Homeownership and Taxes: How Does Buying a House Affect Your Taxes?

Purchasing a home comes with a range of financial benefits, including potential tax advantages.

Tax laws can be complex, and every homeowner’s situation is unique. It’s best to consult with a tax professional before making financial decisions related to homeownership.

In this article, we’ll explore the common ways buying a home can impact your taxes.

Are there tax benefits for owning a home?

Certain deductions and credits can help homeowners reduce their taxable income and lower their tax bills.

Let’s look at the most common tax advantages associated with homeownership.

Mortgage interest deduction

When you take out a mortgage to buy a home, you repay the loan over time with interest.

The mortgage interest deduction is one of homeowners’ most significant tax benefits. It allows you to deduct the interest you pay each year within the allowed limits.

The limits include:

• Homeowners who took out a mortgage after December 15, 2017, can deduct interest on mortgages up to $750,000 for individuals or married couples filing jointly (or $375,000 if married couples file separately).
• If your mortgage was taken out before December 15, 2017, you may be able to deduct interest on loans up to $1 million.

The deduction is most beneficial in the early years of the mortgage, when a larger portion of your monthly payments goes toward interest.

However, homeowners may need to itemize their deductions instead of taking the standard deduction to claim the mortgage interest deduction. (This will entail keeping accurate records of all housing-related expenses.)

Property tax deduction

Homeowners must pay property taxes yearly, directly or through an escrow account.

You can typically deduct the state and local property taxes you pay yearly up to a combined limit of $10,000 ($5,000 if married and filing separately).

Mortgage points deduction

Mortgage points, also known as discount points, are optional fees you can pay upfront when you get a mortgage in exchange for a lower interest rate.

Buying points allows you to prepay interest and reduce your monthly mortgage payments over time.

Homeowners who paid mortgage points may be able to deduct them from their taxes. Sometimes, the full amount can be deducted in the year you purchase the home.

To qualify for this deduction, you must meet the following criteria:

• The loan is for your primary residence.
• The payment of points is a common practice in your area.
• The points must be a percentage of the loan amount and not disguised as other fees.
• The points don’t cost more than what is usually allowed in the area.
• The points must be paid directly by the borrower as cash at closing.

If you don’t meet all of these conditions, you may still be able to deduct points, but you’ll need to spread them out throughout the loan.

Energy-efficient home credits

Energy-efficient home improvements like solar panels or high-efficiency HVAC systems reduce energy use and lower utility bills.

Some of these improvements may qualify for federal tax credits that help homeowners offset the costs.

You’ll file Form 5695, Residential Energy Credits, to claim these credits.

Home office deduction (for self-employed individuals)

Self-employed borrowers who use part of their home exclusively for business purposes may qualify for the home office deduction.

The space must be used regularly and exclusively for business; shared spaces are prohibited.

Medically necessary home improvements

You can deduct some expenses if you or a family member requires modifications to your home for medical reasons.

Qualifying improvements include:

• Entrance or exit ramps
• Widening doorways
• Installing railings
• Lowering cabinets or countertops

Your tax preparer can help you determine which improvements are eligible.

Tax considerations for homebuyers

Before purchasing a home, it’s important to understand how homeownership will impact your taxes.

Here are the key factors to consider before you buy.

Should you itemize deductions or take the standard deduction?

When you file your taxes, you have the option to reduce your taxable income in two ways:

1. Take the standard deduction: A fixed amount that everyone can claim
2. Itemize deductions: List out individual deductible expenses instead of taking the fixed amount

A tax professional can help you compare both methods to determine which of the two lowers your taxable income more.

How will property taxes affect your budget?

Property taxes vary based on location and home value. Some areas have significantly higher rates than others.

Before purchasing a home, research the property tax rate in your area to estimate how much you’ll pay each year.

Will you have to pay taxes on a home purchase?

There is no federal tax for purchasing a home, but some states and local governments charge real estate transfer taxes or recording fees when a property changes ownership.

These fees are typically paid at closing.

How will homeownership affect your tax filing?

Owning a home can make tax filing a bit more complex, but a tax professional can walk you through the changes.

Here are some of the documents you’ll need for filing:

• Form 1098, showing how much mortgage interest you paid
• Total amount of property taxes paid
• Closing disclosure for information on mortgage points paid
• Receipts for eligible home upgrades
• Home office documentation (if applicable) that includes the square footage of your space

Talk to a tax professional before filing to ensure you’re taking advantage of any available deductions, and make certain you can gather the necessary documentation.

Common tax mistakes to avoid

Tax errors, at best, lead to missed deductions; at worst, they can result in audits or penalties.

To avoid making tax mistakes, work closely with a tax professional and beware of common errors, including:

• Overestimating deductions
• Failing to keep records of home-related expenses that could impact your deductions
• Overlooking state and local tax incentives that could provide additional savings

To maximize your tax benefits, ensure you understand which expenses are deductible and those which aren’t.

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