You have heard it before. Owning a home is a great tax deduction. It is one thing to make a general statement. It is another to understand the specifics of how owning a home may lower your tax liability. Below is a list of important points that every homeowner should know. Note that this is not a complete list of allowable deductions.
Itemizing deductions. In order to deduct your mortgage interest, you must itemize deductions rather than take the standard deduction. As a general example, if your allowable standard deduction is $12,000 and you only have $6,000 in itemized deductions, you will be better off taking the standard deduction. However, if the home gives you an “extra” $10,000 in itemized deductions, you are better off itemizing. Note that the “excess” $6,000 ($12,000 minus $6,000) will not garner any benefit because you are now itemizing.
The housing payment. The housing payment is generally comprised of four segments: Principal, interest, taxes and insurance (PITI). Generally, you can deduct two of these—mortgage interest and taxes. The good news is in most cases these two items comprise the greatest majority of the total payment. For example, here are some fictitious numbers given to illustrate this point:
$1,750 Total Payment (PITI)
Of this example, $1,400 out of $1,750 is deductible, or approximately 80% of the payment.
Again, using fictitious numbers, if the above homeowner was in a 25% tax bracket, the home payment would actually be reduced by approximately $350 per month after taxes. There are a few exceptions or requirements with regard to this rule—
- The deduction is only allowable for principal residences and second homes. Homes which are rented out (investor properties) have additional tax benefits.
- You cannot deduct interest on any loan amount above $750,000.
- You can only deduct interest on a mortgage which is taken out to purchase, build or improve a property. You may be able to deduct a mortgage insurance payment under certain conditions depending upon the year that you paid them.
Points. A point is a cost charged by a mortgage company for originating a mortgage and/or buying the rate down on that mortgage. Generally, points can be deducted in the year that they are paid when they are used to purchase a primary residence. If the purpose of the mortgage loan is to refinance an existing loan, then the points may still be able to be deducted, but the deduction must be spread out over the life of the loan, unless the refinance was to improve the present home. There are additional restrictions regarding the deducting of points which are not delineated herein.
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