Tax Tips for New Homeowners (Including Tax Credits)
June 25, 2015 : Nathan Rigney – The Tax InstituteLeer en español
Editor’s Note: Congratulations on buying a new home! While it’s easy to get caught up in picking paint colors and planning where the furniture will go, don’t forget that there are new homeowner tax credits you can take advantage of. Read on to learn more here…
From determining how much you can afford to finding the perfect place, buying your first home can be daunting. Luckily, there are new homeowner tax credits that come with getting your piece of the American dream.
Home Mortgage Interest and Points
The largest itemized deduction on a homeowner’s tax return is typically the amount of qualified mortgage interest they paid in a year. These amounts are typically reported on Form 1098, which is sent to the homeowner from the lender.
To be “qualified mortgage interest,” it must be interest paid on a mortgage secured by your main home (or a second home) that is not used in a rental or business activity. The deduction may be limited based on factors like the amount of the loan and its use. It will not be limited by your income.
For example, the mortgage interest deduction for a loan that was used to buy, build or improve the home is limited if the loan balance exceeds $1 million ($500,000 if married filing separately).
For home equity loans that were not used to improve the home, the mortgage interest deduction is limited if the loan balance exceeds $100,000 ($50,000 if married filing separately).
Amounts that are clearly designated as points are deductible in the year paid but only if the loan is secured by the main home and the loan proceeds were used to buy, build or improve the home. However, points must be spread over the life of the loan if they were paid in place of amounts that are ordinarily stated separately on the settlement statement, such as appraisal fees, title fees and attorney fees.
Real Property Taxes
Real property taxes can be deducted on Form 1040, Schedule A. To be deductible, real property taxes must be assessed as a percentage of the value of the property. Additionally, the taxes must go into the taxing authority’s general fund. If the taxes are paid in exchange for a special project that increases the property’s value, the taxes are not deductible. Nondeductible real property taxes are typically called “special assessments” by the taxing authority. An example of a special assessment would be an amount is used for an economic development project. Similarly, homeowner association dues are not deductible as real property taxes.
If you pay real property taxes as part of closing the sale, the deduction will be divided between you and the seller. You can only deduct property taxes that are allocated to the part of the year you own the property. If you pay the seller’s real property taxes, that payment is included in your cost basis of the property and is not deductible.
Recordkeeping and Basis
It is important to keep track of your basis in the property. The basis generally equals your investment in the property. The starting point for the tax basis is typically the purchase price, plus amounts paid as part of closing. This is true even if a portion of the purchase price was paid with borrowed funds. Your basis is then increased by amounts paid to improve the property, such as renovations. Later when you sell the home, your gain on the sale is determined by reducing the sale price by this basis.
If the IRS challenges the property’s basis, you must be able to substantiate the basis with receipts and invoices. Thus, it is advisable to keep a file for invoices related to that expensive kitchen or bathroom remodel.
When the property is sold at a gain, the gain is typically taxed at capital gain rates. However, if you lived in the home as your principal residence for at least two years out of the five-year period ending on the date of the sale, the gain may not be taxable at all.
You may be able to exclude up to $250,000 ($500,000 if married filing jointly) of gain from the sale of a principal residence if you satisfy the use and ownership tests.
Even if you don’t live in the home for two full years, you may still qualify for a reduced exclusion under certain circumstances. For example, if you sell the home to move to another city for a new job, you can exclude a portion of the gain. Any taxable portion will be subject to capital gain rates.
Private Mortgage Insurance
While private mortgage insurance premiums were deductible in tax year 2014 under certain circumstances, premiums paid in 2015 are not deductible under current tax law.
While home ownership certainly has costs, you can see that it also has a number of great tax perks. If you still have questions on new homeowner tax credits, don’t hesitate to reach out to our tax pros at H&R Block for help filing your first return as a homeowner.