Home ownership can provide tax benefits to:

1. Individuals who own a home which is their principal residence,
2. Individuals who own a vacation home, in addition to their principal residence, and
3. Individuals who own a home which they rent out.

This article will focus solely on the tax benefits available to the first category of taxpayers.

Real Estate Taxes

Taxpayers may deduct from income the real estate taxes paid to state and local taxing authorities. An expense which is payment for services cannot be deducted as a real estate tax even if the expense is paid to a state or local taxing authority. For example, charges for residential services such as trash or water are not deductible real estate taxes.

The real estate tax deduction is limited to $40,000 ($20,000 if the taxpayer files as married filing separately). This deduction is an itemized deduction. Taxpayers can claim either itemized deductions or the standard deduction available for their filing status, whichever is higher.

Mortgage Interest

Taxpayers may deduct home mortgage interest to the extent that the loan proceeds from the home mortgage were used to buy, build, or substantially improve the home securing the loan. Generally, taxpayers can deduct in each year only the interest that qualifies as home mortgage interest for that year. If interest is pre-paid the deduction must be taken in the year to which the interest actually applies. Taxpayers may also deduct as home mortgage interest late payment charges and prepayment penalties if these charges do not relate to a service provided by the lender. The mortgage interest deduction, like the real estate tax deduction, is an itemized deduction.

The amount of deductible home mortgage interest is limited to $750,000 ($375,000 if married filing separately) if the mortgage was taken out after December 15, 2017. The mortgage interest deduction is limited to $1,000,000 ($500,000 if married filing separately) if the mortgage was taken out prior to December 15, 2017. However, there are special rules if a home is subject to more than one mortgage where some were taken out before and others after December 15, 2017 and for mortgages taken out after December 15, 2017, but before April 1, 2018. These special rules are beyond the scope of this article.

Points

Generally, points are treated as prepaid interest and are deductible throughout the term of the loan and not in the year in which paid. However, the points can be fully deducted in the year in which paid if the taxpayer meets all the following conditions. When deductible, points are an itemized deduction.

• The mortgage loan secures your principal residence.
• Paying points is an established business practice in the area in which the loan was made.
• The points paid were not more than the points generally charged in the area.
• The taxpayer uses the cash method of accounting.
• The points are not disguised fees for items which normally appear on a closing statement such as appraisal fees, attorney’s fees, title fees, property taxes or inspection fees.
• The down payment or other funds the taxpayer provided at or before closing plus any points paid by the seller were at least as much as the points charged. The funds provided at or before closing were not borrowed and it was not a requirement that these funds be used to pay the points.
• The loan proceeds are used to buy or build the home.
• The points were figured as a percentage of the principal amount of the mortgage.
• The amount is clearly shown on the closing statement as points charged for the mortgage.

There are similar rules for loans obtained for the purpose of refinancing a mortgage loan and for home improvement loans. There are also rules if the points were paid by the seller. These matters are beyond the scope of this article.

Mortgage Interest Credit

The mortgage interest credit helps lower income taxpayers afford home ownership. Only taxpayers who were issued a qualified Mortgage Credit Certificate from their state or local government qualify for the credit. These certificates are issued only in connection with a new mortgage for the purchase of a principal residence. The residence must be located in the jurisdiction of the government agency that issued the Mortgage Credit Certificate. The mortgage cannot be issued by a person related to the taxpayer claiming the credit.

Specifics regarding the requirements and limitations regarding the credit are beyond the scope of this article. For more information, see: https://www.irs.gov/forms-pubs/about-form-8396

Tax Free Sale of Home

Taxpayers may qualify to exclude $250,000 of the gain ($500,000 if married filing jointly) from the sale of their principal residence.  For information regarding this benefit see: https://magdaabdogomezlaw.com/tax-considerations-selling-home/

 Closing Costs

Home purchasers generally incur closing costs at the time of purchase. These costs generally include: abstract fees, installation of utility services, legal fees, recording fees, surveys, documentary stamp taxes, and owner’s title insurance. A purchaser may also agree to pay the seller’s expenses. These expenses generally include: delinquent real estate taxes, interest, mortgage recording fees, mortgage fees, repair costs, and sales commissions.

The only portion of the closing costs that can be deducted as itemized deductions in the year of purchase are mortgage interest and certain real estate taxes. While the remaining costs cannot be deducted, they do provide a tax benefit, even though the benefit is not immediate. When the home is sold, gain is determined by subtracting the purchase price of the home (referred to as basis) from the adjusted selling price. All the closing costs detailed above can be added to the property’s basis in determining gain thereby producing a reduction in the gain on the sale of the property. For this reason, retaining the closing statement is important.

Other Homeownership Expenses

Home ownership involves many other expenses such as utilities, homeowner’s and flood insurance, association fees, and home repairs. These expenses are not deductible at any time. However, if the home repair is a capital improvement (for example, building an extension or a pool, replacing the home’s roof or windows, rewiring, etc.) the cost of the capital improvement is added to basis. This increase in basis would result in a decrease in the gain upon the sale of the property. It is important that proof of capital expenses incurred throughout the time the home is owned be retained until the home is sold.