The Tax Benefits Of Buying A Home Explained

If you're thinking about putting down roots by buying a house, you've probably heard about the tax benefits of buying a home. But what are they, and how do you benefit from them?

Let's explore the tax benefits of buying a home and being a homeowner. You might be surprised to learn about all the opportunities available due to homeownership.

Does Buying A House Help With Taxes?

The Internal Revenue Service (IRS) offers tax benefits for homeowners, even if you aren't buying a primary residence. Other types of real estate investing also come with tax benefits.

Homeowners can take advantage of tax deductions and credits when filing taxes. First-time home buyers may also benefit from tax advantages.

• Tax deduction: Tax deductions are expenses you can subtract from your income to reduce your taxable income. Deductions lower your taxable income but not by lowering your taxes directly.
• Tax credit: Unlike tax deductions, tax credits lower your taxes dollar for dollar – they directly decrease the tax you owe.

Here's an example of both: Let's say you receive a $1,000 deduction and a $1,000 credit with a tax liability of $3,000.

The tax credit will lower your tax bill to $2,000. A tax deduction lowers your taxable income depending on your tax bracket. In other words, if you're in the 22% tax bracket, the $1,000 deduction takes $220 off your taxable income, not your tax bill.

Tax Benefits Of Buying A House

The tax benefits of buying a home include a few widespread benefits. We'll review some of these benefits below.

Mortgage Points

Mortgage points help borrowers save money by reducing the interest rate on their home loan. You can "buy" points upfront at 1% of the total loan amount at closing and lower your monthly payment and interest you'll pay on the loan.

Since mortgage points are prepaid interest, they're tax deductible as long as you itemize your deductions. Itemizing means picking and choosing from individual tax deductions instead of taking the standard deduction.

Mortgage Interest

The mortgage interest deduction allows homeowners to reduce their taxable income based on interest paid on the home during a particular year. An itemized deduction helps homeowners save on the amount of taxes they owe. Most types of home loans qualify for the deduction, which can especially help if you took out a large mortgage.

Property Taxes

Property taxes are taxes based on the value of your property and come from state and local governments. Property taxes cover taxpayer services, like public schools and public safety positions – think police and fire services. 

If you file taxes single or married filed jointly you can deduct up to $10,000 of property tax. If you file taxes as married but filing separately, you can deduct up to $5,000.

Mortgage Insurance Premiums

Mortgage insurance is a type of insurance that protects your lender if you default on a home loan. Private mortgage insurance (PMI) is a type of mortgage insurance that allows individuals to purchase a home with down payments of less than 20%.

Unfortunately, you can no longer claim the itemized deduction for mortgage insurance premiums beginning in 2022 and beyond.

Home Office

The tax deductions for homeowners include the home office deduction, which applies if you operate a business in your residence. You must use your home office for regular and exclusive business use to qualify for this deduction, not just for occasionally working from your kitchen table instead of going into the office.

The amount you can deduct depends on the percentage of your home you dedicate to your business.

Capital Improvements

Making tax-deductible home improvements, or capital improvements, must substantially improve your home and its value. A renovation or remodel can help lower tax payments if it meets IRS standards. For example, it must be a permanent fixture, desirable and/or increase your home value. A concrete example could include an improvement added to your home for medical purposes.

Capital improvements might also mean you can deduct the interest on a second mortgage like a home equity loan.

Tax Credits For Home Buyers And Homeowners

Home buyers and homeowners can tap into a few different tax credits – energy-efficient upgrades, first-time home buyer credits and/or state and local tax credits.

Energy-Efficient Upgrades

Homeowners who make certain energy-efficient upgrades can also take advantage of tax credits. You can unlock a tax credit by installing a solar power system, for example, or installing efficient appliances or other green home upgrades.

The size of the tax credit varies based on the type of upgrade you choose. Before paying for upgrades, confirm the benefits with a tax professional.

First-Time Home Buyer Credits

Are there tax benefits of buying a house for first-time home buyers?

Not right now. However, legislators proposed the First-Time Homebuyer Act of 2021, allowing you a tax credit of up to $15,000. However, the legislation has still not passed in Congress as of January 1, 2024.

State And Local Tax Credits

State and local governments often offer citizens tax credits and exemptions, meaning you can protect a flat amount or percentage from taxes. Your exemptions and tax credits depend on your financial situation, your state and your municipality.

A few common types of exemptions include:

• Senior property tax exemption: Senior citizens who have reached certain ages may not have to pay property taxes, though it often depends on residency and income restrictions.
• Veteran property tax exemption: Veterans and members of the armed forces, including qualifying surviving spouses who have not remarried, can often claim an exemption from property taxes, depending on the rules in your state. You may also receive a complete property tax waiver.
• Disability exemption: Those with a disability may get relief from a portion of property taxes through exemptions, income exclusions and credits. You may have to offer proof of your disability.
• Homestead exemption: A homestead property tax exemption allows you to shelter a certain amount of your primary property from taxes, typically based on a flat rate or percentage of the taxable value. Some states offer a larger homestead exemption for married couples and joint owners.

Other Tax Breaks For Homeowners

Some other common tax benefits of real estate investing include popular tax breaks. Let's take a look.

Capital Gains Taxes When Selling

When you sell a primary residence, you might profit from the sale. However, you may worry about real estate taxes, and rightly so.

Profits on a home sale often result in capital gains taxes. Many people buying a home are also selling one, so this is another possible tax advantage. Homeowners who used the home as a primary residence for at least 2 of the last 5 years can keep a portion of these capital gains without paying taxes on the proceeds.

Single filers can keep up to $250,000 of the capital gains, while married couples filing jointly can keep up to $500,000 tax-free. Depending on your home's value, this could be a considerable deduction.

Here's an example: Say you bought your home for $200,000. Ten years later, you sell the home for $300,000. In this case, you could pocket $100,000 without capital gains tax if you meet the residency requirements.

Use Your IRA To Buy A Home

If you have an IRA, you can withdraw penalty-free to buy a home as long as you meet certain qualifications. If you don't meet the qualifications and withdraw money, you may have to pay a 10% early withdrawal penalty.

You can qualify for an exemption if you're a first-time home buyer: Qualified first-time home buyers can withdraw $10,000 from an IRA to build, buy or rebuild their first home. You must close on the transaction within 120 days of receiving funds.

SALT Deduction

The state and local tax (SALT) deduction allows taxpayers of high-tax states to deduct local tax payments on federal tax returns. There is a $10,000 maximum cap on the SALT deduction.

The highest average deduction comes from those who are residents of New York, Connecticut, California, New Jersey, Washington, D.C. and Massachusetts and only applies to individuals who itemize deductions.

Itemizing Vs. Taking The Standard Tax Deduction

What's the difference between the standard deduction vs. itemizing?

Claiming the standard deduction is easier, because you don't keep track of expenses like medical expenses, business expenses and state income taxes you paid throughout the year.

The standard tax deduction based on tax year looks like this:

So, should you itemize or not? Great question.

Deciding whether to itemize can depend on a few different factors, including whether your available itemized deductions exceed the standard deduction for your filing status. Consider consulting a tax professional to determine whether or not you should itemize.

The Bottom Line

Remember the tax breaks for buying a house and other benefits when filing your tax return this year. Mortgage points, mortgage interest, property taxes, home office deduction, capital improvements, tax credits and other benefits may be available to you.

The amount homeowners can save in taxes varies from household to household. Sometimes, homeowners stick with the standard deduction, which leads to no extra tax savings. For other homeowners, itemizing tax-deductible house expenses leads to significant savings. Consult a tax professional to assess how much you might save with each option.

Ready to buy a house for all its benefits (not just taxes!)? Connect with an agent today to find a new home.