Exploring the tax benefits of homeownership
Owning a home can be a smart financial investment and a great way to build your equity. But another substantial benefit can involve a bigger break on Tax Day.
Whether you own now or you’re thinking about buying, tax season is the best time to become familiar with the financial benefits of owning a home.
Fire and comprehensive insurance coverage, title insurance, depreciation, and the cost of utilities such as gas, electric and water are among the items you can’t deduct. But don’t worry—there are plenty of other ways to reduce the amount you owe Uncle Sam.
For homeowners to reduce the amount owed at tax time, start by saying goodbye to the standard deduction and hello to itemizing.
Home mortgage interest
The most significant tax break for many homeowners is the ability to deduct mortgage interest. Assuming you took out a loan to buy your primary home, this applies to you. The entire portion of your payment for mortgage interest can be deducted by itemizing on Form 1040’s Schedule A.
Don’t worry about calculating this amount yourself—your lender will send you a Form 1098 in January that lists the mortgage interest you paid the previous year.
Since the passage of the Tax Cuts and Jobs Act in 2018, the maximum mortgage principal eligible for deductible interest is $750,000. It had been $1 million. That law also made it easier for taxpayers to save more money on their returns by raising the standard deduction amount. That’s why the vast majority of taxpayers now take the standard deduction.
If you took out home loans before December 15, 2017, you are grandfathered into pre-reform limits:
- $1,000,000 for single or married taxpayers filing jointly
- $500,000 for married taxpayers filing separately
If you took out home loans on or after December 15, 2017, your total home loan limits:
- $750,000 for single or married taxpayers filing jointly
- $375,000 for married taxpayers filing separately
The more you pay in mortgage interest payments in a year, the more it makes sense to itemize your deduction. You’ll likely be able to save more that way than with a standard deduction, but you should probably run the numbers to find out.
Real estate taxes
Most state and local governments charge an annual tax on the value of real property, often called property taxes. These funds, though annoying to pay, are used by local and state governments for many positive initiatives in your area. Fortunately, this amount, which varies from state to state, can be deducted. The higher rate your state charges in property taxes, the more you can recoup when filing.
In addition to the property taxes you pay on your home, you may be able to deduct the taxes you pay on a vacation home, car, RV or boat. There are certain restrictions, however, such as the part of your tax bill that goes toward water or trash services. Also, since the implementation of the Tax Cuts and Jobs Act, foreign property taxes can no longer be deducted, and a $10,000 cap ($5,000 if married filing separately)3 has been put in place.
If you’ve taken on a big home improvement project, and took out a loan to help you finance the project, you’re likely able to deduct interest on it. This includes cash out refinance loans as well as home equity loans and HELOCs. Funds from the loan or cash-out refinance must be used to build or improve your home, or the interest is not deductible.
If you are self-employed as a small business owner, freelancer or contract worker, and you work primarily from a dedicated office in your house or apartment, you can probably claim the valuable home office deduction come tax time.
If you own or rent your dwelling and use part of your home for your business, you may be able to deduct business expenses tied to that use. Your home office has to be used “regularly and exclusively” as your “principal place of business.” So, no claiming the deduction while typing from your pillow-strewn bed or dining room table where you eat.
If you work from multiple locations but claim your home office as your principal place of business, that probably won’t fly, either. The IRS’s rules on this are very prickly, and not following them can raise a red flag.
Ideally, your home office is a separate room. Obviously, that’s not always possible, particularly in small apartments in big cities like New York or Chicago. You need to have what the IRS calls a “separately identifiable space.” It doesn’t have to be sectioned off by a wall or Ikea-style cubicle structure. Many accountants say that installing a folding screen or curtain will do the trick. If you have a separate, free-standing structure, like a studio, garage, workshop or barn, and you use it exclusively and regularly for your business, that can also qualify for the deduction.
What can you deduct, and how do you calculate the amount?
You can deduct from your taxable income certain expenses that are directly and proportionally related to the cost of your home office, like rent, mortgage interest, utilities, painting and repairs. You can also deduct the cost of supplies like computers and desks.
There are two ways to compute the deduction. The first is the regular method: You tally up your entire home’s total expenses and then compute a percentage of them for your home office, as measured in square feet. You also calculate depreciation of eligible property in your home office. In general, if your apartment is 1,600 square feet and your home office is 200 square feet, you would claim 12.5% of your total eligible expenses as your home office deduction.
The second, simpler, method lets you monthly deduct $5 per square foot of the portion of your home that is used for business, up to 300 square feet. For the example above, that would yield a deduction of $1,000.
It may seem obvious, but it’s important not to deduct expenses for any part of your home that is not regularly and exclusively used for business purposes.
Always trust the professionals
While these cover the basics, there are additional ways that savvy homeowners can take advantage of various provisions, from energy credits to penalty-free IRA payouts for first-time buyers.
If you’re looking for more specifics as you prepare to file, check out Publication 530, Tax Information for Homeowners, courtesy of the IRS. You can also talk to a tax advisor, who should be able to help you demystify the tax laws. Complex financial situations like this are why it's so important to talk to a trusted loan officer when making decisions about your mortgage
Guaranteed Rate does not provide tax advice. Please contact your tax advisor for any tax related questions.