When you picture yourself buying a home, you probably feel emotional. You dream about family celebrations, friendly neighbors, digging in the garden, and decorating for the holidays. But did you know there are also perks in the financial realm—BIG tax savings—that come from owning a home?
If you are trying to decide whether to buy or rent a house, consider the following tax breaks for home buyers and how they can improve your short term and long term financial health.
Your Guide to Tax Breaks for Home Buyers
Tax breaks for home buyers come from many different expenses associated with buying and owning a home. From interest payments to home improvements, there are many ways to save on tax day.
Here are some of the most popular tax breaks you can look for.
Interest Payments On Mortgages
When you finance your home, you are eligible to deduct some of the interest that you pay on your mortgage each month. For most home buyers, this will mean big deductions during the first few years of home ownership, because of the way interest payments are front-loaded as a percentage of your monthly payment.
Property Tax Payments
When your city or county charges property taxes, these payments are usually looped into your mortgage and paid directly from your lender. You can deduct some or all of these property taxes.
Home Equity Line Of Credit Interest
If you have equity in your home, you can create an account using that equity as collateral. Depending on how you appropriate money, you may be able to deduct some of the interest on your line of credit. A quick reminder here—if you are approved for a home equity line, don’t treat it like an ATM!
One of the tax breaks for home buyers that many people overlook is for points. Most borrowers pay for points when they first negotiate their mortgage: one point is equal to 1% of your loan amount.
One of these comes in the form of discount points, which allow you to prepay some of your loan interest in order to get a better mortgage rate. The other type of points are in the loan origination fee. Both of these are tax deductible.
Home Office Expenses
If you are self-employed, you can deduct some expenses associated with a home office from your self-employment tax. The space you claim (e.g. a fraction of your total livable square footage) must be used solely for your business.
You can’t call the guest room a home office or claim a home office used only part of the time for your business.
The rules regarding capital gains have stayed the same under the new tax law. If you sell a home, you are able to exclude a difference of up to $500,000 between the price you paid for the home and the price you sold it for.
What You Can’t Deduct
Mortgage Insurance Premiums
If you have a low down payment mortgage—purchasing a property with little down payment— you may have very little equity in your home. Mortgage insurance is a payment that is required by some lenders to protect their investment and is not deductible.
Home And Title Insurance Coverage
You can’t deduct your homeowners insurance or title insurance on your taxes.
If your home loses value you, generally cannot deduct that loss. However, if you are self-employed and have a home office, you may be able to deduct some depreciation as a business expense.
Utilities, such as gas, electricity, water and maintenance are generally not deductible.
Most Settlement Costs
When you purchase your home, you’ll have a number of fees and costs to pay as part of that process. Most of these are not deductible.
Forfeited Deposits, Down Payments or Earnest Money
If you go under contract on a home and the deal falls through, you may lose your earnest money or deposit. You cannot claim this as a loss on your taxes. In addition, your down payment becomes a part of your home’s equity, so it cannot be deducted.
Homeowners Association Fees
If you live in a neighborhood with a Homeowner’s Association (HOA) or in a condominium or co-op with fees, you cannot deduct these from your income tax.
How the “Trump Tax Law” Affects Homeowners
The Trump Tax Law, otherwise known as the Tax Cuts and Jobs Act of 2017 (TCJA), creates a number of changes to the tax guidelines for homeowners. In many cases, these make it harder for you to deduct expenses and reduce the amount of your deduction.
It is important to understand these changes in order to ensure you are getting all of the tax breaks for home buyers that you deserve.
Less Mortgage Interest Deductible
Before the tax law, homeowners could deduct mortgage interest on loans of up to $1 million. Under the new law, that number has been reduced to $750,000.
For refinancing, the date of the original mortgage is the guide, so if you are refinancing an older mortgage (before 2018), your limit is still $1,000,000.
Less Property Tax Deductible
Homeowners used to be able to deduct property taxes, state and local income taxes, and sales taxes. Now, the total for all of these has been capped at $10,000 per year.
That means that if you live in a state with high income or property taxes, you could find yourself paying considerably more.
Limits On Home Equity Expenses
Homeowners were once able to tap into their home equity to pay off credit card debt or to pay a child’s tuition, then deduct that interest on their taxes. No more.
Now, only home equity funds that are used for home improvement or repair are eligible.
Less Mortgage Interest Deductible On Second Homes
Just as with a first home, mortgage interest is only deductible on second home debt up to $750,000.
Only Active-Duty Military Can Deduct Moving Expenses
Under the previous tax laws, if you moved to take a new job you were able to deduct many of your moving expenses as qualified business expenses.
However, those deductions have been removed for everyone except active-duty military members and their families.
Less Incentive To Itemize
An increase in the standard deduction and new limits on deductible expenses means that many homeowners who used to itemize their deductions no longer have a reason to do so.
This can mean big savings for some homeowners but losses for others, depending on your individual tax situation and strategy. As always, check with your financial advisor or CPA for more specific guidance.
Tax Savings You May Not Have Heard About
When you are putting together a plan for your income taxes, you may have an idea of some of the items you can deduct. However, there are a number of smart tax strategies you may not have heard about.
While some of these are specifically tax breaks for home buyers, some of them are tax breaks for your family or for expenses associated with your job. There are a variety of deductions, credits, and tax strategies you may not know about. Here are some unexpected tax breaks for home buyers.
Payments For Last Year’s State Taxes
If you paid state taxes last year, you may be able to deduct the amount you paid from this year’s taxes.
Credit For Dependents Not Covered By The Child Tax Credit
If you support an adult child or an elderly family member, there are new deductions that you can claim.
Expenses Associated With Work For A Charity
Besides money donated to charity, you can now deduct some of the expenses you may have when you work for or donate time to a charity.
Student Loans Paid By Parents
If your parents are paying your student loans, you can deduct up to $2,500 of the interest you pay.
Higher Education Expenses
If you are paying for college to help you get a job or a promotion, you may be able to deduct a variety of higher education expenses under the “Lifetime Learning” qualification.
Private School Tuition
You can now use tax-free 529 college savings plans to pay for other education-related expenses, including private school tuition.
Travel for National Guard or Reservists
When you are traveling for weekends and training weeks with the National Guard or Reserve, you are now able to deduct associated travel costs.
Medical Insurance and Medicare Premiums for Self-Employed
If you are self-employed, you can deduct your medical insurance or Medicare premiums. This is a great deal for those who have retired, are covered by Medicare, and are beginning a second career.
Child Care Expenses
Many child care expenses are now tax deductible. This is especially useful if you also have an employer-provided child care savings account.
Deducting Medical Home Improvements
If you have a change in your medical condition or if you buy a home and need to make accessibility updates, some of your changes may be deductible as medically necessary home improvements. These can include the following:
- Entrance and exit ramps
- Wider interior and exterior doorways
- Railings and support bars in bathrooms
- Lowering kitchen cabinets
- Moving electrical outlets
- Installing lifts
- Adding visual elements to alarms and smoke detectors
- Changing stairways
- Changing hardware and handles on doors
- Re-grading the ground for outdoor access
Be sure to speak with your financial advisor or tax professional about the kinds of documentation you will need to show that your home improvement is medically necessary.
In addition, your doctor may have insights on the type of letters you need based on the experiences of past patients.
The Two Rules That Limit Medical Deductions
- You must itemize to take advantage of medical deductions. Since the TCJA, it is much more difficult to itemize deductions. This is because the standard deduction was almost doubled while many of the old deductions are no longer valid.
- There are adjusted gross income (AGI) limits on medical deductions. Starting in 2019, you can only deduct medical home improvements if they make up more than 10% of your total AGI. That means that if your AGI is $100,000, you’ll only be able to deduct medical expenses if they cost more than $10,000.
Tax Breaks for Landlords and Real Estate Investors
Many home buyers are able to finance their homes, in part, by renting out a room or a small apartment. This is an especially popular option if you live in a college town or near a major employer, like a hospital, retail center, or distribution hub.
If you have a garage apartment, carriage house, guest house, basement apartment, or other space, you may be thinking of renting it out. You can choose either long-term tenants or short-term ones through AirBnB or a similar platform.
While the rent you earn will be taxed as income, you will be able to deduct the cost of repairs and improvements to the rental space. This can mean big savings over time along with positive, monthly income (or cash flow) to offset your mortgage payment.
If your real estate investment property is separate from your primary residence, different rules will apply. The good news is that you will be able to deduct repairs to those separate properties as well.
Be sure to talk to your real estate agent or broker to understand if there are local requirements for renting out a home.
In addition, be sure to check with your homeowner’s association or condo board in order to find out if they have rules that limit your ability to rent out part of your home.
Every Tax Story Is Different
Tax situations can change from year to year—even within the same year. It is important for you to understand your individual tax picture in order to make sure that you are doing what’s best for you and your family.
In addition, because tax law changes each year, both at the federal and state level, you need to keep up to date with the current rules.
If you don’t already have an accountant or financial planner, find one you can trust and discuss short-term and long-term your goals and financial history. They can help you come up with an actionable plan to track your expenses throughout the year so that you will be ready when it is time to file your taxes.
The most important they help you with is how to think ahead so that you can make smart financial decisions over the long term.