Tax Implications for Homebuyers
As the government continues to allow tax breaks for both existing and new homeowners, it's becoming increasingly beneficial to take the step into home ownership.
While purchasing a home can lower your overall tax bill, it’s a good idea to consider all the information before moving forward. And, since the tax code undergoes almost annual changes, it can sometimes be difficult for a new homebuyer to keep track of what is and isn’t allowed as a deduction or credit.
Don’t let this be a deterrent; even with the regular changes, homeownership still offers many home tax deductions, tax credits and other financial breaks that aren't available to renters.
It’s not just the home-related tax breaks you get access to, either. According to Lisa Greene-Lewis, a CPA and tax expert for TurboTax, “enough qualified expenses can raise you over the standard deduction, allowing you to itemize and deduct many other expenses you wouldn’t be able to otherwise.”
Tax Deductions vs. Tax Credits
Before moving onto the specific benefits of buying a home, we should take a minute to define the differences between a Tax Deduction and a Tax Credit. Very often, you hear these words used interchangeably, which can be very confusing when sorting through the this, that, and the other of home ownership and its advantages.
The best way to show the difference is an example of each, using $1000 as the sum being credited and deducted. If you’re receiving a $1000 Tax Credit, your tax bill will be reduced by the entire $1000. If you have a Tax Deduction of $1000, your tax bill will be reduced based on your current tax bracket (which is based on your annual income). If you’re in, say, the 25% Tax Bracket, your $1000 deduction will only reduce your taxes by 25%, or $250.
So, the credit would lower your tax bill $750 more than the deduction.
Possible Tax Credits Available When Purchasing a Home
Of course, the biggest credit in the news the last several years has been the First-Time Homebuyers Tax Credit. This credit has added up to $8000 extra in first timer’s bank accounts since 2008. Although some changes have been made along the way, it's still one of the top motivations pushing people to purchase a home.
Energy Credits are also a very popular trend. With the Green movement building more momentum, many homeowners are taking the plunge to improve their homes with Energy Saving products.
The most common credit allows 30% of your expenses for certified work to be credited back to your tax bill; this typically applies to existing homes and new construction, both for primary residences and second homes. Before you consider a renovation or upgrade, check with your local dealers to see what products may qualify for a credit. Then make sure you save your receipts.
Items and Expenses That Are NOT Tax-Deductible
According to IRS Publication 530, the following items are NOT deductible:
- Insurance (except mortgage insurance premiums)
- Fire Insurance
- Comprehensive Coverage Insurance
- Title insurance
- Domestic Help Wages
- Depreciation Amounts
- Utility Costs (gas, electricity, water, etc.)
- Forfeited Deposits, Down Payments, or Earnest Money
- Most Settlement Costs
- HOA Fees
Although there are Real Estate Taxes that are deductible, the following can’t be included in those amounts even if the charge is paid to a taxing authority. These are taken directly from IRS Publication 530.
- A unit fee for the delivery of a service (such as a $5 fee charged for every 1,000 gallons of water you use).
- A periodic charge for a residential service (such as a $20 per month or $240 annual fee charged for trash collection).
- A flat fee charged for a single service provided by your local government (such as a $30 charge for mowing your lawn because it had grown higher than permitted under a local ordinance).
NOTE: You’re responsible for checking your real estate tax bill to decide if any nondeductible itemized charges like the ones above are included in the bill.
If your taxing authority or lender does not provide you a copy, it's your responsibility to request one. Contact the taxing authority if you need additional information about a specific charge on your real estate tax bill.
Standard Deductions a Homeowner Can Take
The most common deductions available can make a nice dent in your final tax bill. While some are only available the year you make the purchase, others are deductible every year you own your home.
Tax-free IRA Withdrawals
Saving money for a down payment and closing costs can be daunting; fortunately, the IRS allows taxpayers to pull funds (up to $10,000) from their IRA accounts to help while avoiding the 10% penalty normally applied if you’re under the age of 60 years.
Points are the extra fees you pay to obtain and also lower your mortgage’s interest rate. These are usually deductible the same year of your purchase.
The interest paid on a mortgage is usually the largest deduction on most payer’s taxes, and unlike mortgage points, it can be calculated annually and deducted each year for the life of the loan
Local and State Property Taxes
You can also deduct state and local taxes paid during the year. These deductions can include state and local income taxes OR state and local sales taxes, but not both. If your local tax rates are relatively low, you’ll want to calculate which options will give you the best deduction.
A note on what types of properties may or may not qualify for credits or deductions. If you’re considering less traditional means of living, like a mobile home, tiny house, RV or even a Boat, make a point to check with current tax regulations for any credits or deductions that may be available.
Are You Ready?
Buying a house is a great way to build equity and provide a solid foundation for your family.
It also protects you from dealing with rent hikes and bad landlords and allows you the freedom to knock down a wall, or even paint a room orange. And, while there is no concrete answer to whether you should continue renting or settle into a house, as long as you know what the pros and cons are, you will be able to make an informed decision.
Troy Martin is a shareholder in Cook Martin Poulson, a Utah accounting firm. He has been married to his wife Shauna, with whom he has six active children, for 27 years. Martin has a vast amount of experience in the following business sectors: medical, dental, manufacturing, retail, restaurants, construction, farming, and ranching.