An improved housing market has made home ownership a reality for many Americans, and with the thrill of the purchase comes the thrill of the tax breaks that go with owning your own home. Whether yours is a single-family house, townhouse, condo or mobile home, you’ll be able to deduct a host of expenses over the years.
In order to take full advantage of your home’s tax breaks, you will probably need to detail your tax-deductible expenses on a Form 1040 Schedule A, although some homeowners choose to claim just the standard deductions rather than hassle with itemizing. If you plan to itemize your home expenses, we have some tips to get the most bang for your home ownership tax dollar buck.
The interest on your mortgage
Your most substantial tax break will come from the interest paid monthly on your mortgage. All mortgage interest is deductible on home loans less than $1 million. If you paid $1 million or more for your castle, the IRS puts limits on the interest you can deduct. If you decide later on to take out a home equity loan or line of credit, you’ll benefit from additional tax breaks. Equity debt up to $100,000 is generally fully deductible.
If you own a second home, a boat, RV or other structure that includes a bathroom, sleeping facilities and cooking facilities you can claim a mortgage interest tax deduction, provided you spend some time residing there. You can rent out a second property, but it’s important to understand the tax laws involved. If you don’t vacation there at least 14 days per year (or more than 10 percent of the number of days that you rent it out) the IRS may consider it a residential rental property and revoke your interest deduction.
Points paid on your home loan
If you paid points for a better rate on your home loan, those are eligible for a tax break too. The only issue is exactly when you get to claim them.
The IRS allows you to deduct points in the year you paid them if you meet certain criteria; for instance, if the loan was earmarked to build or purchase your primary residence. Make sure your loan meets all the qualification requirements in order to deduct points all at once. If you pay points on a refinanced loan, you should be eligible for the tax break, but usually the points have to be deducted over the life of the loan. Points paid on a loan secured with a second home must be amortized over the life of the loan.
Property taxes comprise another major deduction for your home.
If this is the first tax year since purchasing in your house, review the settlement sheet you received at closing to find additional tax payment data. Once the property transferred to you, the year’s tax payments were divided between you and the seller so that each of you paid the taxes for the portion of the tax year in which you owned the home, and your share of these taxes is fully deductible. Property taxes must be deducted as an itemized expense on Schedule A.
When it’s time to sell
When it comes time to sell your home, you should be able to avoid some taxes on any profit you make.
In the past, homeowners needed to buy another house in order to avoid paying taxes on the sale of their current home. The law changed in 1997, replaced by new language that states up to $250,000 in sales profit (or $500,000 for married couples filing jointly) will be tax-free, provided the seller owned the property for at least five years and lived in the home for at least two of the five years before selling. Anyone who sells their home without meeting these ownership and residency requirements must pay tax on any profit. The IRS can provide some tax relief when the sale is the result of a change in the owner’s health, employment or other unforeseen circumstances. In these circumstances, the tax-free gain amount will be prorated.
If the sale was prompted by damage from a natural or man-made disaster, or the property was involuntarily converted—for example, taken by a local government under eminent domain law, a partial exclusion may be claimed.
When it comes to second homes, the law is different. Before 2008, you could move into your second home or vacation property and live there as your primary residence for two years, then sell and pocket up to $250,000 / $500,000 in profit without paying taxes. New laws put into effect in 2008 mean you owe tax on part of that profit, calculated according to how long the house was used as a second residence.