Tax Benefits of Owning a Home

How Homeownership Can Reduce Your Tax Burden

A family relaxes in a home.
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Buying a house is often one of the largest purchases people make in their lifetime. Mortgage payment that includes interest, property taxes, and homeowners insurance can last 30 years with a traditional mortgage. 

One way to offset this financial burden in the United States is through taking advantage of a variety of deductibles and other tax benefits. 

Let’s learn how homeownership benefits you passively, through something called imputed rent, as well as actively when you choose to itemize tax deductions in order to deduct various homeownership expenses. Understanding these benefits can help you accurately estimate how much of a tax advantage owning a home can provide.

Key Takeaways

  • Buying a house comes with the tax benefit of deducting eligible discount points or eligible prepaid property taxes assessed at closing.
  • Owning a house includes ongoing possible deductions of mortgage insurance premiums, qualifying mortgage interest, and local and state property taxes.
  • Selling a house after at least two years of ownership and residence comes with exclusion of any sales profits from capital gains tax.

How Homeowner Tax Benefits Work

Tax benefits with owning a home work in various ways, depending on the type of benefit. Deductions are a common form of tax benefits. For a deduction, you can exclude the amount allowed in the deduction from your taxable income, ultimately lowering your tax burden. 

In other tax benefits with homeownership, you may not be required to pay higher capital gains taxes even if your primary residence sells and makes a profit. Or, you could receive credits that lower the total tax bill rather than the taxable income.

Homeowner tax benefits aim to help incentivize the stability and wealth-building potential of homeownership. When you own a home, you can build equity in an asset through your monthly mortgage payments. Instead of paying money toward rent each month, you can make payments toward the debt on the home.

In the long-term, you can likely sell your home for a profit as home prices tend to appreciate, although they can be cyclical. Or, you could tap the equity and secure loans for other uses. In many cases, depending on the local market, your monthly payments may be less with a mortgage than for rent on a similar property.

Some studies have found that tax benefits may have a negligible impact on homeownership rates. A Brookings Institution study found that it is more common for these benefits to be used by middle and high-income earners, who are more likely to itemize deductions at all rather than taking the standard deduction.

High-income earners claim itemized deductions, they may benefit disproportionately, since the highest part of their income is taxed at a higher rate according to the higher tax brackets. A purported impact of having incentives available for relatively large mortgage loans is that people may choose to buy a larger house than they would have bought without the incentives.

Tax Benefits for Buying a Home

You can start to receive tax benefits as soon as you purchase the home. Here are some of the common tax benefits for homeowners.

Deductions of Costs at Closing

When you first purchase a home, you pay several closing costs, most of which, like a downpayment, aren’t deductible. However, if you pay discount points, you may be able to deduct them. 

Discount points are effectively prepaid interest that reduces your long-term interest rate, and they can be deducted ratably over the life of the loan, or, if you meet certain requirements, you can deduct them in full for the year you pay them.

Tax Benefits for Owning a Home

Once you own your home, you take advantage of other credits or deductions. Tax benefits while owning a home depend on the interest and mortgage insurance you owe on your loan, as well as other factors.

Keep in mind you typically can’t deduct items like insurance (other than mortgage insurance), pay for domestic help, utilities bills, depreciation, or homeowners association fees. 

Mortgage Interest Deduction 

When you have a mortgage, you can take mortgage-related deductions like mortgage interest up to a certain amount. Your bank will typically send you a statement called Form 1098 each year acknowledging what parts of your payments were toward interest (if those costs were higher than $600). You can use that when you itemize deductions.

Homeowners may find that it makes more sense to take the standard deduction if their itemized deductions total less than than the standard deduction. For tax year 2022, the standard deduction is $12,950 for single individuals and married filing separately, $19,400 for heads of households, and $25,900 for married couples filing jointly in tax year 2021.

Mortgage Insurance Deduction

If you are still paying mortgage insurance on your loan, you may qualify to deduct the mortgage insurance premiums from your taxes. You are usually required to carry mortgage insurance if your down payment is less than 20%.

You can report mortgage insurance premiums from Form 1098. If they are not included on the form, you can contact your lender to find out why they weren’t included.

Mortgage Interest Tax Credit

The mortgage interest tax credit applies only to those who are issued a qualified Mortgage Credit Certificate (MCC) from their state or local government. You can claim mortgage interest on Form 8396.

This benefit is geared for lower-income individuals. As a tax credit, it offers a dollar-for-dollar tax reduction instead of the reduction in your taxable income that a deduction provides.

The credit usually cannot be more than your tax liability, and it can be carried forward for up to three years. But you will have to reduce your home mortgage interest deduction by the amount of interest used to figure the credit because you cannot claim interest for both a deduction and a tax credit. 

State and Local Tax Deduction

Another deduction for owning a home is the deduction for state and local real estate tax. This allows you to pay less in federal taxes by deducting the amount you spent on qualifying state and local taxes, including some real estate-related taxes.

The cap on deductions for state and local taxes (combined local income tax, sales tax, and personal property tax) was $10,000 as of 2022.

Imputed Rent Excluded From Taxation

Essentially, homeowners live in their homes rent-free. Imputed rent, or the return on homeownership, also brings tax advantages for homeowners because returns are excluded from taxable income. In contrast, landlords must pay taxes on the rental income they gain, and renters don’t get to deduct their rent costs from their taxes.

Because you’re neither a landlord nor a renter when you own your primary residence, you get the benefits of owning the property like the investment potential that its value could appreciate. You also get the benefit of living rent-free. 

Residential Energy Tax Credit

Homeowners can receive a credit associated with renewable energy improvements approved by the IRS. This credit is typically 26% of costs for projects like solar electric additions, solar water heaters, small wind energy property, geothermal heat pumps, and costs associated with using biomass fuel.

As with other tax benefits, residential energy tax credits have exclusions and requirements. For example, solar roofing shingles are eligible for credit while roof decking and rafters are not, even if they support solar roofing shingles.

You can confirm that an expense will qualify for this deduction before you commit to a project since the credit can impact the total cost of a project substantially. 

Specific Contexts of Home Improvement Expenses and Associated Loan Interest

If you have expenses related to home improvements that you need because of a medical condition, you may qualify to deduct interest you pay on those expenses from your taxes.

Also, if you take out debt against your home equity, you may be able to exclude interest on that debt if it is proven to “substantially improve” your home, like if you add a bedroom or sunroom.

Tax Benefits for Selling a Home

One major benefit of homeownership is the potential to sell your home for a profit. Typically, you have to pay capital gains on the profits from investments, but your primary residence has an exception.

Depending on how long you’ve lived in your home, you may be able to take advantage of tax benefits for selling a home.

Capital Gains Tax Exclusion

When you sell a home that was your primary residence for at least two out of the past five years, you may qualify to exclude any profit you make on that sale from capital gains tax

The other requirement is that you cannot have claimed that same exclusion from capital gains tax in the past two years on another property. This exclusion can help you to avoid a costly tax bill for the tax year that you sell a home.

The Bottom Line

Owning a home brings a number of tax advantages in the U.S., from deductions for mortgage interest and property tax costs to capital gains tax exclusion on profits from the sale of your home. 

The specific tax benefits for which you can qualify will depend on factors like how many homes you have, your income, and your loan structure, among many others. And these rules for tax benefits may change, so consider consulting a tax professional when you make financial decisions based on tax benefits of owning a home.

Frequently Asked Questions (FAQs)

What do I need to do my taxes after buying a house?

An important document to have on hand as you prepare your taxes after buying a house is your Form 1098 from your lender. This form will mention deductible expenses like property tax, mortgage insurance premiums, and mortgage interest. Most accountants and tax software can walk you through filing taxes for your specific situation.

Do you pay sales tax when buying a house?

You don’t pay a traditional sales tax on a house. Instead, you’ll face other local and state property taxes, depending on your jurisdiction. Property taxes are often part of a mortgage payment.

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