Making the big leap to homeownership may seem less daunting when you understand the tax benefits of buying a home. Several tax deductions and tax credits offer home buyers the opportunity to offset some initial and ongoing costs against their income. Buying a home is a significant purchase, possibly the largest purchase you’ll ever make, so it pays to understand how to report the costs of homeownership on your tax forms.
How does buying a house help with taxes?
Taxpayers calculate the tax benefits associated with owning a home on Form 1040. If you itemize deductions on Schedule A, report expenses such as mortgage interest, points, and property taxes. To receive the benefit of itemized deductions in 2022, the total amount on Schedule A must exceed the standard deduction of $12,950 for single filers or $25,900 for married couples filing jointly.
Additionally, the IRS offers tax credits for homebuyers. Unlike tax deductions that lower your taxable income, tax credits are deducted from the total amount of tax you owe. They represent a dollar-for-dollar decrease in your tax bill at the end of the year.
Tax Deductions for Homebuyers
Tax deductions decrease the amount of income subject to federal tax. A taxpayer with $100,000 of gross income who claims itemized deductions of $15,000 would owe federal tax on $85,000, assuming no other deductions or credits are applied. In a 30% tax bracket, the taxpayer would owe $30,000 in taxes on the $100,000 of income, while after deductions, they would owe only $25,500 of taxes or 30% of $85,000.
Homeowners can deduct the following expenses on Schedule A:
Each year, mortgage lenders prepare and send a Form 1098 to borrowers. This form documents the mortgage interest the borrower paid during the year. Taxpayers can then report the amount of mortgage interest paid on their Schedule A.
Generally, taxpayers can deduct the full amount of mortgage interest paid each year. But in some cases, the IRS limits the amount of deductible mortgage interest.
The following cases are examples of limits the IRS puts in place for mortgage interest deductions:
- All interest on loans taken out before 1987 may be deducted. For loans originated between 1987 and 2017, only interest related to $1 million of the balance is deductible. For loans originating after 2017, only interest related to $750,000 may be deducted.
- The interest paid must be associated with a loan to buy, build, or substantially improve the home.
- Mortgage interest for a primary and second home qualifies, but the combined debt must fall under the thresholds for loans stated above, based on origination dates.
Mortgage points count as prepaid interest and are deductible for tax purposes. The method of deducting points can vary. In some situations, taxpayers deduct the total amount of points paid in the year of the home purchase. To deduct all the points up front, you must meet several IRS tests to determine if you qualify. If not, the value of the points amortizes over the life of the mortgage. If you amortize $1,000 in points on a ten-year loan, you will deduct $100 per year for ten years on your Schedule A.
Home buyers with a down payment of less than 20% generally pay for private mortgage insurance, or PMI. In the past, PMI has been deductible for tax purposes. Currently, the IRS has not determined if the PMI deduction will be extended for 2022.
State and Local Real Estate Taxes
Taxpayers can deduct up to $10,000 of state and local property tax expenses on their Schedule A. You can only report the amount of real estate property tax paid to a state or local tax authority, not the amount your lender withheld from your monthly payments for escrow. Due to the timing of mortgage payments or the amount of escrow required, your bank may report a different amount of property taxes. Use the official tax bill from your state or local municipality to support your deduction.
Expenses that cannot be deducted for tax purposes
The IRS determines which of the costs related to homeownership are deductible. Some expenses cannot be deducted, such as:
- Homeowners insurance
- Title insurance
- Utility costs or homeowners association fees
- The principal portion of mortgage payments
- The cost of home repairs
- Most settlement costs, such as appraisal fees or document prep fees
Tax Credits for Homeowners
Unlike a deduction, tax credits make a dollar-for-dollar impact on your annual tax liability. Because tax rules change frequently, homeowners should ask their tax advisor about newly available credits to determine if they qualify.
Mortgage interest credit
Mortgage credit certificates issued by state or local governments and agencies provide lower-income homebuyers with access to a federal tax credit to help them afford homeownership. Take note that this tax credit cannot exceed the tax owed. But if the credit exceeds the amount of tax owed in a given year, you can carry the excess amount forward to the next year.
Energy savings credits
The recent passing of the Inflation Reduction Act grants a tax credit for homeowners making an investment in energy savings upgrades. This includes new windows, doors, or added home insulation. The previous $500 lifetime limit has increased to a $2,000 limit per year and will take effect in 2023.
For 2022, tax credits are still available for energy-saving home upgrades, such as the installation of Energy Star-rated heaters and hot water heaters. If you’ve made any home upgrade in the past year, don’t forget to check about the possibility of a tax credit.
Other Tax Benefits of Homeownership
Additional tax benefits may be available for homeowners. If you run a business from your home or have invested in a clean energy system, you may qualify for tax deductions and credits.
Home Office Deduction
Individuals filing a Schedule C to report profit or loss from a business may deduct certain expenses if they work from home, using the home office deduction. Although you can file for a home office deduction as a homeowner or a renter, you may have more qualifying expenses to report as a homeowner, including mortgage interest, utilities, and repair costs.
Clean energy credit
In 2022, the tax federal credit for installing a clean energy system, such as solar panels, rose from 26% to 30% of the installation costs. This increased credit percentage extends until 2032.
State tax benefits and rebates
Some states offer additional tax credits, such as the new New York property tax credit for homeowners who pay property taxes in excess of 6% of their qualified gross income. New York also offers the STAR program, which offers rebates on school property taxes to qualifying homeowners.
First-time homebuyers may also take advantage of additional government programs and tax benefits.
Additionally, two new rebate programs passed as a part of the Inflation Reduction Act. These programs allow states to issue rebates to homeowners who make energy-saving upgrades or convert their homes to electric power. Look for more information on these programs in the coming year.
Buying a home is an investment, but it comes with a hefty price tag. Tax deductions and credits can help to ease some of the costs associated with homeownership and allow owners to spend more of their money on home improvements, repairs, and exciting features.
Jennifer DiGiovanni is a freelance writer, an author, and a small business owner. She previously worked in the financial services industry and received an MBA from Villanova University. Jennifer enjoys writing about real estate, small business, personal finance, and home improvement.