Homebuying is a major life event, often bringing great changes and rewards. As a homebuyer, you are making the transition from paying rent to generating equity in your own property investment and qualifies you for new tax deductions. Although the most recent update of the tax code did restrict deductions for some homeowners and make them irrelevant for others, many deduction opportunities are still available. Here are 5 tax deductions you may be able to take advantage of to help reduce your tax bill as a homeowner:
Homeowners are allowed to deduct certain closing costs, including home mortgage interest and specific real estate taxes. These costs can be deducted in the year that you purchased your home. As outlined in IRS Publication 530, homeowners can also add the following closing costs to the basis of your home.
- Abstract fees (abstract of title fees).
- Charges for installing utility services.
- Legal fees (including fees for the title search and preparation of the sales contract and deed).
- Recording fees.
- Transfer or stamp taxes.
- Owner's title insurance.
- Any amount the seller owes that you agree to pay, such as back taxes or interest, recording or mortgage fees, cost for improvements or repairs, and sales commissions.
The following closing costs cannot be deducted or added to the basis of your home:
- Fire insurance premiums.
- Charges for using utilities or other services related to occupancy of the home before closing.
- Rent for occupying the home before closing.
- Charges connected with getting or refinancing a mortgage loan, such as:
- Loan assumption fees,
- Cost of a credit report, and
- Fee for an appraisal required by a lender.
Mortgage interest is often one of the largest tax deductions for homeowners. Typically, as a homeowner, you can deduct the entire portion of your house payment that is for mortgage interest, as long your deductions are itemized using Schedule A (Form 1040). Currently, individual taxpayers or a married couples filing jointly are allowed to deduct the interest paid on up to $750,000 of mortgage debt. The limit for married couples filing separately, this $350,000. Mortgage interest deductions may be limited however, so taxpayers are encouraged to refer to “Is My Home Mortgage Interest Fully Deductible?” chart provided by the IRS for more information
Some homebuyers elect to pay mortgage points in exchange for a lower interest rate on their home purchase. If you were one of these homebuyers, the mortgage points your paid may be deductible in full in the year you paid them, providing you meet all the following IRS requirements:
- Your main home secures your loan (your main home is the one you live in most of the time).
- Paying points is an established business practice in the area where the loan was made.
- The points paid weren't more than the amount generally charged in that area.
- You use the cash method of accounting. This means you report income in the year you receive it and deduct expenses in the year you pay them.
- The points paid weren't for items that are usually listed separately on the settlement sheet such as appraisal fees, inspection fees, title fees, attorney fees, and property taxes.
- The funds you provided at or before closing, including any points the seller paid, were at least as much as the points charged. You can't have borrowed the funds from your lender or mortgage broker in order to pay the points.
- You use your loan to buy or build your main home.
- The points were computed as a percentage of the principal amount of the mortgage, and
- The amount shows clearly as points on your settlement statement.
For more information on points, refer to Publication 936, Home Mortgage Interest Deduction and Publication 530, Tax Information for New Homeowners.
Real Estate Taxes (Property Taxes Paid)
As a homeowner, you are allowed to deduct your local property taxes paid each year. New homebuyers are typically required to reimburse the seller at closing for real estate taxes prepaid for the time the new homeowner really owned the home. If you are a new homebuyer, the amount you reimbursed the seller will be shown on your settlement sheet and can be included in your real estate tax deduction. Established homeowners who are required by their lender to pay taxes via an escrow account, are typically sent a form from the lender with the amount of taxes paid. The total deduction allowed for all state and local taxes (for example, real property taxes, personal property taxes, and income taxes or sales taxes) is limited to $10,000; or $5,000 if married filing separately.
Energy Efficiency Credits
If you are a homeowner who has made energy-efficient improvements to your home, you may qualify for an energy efficient property credit. In 2021, an individual may claim a credit for (1) 10% of the cost of qualified energy efficiency improvements and (2) the amount of the residential energy property expenditures paid or incurred by the taxpayer during the taxable year (subject to the overall credit limit of $500). The IRS considers the following as qualified energy efficiency improvements:
- Energy-efficient exterior windows, doors, and skylights
- Roofs (metal and asphalt) and roof products
Residential energy property expenditures include the following qualifying products:
- Energy-efficient heating and air conditioning systems
- Water heaters (natural gas, propane, or oil)
- Biomass stoves (qualified biomass fuel property expenditures paid or incurred in taxable years beginning after December 31, 2020, are now part of the residential energy efficient property credit for alternative energy equipment.)
The residential energy property credit is nonrefundable. A nonrefundable tax credit allows taxpayers to lower their tax liability to zero, but not below zero.
Stay Prepared for Tax Season
Homeowners should be conscious of their taxes throughout the year. Staying organized, by keeping all documents and tax records together, including all mortgage-related payments and receipts from home improvements, can make tax season easier. If you have questions about estate tax laws, individual taxes, trust tax returns, or homeowner deductions, please contact us for a free consultation at (914) 228-7448.