The federal government wants you to be a homeowner. This is demonstrated in several ways. First, the government encourages homeownership by insuring mortgages against default. Secondly, a variety of tax deductions are available for homeowners. Even in a depreciating real estate market, the tax benefits of owning a home can be compelling reasons to buy instead of rent. However, there is much confusion about what can and cannot be deducted regarding home ownership. Every situation is a little different, and seeking professional tax advice prior to using these suggested home ownership tax benefits is advised. (For more on taxes and homeownership, read A Tax Primer For Homeowners)
TUTORIAL: Buying A Home
Here are the three top tax benefits for homeowners:
Mortgage Interest Deductions
The mortgage interest deduction is perhaps the most popular home ownership tax deduction. The tax code reads that you can deduct the interest payments used to refinance or acquire your principal residence. This deduction can result in homeowners lowering borrowing costs by almost a third. Many homeowners use this tactic to turn high-interest credit cards and automobile loans into low interest, tax deductible expenses. However, one needs to think carefully about doing this. Although it does provide tax benefits and a lower monthly payment, you are securitizing an unsecured debt with your home in the case of credit cards. Therefore, if you don't make your second mortgage payment, you will not only get a negative mark on your credit report, you could lose your home. (For more on this deduction, check out Calculating The Mortgage Interest Tax Deduction.)
Home Purchase Deductions
As you know, mortgage interest is deductible. What many new homeowners do not realize is the portion of interest generally paid upfront at the closing is also tax deductible. If you purchase your home on any day other than the first of the month, interest is due between the purchase day and the closing. Remember to take advantage of this homeownership tax benefit. In addition, loan discount points and origination fees are also generally tax deductible. Believe it or not, it doesn't matter who paid these fees for the new homeowner to deduct them. Therefore, even if the seller pays the costs, you can deduct them off of your tax return.
Home Sale Deductions
This is where things really get exciting regarding homeownership tax benefits. The law reads that if you have occupied your home for at least two of the past five years, you can earn up to $500,000 profit on the sale without having to pay any taxes on the gains. This is a powerful incentive to invest in your own home instead of renting.
The Bottom Line
Remember to use these tips only as basic guidelines. Always consult a tax professional prior to making any tax decisions. (For other deductions, read 10 Most Overlooked Tax Deductions.)