The housing market has been improving the last few years as property values are rising and unemployment is dropping. So, more Americans are becoming homeowners again. One of the major benefits of owning a home and enjoying the American Dream is the tax benefits of homeownership. While owning a home does make your taxes more complicated, the good news is that it usually saves you substantially at tax time. You will need to itemize your taxes, but you will save a lot in most cases. To maximize your savings, let's take a look at some of the big deductions you will enjoy:
1. Mortgage Interest
Without a doubt, the biggest tax break you enjoy as a homeowner is the mortgage interest deduction. When you first buy your home, the majority of your payment is interest, unless your home loan is for more than $1 million. The IRS will limit your deductible interest in that case.
But for most people, you will enjoy a substantial tax savings over most renters.
What's more, if you own more than one home, you also enjoy deducting the mortgage interest on that property. However, you will need to stay there at least 14 days per year, or the IRS can limit your interest deduction.
2. Points or Origination Fees
If you paid points when you got your home loan to lower your rate, you will get a tax deduction on that. The IRS allows you to deduct those points in the year you paid them, if the loan was used to purchase your primary residence. Also, if you refinanced your loan and paid points, you can write the points off as well. However, for most of us, the points have to be deducted over the life of your loan. It's the same deal if you got a home equity loan or line of credit. If the loan was used for work on the home, you can deduct the points in the year you got the loan.
3. Property Taxes
Another big deduction related to your home is property taxes. A major part of your monthly payment is for property taxes. The taxes are escrowed and are paid yearly. You get an annual deduction for the taxes as long as you own your home. If it is the first tax year on your home, you need to figure out how much of the tax bill you were responsible for and how much was on the previous owner. It can be found on your settlement paperwork. You can write off whatever your share was. This can be a major write off, depending upon your state of residence. Some states, such as Texas, have no state income tax but high property taxes. You could easily have a property tax write off of several thousand dollars in some states. That can save you a bundle.
4. When You Sell Your Home
If you decide to buy another home, you also can avoid federal taxes on much of the profit you make. As of 1997, federal tax laws were changes so that as much as $250,000 of a gain when you sell your home is free of tax. However, you have to have owned the home for two years and have lived in it for two of the five years just before the sale. If you sell before you meet these requirements, you will owe taxes on the gain.
5. Home Improvements
If you have been paying your mortgage faithfully, and your house also has increased in value, you may have some equity you can pull out of your home. You can use this money to fund some home improvements to increase its value more.
Getting a home equity line of credit can be a smart way to do improvements on your home. The reason is, whatever interest you pay on that line of credit, it is tax deductible at tax time. If you use $10,000 of your equity to fund home improvements, you can write off the interest you pay on that loan. True, it's only a few hundred dollars, but if you had put that on a credit card, you would have paid a much higher rate and it would have been fully taxable.
There is no doubt that the federal government uses our tax laws to encourage home ownership. There are many substantial tax benefits to owning a home that someone who rents could never dream of. When you buy your first home, you should remember all of the above tax deductions. You easily could save more than $1000 or $2000 on your annual tax bill, if you are in the 25% tax bracket and your home is in the $200,000 range.
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