For many people, purchasing a home, or homes, is the single largest investment they will make in their lifetime. It is a decision that will affect their finances, lifestyle, and family for years to come. Because of this impact, it is important to consider all aspects of home buying, along with the pros and cons of the choices that are being made. Aside from the actual home buying process, a question most homeowners have is: “What are the tax advantages of buying a home?”
The answer is: DEDUCTIONS, DEDUCTIONS, DEDUCTIONS!
When considering a home purchase, one very big pro is the favorable tax treatment you are able to take advantage of on your individual tax return. Deducting mortgage interest and real estate taxes is often what makes it more beneficial for taxpayers to itemize their deductions (rather than using the standard deduction); along with state income taxes paid. This makes itemizing more advantageous. These deductions reduce taxable income, which in turn, reduces taxes due. Typically, personal interest, such as credit card or car loan interest paid is not deductible, but qualified residence interest (with a few restrictions) is fully deductible.
You can deduct the interest paid if you meet the following criteria:
–Your home is your principal residence (meaning that’s where you spend the majority of your time)
–The loan is $1 million or less, and secured by your home
–The loan proceeds were used to acquire the home, or were used to substantially improve your home
You can also deduct the interest on a second home mortgage (such as a vacation or mountain home), as long as the second home mortgage amount, when combined with the principal residence mortgage, does not exceed a combined total loan amount of $1,000,000. For example, if your principal residence mortgage equaled $700,000, and you purchased a second home with a mortgage of $600,000, you would be able to deduct the interest on your $700,000 principal residence mortgage and you would be able to deduct the interest on $300,000 of your second home mortgage ($1,000,000 – $700,000) for a total interest deduction on $1,000,000 of your mortgage balances.
The interest on home equity loan debt is also deductible. The home equity loan interest deduction is the interest on a loan amount that is the lesser of the loan balance, up to a $100,000 loan, or the fair market value of the home minus acquisition indebtedness. This interest is deductible for regular tax purposes, no matter the use for the money. If the loan is not used to acquire the property or make substantial improvements to the property, then careful consideration should be made before securing consumer debt with your home. If it is the right option for you, home equity loan debt can be used to purchase a new car, a vacation, a hot tub, consolidate credit card balances — whatever your heart desires. The interest will be deductible for regular tax purposes, however the amounts are not deductible when calculating alternative minimum tax (AMT) . The ability to deduct home equity loan debt interest allows individuals to effectively exceed the $1 million loan limit by an additional $100,000, thus making the interest on combined home-secured loans up to $1.1 million, deductible.
The table below illustrates how various income levels and age groups would likely be affected if the mortgage interest deduction were not allowed. For, example, average homeowners with income over $250,000+ would generally see an increase in their tax bill of $5,408, if the mortgage interest deduction were not allowed. Another way to look at it, is that homeowners with income over $250,000 on average will see a $5,408 reduction in their tax bill when taking the mortgage interest deduction. The ultimate benefit to a particular taxpayer is a case by case analysis that depends on the timing of the home acquisition, the interest rate of the loan, the principal of the loan, income level, other itemized deductions, etc.
Points paid that are associated with initial acquisition indebtedness or are associated with the substantial improvement of a principal residence may be fully deductible. Points paid that are associated with the acquisition indebtedness of a second home must be amortized over the life of the loan. Points paid on all refinances must be amortized over the life of the loan. All other settlement costs are required to be capitalized and added to the basis of the property.
Every home has real estate taxes and those are deductible as well. And unlike qualified residence interest that can be deducted on a principal residence or second home, the real estate taxes paid on all of your properties is deductible, even if you own more than two properties!
A final major tax advantage comes when it is time to sell your home. If you own and live in your home for two of five years and you haven’t sold another home within the two years prior to the sale date, the gain on the sale, up to $250,000 ($500,000 for married filing jointly), is excluded from income tax. The con side to this exclusion is that any loss on personal residence is not deductible.
There are significant tax advantages to owning a home, and several rules and restrictions in place on the tax treatment of various items. Consult your tax advisor on the proper treatment for your situation. Should you need a tax advisor, Thompson Greenspon is happy to assist with your tax preparation and planning needs.