Owning a home isn't just about finding the perfect space; it also comes with financial perks, particularly during tax season. Before you prepare for tax season, you must grasp what non-deductible expenses and which tax breaks you can leverage as a homeowner. 

In this comprehensive guide, we explore the details of tax deductions for homeowners, covering everything from mortgage interest and property taxes to necessary home improvements and capital gains. Whether you're a seasoned homeowner or a first-time buyer, this guide aims to explain the complexities of tax benefits associated with homeownership.

 

Standard vs. Itemized Deductions Explained

 

To better grasp the deductions tailored for homeowners, it's crucial to differentiate between standard and itemized deductions. Both play a role in diminishing your overall income tax burden by reducing your taxable income.

The Internal Revenue Service (IRS) extends the standard deduction to all tax filers. In 2021, the standard deduction will be as follows:

• $12,550 for single individuals and those married but filing separately
• $25,100 for married couples filing jointly
• $18,800 for heads of households

 

Opting for the standard deduction allows you to decrease your taxable income by a fixed amount. On the other hand, when itemizing deductions, which may include tax benefits for homeowners, you forego the standard deduction. Instead, the cumulative sum of itemized deductions is subtracted from your taxable income, reducing your tax burden.

 

Before venturing into homeowner tax deductions, it's essential to weigh whether your itemized deductions surpass the standard deduction. If they don't, opting for the standard deduction is the more financially prudent choice to minimize your tax liabilities.

 

Non-Deductible Home-Related Costs

 

Explore the list of home expenses that homeowners are unable to deduct:

• The costs of obtaining or refinancing a mortgage include loan assumption, credit report, and appraisal fees
• Depreciation
• Forfeited deposits, down payments, or earnest money
• Home insurance premiums
• Homeowner association fees
• Mortgage insurance (Note: While mortgage insurance was deductible in previous tax years, the itemized deduction has since expired)
• Rent for living in the home before closing
• Transfer taxes or stamp taxes
• Utilities
• Wages for domestic help

 

8 Tax Breaks For Homeowners

 

The IRS provides comprehensive guidelines on the various tax breaks accessible to homeowners. Let's delve into the specific tax breaks that homeowners should carefully consider.

• Mortgage Interest

Utilizing the mortgage interest deduction is beneficial for homeowners with an existing mortgage. This itemized deduction allows you to decrease your taxable income.

Historically, homeowners could deduct mortgage interest up to $1 million. However, due to the Tax Cuts and Jobs Act, the deduction limit has been revised to $750,000 for single filers or married couples filing jointly. Each party has a deduction limit of $375,000 for those married but filing separately.

• Home Equity Loan Interest

A home equity loan functions as a secondary mortgage on your property, enabling you to tap into the accumulated equity in your home as collateral for borrowing funds needed for various purposes.

Similar to the deduction allowed for regular mortgage interest, you can also deduct the interest paid on home equity loans and lines of credit. However, it's important to note that this deduction is applicable only if the borrowed funds are used for home improvements. Before the Tax Cuts and Jobs Act in 2017, interest on these loans could be deducted regardless of how the funds were utilized.

• Mortgage Discount Points

In the mortgage process, you might be given the choice to buy discount points, aiming to decrease your loan's interest rate. Each discount point typically corresponds to 1% of your mortgage amount.

Suppose you opt for purchasing points to lower your mortgage interest rate. In that case, the expenditure on these discount points is eligible for tax deduction. However, it's important to note that 'loan origination points,' which are fees that do not influence the interest rate, do not qualify for tax deductions.

• Property Taxes

Homeowners contend with property taxes on both state and local levels. Suppose you file jointly as a married couple. In that case, you can deduct up to $10,000 in property taxes—while singles or those married and separately filing can claim up to $5,000.

The significance of the property tax deduction varies based on your location, potentially offering considerable financial benefits.

• Necessary Home Improvements

Tax deductions may apply to necessary home improvements, albeit within specific parameters. Upgrading a fully functional kitchen may not qualify for such deductions.

However, permanent improvements made for medical accessibility reasons are typically eligible. Examples include installing medical equipment and railings or widening doorways to create a more accessible home.

• Home Office Expenses

When conducting business activities within your home, you may be eligible to deduct certain expenses for maintaining that dedicated workspace. To qualify for this deduction, the IRS mandates that your home office be regularly and exclusively used for business purposes. Merely using the office space when convenient or for remote work provided by your employer doesn't meet the qualification criteria.

The amount you can deduct is determined by the percentage of your home allocated exclusively to your business activities.

• Mortgage Insurance

Many homeowners must consider private mortgage insurance (PMI) as part of their budget. PMI protects your lender in case you cannot sustain your mortgage payments.

Your payments for mortgage insurance can be deducted when itemizing on your tax return.

• Capital Gains

Capital gains tax benefits become applicable when you sell your home at a profit. This profit, known as the capital gain, is calculated as the difference between the home's value at the time of purchase and its selling price. For instance, if you bought your home for $100,000 and later sell it for $150,000, your capital gain would be $50,000.

Meeting the requirement of using the home as your primary residence for at least 2 of the last 5 years allows you to retain some profits without incurring any tax obligations. The maximum allowable capital gains for married couples jointly filing are $500,000. On the other hand, for single filers or married couples filing separately, each party can retain up to $250,000 in capital gains without facing tax obligations.

The critical factor here is the two-year residency within the last five years. Given the substantial tax break offered, it is imperative to approach this deduction with due diligence.

 

The Bottom Line

 

Being a homeowner brings various financial advantages. As tax season approaches, homeowners must carefully assess how to maximize these benefits. Considering the potential for substantial tax deductions, it's advisable to calculate your tax breaks diligently. Compare the total of your itemized deductions with the standard deduction to determine the most favorable option for your tax return.

If you own a home, dedicating time to explore your potential tax deductions is worthwhile. For those who find navigating these details challenging, seeking guidance from a tax professional is recommended to ensure you make the most of all available tax deductions.