For many people, homeownership provides opportunities to live more comfortably and put down roots. However, there are also tax benefits that come with buying and owning a home.
From the ability to deduct your mortgage interest to potential credits for making your home more energy efficient, you could see a lower tax bill.
How homeowner tax breaks work
As a homeowner with a mortgage, you have access to a variety of different tax breaks, including several deductions and two notable credits. Taking advantage of these tax breaks could reduce your tax bill, making your home a more cost-effective investment in the long run.
Deductions vs. credits
Deductions and credits both reduce your tax bill, but there are some key differences between the two.
A tax deduction will decrease your overall tax liability by reducing your taxable income, but a tax credit is more like a gift card you can apply to your tax bill to directly lower the amount you owe.
Choosing how to file
Your filing status can have a large impact on your tax bill, along with determining what deductions and credits you’re eligible for. For example, the standard deduction is higher for married couples filing jointly than it is for those filing as single or head of household.
Check Out: How to Buy a House: Step-by-Step Guide
5 tax deductions for homeowners
You’ll need to itemize your return if you want to claim some of the tax deductions available to homeowners. With itemization, you list out eligible deductions, including charitable donations, work-related deductions, and homeownership deductions.
Instead of taking the standard deduction that everyone gets, you can choose to itemize all of your deductions. However, this only makes sense if your itemized deductions add up to more than the standard deduction, which, in 2021, is $25,100 for joint filers, $12,550 for single filers, and $18,800 for those filing as head of household.
1. Mortgage points deduction
At a glance: If money changes hands for points, you can reduce your taxable income whether it’s a new loan or a refinance.
Normally, mortgage points are paid to a lender at closing to reduce your interest rate. They’re expressed as a percentage of the loan, usually 1%.
Because mortgage interest is deductible, the points you pay are as well, assuming you gave the lender money for them.
For example:
If you pay $250,000 for your house, each point will cost you $2,500. You must pay these points upfront to the lender in order to claim them as a deduction on your tax return. You might also be able to do this when you refinance your mortgage.
2. Mortgage insurance deduction
At a glance: Potentially deduct your private mortgage insurance (PMI) if you took out a loan in 2007 or later.
If you make a down payment of less than 20%, you’ll most likely be paying PMI. The good news is that you might be able to deduct your PMI payments if you took out a loan in 2007 or later.
Once your adjusted gross income (AGI) reaches a certain level, though — $50,000 for single filers and $100,000 for joint filers — the deduction gets smaller until you’re ineligible for it based on your income.
Our PITI mortgage calculator can help you determine these costs.
3. Mortgage interest deduction
At a glance: Fully deduct the amount of mortgage interest you pay, up to $750,000 of indebtedness if you’re filing jointly and $375,000 of indebtedness if you’re filing single.
One of the primary tax incentives of owning a home, you can typically deduct all of your mortgage interest, up to a certain amount of indebtedness.
If you acquired your home before Dec. 15, 2017, you can deduct the interest on up to $750,000 if you’re filing jointly and up to $375,000 if you’re filing single.
Good to know:
If you acquired your home before that date, you can potentially claim a deduction on mortgage interest up to $500,000 as a single filer and $1 million as a joint filer.
4. Home office deduction
At a glance: If you use a portion of your home exclusively for business, you can deduct a portion of your costs on your taxes.
It’s possible to deduct your home office space, provided the area is used exclusively for business. There are two methods for figuring out your deduction:
- Simplified: Simply claim $5 per square foot, up to 300 square feet, or $1,500.
- Regular: Calculate the percentage of your home taken up by your home office and then figure out your other costs based on that percentage. For example, if your office accounts for 5% of your home, you can deduct 5% of your mortgage costs.
With the regular method, you need to keep good records of your expenses and consider other issues, such as depreciation.
5. Real estate tax deduction
At a glance: Deduct up to $10,000 (joint) and $5,000 (single) in property taxes during the year when you itemize.
When you pay property taxes, you can deduct the full amount you pay each year, up to $5,000 as a single filer or $10,000 as a joint filer. This limit includes state and local taxes, as well as sales taxes. As with the other deductions listed here, you can only take a deduction on your real estate taxes if you itemize.
Find out: Mortgage Refinance Tax Deductions Every Homeowner Should Know
Two tax credits for homeowners
A tax credit functions more like a gift card that helps lower your tax bill. After everything has been deducted and your bill is finalized, the tax credit comes in and reduces your total owed.
The two main tax benefits of owning a home in terms of credit include the mortgage credit certificate (MCC) and the potential for a residential energy credit.
1. Mortgage credit certificate
At a glance: Receive credit for up to $2,000 per year based on the mortgage interest paid, as long as you meet income requirements.
A program aimed at helping low-income homeowners, the mortgage credit certificate (MCC) is issued by a state or local administration.
Generally, you must be a first-time homebuyer and meet income requirements to receive an MCC. If you meet the requirements, the MCC sets your credit at between 10% and 50%, based on your mortgage amount and mortgage interest rate. There is a cap of $2,000 on the credit.
For example: If you take out a mortgage worth $200,000 with a 3.75% interest rate and the local administration sets the MCC at 20%, you would be eligible for $1,500 in credit.
$200,000 (mortgage amount) x 3.75% (mortgage interest rate) x 20% (MCC percentage) = $1,500 (eligible credit)
2. Residential energy credit
At a glance: If you install certain qualifying energy-efficient improvements, you can receive a credit for a percentage of the cost.
The residential energy credit allows you to receive a credit when you install geothermal, wind, fuel cell, biomass, and solar energy systems to increase the efficiency of your home. The credit received is based on the cost of installation and when you placed these systems in service.
Systems placed in service between the following dates qualify for a certain percentage of credit:
- Dec. 31, 2019, and before Jan. 1, 2023: 26%
- Dec. 31, 2022, and before Jan. 1, 2024: 22%
For systems put in place between December 31, 2016, and before January 1, 2020, there was a 30% credit. So, you’ll benefit from this tax credit more by installing your system sooner rather than later.
Keep Reading: Cash-Out Refinance Tax Implications
