Did you know that you can get a tax break for buying a house, as well as for many of the ongoing expenses of homeownership? You could stand to save thousands of dollars at tax time, but first you have to know which of your expenses qualify and whether you want to itemize your deductions or take the standard deduction.
What are tax breaks: deductions and credits explained
When it comes to tax breaks for buying a house, your CPA might explain the tax benefits of homeownership can come in one of two formats: either a tax deduction or a tax credit.
Deductions are expenses that the IRS has agreed you can subtract from your taxable income so that when you pay your tax bill, you’ll pay less. The government wants to promote homeownership among Americans and offering tax deductions for some of the expenses related to owning a home is one way that it does so.
To take advantage of tax deductions, you need to research and identify which deductions apply to you before filing your taxes. The available tax deductions can change each year, as can your financial situation, however, some homeownership expenses are simply not going to be deductible.
Tax credits are not the same as deductions. Whereas tax deductions reduce how much taxes you’ll pay indirectly, by reducing your taxable income, tax credits reduce your bill directly — they are dollar amounts subtracted from your tax bill itself.
What is the standard deduction?
It’s important to look closely at the standard deduction allowed by the IRS because if you decide to take it, that means you can’t itemize your deductions. Instead of subtracting allowed expenses from your taxable income, you’re agreeing to a “flat” or standard deduction that isn’t associated with any specific types of expenses.
Standard deduction amounts 2022-2023
|Tax filing status||2022 tax year (file by April 18, 2023)||2023 tax year (file by April 15, 2024)|
|Married filing separately||$12,950||$13,850|
|Head of household||$19,400||$20,800|
|Married filing jointly||$25,900||$27,700|
If the deductions you qualify for as a homeowner are higher than the standard deduction amount tied to your tax filing status, then it may make more sense for you to itemize your deductions — otherwise, the standard deduction may work in your favor. Consult your tax professional for specific guidance.
Tax deductions for buying, building or improving a home
Mortgage interest deduction
You can deduct the interest paid up to $750,000 of mortgage debt if you’re an individual taxpayer or a married couple filing a joint tax return. For married couples filing separately, the limit is $375,000. If you bought your home before Dec. 16, 2017, the mortgage interest deduction limit is $1 million for single filers and married couples filing jointly and $500,000 for married couples filing separately.
Interest on home equity loans and HELOC
The same deduction limits apply to the interest paid on home equity loans and home equity lines of credit (HELOCs). If you’re a single taxpayer and the combined amount of your first mortgage and HELOC is less than $750,000, for example, you’re allowed to deduct the full amount of interest paid on both loans — but only if they were both used to build, buy or make improvements to your main or second home.
Mortgage insurance premium deduction
If you pay for mortgage insurance as part of your monthly mortgage payment, you may qualify to deduct that expense from your taxable income. Mortgage insurance protects your lender if you can’t make your mortgage payments and go into mortgage default.
If you got a VA home loan and paid a VA funding fee, or paid a USDA guarantee fee as part of a USDA home loan in the tax year you’re filing for, you can include it as a deduction. The IRS considers these fees to be forms of mortgage insurance and allows you to deduct them even if you didn’t pay the fee upfront and instead rolled it into the loan amount.
Income restrictions on deducting mortgage insurance
Homeowners with an adjusted gross income (AGI) up to $100,000 (or up to $50,000 if they’re married and filing separately) can deduct their mortgage insurance premiums. However, if your AGI is more than $109,000 ($54,500 if married and filing separately), you can’t deduct your mortgage insurance premiums.
Mortgage interest credit
A Mortgage Tax Credit Certificate (MCC) is a tax credit issued by the government directly to a homeowner that allows them to reduce their tax bill by a specific percentage of their mortgage interest. You may be eligible for a mortgage interest credit if you’re a first-time homebuyer, a military service member or are purchasing a home in an area targeted by the U.S. Department of Housing and Urban Affairs (HUD). Targeted areas may have been identified as needing development or revitalization.
Mortgage discount points deduction
Another one of the tax benefits of buying a home is the ability to deduct mortgage points you paid upfront when closing on your home purchase. One mortgage point, sometimes called a discount point, is equal to 1% of your loan amount.
Generally speaking, you’ll deduct points over the life of your loan rather than in the year you paid them. However, there is an exception to this rule if you meet a series of tests, as outlined by the IRS. The tests include:
→ The mortgage is for your primary residence.
→ Paying for points that didn’t cost more than what is generally charged locally.
→ Paying for points that weren’t paid in place of other closing costs, such as appraisal or title fees.
The IRS outlines the entire list of tests you’ll need to pass to fully deduct mortgage points in the year you paid them. If you meet all of the tests, you have the choice to deduct the full amount the points represent in the year you paid or spread them out over the life of the loan.
SALT property tax deduction
There’s a deduction for state and local taxes (SALT), which includes property taxes. The total deductible amount is capped at $10,000 for single taxpayers and married couples filing taxes jointly. The deduction limit is $5,000 for married couples filing separately.
It’s also important to know that, in some cases, if a taxpayer receives a refund because of SALT deductions, some or all of that money may be taxable in the next tax year.
IRA withdrawals with no tax penalty
Using retirement funds to buy a house is not only possible, it’s an option that the IRS supports by making it possible to do so while avoiding any tax penalties. In most scenarios, you would have to pay at least two tax penalties if you withdrew funds from an Individual Retirement Account (IRA) before you turn 59½: income tax as well as a 10% additional penalty. But if you use the money to buy a house, you won’t have to pay the 10% early-withdrawal penalty.
Tax breaks for green upgrades to a home
Residential energy credit
There’s an eco-friendly tax break for homeowners, known as the Residential Energy Efficient Property Credit. The incentive applies to energy saving improvements made to a home, which might include solar panels and wind turbines, among other energy-efficient upgrades. Depending on the specific equipment, improvements made at a second home may qualify.
The residential energy credit ranges from 22% to 30% of the improvement cost, depending on what year the energy upgrades were made, and expires Dec. 31, 2023.
Alternative fuel vehicle refueling property credit
If you install refueling infrastructure for an alternative-fuel vehicle at your home, you may be able to recoup $1,000 or 30% of the installation cost (whichever is lower) by claiming the Alternative Fuel Vehicle Refueling Property Credit.
Tax deductions for special uses of your home
Home office deduction
If you work from home or have a home-based business, you may qualify for the Home Office Deduction, which applies to both homeowners and renters. To qualify, a portion of your home (a bedroom-turned-office, for example) must be used exclusively and regularly for business purposes. You must also show that your home is the main location used to conduct your business.
There are two ways to claim the deduction:
- The regular method, which involves determining the percentage of your home being used for business activities and calculating the actual expenses based on records.
- The simplified option, which allows you to deduct $5 per square foot — up to 300 square feet — for the business use of your home.
Remote workers don’t qualify for the deduction.
Rental expenses deduction
If you rent out all or part of your house, you may be able to deduct some of the expenses related to being a landlord, including:
- Property tax
- Travel costs
Which expenses are deductible varies depending on whether you’re renting out a home you have no personal use of versus one you use personally. The rules also vary depending on whether your use is part-time (like with a vacation home) or full-time, as in a roommate situation.
The rental expenses deduction is also unique in that you can use it even if you don’t itemize on Schedule A. Instead, you’ll use Schedule E (Form 1040) to report the rental income and calculate your deduction.
Tax breaks for selling your home
Tax-free profits on your home sale
One of the tax benefits of owning a home doesn’t kick in until after you sell your home — tax-free profits.
If you sell your house at a profit, in most cases capital gains on a home sale are tax-free up to $250,000 if you’re single, and up to $500,000 if you’re married filing jointly. You must have lived in and used the home as your primary residence for at least two of the five years before the sale date to qualify for this tax break.
Foreclosure or short sale (discharged debt) deduction
If you sell your home in a short sale or go through foreclosure, the house is sold and the proceeds used to pay back the lender. However, if the amount you owed isn’t fully covered by those proceeds, the remaining debt is called a “deficiency,” and your lender could still expect you to pay that debt. If the lender forgives the deficiency, on the other hand, it’s considered part of your taxable income.
However, you may be able to deduct the outstanding mortgage debt you discharged from your taxes. The Consolidated Appropriations Act of 2020, which is in effect until 2025, allows you to exclude the canceled mortgage debt from your taxable income.
How to claim tax deductions
→ Step 1. Wait for your tax forms
Each lender with whom you have a mortgage is required to send you a tax form called a Mortgage Interest Statement (Form 1098). When your 1098 comes, review the amount of interest listed as paid. Box 1 will show how much interest you’ve paid, not including points, and box 6 will show how much you’ve paid in points.
→ Step 2. Determine whether to itemize
Add up the total amount of eligible expenses across all of the deductions that apply to you. Then, compare that number to the standard deduction amount you qualify for. If your total itemized deduction amount doesn’t exceed the standard deduction amount for your tax filing status, then it doesn’t make sense to itemize your deductions.
→ Step 3. Claim your deductions
If you’ve decided to itemize, your final step is to sit down with your Schedule A (Form 1040) and claim all of the deductions you’ve planned for.