How to make the most of tax benefits of homeownership
As the homeownership rate has declined slowly since peaking in 2006 at almost 70 percent, the tax benefits for homeowners have also declined. In 2006, more than 40 million homeowners deducted $443 billion in mortgage interest. But in 2014, 33 million homeowners deducted just $287 billion in mortgage interest and almost $6 billion in mortgage insurance premiums.
Unfortunately, it’s not just that fewer homeowners are claiming fewer tax benefits. Some are leaving money on the table. Only one in three taxpayers itemize but millions more should – especially homeowners. Deducting mortgage interest is just one of the tax benefits that can come with owning a home. Here is a look at tax breaks homeowners can take advantage of to make sure they get the most out of homeownership at tax time.
Itemize all possible deductions
Taxpayers only benefit from itemizing if their itemized deductions are bigger than the standard deduction. The standard deduction is $6,350 for single taxpayers and $12,700 for married taxpayers filing jointly. Owning a home is often the key that unlocks itemization because homeowners may deduct typically larger expenses like mortgage interest and real estate taxes.
Taxpayers can deduct mortgage interest on up to two homes: one primary and one second home. Mortgage interest on up to $1 million in acquisition debt and $100,000 of home equity debt qualifies for deduction.
Homeowners can also deduct their real estate taxes and points. Depending on the circumstances, they may either deduct points in the year they paid them or pro-rated over the life of the loan.
Once itemizing is worthwhile for taxpayer, they can also deduct other qualifying expenses, like:
- charitable donations,
- personal property tax,
- state and local income taxes or sales taxes,
- medical expenses (exceeding 10 percent of adjusted gross income) and
- employee business expenses and other miscellaneous expenses (exceeding 2 percent of adjusted gross income).
Even if the individual expenses are small, adding them all up can make a difference to the taxpayer’s bottom line and be well worth the extra recordkeeping. For example, a taxpayer with a marginal tax rate of 25 percent could save up to $25 for every extra $100 they can itemize. A single taxpayer with a 25 percent marginal tax rate who itemized $9,600 in qualifying expenses could save up to $812.50 more by itemizing instead of claiming the standard deduction. This amount represents 25 percent of the additional itemized deduction total over the standard deduction.
Keep records for eventual sales, when too much profit could mean taxes
When the time comes to sell a home, taxpayers could find their gain from a sale taxed. But taxpayers can decrease or eliminate that tax if they can show they gained less than certain amount. If the seller owned and used the home as a main residence for at least two of the past five years before selling it, they can usually exclude up to $250,000 ($500,000 for joint filers) of the gain from taxable income.
Most people will of course have their HUD or closing disclosure statement showing their original cost, but they also need to keep records of substantial improvements and their costs. To qualify, an improvement must add to the value of the home, prolong its life or adapt it to new uses. Maintenance costs, such as painting the home, do not count as upgrades increasing a homeowner’s basis.
For example, a couple who files jointly bought a home for $50,000 in 1965 and sells it for $700,000 in 2017. They used the home as their main residence for the entire time. The gain is $650,000. They can exclude $500,000 but $150,000 is taxable. Now suppose that over the years they remodeled their kitchen and two bathrooms for a total cost of $100,000. That brings their basis up to $150,000, their gain down to $550,000 and their taxable gain down to $50,000. If they also had records of $50,000 in expenses finishing the basement and installing a new furnace and air conditioner, they would have no taxable gain.
While the gain on the sale of a house can be taxed, the loss on the sale of a personal residence is not deductible.
Make working at home work on the tax return
Taxpayers who work from home, including employees who work from home for the convenience of their employer, may be able to claim a home office deduction. If they qualify, they could either deduct actual expenses based on a percentage calculation of how much space the office takes up of the home or they could deduct $5 a square foot for up to 300 square feet, maxing out at $1,500. This safe harbor calculation doesn’t require tracking home expenses individually and adding them up, so it is convenient for most taxpayers.
Either way, the office would need to meet a few criteria to qualify. First, the taxpayer must use the office regularly and exclusively for business. That means the taxpayer must not use the area – whether a separate room or a corner or portion of a room – for personal reasons. The taxpayer must also use the office habitually for business.
If the home office qualifies, all expenses directly related to the room are deductible, such as painting or decorating. Additionally, general expenses that apply to the house as a whole, such as mortgage interest, utilities and insurance, should be prorated based on the square footage used for the office relative to the home’s total living space. They can also depreciate their home office.
For example, if the office is 200 square feet and total living space is 2,000 square feet, the taxpayer can deduct 10 percent of mortgage interest, homeowner’s insurance, utilities and other eligible expenses on Schedule C if they are self-employed. If they are an employee working from home for the convenience of their employer, they could deduct their expenses that exceed 2 percent of their adjusted gross income on Schedule A. Or they could deduct $1,000 using the safe harbor calculation.
Homeownership can add some complexity to taxpayers’ financial lives, but it can also open up hundreds or thousands of dollars in tax benefits. Homeowners can learn more about tax situations they may face, like taxes on forgiven mortgage debt, the home office deduction and deciding to rent out their home.
By Annelise Wiens
As the newsroom editor, Annelise Wiens is interested in more than just tax and industry news, but the stories of H&R Block's 80,000 associates, their communities and H&R Block's world headquarters in Kansas City, Missouri. Wiens joined H&R Block in 2014 from a public relations agency, where she worked with clients in the financial services industry. Before that, she worked as a communicator for a senior member of the United States House of Representatives. She graduated from Biola University in La Mirada, CA with a bachelor's degree in history.