by Laura Johnson, EA
The government will pay you to own a home. If you rent, your monthly payment is a personal expense, not deductible on your tax return. If you own, the interest and property tax you pay can save you thousands, maybe tens of thousands of dollars in taxes. When you sell a house, a big slice of profit can escape tax. And if you upgrade your home, the federal or state government might pay part of the cost of renovation. Here are some of the more common, and more valuable, deductions, for homeowners.
The interest you pay to acquire a principal residence is deductible. That includes indebtedness to construct or substantially improve your home. Generally, the interest you pay on a home equity line of credit is also deductible (see Home Equity Interest, below).
Taxpayers can deduct the interest on up to $1.1 million of home acquisition debt. If you have a second or vacation home which you use personally, you can deduct interest on a loan secured by such a property, if the total debt between both residences does not exceed the limit above. Interest you pay on debt in excess of the limit is not deductible unless you used the borrowed funds for something like a business or making an investment.
A valuable, but often overlooked, deduction is what is commonly known as points. That is, cost associated with acquiring the financing needed to purchase the home. There are two main types of points – a premium you pay to acquire a lower rate from your lender, and loan acquisition costs, for example, loan processing fees. Costs to acquire the home are deductible in the year paid. Points paid in association with a refinancing are amortized over the life of the loan.
Home Equity Interest
Perhaps you took out a home equity loan to finance a renovation? To the extent the loan does not exceed $100,000, the interest is deductible.
When preparing your return, be wary of home equity interest on borrowing not used to improve the home. If you are subject to Alternative Minimum Tax (AMT), and you used the borrowed money for personal expenses, such as medical expenses, or your child’s education, you are not eligible for a deduction. AMT is an alternate system of federal income tax, where fewer write-offs are allowed, but the tax rate is lower. Taxpayers must figure their tax twice: under the regular system and also using AMT rules, to see if AMT applies to them for a given tax year.
Property tax paid on any number of homes is deductible, so long as you are not subject to AMT.
Federal and State Credits for Energy-Efficiency Related Improvements
If undertaking improvements designed to make your home safer or more energy-efficient, be sure to check with state and federal tax authorities to see if tax credits apply. For example, Massachusetts offers credits for the removal of lead paint and the replacement of old septic tanks. Federal credits abound for energy efficiency improvements. These rules are changeable, and subject to limitations, but worth looking into before updating your home.
Exclusion of Gain on the Sale of a Principal Residence
Perhaps the most valuable of all the home-based tax incentives is the tax provision which allows homeowners to exclude the first $250,000 (for singles) and $500,000 (for married couples filing jointly) of gain on the sale of a principal residence. For example: You purchased your only home in 1990 for $200,000. You sold your home in 2015 for $400,000. Your gain on the sale is $200,000. You pay not a penny of tax on that $200,000. Generally, you must have owned and used the property as your principal residence for two out of the past five years to qualify for this exclusion. If you ever used the property as a business or rental property, the exclusion will be limited.
At John Schachter + Associates, we help our clients capture all possible tax benefits from their homes. Let us know if we can help you.