Money and Mortgage What are the Tax Advantages for Your Home?
Understanding How a Home Purchase or Sale Affects Your Taxes
With a newly purchased or sold home, homeowners receive deductions they can apply to their taxes. However, many homeowners don’t know where to start or how to apply them on tax forms. Read this quick guide to learn which deductions you can expect from your new home purchase or sale.
Types of Deductions
A deduction is an expense that you can subtract from your gross income to reduce the amount that actually gets taxed. There are several types of deductions you can apply to your taxes if you recently purchased a home in 2021, such as:
Mortgage Interest Deductions: Form 1098 details the amount of mortgage interest paid in the previous year. Lenders will often include interest for the partial first month of your mortgage as part of your closing costs, but if they didn’t include this number on your 1098, add this to your total mortgage interest when doing your taxes.
Mortgage Point Deductions: If you choose to pay mortgage points to your lender as part of a new loan, each point will cost 1% of the total loan and can lower your interest rate by 0.25%. For example, if you paid $400,000 for your home, each point would equal $4,000. If you purchased mortgage points, you will receive a deduction.
Private Mortgage Insurance (PMI): PMI protects the lender if the seller stops making mortgage payments. Lenders charge PMI to borrowers who put down less than 20% on a conventional loan. You may be able to deduct your PMI payments if this situation applies to you, depending on your income and when you purchased the home.
State and Local Deduction: This deduction includes specific taxes paid to state and local governments. You can deduct up to $10,000, or $5,000 if married and filing separately, of property taxes in combination with state and local income taxes or sales taxes. It is important to note that you must itemize your deductions to claim the mortgage interest deduction, mortgage points deduction, and state and local tax deduction.
Home Office Deduction: The ongoing pandemic has forced many businesses to conduct work remotely, leading to workers renovating their living spaces to become a home office. If you use your personal space as a home office, you can apply this as a deduction on your tax form.
Does a Home Sale Apply?
If you owned and lived in your previous home for at least two of the five years before the sale, you won’t pay taxes on the first $250,000 of profit, $500,000 if you’re married filing jointly. However, it is required that at least one spouse meet the ownership requirement, and both spouses meet the residency requirement. Exclusions to this include if you had to sell your home early due to a divorce, a job change, or something else among similar severity.
What About Capital Gains Tax?
A capital gain occurs when you sell an asset for more than what you originally paid for it. The Internal Revenue Service (IRS) taxes individuals on capital gains in certain circumstances, especially when selling a home. Capital gains tax is dependent on how long you owned the home. Short-term capital gains tax rates apply if you owned the home for less than a year, while long-term capital gains tax rates apply if you owned the home for more than a year. Just as you can experience a capital gain, you can also experience a capital loss. This occurs when the home is sold for less than what was originally paid for it.
What Isn’t Taxable?
There are several costs that homeowners experience that do not apply as deductions. These include:
- Home insurance premiums
- Homeowner association fees
- Transfer taxes
- Utility costs
- Credit and appraisal fees
- Forfeited deposits
With so much to keep track of with your taxes, it is difficult to know how to proceed. Here are some tax resources to help you navigate easier:
- For help finding a free tax professional for qualifying taxpayers, click here.
- For help resolving tax disputes with the IRS, click here.
- For help choosing the right tax professional, click here.
- To learn which system you should use to file your taxes on your own, click here.
- To pay for your taxes directly, click here.