Contributed by: PhillipB, FreeTaxUSA Agent, Tax Pro
Buying a home is exciting! Homeownership is an important part of the American dream and can provide a strong sense of security and peace of mind.
Whether you’re buying your first home or your tenth, it’s important to understand the tax benefits available in the first year and in the years that follow. Let’s explore the potential tax benefits of homeownership.
First year considerations
In the first year you own your home, you may be eligible for several tax benefits if you itemize deductions. Here are some nuances to consider.
- Real estate taxes: You can deduct the real estate taxes you pay each year you own the home, subject to applicable limits. However, in the year of purchase, the taxes will need to be prorated based on the time you own the home. Either you or the seller may pay the taxes, with one party reimbursing the other at closing. For example, you buy a home in October after the seller has paid the property taxes for the year. You reimburse the seller for 2 of the 12 months of real estate taxes. In this case, you may deduct the amount reimbursed for those 2 months on your return.
- Prepaid interest: If there’s prepaid mortgage interest on your closing statement that’s not included on Form 1098, you may be able to deduct that amount in addition to the mortgage interest reported on Form 1098. This prepaid mortgage interest typically accrues from the closing date to the end of the month.
- Mortgage points / Origination fees: You may deduct mortgage points in the year of purchase if the following applies:
- The loan is secured by your primary residence.
- Paying points is an established business practice in your area.
- The points don’t exceed market rates for your area.
- You’re a cash method taxpayer.
- The points are clearly itemized on the HUD-1 or other closing documents and were not charged instead of appraisal fees, inspection fees, title fees, attorney fees, or property tax.
- Points were paid in cash at or before closing.
- The points are calculated as a percentage of the mortgage principal.
- The loan is acquisition debt — money used to buy, substantially improve, or build the home.
- Mortgage interest: You can deduct mortgage interest reported on Form 1098 for the year you purchase the home, subject to applicable limits.
💡Note: If the points were financed, the points could be deducted over the life of the loan.
Each year you live in the home
Every year, all taxpayers can deduct mortgage interest and property taxes as itemized deductions on their tax returns.
Home office expenses
If you’re a business owner who operates your business from home, you may qualify for a home office deduction. You may use the regular method to deduct a portion of certain household expenses and depreciation, or you may choose the simplified method, which requires less recordkeeping.
In rare situations, people who are required to work from home may be able to take advantage of the home office expense either as a deduction or by being reimbursed for the home office expense through their employer’s accountable reimbursement plan. The following employees may be able to deduct certain unreimbursed employee expenses, including home office expenses, on their tax return:
- Armed Forces reservists – Members of the reserve components of the Armed Forces.
- Qualified performing artists – Artists who work for 2+ employers, earn at least $200 from each employer for their artistic work, and have art expenses which exceed 10% of their art related income
- Fee-basis state or local government employees — Must be state or local government employees who are paid on a fee basis.
- Employees with impairment-related work expenses — Employees who incur work expenses because of a physical or mental disability.
The year you sell your home
You can deduct all otherwise allowable deductions for expenses related to your home through the date of sale.
If you owned and used the home as your principal residence for at least 2 out of the 5 years before the sale, you’ll qualify to exclude some or all the gain from your income. The exclusion amount is $250,000 for an individual or $500,000 for a married couple filing a joint return if all applicable requirements are met.
If you don’t meet the eligibility test to claim the maximum exclusion, you may still qualify for a partial exclusion based on the portion of time you owned and lived in the home during the required 2-year period. The circumstances which would qualify are as follows:
- Work-related move
- Health-related move
- Unforeseeable event, such as divorce, death, or a natural disaster
Conclusion
Buying a home can provide many tax benefits, but the rules may differ in the year of purchase, during the years you own and live in the home, and in the year you sell it. If you decide to convert the home into a rental property, you may find some additional tax benefits related to rental income and expenses.