As people count their blessings this holiday season, they are also determining what is tax-deductible and what is not. Today, just about everyone knows that there are tax benefits to owning a home, yet few first time homebuyers understand the significance of home ownership, and for that matter, many move-up buyers don’t really understand the tax benefits of home ownership either.
Taxes, of course, are unique to every tax payer. Many tax laws are constantly changing. Taxpayers should not rely on this article as advice or as authority in making any decision regarding real estate and tax-planning strategies. What I do offer, however, is some insight for meeting with a tax professional that will allow homeowners to be better equipped to ask the right questions and to plan the right strategy for them.
First, think about capital gains.
As a homeowner, it’s nice to know the most substantial tax benefit will occur upon the sale of the home, assuming it’s for a profit. When a married couple sells a home, they’ll be able to pocket tax-free up to $500,000 in profit from the sale and $250,000 for a single homeowner.
The theory behind this exclusion is that when most people sell a home, they will reinvest the profits into another home. This reinvestment is a smart move for the economy.
Next, consider the mortgage interest paid.
When a homebuyer takes out a mortgage, or a home loan, they’ll be spending a considerable amount each month on the interest of the loan. The way an amortized loan works is that they are front loaded, meaning the homeowner will be spending more in interest and less on principal during the early years of the loan. Most home loan monthly payments are initially more than two-thirds interest for the first several years – even with a great interest rate, the interest on hundreds of thousands of dollars for a home add up very quickly.
Both federal and California tax laws allow homeowners to deduct all of the interest paid on a home loan. There are some details to check out, that may change from year to year, such as the total amount of interest that may be deducted. Currently, it is $1,000,000 for married homeowners. For most people, they’ll be able to deduct all of the interest paid on their home, every year from federal and state taxes.
For example, if a homebuyer borrow $300,000 for a home with a 4 percent interest rate, they can expect to pay somewhere around $11,000 in the first year toward interest. If they’re in the 25 percent tax bracket, they can deduct about $2,750 off their taxes. Wow, $2,750 – that might represent a month or two in rent that’s been paid.
Also, check for discount points.
Discount points are a fee a homebuyer may have paid to get the loan they wanted. A point represents 1 percent of the loan amount. Many times, a buyer who is planning on staying in the home for a longer time may ‘pay points’ to ‘Buy-Down’ the interest rate on a loan. In other words, using the $300,000 loan example from above, they may have initially qualified for a 5 percent loan but by paying a point in advance or $3,000, they were able to ‘Buy-Down’ or lower your interest to only 4 percent.
The good news is that discount points are tax deductible just like mortgage interest. One point could save an extra $500 or more off next year’s tax bill.
Property taxes are tax deductible.
Property taxes are the taxes that are paid to the county or state based on the assessed value of real estate. While there is much to cover in a discussion about property taxes, suffice it to say that regardless of where someone lives they can expect to pay property taxes. In California, homes are taxed based on the assessed value. The rates can vary from city to city and neighborhood to neighborhood, so understand this issue when purchasing a new home. Rates can be as low as 1 percent and in some cases as high as 3 percent.
Using the $300,000 home example, this amount could be a $3,000 annual property tax bill with $250 a month liability or up to a $9,000 annual property tax bill with a $750 a month liability. Property taxes are a tax deduction. Another $3,000 to $9,000 tax deduction is something everyone can appreciate.
Deduct mortgage insurance payments.
Unless a homeowner puts 20 percent or more down on a new home, they can expect to pay mortgage insurance on their home loan amount.
The good news is the money spent every year on mortgage insurance will be deductible; although there are income restrictions for this deduction, so again check with a tax professional before depending on this added deduction that will average around another $1,000 annually.
Also, home improvements can be tax deductible.
Home improvements add value to a home and also can be added to the purchase price of a home for determining capital gains.
Home improvements and repairs are two different things. Replacing a roof, adding a swimming pool or resurfacing the driveway can all be considered improvements. Fixing a broken window, stopping a leaky faucet or any regular maintenance is not considered a home improvement and is not added to the purchase value of the home.
Home office deductions count too.
Depending on someone’s line of work, it may be possible to deduct for a home office on their taxes. There are some pretty stringent requirements for this deduction, and it carries a high audit rate among those who do claim it. If the home is a principal place of business and the worker meets all of the IRS guidelines, they just may get another great tax deduction – all because they own their own home.
Call (951) 296-8887 and get the information needed to make an informed, educated decision.
For questions regarding available inventory and/or other real estate matters, contact [email protected] Mike Mason, Realtor and Broker/Owner of MASON Real Estate. LIC: 01483044, Temecula Valley resident for 30+ years, Board of Director (since 2011) Southwest Riverside County Association of Realtors.