U.S. markets closed

3 Tax Benefits of Purchasing a Home

TurboTax Staff
Buying your first home is cause for celebration - and tax savings.

Purchasing a home is a major life decision, but it’s one made easier by the many tax advantages available to homeowners. A few homeowner tax deductions that can have a significant effect on your taxes include:

In addition to these three, you can also benefit from a tax shelter on profits from the sale of your home. You also may be able to reduce their federal tax withholding in anticipation of lower tax bills related to future mortgage interest and property tax deductions. This can increase your take-home pay and make it easier to make your monthly payments.

1.  The mortgage interest deduction

Often, the largest tax deduction for most homeowners is for mortgage interest paid throughout the year. Because this deduction can only be claimed for interest payments made during the tax year, first-time home buyers usually gain a larger mortgage interest deduction from purchases made early in the year than they do from purchases made later in the year.

  • For mortgages originated after December 14, 2017, homeowners can deduct interest paid on home loans up to $750,000. Interest on debt above that amount is not tax-deductible.
  • For mortgages originated prior to this date the limit is $1,000,000.

The amount of mortgage interest you paid throughout the year will usually be provided to you by your lender in January on Form 1098. Because of this large deduction, most new homeowners who claimed the standard deduction in the past find it beneficial to begin itemizing their deductions. Combining deductible mortgage interest and property taxes with other deductible items such as charitable giving often totals up to more than the standard deduction. This can result in a larger deduction that can lower your taxes.

2.  Lender points

Many lenders require home buyers to pay a percentage of the loan amount up front in what are known as percentage points or simply “points.” Like monthly mortgage interest payments, these up-front interest payments are tax-deductible, as long as they are secured by the home and are paid at the closing. Important: you can deduct the points whether you paid them or the seller did as part of the closing agreement.

Example: You pay two points (2%) on a $400,000 mortgage. You can deduct $8,000 on your taxes ($400,000 x .02 = $8,000).

The Form 1098 that you receive from your lender should show the deductible amount for points.

3.  Property taxes

In some states, one of the largest itemized deductions homeowners can take is for the property taxes they pay. Up to $10,000 of state and local taxes, including property taxes, are tax deductible. If you pay property taxes through an escrow account, this amount is often included on a form provided by your lender. If you pay your property taxes directly, rather than through an escrow account, you need to track these payments so you can deduct them on your tax return.

Note: You can only deduct property taxes that you paid because you were assessed, i.e. for which you have received a property tax bill. If you want to pre-pay property taxes to take the deduction this year, you can only do so if you have already received the tax bill.

In the year you purchase a home, you may be required to reimburse the seller for prepaid property taxes that covered some of the time you owned the home. These payments are usually tax-deductible.

Shelters for profits on the sale of a home

Homes don’t always increase in value, but when they do, the profit can be considerable. Normally, profits from the sale of personal property, such as stocks and bonds, is taxable. But the profits from the sale of a home are tax-free up to certain amounts and under certain conditions. For example:

  • If you have used the home as a primary residence for two of the five years preceding the sale, then up to $250,000 of the profits from the home sale is exempt from taxation.
  • The tax-free amount increases to $500,000 for married couples filing a joint return when one or both spouses owned the house as a primary residence for two of the five years preceding the sale and both spouses occupied the residence for two of the five years prior to the sale.

This tax shelter is available for every home you sell, provided you owned and occupied it for at least two of the five years preceding its sale and that you did not use the tax-free exclusion for another home in the prior two years.

You might be able to shelter some of the profits from the sale of your home if you qualify under certain exceptions, even if you lived in it less than two years. These exceptions involve unforeseen circumstances that required you to sell the home. Qualifying exceptions can include:

  • A change of employment
  • A change of health
  • A divorce
  • Multiple births from a single pregnancy

Under these exceptions, you can usually shelter a portion of the exclusion amount based on the portion of the 2-year requirement that you meet. For example, if you lived in the home for one year, you might qualify to take 50% of the usual deduction, since one year is 50% of the 2-year requirement.

Reducing your federal tax withholding

There is no reason to wait until you file taxes to start benefiting from home ownership. Based on your anticipated tax savings, you can reduce your federal income tax withholding, increasing your take-home pay. To do so, obtain a W-4 form and its instructions at work (or visit www.irs.gov to download one), complete it, and turn it in to your employer.

To learn other tax advantages when buying your first home, visit TurboTax.com.

 

 

Property taxes

In some states, one of the largest itemized deductions homeowners can take is for the property taxes they pay. Up to $10,000 of state and local taxes, including property taxes, are tax deductible. If you pay property taxes through an escrow account, this amount is often included on a form provided by your lender. If you pay your property taxes directly, rather than through an escrow account, you need to track these payments so you can deduct them on your tax return.

Note: You can only deduct property taxes that you paid because you were assessed, i.e. for which you have received a property tax bill. If you want to pre-pay property taxes to take the deduction this year, you can only do so if you have already received the tax bill.

In the year you purchase a home, you may be required to reimburse the seller for prepaid property taxes that covered some of the time you owned the home. These payments are usually tax-deductible.

For more tax tips in 5 minutes or less, subscribe to the Turbo Tips podcast on Apple Podcasts, Spotify and iHeartRadio.

Brought to you by TurboTax.com