Explaining the tax benefits of being a homeowner may not be the first thing you consider when working with buyers or sellers. However, in addition to real estate continuing education, knowing how owning a home changes your financial life can significantly increase your value as a professional.
Here are nine ways buying, owning and selling a home cuts taxes and improves your overall finances.
1. Claiming the mortgage interest tax deduction
A tax deduction is an amount you’re allowed to subtract from your taxable income, reducing the amount of tax you owe. To incentivize homeownership, the government offers a mortgage interest tax deduction. It allows homeowners to deduct interest paid, up to certain limits, on funds borrowed to buy, build or remodel a home.
Let’s say you get a 30-year fixed-rate mortgage of $350,000 with a 6.5% interest rate to buy a condo. Your payment for principal and interest would be close to $2,200 a month or $26,400 a year. In the first year, your mortgage payments would break down into about $4,000 paid toward the principal debt balance and $22,400 for interest.
If you claim the mortgage interest deduction, that’s $22,400 you get to deduct from your taxable income and avoid paying tax on. Depending on your income and average tax rate, that deduction could cut your tax bill or increase your tax refund by thousands!
However, you must meet two conditions to be eligible for the mortgage interest deduction: You must file IRS Form 1040 and itemize deductions on Schedule A, Itemized Deductions, and you must have secured debt on a home you own.
Itemizing means you choose to list individual deductions instead of taking a standard deduction on your tax return. If they exceed the standard, you come out ahead. You can choose the method that gives you the lowest tax liability in any tax year. But you can’t itemize and claim the standard deduction.
For 2022, the standard deduction is:
- $12,950 for single taxpayers and married people filing taxes separately
- $19,400 for taxpayers filing as head of household
- $25,900 for married taxpayers filing a joint return
And note that for 2023, the standard amounts will increase to:
- $13,550 for single taxpayers and married people filing taxes separately
- $20,800 for taxpayers filing as head of household
- $27,700 for married taxpayers filing a joint return
If you’re single and the total of your annual eligible tax deductions – such as mortgage interest, charitable contributions and a certain amount of medical expenses – exceed the standard deduction of $12,950 for 2022, you’ll come out ahead by itemizing using Schedule A.
Going back to my example of having paid $22,400 in mortgage interest for the year, that expense alone would make it worthwhile for a single homeowner to itemize and claim the mortgage interest deduction.
In addition to interest, you may also deduct late payment charges, prepayment penalties, and prepaid interest, such as points or loan origination fees. Plus, you may deduct up to $5,000 or $10,000 if you’re married and file joint taxes for state and local real estate taxes.
Also, if you pay mortgage insurance premiums (because you put down less than 20% for a home purchase) and got your loan after 2006, you may deduct them or a reduced amount depending on your adjusted gross income.
2. Claiming the interest deduction on second mortgages
The mortgage interest deduction applies to first mortgages secured by your main home or a second home—but also includes second mortgages.
So, if you have home improvement loans, home equity loans, home equity lines of credit (HELOCs) or refinanced mortgages, you can deduct interest paid on up to $375,000 of the total debt or $750,000 for couples filing jointly.
3. Claiming tax credits
In addition to home-related tax deductions, you may qualify for tax credits. Instead of decreasing your taxable income, tax credits cut the dollar amount of tax you owe.
For instance, if you owe $1,000 in taxes and have a $750 tax credit, you’d only owe the government $250. That can make them even more valuable than deductions!
Some excellent tax credits incentivize the installation of alternative energy equipment, such as the residential energy efficient property credit. It offsets taxes for certain expenses like installing solar electric panels, solar water heaters, geothermal heat pumps, small wind turbines and fuel cell property expenses in your primary residence and a second home. You can learn more and claim the credit using Form 5695, Residential Energy Credits.
4. Getting capital gains tax exclusions
In addition to home-related tax deductions and credits, one of the most significant tax savings for homeowners happens when they sell the property. Generally, your gain is taxable when you sell an asset for a profit. However, many homeowners qualify for exclusion and get to keep their gain tax-free!
Here’s how it works: If you lived in the home for two of the previous five years before the sale, you qualify to exclude up to $250,000, or $500,000 if you file taxes jointly with a spouse, of profit from taxation. This fantastic benefit is available no matter your age and as often as you sell a primary residence in your lifetime.
You must complete Schedule D, Capital Gains and Losses and Form 8949, Sales and Other Dispositions of Capital Assets, to report your home sale and avoid taxation.
5. Claiming the home office tax deduction
You can claim your home office expenses if you have part- or full-time self-employment income and work from home.
Note that the deduction is available for renters, too, if you use a space in your home regularly and exclusively for business. But you’re not eligible to claim a home office if you work remotely as an employee.
To claim the standard deduction, use Form 8829, Expenses for Business Use of Your Home, to determine the expenses you can deduct and then file it with Schedule C, Profit or Loss From Business.
6. Hedging against inflation
If you have a fixed-rate mortgage, the price you pay to have a roof over your head can’t change—no matter what happens to interest rates or the economy. The cost of your home gets locked in for the term of your loan, such as 15 or 30 years.
Even an adjustable-rate mortgage or ARM comes with an interest rate cap, so you know the maximum potential mortgage payment you could ever have to pay.
As the inflation rate goes up, rent prices can skyrocket, which we’ve seen in many cities. That makes owning a home much more affordable when inflation rears its ugly head.
7. Paying less than renting (in some areas)
Even though interest rates are higher than they’ve been in many years and homeowners have various expenses (such as a down payment, closing costs, property taxes, homeowners insurance, homeowners association fees, repairs and maintenance), buying a home can still be less expensive than renting in many cities.
8. Amortizing a fixed-rate mortgage
What’s excellent about fixed-rate mortgages is that each payment comprises a principal and interest portion.
Each monthly payment automatically reduces your outstanding loan balance by a slightly larger amount, known as amortization. Therefore, every payment allows you to own more of your home and owe less.
9. Building equity
Most homeowners who keep a home for at least five years will enjoy building some equity. That’s the value of a property, less what you owe for it. For example, if your home’s market value is $400,000 and you owe $100,000 for a mortgage and $50,000 on a home equity line of credit, you have $250,000 in equity.
Although real estate values can go up and down, over the long term, they have appreciated. If your home value goes up while your debt goes down, it’s a powerful combination for building equity.
If you or your clients have questions about real estate tax benefits or how owning a home compares to renting, get guidance from a certified tax professional or financial advisor.
Laura Adams is the author and host of the Money Girl podcast.
This content should not be considered accounting or legal advice. You should consult your local tax or legal professional in your state for appropriate strategies.
This column does not necessarily reflect the opinion of RealTrends’ editorial department and its owners.
To contact the author of this story:
Laura Adams at laura@lauraadams.com
To contact the editor responsible for this story:
Tracey Velt at tracey@hwmedia.com
