Income Tax Savings
We all like getting money from the government. What many of us tend to forget is, that’s exactly what we’re getting when we buy homes. In the U.S., mortgage payments, property taxes and a couple of other home-related costs are tax-deductible. What this means is, the government is essentially subsidizing your purchase of a home.
The second you purchase that home, you’ll begin to reap tax benefits. When tax-filing time comes around, you can deduct the following:
mortgage interest real estate taxes loan points
You’re entitled to file these costs as long as you meet two conditions:
you maintain good records you file Schedule A to claim your home-related deductions
Mortgage Interest
Most people consider the deduction they make on their mortgage interest the best home deduction. To file for this deduction, first figure out how much you have paid in mortgage interest during the past year.
By the end of January, your lender should send you a form called Form 1098. Form 1098 is a statement listing the mortgage interest you have paid during the previous year. This form may arrive attached to your monthly mortgage statement. It can also be printed as part of your mortgage statement, so ensure that you examine your January statement carefully for a portion labeled as Form 1098.
Form 1098 will contain a field describing the amount you paid as interest. This amount is the amount you can deduct on your tax return.
Sometimes, a portion of home mortgage interest shows up on your settlement statement in the year you purchased your home. Check to make sure this interest is included in the Form 1098 statement that your lender sends you.
To claim the amount to which you’re entitled based on your mortgage interest, fill out Schedule A, Itemized Deductions.
If you received a Form 1098 detailing the amount of mortgage interest you paid for the year, write down this interest deduction on line 10 of Itemized Deductions. If you did not receive Form 1098, fill out line 11 instead of line 10.
Not all mortgage holders receive a Form 1098 (hence the need for line 11). Typically, you won’t receive a statement of interest paid if your home loan is with a private party. For example, perhaps your home loan is from the person who bought your old home. Your mortgage holder should have completed the form for you; however, this doesn’t always happen. You can still deduct your interest, with or without a Form 1098, provided that your loan is secured by your home. Be sure to note the name, address, and social security number of your lender on the lines next to line 11 of your Schedule A, Itemized Deductions form. Your lender should have provided you with this information at the time you closed the purchase of your home.
You are eligible to deduct a late payment charge as home mortgage interest as long, unless the charge was for a specific service you sought the assistance of in a matter connected to your mortgage loan.
Some mortgages, especially fixed-rate mortgages, require you to pay a prepayment penalty if you end up repaying your mortgage earlier than your agreed-upon date. If you pay a prepayment penalty, you can deduct that penalty as home mortgage interest. The only exception would be if you paid this penalty for a specific service you sought the assistance of in connection with your mortgage loan.
Points
When you purchase a home, you usually have to pay points to the lender in order to get your mortgage. These points are often deductible because they are seen as a prepayment of interest. Other terms for points are:
Loan origination fees Maximum loan charges Loan discount Discount points
You may deduct any points that you pay, or points your seller paid on your behalf, in the year in which you pay the points. The catch is, you must meet all these requirements:
Your loan is secured by your main home—that is, the home in which you live most frequently. You cannot use a summer home, for example, for points deduction. Paying points is typical for your neighborhood. The amount of the points is in accordance with points paid in your area. You use the cash method of accounting for expenses. The cash method means you report income in the year you obtain it and deduct expenses in the year in which you pay the points. The loan was used to purchase, improve upon or build your home. The points are calculated as a percentage of the loan principal. The points are clearly delineated on the statement of your settlement. You put cash into your home purchase in an amount equal to or more than the points you were charged.
Not all points fit these criteria. These points can still be deductible, but you have to deduct them over the life of the loan rather than in one year. These points include:
Points paid for refinancing Points paid on loans secured by your second home
Points charged for specific services, like preparation costs for a mortgage note, appraisal fees or notary fees are not interest charges. Therefore, these points are not deductible.
Real Estate Taxes
Annual taxes based on the assessed value of your property are tax deductible. These taxes are known as real estate taxes or, more commonly, property taxes.
Your mortgage interest statement might report the amount of real estate taxes you paid during the previous year if you use an impound account with your lender to cover real estate taxes and homeowners’ insurance.
If your real estate taxes are not included in impound payments paid along with your mortgage payments, search through your cancelled checks. They should give you the information you need to figure out how much you have paid in property taxes throughout the year.
Make sure that you have picked up any real estate taxes included on your settlement or closing statement, too.
Be careful not to deduct your full payments into your impound account property taxes. Your impound account deposits are just money set aside to pay for tax and insurance. This means that you can deduct only the actual real estate tax payments made from the impound account by your lender.
Use Schedule A, line 6, to deduct your real estate taxes.
Costs you Can’t Deduct as Propety Taxes
As always, charges you paid for services related to your home cannot be deducted. Examples of services you cannot deduct include:
A unit fee for the delivery of a service (for example, water delivery) A charge for a residential service (for example, garbage collection) A flat charge paid for a single service provided to you specifically by your local government Local benefits payments that tend to increase the value of your property. Examples include community improvements, like street/sidewalk improvements, or water and sewer system improvements. Note that you can, however, deduct the amount you pay for assessments for repairs or maintenance.
Home Improvement Deductions
Save receipts and records for all improvements you make to your home, such as landscaping, storm windows, and fencing. You can’t deduct these expenses now, but when you sell your home, the cost of the improvements are added to the purchase price of your home to determine the “cost basis” in your home. This serves to reduce any potential taxable gain that you may have from the sale of your home. For more information, see How Home Improvements Affect Your Taxes.
Home Expenses That You Can’t Deduct
A lot of the costs of home ownership are not deductible. Don’t get caught trying to claim any of the following expenses as a deduction:
Homeowner’s insurance premiums Fire insurance premiums FHA mortgage insurance premiums Principal payments made on your mortgage Title or mortgage insurance Utilities, such as gas, electricity, water or trash collection Most settlement costs on your closing or settlement statement Homeowners’ association dues and fees
Because of income tax deductions, the government is subsidizing your purchase of a home. All of the interest and property taxes you pay in a given year can be deducted from your gross income to reduce your taxable income.
For example, assume your initial loan balance is $150,000 with an interest rate of eight percent. During the first year you would pay $9969.27 in interest. If your first payment is January 1st, your taxable income would be almost $10,000 less – due to the IRS interest rate deduction.
Property taxes are deductible, too. Whatever property taxes you pay in a given year may also be deducted from your gross income, lowering your tax obligation.
