Owning a home is a financial goal for Americans at every income level. Homeownership is an integral part of the American dream—and it also comes with a host of tax benefits that can help to offset the expenses associated with owning a home.
At CMP, many of our clients are homeowners. However, some are new homeowners who may not be well versed in the many tax advantages available to them. To ensure you take advantage of every tax break or deduction you’re entitled to, we have created this complete guide to the tax benefits of owning a home.
One thing to keep in mind is that we are talking about the tax benefits of a primary residence. Check out the following post to learn more about taxes on rental income property.
An Overview of Tax Breaks for Homeowners
Tax breaks for being a homeowner are designed to offset some of the expenses that come with being a homeowner. Unlike renters, homeowners are required to pay property taxes. They are also responsible for all maintenance and repairs.
Tax breaks come in many forms. Homeowners may qualify for tax deductions for everything from the interest they pay on their mortgages to expenses related to a home office. In some cases, you may be able to deduct expenses for medically necessary home improvements as well.
As a homeowner, it’s essential to understand the tax benefits associated with homeownership and take advantage of any that apply to you. You may want to work with an experienced tax professional to be sure you’re not overpaying when you file your taxes.
Tax Benefits of Owning a Home
Tax benefits for homeownership are more extensive than you might realize. Here is a breakdown of each benefit along with information about how it works and who qualifies to take advantage of it.
Mortgage Interest Deduction
The interest you pay on your mortgage accrues daily and adds thousands of additional dollars to your debt. Fortunately, you may deduct some or all of your interest when you file your taxes.
The rule for 2023 is that you can deduct mortgage interest on the first $750,000 of your mortgage debt. The amount is $375,000 if you are married and filing separately. For debt incurred before 2017, you may deduct interest for the first $1,000,000 of debt.
Prepaid Mortgage Points
Prepaid mortgage points provide homebuyers with a way to reduce their interest rate and total interest paid by paying some of it upfront. In many cases, the money you pay for points may be tax deductible. Here are the requirements:
- Your main home secures the loan.
- You used your loan to buy or build your main home.
- Selling points is an established business practice in your area.
- You paid an amount in line with what is normally charged in your area.
- You did not borrow money from your lender to pay for the points.
- The points were calculated as a percentage of the principal amount of the mortgage.
- The amount you paid is clearly marked as points on your settlement statement.
Keep in mind that you may not be able to deduct everything you paid for your points if your total mortgage debt is over $750,000 (or over $1 million for debt incurred before 2017.) You can read more about how to calculate your points deduction here.
Home Equity Loan Interest
Home equity loans and lines of credit (HELOCs) may be used for many purposes, including debt consolidation and home improvement. If you have home equity debt and have used the funds to make substantial improvements to your home, then you may be able to deduct the interest when you file your taxes.
There are a couple of additional requirements to keep in mind. First, you may not deduct home equity interest if you are upside-down on your mortgage. Second, you must itemize your deductions when you file your taxes. That means that your total deductions must be higher than the standard deduction, which in 2023 is $13,850 for single filers, $20,800 for heads of household, and $27,700 for married couples filing jointly.
Property Tax Deduction
Paying property taxes is a requirement for all homeowners. The IRS allows deductions to offset some property tax expenses up to a maximum of $10,000 per year. The taxes must have been paid during the tax year to qualify.
You may not deduct certain expenses, including HOA fees, transfer taxes, or charges for water, sewer, or trash pick-up. You can read more about the requirements here.
Home Office Deduction
Taxpayers who maintain a home office, whether they work from home full-time or part-time, may be able to take a home office deduction to offset the expense of maintaining a home office. The requirements are strict and since the passage of the Tax Cuts and Jobs Act of 2017, they no longer apply to W-2 employees.
If you are self-employed, you may choose the simplified option, which allows you to deduct $5 for each square foot of space dedicated exclusively to work. With the regular method, you’ll need to track your expenses and itemize your deductions. You may also be able to deduct expenses related to converting a room in your home into an office. Keep in mind that you’ll qualify only if your home is the principal place you do business.
Home Improvements with a Medical Necessity Focus
Home improvements that address medical requirements are deductible in some circumstances. Some examples of medically necessary home improvements include the installation of ramps, handrails, porch or stair lifts, or modifications to counters, appliances, or other home features to make them accessible.
You may deduct expenses only in the amount that exceeds 7.5% of your Adjusted Gross Income. You must itemize deductions. Deductions may be reduced if the improvements you make add to the value of your home. You can read more here.
Capital Gains Exclusion
The capital gains tax exclusion isn’t a deduction, but rather a rule that allows homeowners to reduce their capital gains tax when they sell a home. Capital gains tax rates are typically lower than ordinary tax rates, maxing out at a rate of 20%. Keep in mind that these are long-term capital gains rates applying to assets that you have owned for at least a year. That means if you flip a house and own it for less than a year, you’ll need to pay the ordinary tax rate on any capital gains.
As of 2023, the rule says that individual taxpayers are not required to pay a capital gains tax on the first $250,000 they get when they sell their home. The amount increases to $500,000 for married couples filing jointly.
Energy Efficiency Upgrades
As of January 1, 2023, there is a tax credit available to homeowners who invest in energy-efficient upgrades. The Energy Efficient Home Improvement Credit allows homeowners to deduct 30% of qualified expenses, including the following:
- Home energy audits
- Residential energy property expenses
- Qualified energy efficiency improvements installed during the year
The credit maxes out at $1,200 for energy property costs, with individual limits on doors, windows, and home energy audits. The limit is $2,000 per year for qualified heat pumps, biomass stoves, and biomass boilers. You may take the maximum credit every year you make qualified improvements. The credit is nonrefundable and you may not carry it forward.
State and Local Tax (SALT) Deduction
The State and Local Tax Deduction has been partially explained in the section about property taxes. What we haven’t mentioned yet is that certain additional taxes may be deductible for people who have paid less than $10,000 in property taxes.
SALT deductions may include payments for state income taxes or state sales taxes. You should know that you may deduct one or the other, but not both. The total amount deducted may not exceed $10,000 for all property taxes and state income or sales taxes combined.
Mortgage Credit Certificate
The Mortgage Credit Certificate, or MCC, is a program designed to help low-income homeowners offset the cost of owning a home. While many of the other tax benefits on our list are deductions that reduce your taxable income, the MCC provides a dollar-for-dollar reduction in the amount of tax owed.
MCC percentages may vary from state to state but they typically fall between 20% and 40% of the mortgage interest paid in any given tax year. The maximum credit allowed is $2,000. Unlike many deductions and credits, the MCC is fully refundable. That means that if you qualify and the MCC eliminates your tax liability, you can get a refund for the remaining credit.
Which Expenses Are Not Tax Deductible?
There are some expenses associated with being a homeowner that are not tax deductible under any circumstances. These include the following.
- Homeowner’s insurance premiums
- Fire insurance
- The principal amount of your mortgage payment
- Domestic service
- Utility payments, including electricity, gas, or water
With any tax deduction or credit, we recommend paying careful attention to the requirements and limitations before you file your taxes. Remember that your home’s value, your income, your state laws, and other factors, may impact how much you can deduct when you file your taxes.
Since the laws about which expenses are deductible can be complex, we recommend working with an experienced tax professional to make sure you meet your obligations without over or underpaying.
Potential Tax Changes That May Impact Homeowners
One of the reasons that it can be difficult to keep up with the tax advantages of owning a home is that the tax code changes all the time. Even if no new law has been passed, tax deductions and credits may expire. A case in point is the first-time homeowners' tax credit, which used to provide a $7,500 repayable tax credit to first-time buyers. That credit expired in 2010. In 2021, President Joe Biden asked Congress to enact a new, $15,000 refundable tax credit for first-time homeowners, but that bill has not yet become a law.
Another example of a change in the tax code is the expiration of the Mortgage Insurance Credit, which helped to offset the expense of private mortgage insurance.
We will update this post as new tax deductions and credits become available to homeowners. Keep in mind that you should also look at state tax benefits to make sure you’re taking advantage of them when you file your taxes.
Navigating the Tax Benefits of Homeownership
Owning a home comes with a host of financial responsibilities and obligations that can put a strain on your budget. Fortunately, the availability of a wide array of tax deductions and credits can help to offset your expenses and ease some of the financial stress of homeownership.
Do you want to ensure you're taking advantage of every available tax deduction or credit associated with homeownership? CMP is here to help you! Contact us today to schedule a free consultation and learn more about our income tax services.