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4 Ways Home Ownership Can Reduce Your Tax Bill

January 2, 2024No Comments
 

home ownership and taxes

 

 

 

Key takeaways from 4 Ways Home Ownership Can Reduce Your Tax Bill:

  • As a homeowner, you are eligible for both a property tax and mortgage interest tax deduction.
  • Business owners who own their home might qualify for the home office deduction.
  • The Section 121 exclusion provides one of the largest tax benefits for individuals.

If you believe that wealth is built through equity and smart tax strategies, homeownership could be your keystone.

Delve into the world of tax advantages offered by the IRS for homeowners, as we unveil four key benefits of home ownership.

1. Property Tax

Every home is subject to a property tax. Local governments impose taxes on properties to pay for roads, buildings, schools, and other programs. The amount of property tax paid is usually a percentage of the property’s current market value.
 
Property tax is considered a state and local (SALT) tax deduction and is reported on Form 1040, Schedule A.
 
If you itemize your deductions on your personal tax return, you can deduct property tax paid during the year.
 
Under the 2017 Tax Cuts and Jobs Act, the maximum amount of state and local tax deductions allowed on your federal tax return is capped at $10,000.  

2. Mortgage Interest

When a home is financed with a mortgage, you borrow the cost of the home from a lender.
 
A homeowner pays a monthly fee to their mortgage lender for a period of time until the amount borrowed is fully paid.
 
The monthly fee paid to the lender includes a principal and interest amount.
  • Principal – the total amount borrowed.
  • Interest – the cost of borrowing the loan paid at a fixed or variable rate.

Although the principal payments are not deductible, interest payments are.

Even better, mortgage interest payments are often higher in the early years of mortgage payoff. For those who buy homes mid-career, this means you might receive a significant and useful tax-deduction during your highest earning years.

Now, before you start racking up debt for the tax write-off, keep in mind that not all mortgage interest is tax deductible. Mortgage interest is tax deductible if paid towards home acquisition debt up to $750,000 ($375,000 for single filers) on mortgages acquired after December 15, 2017.

For mortgages that exceed $750,000, tax deductible interest is prorated to only include interest paid on up to $750,000.

Mortgage interest on mortgages acquired before December 15, 2017 is tax deductible if paid towards home acquisition debt up to $1,000,000 ($500,000 for single filers).

Similar to property tax, mortgage interest is deducted on Form 1040, Schedule A.

Taxpayers who itemize their deductions can write-off qualified mortgage interest.

3. Home Office Deduction

If you use part of your home for business, you may be able to deduct expenses paid for the business use of your home.
 
Although the goal of this article is to share all of the cool tax benefits of home-ownership, renters should pay attention to this deduction too.
 
The home office deduction is available for homeowners and renters. It applies to all types of homes.

woman in yellow sweater sitting beside table with laptop computer

To qualify for the deduction, you must:

  • Regularly use part of your home exclusively for conducting business. For example, if you use an extra room to run your business, you can take a home office deduction for that extra room.
  • Show that you use your home as your principal place of business. If you conduct business at a location outside of your home, but also use your home substantially and regularly to conduct business, you may qualify for a home office deduction.
The home office deduction is calculated on Form 8829 and reported on Schedule C of your Form 1040. The IRS gives taxpayers the option to calculate the deduction via the simplified method or the standard method.
 
It is important to note that, for homeowners,  depreciation claimed via the home office deduction might be taxed when you sell your home under the standard method.

Sale of Home

man in blue and white plaid dress shirt beside woman in black crew neck shirt

If you have a capital gain from the sale of your main home, you may qualify for the Section 121 exclusion.
 
Under this section of the tax law, you can exclude up to $250,000 of gain from your income, or up to $500,000 of gain if you file a joint return with your spouse.
 
Let’s say you and your spouse purchase a starter home for $400,000. You live in the home for three years before you decide to sell it and move into your dream home. 
 
If the home sells for $900,000 (good ol’ appreciation), your realized gain on the home sale would be approximately $500,000 (does not consider home improvement items included in basis).
 
Well, under IRS Code Section 121, the full $500,000 gain is excluded from taxable income. 
 
Incredible, right?
 
$500,000 tax free dollars just from owning a home.
 
You are eligible for the exclusion if you have owned and used your home as your main home for a period aggregating at least two years out of the five years prior to its date of sale. So, make sure you keep track of the dates you moved into and out of your home.
 
Timing your home sale correctly can significantly reduce your tax liability.
 

Conclusion

 
As you can see, home ownership is multifaceted.
 
When deciding whether to rent or buy, it is important to consider all tax implications.
 
For some, home ownership is an effective tax strategy to limit their tax liability and keep more income for themselves. For others, the repair, maintenance and other responsibilities that come with home ownership create more costs than benefit.
 
Weigh the pros and cons for your specific situation, but don’t forget to add tax!
 

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Last updated on January 13, 2024

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