Buying a home is an exciting milestone that also comes with tax implications. As a new homeowner, you’ll be able to deduct mortgage interest and property taxes from your federal income taxes. You may also face some new costs like mortgage interest, property taxes, and homeowners insurance that can change your tax situation.
How Does Buying a House Affect Your Taxes?
When you buy a house, you can deduct the mortgage interest and property taxes you pay from your federal income taxes. This lowers your taxable income and can result in substantial tax savings each year. Here’s a quick overview of how buying a home affects your taxes:
- You can deduct mortgage interest on up to $750,000 in mortgage debt on new homes purchased after December 15, 2017.
- Property taxes can also be deducted with no limit.
- These deductions lower your taxable income if you itemize deductions on Schedule A.
- You may pay more in mortgage interest, property taxes, and homeowners insurance which can affect your tax situation.
- You may be eligible for additional tax credits like the Mortgage Credit Certificate.
Mortgage Interest Deduction
One of the biggest tax benefits of homeownership is being able to deduct your mortgage interest. Here’s how it works:
- You can deduct the interest portion of your mortgage payment.
- This applies to up to $750,000 in mortgage debt incurred after December 15, 2017.
- Mortgages taken out before this date have a $1 million limit.
- The interest deduction applies to primary residences and second homes.
- Investment properties do not qualify for the interest deduction.
This deduction can lower your taxable income substantially. For example, if you pay $15,000 in mortgage interest in a year, that $15,000 can be deducted from your taxable income. This saves you money by reducing the income taxes you owe.
Other Mortgage Interest Deduction Rules
Here are some other key points on the mortgage interest deduction:
- You must itemize deductions using Schedule A to claim the interest deduction.
- The mortgage must be secured by the home – unsecured home equity loans don’t qualify.
- Interest on home equity debt used to improve your home can still qualify for the deduction.
- Refinanced mortgages qualify provided the debt doesn’t exceed the home’s value.
As you can see, the mortgage interest deduction can lower your taxes substantially as a homeowner. But you need to itemize deductions to claim it.
Property Tax Deduction
Property taxes levied by state and local governments can also be deducted from your federal taxes. Key facts on deducting property taxes include:
- There is no limit on the amount of property taxes you can deduct.
- The deduction applies to all property owners, not just homeowners.
- You must itemize to claim the property tax deduction.
- Property taxes can be deducted in the year they are paid.
For example, if you pay $5,000 in property taxes, you can deduct the full $5,000 from your taxable income when itemizing deductions. This further reduces your taxable income.
Mortgage Insurance Premiums
Mortgage insurance premiums can also be deducted from your taxes in some cases:
- This applies to mortgage insurance provided by the FHA, VA, and Rural Housing Services.
- Private mortgage insurance (PMI) premiums are not deductible.
- The deduction is phased out at higher incomes.
This smaller deduction can help save money if you have an FHA, VA, or Rural Housing Services loan.
Homeowners Insurance
Homeowners insurance premiums are not tax deductible. While this is an necessary cost of homeownership, it will not provide any tax savings.
Higher Interest Costs
While you can deduct mortgage interest, buying a home also comes with higher interest costs than renting. First-time home buyers often get sticker shock from the mortgage payment, taxes, insurance, and maintenance costs.
Make sure you budget for these new costs when considering buying a home. While the interest deduction helps, mortgage payments are often substantially more than rent payments.
Higher Ongoing Costs
Owning a home also comes with higher ongoing costs beyond just the mortgage payment. You’ll now be responsible for:
- Property taxes
- Homeowners insurance
- Maintenance and repairs
- Lawn care and landscaping
- Snow removal
- Homeowners association dues
While property taxes are deductible, all the other costs are not. Make sure you budget for these new expenses that you didn’t face as a renter.
Mortgage Credit Certificate
Some homebuyers may qualify for the Mortgage Credit Certificate (MCC) program. This provides a non-refundable tax credit each year. Key facts on the MCC program:
- Provides an annual federal tax credit up to $2,000.
- The credit is calculated as 20-25% of your mortgage interest.
- You must have a mortgage to qualify.
- Income and purchase price limits apply.
- You must apply through a participating state or local agency.
The MCC can help first-time homebuyers by providing a dollar for dollar tax credit up to $2,000. This is in addition to the mortgage interest deduction.
Capital Gains Tax Exclusion
When you eventually sell your home, you can exclude up to $250,000 in capital gains ($500,000 for married couples) when meeting certain criteria:
- You must have owned and lived in the home as your primary residence for 2 out of the past 5 years.
- You can only utilize the capital gains exclusion once every 2 years.
- Any capital gains above the $250K/$500K limits will be taxed.
- You may qualify for a partial exclusion if you don’t meet the 2 year rule.
This capital gains tax break allows homeowners to excluded large gains when selling their home. Make sure you meet the ownership and use tests to qualify.
Should You Buy a Home for the Tax Benefits?
While buying a home does come with valuable tax deductions, it shouldn’t be your only motivation. Here are other key considerations:
- Interest rates also impact affordability. Low rates help offset loss of deductions.
- You need to itemize deductions to benefit. The higher standard deduction reduces this incentive.
- Upfront and ongoing costs still need to be affordable.
- You should plan on staying put for several years.
- Owning isn’t for everyone – renting may make more sense.
Buying solely for tax benefits is risky. Make sure homeownership fits your lifestyle and budget overall.
Consult a Tax Professional
Determining the tax implications of buying a home can be complicated. I recommend consulting a qualified tax professional who can review your specific situation. They can help you claim all the deductions and credits you are eligible for.
Every person’s tax situation is different. A tax pro can assess your income, debts, assets, family status, and home purchase details. They can then provide tailored guidance on the tax implications.
The Bottom Line
Buying a home comes with several tax benefits, primarily the mortgage interest and property tax deductions. These can lower your taxable income when you itemize deductions on your federal return. However, homes come with significant costs as well. Look at the whole financial picture when deciding if homeownership is right for you, not just potential tax breaks.
