Tax Benefits of Homeownership After Tax Reform
Buying a home can be a major expenditure.
Fortunately, federal tax benefits are still
available, even after recent tax reform
legislation, to help make homeownership more
affordable. There may also be tax benefits
under state law.
Mortgage interest deduction
One of the most important tax benefits of
owning a home is that you may be able to
deduct the mortgage interest you pay. If you
itemize deductions on your federal income tax
return, you can deduct the interest on a loan
secured by your home and used to buy, build,
or substantially improve your home. For loans
incurred before December 16, 2017, up to $1
million of such "home acquisition debt"
($500,000 if married filing separately) qualifies
for the interest deduction. For loans incurred
after December 15, 2017, the limit is $750,000
($375,000 if married filing separately).
This interest deduction is also still available for
home equity loans or lines of credit used to buy,
build, or substantially improve your home. [Prior
to 2018, a separate deduction was available for
interest on home equity loans or lines of credit
of up to $100,000 ($50,000 if married filing
separately) used for any other purpose.]
Deduction for real estate property taxes
If you itemize deductions on your federal
income tax return, you can generally deduct
real estate taxes you pay on property that you
own. However, for 2018 to 2025, you can
deduct a total of only $10,000 ($5,000 if
married filing separately) of your state and local
taxes each year (including income taxes and
real estate taxes). For alternative minimum tax
purposes, however, no deduction is allowed for
state and local taxes, including property taxes.
Points and closing costs
When you take out a loan to buy a home, or
when you refinance an existing loan on your
home, you'll probably be charged closing costs.
These may include points, as well as attorney's
fees, recording fees, title search fees, appraisal
fees, and loan or document preparation and
processing fees. Points are typically charged to
reduce the interest rate for the loan.
When you buy your main home, you may be
able to deduct points in full in the year you pay
them if you itemize deductions and meet certain
requirements. You may even be able to deduct
points that the seller pays for you.
Refinanced loans are treated differently.
Generally, points that you pay on a refinanced
loan are not deductible in full in the year you
pay them. Instead, they're deducted ratably
over the life of the loan. In other words, you can
deduct a certain portion of the points each year.
If the loan is used to make improvements to
your principal residence, however, you may be
able to deduct the points in full in the year paid.
Otherwise, closing costs are nondeductible. But
they can increase the tax basis of your home,
which in turn can lower your taxable gain when
you sell the property.
Home improvements
Home improvements (unless medically
required) are nondeductible. Improvements,
though, can increase the tax basis of your
home, which in turn can lower your taxable gain
when you sell the property.
Capital gain exclusion
If you sell your principal residence at a loss,
you can't deduct the loss on your tax return. If
you sell your principal residence at a gain, you
may be able to exclude some or all of the gain
from federal income tax.
Capital gain (or loss) on the sale of your
principal residence equals the sale price of your
home minus your adjusted basis in the
property. Your adjusted basis is typically the
cost of the property (i.e., what you paid for it
initially) plus amounts paid for capital
improvements.
If you meet all requirements, you can exclude
from federal income tax up to $250,000
($500,000 if you're married and file a joint
return) of any capital gain that results from the
sale of your principal residence. Anything over
those limits may be subject to tax (at favorable
long-term capital gains tax rates). In general,
this exclusion can be used only once every two
years. To qualify for the exclusion, you must
have owned and used the home as your
principal residence for a total of two out of the
five years before the sale.
What if you fail to meet the two-out-of-five-year
rule or you used the capital gain exclusion
within the past two years with respect to a
different principal residence? You may still be
able to exclude part of your gain if your home
sale was due to a change in place of
employment, health reasons, or certain other
unforeseen circumstances. In such a case,
exclusion of the gain may be prorated.
Other considerations
It's important to note that special rules apply in
a number of circumstances, including situations
in which you maintain a home office for tax
purposes or otherwise use your home for
business or rental purposes.
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