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Mortgage and Home Ownership Tax Deductions

The $8,000 first-time homebuyer tax credit and recently added $6,500 credit for repeat buyers have been getting all the attention. But those are only the beginning of the tax benefits available to those who buy their own homes.

There are deductions you can take when you buy the home, deductions you can take while you own the home and tax advantages when you finally sell it. All of which become available when you move out of the ranks of renters and become a homeowner.

Tax credit vs. tax deduction

The homebuyer tax credits, of course, are the hot topic of the moment. The important thing to note here is that, unlike other tax benefits of buying or owning a home, these are outright credits, not just deductions – they lower your tax bill one dollar for each dollar of credit you receive. Tax deductions , on the other hand, lower your taxable income instead, so the savings are far less dramatic - about 10 to 35 cents per dollar of deduction, depending on your income level, with the higher figure for higher tax brackets.
The first-time and repeat homebuyer tax credits are available on home purchases where a sales contract has been signed by April 30, 2010 and the sale closed by June 30, 2010. Some restrictions apply – the credits are phased out for single homebuyers with a modified adjusted gross income over $125,000 and $225,000 for couples filing a joint return.
To qualify as a first-time buyer, you and your spouse (if married) may not have owned a home in the past three years; to qualify as a repeat buyer, you must have lived in the same house for five of the past eight years.

Mortgage interest deduction makes itemization worthwhile

But the granddaddy of all homeowner tax benefits is the mortgage interest deduction. For most homeowner, this will be the biggest tax benefit they realize from home ownership. You can take a deduction for every cent of interest you pay on your mortgage each year. And because interest charges typically make up the vast majority of your monthly mortgage payment during the early years of your mortgage, it can be a hefty sum.
In fact, the mortgage interest deduction is often what makes it worthwhile for taxpayers to itemize their deductions in the first place. The standard federal tax deduction is $5,150 for a single taxpayer, $7,550 for the single head of a household and $10,300 for married couples filing a joint return. If you can’t claim at least that much in deductions, there’s no sense in itemizing. Not only does the mortgage interest deduction commonly exceed those levels by itself, by allowing you to itemize it also enables you to claim other deductions you couldn’t claim under the standard deduction – things like state and local taxes, charitable deductions, job-hunting costs and moving expenses, union and professional dues, and the like.
Keep in mind too, that the mortgage interest deduction can also be taken for interest paid on second mortgages, home equity loans and home equity lines of credit. So if you take out a home equity line of credit for home repairs or to pay off credit cards, you can deduct that interest as well, provided you don’t borrow more than the home is worth (which banks aren’t likely to allow these days). You can even deduct the interest paid on a vacation home, provided that you use it at least 14 days a year or 10 percent of the days you rent it out for.
Because the mortgage interest deduction lowers your adjusted gross income, it not only reduces your federal taxes, it lowers your state income taxes too.

Home purchase tax deductions

There are also other deductions you can take for expenses incurred at the time you purchase your home. Loan origination fees are deductable, as are any sales taxes that apply to the transfer of the property. You can also deduct any seller concessions that are used to help cover closing costs, including discount points to reduce the interest rate on the loan.
You can also deduct discount points you paid yourself, but with a twist – because discount points are a way of prepaying interest, the IRS requires that this deduction be spread over the life of the mortgage, just as the interest savings are. However, if you pay discount points on a refinance used to fund improvements or repairs to your home, you can claim the deduction all in one year. You can also deduct a certain number of points the same year that you take out the loan if paying those points is standard practice in your area.

Capital gains benefits

The other big tax benefit you can get is when you eventually sell your home. Assuming your home has grown in value over the years, you can avoid paying capital gains taxes on up to $250,000 in increased value for a single homeowner and $500,000 for a couple. That makes for a pretty nice nest egg. Of course, these days people are more focused on falling property values than rising ones. But the historical trend has been that prices do tend to rise over time, and if you plan to stay in the house for 10-15 years or more, this may turn out to be a significant benefit.
Finally, there are some things you can’t deduct, although it may seem reasonable to do so. The cost of homeowner’s insurance is not deductable, nor are homeowners’ association or condominium fees. The cost of home improvements or repairs are not deductable, but it’s still a good idea to keep track of them for when you eventually sell – they can be added to the basis cost of your home that is used to determine how much it’s appreciated.
Also, most homeowners cannot deduct the cost of private mortgage insurance, or PMI. However, you may be able to deduct PMI if you took out your mortgage between Jan. 1, 2007 and Dec. 31, 2009, under a special law passed by Congress – however, there are limits on eligibility. Check with your tax advisor to be sure.
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