat water or regulate the temperature in your home. The credit for fuel cell equipment
is limited to $500 for each one-half kilowatt of capacity.
Homeowners going green can also shave up to $500 off their tax bill with another credit
by installing energy-efficient insulation, doors, roofing, heating and air-conditioning
systems, wood stoves, water heaters, or the like. The credit isworth up to $200 for new
energy-efficient windows.
If you qualify for either of these tax credits, use Form 5695 to calculate the amount and
then claim the credit(s) on line 5 of Schedule 3 (Form 1040).
Click on the link to access this article online: 13 Tax Breaks for Homeowners and Home
Buyers Page |79. DEDUCTION OF MEDICALLY NECESSARY HOME IMPROVEMENTS
You may qualify for a medical expense deduction if you install special equipment in or
make modifications to your home for medical reasons. Common examples of medically
necessary upgrades to a home include adding ramps, widening doorways, installing
handrails, lowering cabinets, moving electrical outlets, installing lifts or elevators,
changing door knobs, and grading the ground to provide access to the home. Costs for
the operation and upkeep of these upgrades are also deductible as medical expenses
if the upgrade itself is medically necessary. However, improvements that simply make
your home more elderly-friendly (such as "aging-in-place" upgrades) aren't deductible if
they're not medically necessary.
There are some limitations, though. You have to itemize on Schedule A (Form 1040) to
claim the deduction, and you can only deduct medical expenses that exceed 7.5% of
your adjusted gross income (10% after 2020). The deduction is also reduced by any
increase in the value of your property. So, for example, if you spend $50,000 to install an
elevator, and that increases your home's value by $40,000, you can only deduct $10,000
($50,000 – $40,000). And, again, the upgrade must be for a medical reason.
10. DEDUCTION OF RENTAL EXPENSES
What if you rent out a part of your home, such as a room or the basement? You'll owe tax
on your rental income, but you can deduct expenses for the rental space. Potentially
deductible expenses include insurance, repair and general maintenance costs, real
estate taxes, utilities, supplies, and more. You can also deduct depreciation on the part
Click on the link to access this article online: 13 Tax Breaks for Homeowners and Home
Buyers Page |8of your house used for rental purposes, and on any furniture or equipment in the rented
space. You don't have to itemize to deduct the rental-space expenses on Schedule A,
either. Instead, you claim them on Schedule E (Form 1040) and subtract them from your
rental income.
The tricky part is figuring out how much you can deduct if an expense covers the whole
house, such as an electric bill or property taxes. In this case, you have to divide the
expense and allocate a portion of it to the rental space. You can use any reasonable
method for dividing the expense. For example, if you rent a 200-square-foot room in a
2,000-square-foot house, you can simply allocate (and deduct) 10% of any whole-house
cost as a rental expense. You don't have to divide expenses that are only connected to
the rented area. For instance, if you paint a room that you rent, your entire cost is a
deductible rental expense.
The rules are a bit different if you're renting out a vacation home or investment property.
You'll still owe tax on the rental income, and you'll still be able to deduct rental expenses,
but there are other methods for calculating those two amounts.
11. FORGIVENESS OF DEBT ON A FORECLOSURE OR SHORT SALE
In tough economic times, more homeowners fall behind on their mortgage payments. In
some case, the lender may eventually reduce or eliminate your mortgage debt through
a "short sale" or foreclosure. Normally, when a debt is wiped clean, the amount forgiven
is treated as income to the debtor. But, when it comes to mortgage debt forgiven as part
of a foreclosure or short sale, up to $2 million of discharged debt on a principal residence
is tax free ($1 million if married filing separately).
The exclusion only applies to a mortgage you took out to buy, build, or substantially
improve your main home. It also must be secured by your main home. Debt secured by
your main home that you used to refinance a mortgage you took out to buy, build, or
substantially improve your main home also counts, but only up to the amount of the old
mortgage principal just before the refinancing.
No tax break is available if the discharge of debt is because of services you performed
for the lender, or for any other reason not directly related to a decline in your home's
value or your financial condition. In addition, the amount excluded reduces your cost
basis in the home.
Click on the link to access this article online: 13 Tax Breaks for Homeowners and Home
Buyers Page |9The exclusion is only available for mortgage debt discharged before 2021.
12. CAPITAL GAIN EXCLUSION WHEN SELLING YOUR HOME
The IRS has a special gift for you when you sell your home: You probably won't have to
pay taxes on all or part of the gain from the sale. Your home is considered a capital asset.
Normally, you have to pay capital gains tax when you sell a capital asset for a profit.
However, if you're married and file a joint return, you don't have to pay tax on up to
$500,000 ($250,000 for single filers) of the gain from the sale of your home if you (1) owned
the home for at least two of the past five years, (2) lived in the home for at least two of
the past five years, and (3) haven't used this exclusion to shelter gain from a home sale
in the last two years. So, for example, if you bought your home five years ago for $600,000
and sold it for $700,000, you won't pay any tax on the $100,000 gain if all the exclusion
requirements are satisfied. (Unfortunately, if you sold your home for a loss, you can't
deduct the loss.) Any profit over the $500,000 or $250,000 exclusion amount is reported as
capital gains on Schedule D.
If you don't meet all the requirements, you still might be able to exclude a portion of your
home-sale profits if you had to sell your home because of a change in your workplace
location, a health issue, a divorce or some other unforeseen situation. The amount of your
exclusion depends on how close you come to satisfying the ownership, live-in and
previous-use-of-exclusion requirements. For instance, if you're single, you owned your
home for two out of the past five years, you did not use the exclusion for another home
sale in the past two years, but you lived in your home for only one of the past five years
because your employer transferred you to another city, you can exclude $125,000 of
profit—half the normal exclusion, because you satisfied only half of the live-in
requirement.
Caution: When you sell your home, you might have to pay back any depreciation you
claimed for a business use of your home, first-time homebuyer credits if you purchased
your home in 2008, or any federal mortgage subsidies you received.
Click on the link to access this article online: 13 Tax Breaks for Homeowners and Home
Buyers P a g e | 1013. INCREASED BASIS WHEN SELLING YOUR HOME
If the capital gain exclusion doesn't completely wipe out your tax bill when you sell your
home, you can still reduce the tax you owe by adjusting the basis of your home. Your
taxable gain is equal to the sales price of your home, minus the home's basis. So, the
higher the basis, the lower the tax.
What you originally paid for the home is included in the basis — that's good! But you can
also tack on various costs associated with the purchase and improvement of your
home. For example, you can include certain settlement fees and closing costs you paid
when you bought the home. If you had the house built on land you owned, the basis
includes the cost of the land, architect and contractor fees, building permit costs, utility
connection charges, and related legal fees. The cost of additions and major home
improvements can be added to the basis, too (but not basic repair and maintenance
costs).
Securities offered through Cetera Advisor Networks LLC, Member FINRA/SIPC. Investment advisory services offered through
CWM, LLC, an SEC Registered Investment Advisor. Cetera Advisor Networks LLC is under separate ownership from any
other named entity. Carson Partners, a division of CWM, LLC, is a nationwide partnership of advisors.
Rocky Mengle is not affiliated with Taylor Financial Group, LLC, Cetera Advisor Networks LLC or Carson Partners.
Click on the link to access this article online: 13 Tax Breaks for Homeowners and Home
Buyers P a g e | 11You can also read
