Image courtesy of Flickr, Brian J. Matis
List of the most common mortgage and real estate tax deductions you need to know about.
While being a homeowner is a rewarding experience, it also comes with big financial responsibility. From paying your mortgage, property taxes and unforeseen repairs, sometimes it seems like all you do is spend money.
Fortunately, the IRS has created tax deductions made especially for homeowners to reduce your personal income taxes. Below is a list of those tax deductions you may be able to benefit from.
Most state and local governments charge an annual property tax. You can deduct all the property taxes actually paid to help you reduce your tax burden. In the case that you pay property taxes through an escrow account, be aware that you can only deduct the amount actually paid to the taxing authority, which may be different than what you paid into the escrow account.
Note that your tax bill may also include additional fixed charges, special assessments and bond indebtedness. These are not deductible.
Tip: You can prepay the next installment of your property tax bill before the end of the year to increase your deductions for the current year. However, this prepayment strategy may not be beneficial if you anticipate being subject to the alternative minimum tax. Speak with your tax professional for details.
To take advantage of the mortgage interest credit you must have qualified for the Mortgage Credit Certificate (MCC) - a tax credit program. This program is made for low to moderate income families to help them afford a home. It allows homeowners to convert 20% of their annual mortgage interest into a tax credit.
If you believe you may qualify for the tax credit program you can contact your local lender to see if they are approved to issue the MCC.
Tip: The MMC tax credit program is administered by both your local and federal government. To find out more about the process and how you can qualify, contact your local Housing Finance Agency (HFA). Click here for a list by state.
The interest you pay on your mortgage loan is tax deductible if your loan is secured by your main home or second home, and if you itemize your tax deductions. For many, the mortgage interest deduction may significantly decrease your taxable income.
There are additional rules you should be aware of. Click here to learn more about the mortgage interest tax deduction.
Tip: Investment properties do not apply. Therefore, your second home cannot be a rental property and must be occupied by the owner at least part-time. Talk to your tax professional to find out if you qualify to benefit from the mortgage interest deduction.
Home mortgage points, also known in the industry as mortgage discount points, are prepaid interest according to the IRS. Therefore, you are able to claim the entire amount of points paid as a deduction in the year you paid them if the mortgage loan is secured by your primary home, among other minimum rules listed here.
Points paid on a mortgage secured by a second home must be amortized over the life of your loan. Points paid as part of a refinance must also be amortized over the life if your loan, unless the refinance proceeds were used to improve your home.
Tip: Deducting points paid on your mortgage loan can be a little tricky to understand due to the timing and amortization rules due to type of loan, use of loan funds and property type. Be sure to check with your tax professional to see when and how much you can claim.
You can deduct the money you spend home improvements, but not money spent on home repairs.
As explained by the IRS, home improvements must materially add value to your home, prolong your home's useful life, or adapt your home to new uses. These may include, but are not limited to the following: adding a new room, upgrading a roof or installing a home security system.
Small scale improvements such as painting a room, replacing a toilet or fixing a leak do not qualify as a home improvement and are considered a home repair. These are not tax deductible.
Unlike the other examples in this post, you cannot claim home improvement deductions in the year you paid them. Home improvement deductions only come into play when you sell your home, and works by reducing your overall gain at the time of sale.
Tip: When many small repairs are combined into a larger project, such as extensive remodeling, the entire project can be considered a home improvement. If you suffer a casualty and your home is damaged, the money spent on repairs to restore your home is considered a home improvement.
Although not technically a tax deduction, the gain you make when you sell your principal residence is tax free up to $250,000 if you're single, and up to $500,000 if you're married and file jointly.
The IRS has specific rules as to how you can exclude the gain from your income, but the most important rule to understand is that your home must be a primary residence, meaning that you have owned and lived in the home for at least two of the five years leading up to the sale.
Tip: You don't have to be currently living in the property at the time of sale to qualify. Additionally, if you're a renter and later purchase the property you've been renting, the time you've already spent in the home as a renter counts towards the two year ownership and use rule.
Laws change all the time when it comes to tax deductions. What was available last year may not apply today. During the 2008 home crisis there were many tax breaks that people were able to benefit from, but as of 2014 many of those tax breaks will expire.
Be sure to consult with your tax professional for clarification so you don't count on any tax deductions that are expiring, or miss out on tax deductions you don't know about.
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