10 Tax Benefits for Homebuyers
Last Updated: January 17, 2023

10 Tax Benefits for Homebuyers

There are few things in life that are as dreadful as paying extra taxes. What’s worse is that the US tax code is so complex that residents often get themselves into taxable situations without realizing the full extent of their liability.

But as much as taxes induce fear and panic, the potential for tax breaks can feel like a relief. What many don’t realize is that there are a number of tax benefits that come with buying a home. Here are 10 tax benefits that homebuyers can take advantage of.

Understand the Difference Between Tax Credits and Deductions

When it comes to saving money on your taxes, there are two common ways that this happens. The first is through tax deductions. These are dollar amounts that are deducted from taxable wages, lowering the amount of tax that you will likely owe. Since income taxes are levied on a graduated scale, this can be really helpful when your earnings reach the next higher tax bracket.

The second way that homebuyers can save money on their taxes is through credits. Tax credits reduce the amount owed on the tax bill. For example, if an individual owes 12,440 for the year and they receive a credit for $440, they only pay the balance of $12k.

Tax credits and tax deductions both save you money on your tax bill. Typically speaking, credits are more valuable because they reduce what you owe on a dollar-for-dollar basis. This means that if you get a credit for $300, what you owe is $300 less. 

By contrast, a deduction reduces taxable income, which may or may not change the tax bracket or amount of tax collected on earnings, but you will see savings by reducing the dollar amount used to calculate tax liability.

1. Get a Tax Deduction for Prepaid Mortgage Interest

Some sellers choose to prepay a portion of the interest on their mortgage in order to lower their monthly payments. This typical practice is referred to as paying points.

The benefits of paying points at closing go beyond lower payments. Since the funds are applied towards interest, which is a deductible expense, buyers can benefit from a tax break as well.

This means that paying more points (as long as the value is in line with your local market) can yield a bigger deduction against taxable income.

Here’s what you need to know:

● Points must be paid in cash at closing.

● This amount is reported by your lender on IRS Form 1098

● Points must be paid for your principal residence.

There are limits to how much you can deduct. Since home values and interest rates vary widely, the IRS caps mortgage point deductions at a maximum of $75k–or 1% of the first $750,000.

2. Take Money Out of Retirement Accounts (For Free)

Retirement accounts come in different forms, but they all have some sort of restriction designed to safeguard the money for future retirement. There are, however, some exceptions to the rules and buying your first home is one of them.

For IRA accounts, withdrawals before the typical retirement age of 59½ are levied a penalty of 10%. That is on top of any taxes owed on the income resulting from the withdrawal. For first-time homebuyers (including withdrawals that go towards helping family members purchase a home), the penalty is waived.

Another bit of good news is that the term ‘first-time homebuyer’ is flexible. In most cases, it refers to anyone who hasn’t owned a home in the previous two years, even if they have bought a home in the past. Keep in mind that there is a lifetime limit of $10k for penalty-free IRA withdrawals.

Roth IRAs are a special type of investment account where taxes are paid pre-deposit, so withdrawals are not penalized in the same way.

3. Mortgage Interest Deductions

Mortgage interest is the amount of money that you pay to the lender for borrowing money to buy your home. In most cases, deducting mortgage interest on a primary residence is the single most significant tax advantage to owning a home.

And it’s something that homebuyers eagerly look forward to.

In most cases, the amortization schedule levies much higher interest payments at the beginning of a loan compared to the end of a loan.

While the higher interest payments mean that it takes longer to work down the principal on the loan, it also means there is more to work with in terms of a tax deduction.

4. Other Types of Interest Deductions & Home Equity Loans

What’s even better is that all types of mortgage interest on your primary residence are deductible, including interest paid on a home equity line of credit (HELOC). The only catch is that the funds need to be used towards improving or maintaining that home.

In this case, planning a major renovation can lead to sizable tax benefits like extra interest deductions that reduce your taxable income.

However, keep in mind that every financial situation and tax outcome is unique.

5. Get a Break for Monies Paid Towards Private Mortgage Insurance

Some homebuyers get stuck with the extra expense of private mortgage insurance. It’s a tradeoff that enables buyers with lower down payments to get a mortgage.

The private mortgage insurance gives the lender a little extra protection until the homeowner pays down the loan below 20%–the amount that is typically required for a down payment. 

Not everyone qualifies to deduct PMI from their taxable income, but it’s worth checking out. Keep in mind that deductions for PMI are variable based on tax year and income.

This deduction was first introduced in 2006 as part of the Tax Relief and Health Care Act and has changed a lot since then. 

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6. Get Credit for Making Sustainable Living Choices for Your Home

Many of the tax benefits that homebuyers look forward to are directly related to the costs associated with buying. But there are many ways to put money into your home and reap the rewards.

For example, the US government offers many perks for upgrading your home with renewable energy sources like solar panels or energy reduction improvements like new windows.
As a home buyer, look for opportunities to save with:

● Solar Panels
● Energy Efficient Windows & Doors
● Wind Turbine Energy
● Medically-Necessary Home Improvements (Ramps, Accessible Bathroom Remodels, Widening Entryways, Etc.)
● Home Office Renovations

7. Home Office Deductions

A new trend of remote work capabilities is making home offices an increasingly important aspect of the family home. When you want the flexibility to manage family life while keeping a career, a home office can give you separation from the rest of the household when you need it most.

This space also provides an opportunity to take another deduction on your taxes. Depending on individual tax situations, this might be a standard home office deduction calculated based on the square footage of your home and your dedicated office space.

Or, it might be an itemized calculation. Either way, the end result is less taxable income.

8. Skip Situations that Might Result in Double Taxation

The amount of money that homebuyers can expect to pay in property taxes vary by state, city, and property. However, the median tax bill in 2020 is $3,719 per year. That’s enough to warrant a closer look when it comes time to file your annual taxes.

Property tax is a personal item deduction, which means that you will need to itemize your tax return in order to take advantage of this deduction.

The standard deduction, currently set at $12k for individual filers and $24k for joint filers, simplifies the tax filing process for millions of Americans.

However, if your deductible expenses exceed the standard deduction for your tax situation, then an itemized deduction can benefit your personal tax situation–and it comes with the opportunity to deduct property taxes.

9. Necessary Home Improvements

If you buy a home that needs a little work, you might be in luck with an opportunity to take an extra deduction when it comes time to file your taxes.

While not every home improvement project fits the definition of a necessary improvement, there are four common types of projects that the IRS recognizes, including:

● Medical Accommodations
● Energy-Efficient Updates
● Capital Improvements
● Home Office Renovations

If anyone in your home requires special features to accommodate wheelchairs or safety enhancements for living spaces, you can generally deduct these expenses as necessary home improvements.

This might be a wheelchair ramp added to the home or a chair lift to make a second floor accessible. It also includes bathroom remodels for ADA-compliant bathing facilities and assistive features for blindness or deafness.

Capital improvements can also be deductible, but not in the year that the home is purchased. These types of renovations can be a good way to reduce taxable income when the homebuyer is ready to sell.

10. Special Tax Credits for First-Time Homebuyers

Other special tax incentives vary by tax year. In times of slow economic growth, like the years following the economic crisis and the housing market crash of 2008, the US government offers unique incentives to stimulate the economy through home ownership.

As of January 2023, the Biden Administration is working on a bill that, if passed, will offer a $15k tax credit to first-time homebuyers. It’s a generous incentive that potential homebuyers should be aware of.

Tax Benefits are Just the Beginning

Buying a home is a big decision. For many, it’s a symbol of success and something that many people take pride in. While there are many notable tax benefits, saving money on your tax bill is just the beginning.

Homeowners benefit from appreciation over time. Real estate housing cycles tend to appreciate in most areas, meaning that a home is generally worth more when you sell it than when you buy it. And when it is time to sell, homeowners benefit from capital gains exclusions on their primary residence.

This means if you have lived in the home as your primary residence for two out of the last five years, you can exclude some of the capital gains from the sale of your home. When it comes to taxable income, this is a significant benefit.

Capital gains is a tax collected on the profits of a sale. Since homes sell for hundreds of thousands, this exclusion is really valuable in years when homebuyers sell a home.

The Takeaway on Tax Benefits for Homebuyers

There are a variety of ways that homebuyers will benefit after the sale, particularly when it comes time to file taxes for the year they purchased the home and again for subsequent years as they own and sell that home.

Most commonly, these deductions include mortgage interest, private mortgage insurance, and property taxes.

However, there are a few lesser-known credits and deductions like those for making energy-efficient improvements or completing an ADA-compliant home remodel. Homeownership can be an investment that pays off in more ways than one. The tax benefits are just the beginning.

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