While buying a house is certainly an exciting experience, the flip side of the coin is also true; it is one of life’s major decisions that would entail you spending boatloads of cash. And if you aren’t careful, you might find yourself in mountainous debt, all while having a house that’s problematic (e.g., the house is in a flood-prone area, the house is termite-infested, etc.).
However, as they say, there is always that silver lining on dark clouds that you can count on. In the case of buying a home and the costs associated with it, it comes in the form of tax breaks.
Uncle Sam happens to throw in a third truth given in life other than death and taxes – and that is, a bucketful of tax breaks so that more Americans are motivated to buy a home.
Yes, buying a home can help reduce your tax bill. It’s important to know and understand what these potential benefits are so you can better decide on the finality of your home purchase plan.
Allow me to share with you some of the expenses that are tax deductible when you’re buying a home.
1. Mortgage Interest
When you buy a home, there are “settlement” or “closing” costs added to the contract price of the property. These are fees associated with the purchase at the time of closing the real estate deal of the said property.
Your mortgage interest paid at closing are deducted from your tax. This is in fact, the biggest tax break you get from owning a home. The mortgage interest of a debt not exceeding $1 million used in the acquisition or improvement of your home can be deducted from your tax.
However, if of you decide to buy a multi-million dollar home, the IRS will limit your deductible tax interest.
Here’s an added good news, the tax breaks on interests do not end with your first mortgage. If you pulled out extra cash through refinancing, or perhaps got a line of credit or a home equity loan, know that equity debts of up to $100,000 are also fully deductible.
When you purchase a house, there are certain charges you pay to your lender in order for you to obtain the home mortgage. These charges, referred to as “points,” are also deductible from your tax bill.
Points are either loan origination fees or discount points. Loan origination fees are compensation required for putting the mortgage in place while the discount points are those which reduces the interest rate of the mortgage.
There is, however, a small issue on this tax break and that is when you can claim them. The IRS has set some conditions for the deductions of points: (1) the points can only be deducted in the same year they were paid; (2) the points paid are loan specific to the purchase or building of your main home; (3) the payment of points by the buyer must be an established practice in the area; (4) the points are within the range of the business.
Given these conditions, you have to make sure that the loan you have acquired meets the requirements set by the IRS so all the points you paid are eligible for deduction.
If you purchased your home through a refinanced loan, you’d still be eligible for deduction on your tax bill if you paid points for the loan. The difference is that the tax breaks for the points paid on your refinanced loans are spread over the entire term of the loan.
It’s also worth pointing out that when transacting parties agree that the seller would pay the points instead of you (the buyer), the points that the seller will be paying can still be eligible for deduction from your tax.
However, when the points paid by the seller are already deducted as an expense on your federal tax returns, the IRS will no longer allow the seller to deduct the same on their account. That being said, this is something that you need to discuss thoroughly with the seller prior to closing.
3. Property Taxes
Property taxes are another major deduction from your tax bill whenever you purchase a new home. The best thing about the tax break is it is deductible over the entire life you own your home.
Taxes make up the big part of your monthly payment for your loan. Local property taxes may vary due to local assessments, but generally, this is equivalent to about 1.25% of the assessed value of your home. This part of your monthly loan payment either goes into an escrow account for payment at year end, or paid directly to your municipality. This is what you can claim as an annual deduction from your tax bills for as long as you own your home.
Most of the time, at closing, the amount of property tax due is divided by the buyer and seller. In this case, you will only be allowed to deduct the share of the property tax you paid.
4. Private Mortgage Insurance
Private mortgage insurance premiums are also tax deductible. However, you must pay close attention on the validity of this tax break since the government is keen on running a yearly review of this deduction.
The same rules in deducting the mortgage interest you paid at closing apply on the deductibility of private mortgage insurance (PMI) premiums. There is just an added restriction eliminating deductions at certain levels of your income. This means that when your income level exceeds $109,000 (for those who are single) or $54,500 (for married couples filing a separate tax return), the deduction is removed entirely.
It’s important to note these two conditions before the deduction of private mortgage insurance premiums may apply: (1) only loans which were taken out on or before January 1, 2007 are qualified to claim deductions for the private mortgage insurance premiums; and (2) the insurance policy is made specific to a home acquisition loan which means the proceeds of the loan is intended only for buying, building, or for making a substantial improvement of a house.
5. Energy Efficiency Upgrades
You may also claim tax credits if you install certain qualified energy-efficient systems in your home. This may not be much of monetary value but the non-monetary benefits are of great value and worth considering.
Although this is limited to a lifetime cap of only $500, you can enjoy a lifetime of savings from the use of the energy-efficient systems.
Apart from the tax credit and financial incentives that you can gain from having energy efficient home improvements, you are also making the world a better place for the next generation by being environmentally friendly.
Since home acquisition is one of the biggest and most important purchase decisions you will have to make in your lifetime, it pays for you to take into consideration all the economic and noneconomic aspects of your doing so.
Now that you’ve learned of several expenses that are tax deductible when buying a home, you can now take advantage of these so you can lower your home-buying expenses.
I am a Real Estate Advisor and Investor. I have a background in tech startups within the real estate space.