I don’t know about you, but sometimes I wonder if anyone really understands our tax systems. And just when you think you do have it all straight, along comes another change for the next tax year. Then you’re confused all over again. Well, fear not. I am no financial expert but I have researched the latest changes. These are the deductions we can and can’t claim on our taxes for buying and owning a home.
Does Buying A House Help With Taxes? You will only benefit, tax-wise, from buying a home if you claim the itemized deduction AND your total itemized deductions are greater than your standard tax deduction.
To find out what this means in real terms for home buyers and homeowners I delved deep into the changes for the 2018 tax year and came to some interesting conclusions.
If I Bought A House Today Would I Pay Less Tax?
First of all, the only way you might pay less tax when you are buying a home, or are a current homeowner, is if you claim an itemized deduction. To do this you must file your taxes on the longer form 1080 and list all of your deductions on Schedule A. Once you have added up all of your deductions you subtract that amount from your gross income and it leaves you with your net income, on which you pay tax.
However, this is only worthwhile if the itemized deductions are greater than the standard deductions. If not, you could end up paying more tax.
Here’s an example:
Two people both earn $50,000 per year. They will both receive the standard single person deduction of $12,000 per year, making their taxable income $38,000 per year.
Person A adds up what she can claim on an itemized deduction and the total comes to $17,000. When she takes that away from her $50,000 a year she is left with $33,000 per year taxable income. In this case, she should use itemized deduction because she will pay tax on a smaller income.
Person B adds up what he can claim on an itemized deduction and the total comes to $9,000. When he takes that away from his $50,000 per year he is left with $41,000 per year taxable income. In this case, he should not claim an itemized deduction or he will pay tax on $41,000 of income.
So you see, whether or not you will benefit, taxwise, by buying a house depends on your income and how much you could potentially claim in deductions. To see if you could be better off, let’s take a look at the deductions available to new buyers and existing homeowners.
Home Mortgage Interest Deductions
Homeowners can deduct the interest they pay on their mortgage, for the year. Your mortgage provider will send you a document that tells you how much of your annual payment total was interest. From 2018 this deduction only applies to the first $750,000 of a loan.
Changes To The Tax Code On Mortgage Interest Deductions
Until 2018 you could claim the interest on a mortgage for a second or holiday home. If you have already made your purchase you can still do this. However second properties purchased in 2018 onwards will no longer qualify for a mortgage interest deduction.
Using This Tax Break To Reduce The Tax You Pay
There is no restriction, for a tax perspective, on how much you can pay off of your mortgage each year. If you are in a position to make an extra mortgage payment or two there are two benefits. You will both reduce the term of your loan and increase the tax deduction you can claim.
Deductions Reduced On Some Refinancing
Up to and including 2017 homeowners who borrowed money against their property either as a second mortgage, a home equity loan, or a home equity line of credit, could claim the interest on up to $100,000 of “equity debt” no matter what they used the money for.
From 2018 you must show that the money was used to improve the home in order to claim the tax deduction.
So to be super clear:
If you borrow money, using your property as collateral, and use the cash for things such as medical expenses, school fees, debt consolidation etc. you can no longer claim the loan interest as a tax deduction.
The change to the law eliminates the deduction for interest paid on home equity loans and lines of credit “unless they are used to buy, build or substantially improve the taxpayer’s home that secures the loan.”
State And Local Tax Deductions
If you itemize your deductions you can claim everything you have paid in state and local sales, income taxes as well as your property taxes. To do this you must have receipts to show the amounts you have paid. The total amount in state and local taxes you can claim is $10,000.
Some high tax states, such as New York and New Jersey are looking at ways to “recharacterize” some of the taxes paid by residents so they will not count towards the $10,000 limit and instead can be claimed elsewhere. For this reason, it is important to consult a tax professional to ensure you are getting the maximum deduction available to you in your state.
Capital Gains Tax
If you buy a property and sell it again at a profit, you might be liable to pay capital gains tax. The first $250,000 profit for single filers and $500,000 for joint filers is exempt from the tax and if you have lived in the home for at least two out of the last five years you may not have to pay the tax at all.
This is an important point to consider if you are thinking of buying a house to rent or flip.
Other Tax Breaks Available To Homeowners
There are plenty of other ways to use your home to reduce your tax bill. They include:
More Cash In Your Paycheck
If you haven’t claimed itemized tax deductions before, but buying a home means you will be from now on, you do not have to wait before you can reduce the tax you pay. Go to the IRS website, or ask your employer for a form W-4. By completing this form you may find that you pay less income tax at source and see an increase in your take-home pay.
There is a tax credit available for the cost of certain energy-efficient home improvements such as heat pumps, furnaces, water boilers, roofs, and outside doors and windows. There is a $500 cap on this credit.
The second tax credit, completely separate from the first, is available for up to 30% of the cost of certain other improvements such as solar-powered hot water heaters and generators.
Contact your local tax office for a full list of improvements and the specific items that qualify for these credits. Do this before starting any work. If you are very smart about it you could take out a home equity loan to pay for the improvements, claim the interest on the loan as a tax deduction and then claim the energy tax credits.
Home Office Deductions
You can claim a home office deduction if you:
- Have a space in your home used solely for business purposes. So working at the kitchen table doesn’t qualify.
- The home office space must be your primary place of business. This means that if you are a consultant who travels to see clients but your home office is your “base” you qualify. If you have another office you work out of and your home is just used on occasion, you do not.
With a home office deduction, you can claim a percentage of your annual household running costs. This deduction is equal to the percentage of your home that your home office occupies.
Imagine you have a 2,000 square foot house and your home office is 200 square feet. You can claim 10% of your general household costs as a deduction. In addition, you can also claim any costs for improvements made to your office such as new lighting.
Things You Can No longer Claim
There are some tax deductions that homeowners could previously utilize that are now no longer deductions.
Up until the 2017 tax year you could claim any economic loss that was a result of a natural disaster. Previously if you were to pay for a storm damaged roof you could claim that cost as a casualty loss. Now, the only casualty loss you can claim is one that happens during an event that is an official Federal Disaster.
Mortgage debt forgiveness
If you default on your mortgage and the lender writes off the debt, the amount written off is reported to the IRS. This amount is then classed, for tax purposes, as income. Until the end of 2017, you could have up to $2 million in debt forgiveness before it was “income”. This exclusion is no longer in place. So any debt forgiveness is now income.
Private Mortgage Insurance
Private mortgage insurance is often required by lenders as a condition of a mortgage when buyers have less than 20% of the purchase price as a deposit. To rid yourself of this unnecessary expense is one of only three reasons you should ever refinance your home. Previously the private mortgage insurance premiums were tax deductible. However, this has been discontinued.
As you can see, there are many variables to the tax system. This makes it impossible to give a clear answer to the question “Does buying a house help with taxes?” In some cases, it does and in other cases, it does not.
The best thing to do is buy your house without relying on it for a tax break. In addition, consult a tax professional to discuss your unique position.
About The Author
Geoff Southworth is the creator of RealEstateInfoGuide.com, the site that helps new homeowners, investors, and homeowners-to-be successfully navigate the complex world of property ownership. Geoff is a real estate investor of 8 years has had experience as a manager of a debt-free, private real estate equity fund, as well as a Registered Nurse in Emergency Trauma and Cardiac Cath Lab Care. As a result, he has developed a unique “people first, business second” approach to real estate.
This article has been reviewed by our editorial board and has been approved for publication in accordance with our editorial policy.