I was just asked by a first-time homebuyer if his family’s new home would change their tax situation. Buying a home can provide tax benefits.
Certain home expenses are deductible
Deductions reduce taxable income:
It is important to distinguish deductions from credits: deductions reduce taxable income, whereas credits reduce tax owed dollar-for-dollar.
A taxpayer will deduct the greater of their standard deduction or their itemized deductions:
The standard deduction is a set amount that can be deducted based on the taxpayer’s filing status. A taxpayer will use the standard deduction when they do not have many itemized deductions.
Itemized deductions are certain expenses or other financial transactions that are deductible.
Two common itemized deductions are home-related:
Property taxes on home. Real estate taxes are an itemized deduction. However, the total for all itemizable taxes cannot exceed $10,000. For example, if a taxpayer has $8,000 of deductible state income taxes and $7,000 of property taxes on their home, they can only deduct the maximum amount of $10,000 - they cannot deduct the true total of $15,000 (8,000 + 7,000).
Mortgage interest. Mortgage interest is deductible as long as the mortgage proceeds were used to buy, build, or substantially improve the property. There is also a cap – only interest attributable to mortgage amounts of $750k or less are deductible. This $750k limit applies to mortgages issued since late 2017 – different rules apply to earlier mortgages. Mortgage points are also deductible in some circumstances.
Other home expenses are not deducible. For example: maintenance, utilities, HOA dues, and insurance are all NOT deductible for a primary residence.
Example of home-related deductions
Reese and Joy are a married couple who just bought their first home. Before buying their home, they had several itemizable deductions: $6,000 of state income taxes, $1,000 of personal property taxes on their cars, and $12,000 of charitable contributions. Now that they’ve purchased a home, they will also have $5,000 of property taxes on their home and $23,000 of mortgage interest.
Before purchasing the house, Reese and Joy’s itemized deductions totaled $19,000, so they would opt to use the standard deduction of $29,200. After buying the home, Reese and Joy’s itemized deductions totaled $45,000, so they would itemize, instead of using the smaller, standard deduction.
Credits
There are also a couple of credits that apply to homeowners. We will not cover these in detail here:
Energy Efficient Home Improvement Credit. This credit was part of the Inflation Reduction Act. It provides tax credits for various qualifying energy efficient improvements to a taxpayer’s primary residence, such as: energy efficient doors, windows, insulation, air conditioners, water heaters, boilers, heat pumps, and more.
Residential Clean Energy Credit. This provides credits for different renewable energy investments to a home, including: wind, geothermal, solar, batteries.
Other considerations
There are other specific scenarios that we will not cover here. For example, the potential for home office deductions or deducting medical-related improvements to a home.
If you have any comments, questions, or ideas for future posts, please let me know
I hope you found this post helpful and educational. If you have any comments, questions, or ideas for future posts, please let me know. You can reach me directly via email at crawford@ulmerfinancial.com.
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