Thursday, February 25, 2021 / by Randy Durham
Tax Credits: A Homeowner's Guide to Tax Season
Despite the many hidden costs associated with homeownership, there are many tax benefits to offset these expenses. If you are still paying your mortgage, there are several deductions available for you. The IRS has 1098 tax forms to report payments or other contributions that may be deductible from your taxable income. Form 1098 is the mortgage interest statement, which is provided by the company that services your loan. This form will tell you how much interest and prepaid points charged for loan origination in the previous year. This form also tells you the amount of mortgage insurance and property taxes paid by the lender. You are also able to write off energy-saving or medical-related improvements to the home, some taxes, and other expenses. Here are the most common deductions used by homeowners.
1. Retirement funds as a down payment: You can withdraw up to 10,000 from a traditional IRA account without paying a 10% early withdrawal penalty. This is only applicable if you are buying your first home. If you want to use a 401k, you will have to pay it back with interest within five years. However, funds up to or equal to have the balance (but no more than $50,000) are tax and penalty-free.
2. Mortgage Points: Any points charged by a lender are fully deductible for the tax year that you paid them. This is done as an itemized deduction. If you refinance your home, you normally have to deduct any points you pay over the life of the loan.
3. Mortgage Insurance: If you have to pay private mortgage insurance on your loan, you can use an itemized deduction. If your income is over $109,000, this deduction is phased out.
4. Mortgage Interest: You can itemize this deduction on up to $750,000 of your loan ($375,000 if you are married filing separately) to buy or improve your primary or secondary home. Improvements can only be deducted if they add value to your home, extend the life of the home or any adaptations for new usage. Basic repairs are not deductible.
5. Mortgage Interest Credit: This credit is available to lower-income homeowners who have a qualified Mortgage Credit Certificate from the state or local government to subsidize purchasing their primary home. The exact percentages vary but typically range anywhere from 10-50% of the paid interest of the tax year. If your credit rate exceeds 20%, you are limited to $2,000. You will be required to complete Form 8396 and attach it to your 1040 form.
6. Property Taxes: As a homeowner, you are responsible for paying your local property tax. You can deduct up to $10,000 for state and local taxes you pay on your primary home, vacation home, co-op with special restrictions, and land. This is commonly referred to as a SALT deduction. However, you cannot deduct HOA assessments, portions of your bill that are used for services like water or trash removal, or special assessments for neighborhood improvements.
7. Home Office Expenses: This only applies if you are self-employed and work from home. The property type doesn’t matter. It can even be a boat. Part of your utility bills, insurance, repairs, and other home expenses can be deducted against your business income. You can use two ways to calculate this deduction. First, in the “actual expense” method, you multiply the operating expenses of your business done at home. The second method is the “simplified” method, which deducts $5 for every square foot of your home used for business.
8. Energy-Saving Improvements: You are eligible for tax credits if you install certain energy-efficient equipment in your home. You can save 30% on new systems that use solar, wind, geothermal, or fuel cell power. You can also save by installing energy-efficient insulation, doors, roofing, HVAC systems, windows, and water heaters. To qualify, use Form 5695 to calculate the amounts and claim credits.
9. Medical Necessities: This pertains to installing special equipment for medical reasons, like adding wheelchair ramps, widening doorways, installing handrails, lowering cabinets, installing lifts or elevators, or changing doorknobs. You can itemize these deductions, along with the operating and maintenance costs as medical expenses if they are necessary for activities of daily living. You can only deduct medical expenses that exceed 10% of your gross income, and the deduction is less if it adds any value to your home.
10. Rental expenses: If you rent out part of your home you are living in currently, you are taxed on the income. However, you can deduct any expenses used for the space you rent. This includes any insurance, repair or maintenance costs, taxes, utilities, and supplies. You don’t have to itemize this deduction, and you can claim it on Schedule E of your 1040 tax form. Subtract the expenses from your rental income.
11. Debt Forgiveness: Concerning foreclosures and short sales, mortgage debt is forgiven up to 2 million dollars of discharged debt and is tax-free.
12. Capital Gains: If you sell your home, you probably won’t have to pay tax on profits gained from the sale up to $500,000 ($250,000 for single filers) if you owned and lived the home for at least two years out of the past five years.
13. Increased Basis: You can reduce the amount of tax you owe by adjusting the basis of your home. The taxable gain is equal to the home’s taxable basis minus the sales price of your home.
You can find a useful calculator for personalized tax benefits here.