Popular home-related tax benefits already in the tax code
Wednesday, September 25, 2024
A home of one’s own has long been part of the traditional American Dream. Nowadays, though, some say it’s a nightmare trying to join the homeownership ranks.
So, of course, as we head into the last few weeks of the 2024 election, candidates at all levels also are focusing on housing.
Vice President Kamala Harris, the Democratic presidential nominee, has proposed tax breaks she says will increase the housing supply, which should lead to lower prices. She’s also promoting a first-time buyer tax to help buyers get into those homes.
Using the tax code to help specific industries and taxpayers is not new. In fact, homeowners have long been beneficiaries of tax laws.
Here are some popular homeownership tax breaks currently in the Internal Revenue Code.
Mortgage interest: Most residential buyers get a mortgage. The interest they pay each month on that home loan is tax deductible.
The one downside here is that you must itemize to claim this tax deduction.
Also, the Tax Cuts and Jobs Act (TCJA) of 2017 reduced this tax benefit a bit. Before the TCJA was enacted, the deduction was limited to interest paid on up to $1 million of debt used to purchase a home.
Now, however, the Republican tax reform law limits the mortgage interest tax deduction to interest on home loans obtained after Dec. 14, 2027, to $750,000.
Homeowners who got their mortgages on Oct. 14, 1987, through Dec. 15, 2017, can still deduct the interest on a home loan of up to $1 million. Interest on mortgages obtained on Oct. 13, 1987, or earlier is fully tax deductible, regardless of the loan amount.
You should get early each year a statement — Form 1098 or an Internal Revenue Service acceptable substitute document — from your mortgage lender showing how much loan interest you paid the prior year.
Loan points: When mortgage rates are high, as they were while the Federal Reserve Board worked to bring down inflation, borrowers sometimes pay points to get a lower loan rate. The tax code considers these discount points, where each is 1 percent of your mortgage amount, as mortgage interest, making them tax deductible.
In most cases, however, you cannot deduct the full points amount in one fell swoop. Instead of claiming them on your Schedule A itemized deductions, you must spread them over the life of the loan, deducting just a portion each tax year.
Property taxes: Most homeowners who get a mortgage authorize that lender to collect additional monthly funds that go toward paying property taxes. Your Form 1098 also will have this amount, which also is tax deductible. Up to a point.
Before the TCJA, all of the residential real estate taxes you paid to your county tax collector were deductible on your federal return as an itemized claim. The tax reform law capped the amount of deductible state and local state and local taxes, or SALT, at $10,000.
The SALT cap covers income and property taxes paid. So, if you live in an area where home values are high or you paid a lot of state income tax, you might not be able to deduct all your SALT payments.
Of course, since the TCJA also essentially doubled the standard deduction amounts, not as many people are itemizing, meaning lots of homeowners no longer rely on property taxes to help lower their overall annual federal tax bill.
Home equity loan interest: Many people view their house not only as an investment, but a structural ATM. They use their home’s value to obtain a home equity line of credit (HELOC) or loan. The tax reform law also changed the tax benefit of such added home-related debt.
Pre-TCJA, homeowners could deduct interest paid on up to $100,000 of home equity debt, regardless of how they used the borrowed funds. Back then, HELOCs or equity loan were popular ways to pay for children’s college costs, take a special vacation, or make improvements to the property.
Now, under TCJA rules, if you use a home-base loan for anything other than upgrading your residence (or to buy or build another home), you cannot deduct the HELOC or loan interest.
Note, too, that the $750,000 limit applies on all home loans. So, if your original mortgage is $725,000 you only have a $25,000 cushion for a subsequent home-based equity loan where you can deduct the interest.
Home improvements tax breaks: Speaking of home improvements, some of these might help lower a current or future tax bill.
From the more immediate standpoint, the cost of making structural changes might be tax deductible. This usually is the case for medically necessary home improvements. For example, the cost of installing health care equipment, adding ramps to entries, or widening doorways to accommodate wheelchairs could be fully deductible in the year spent as long as the changes are required for a medical condition.
Some non-medical upgrades, notably those that make your home more energy efficient, also could offer tax savings. The Biden Administration’s Inflation Reduction Act provides a variety of tax credits when you make such changes to your existing home.
The most common one is a tax credit of up to $3,200. This includes up to $1,200 for energy property costs and certain energy-efficient home improvements, with limits on doors ($250 per door and $500 total), windows ($600), and home energy audits ($150). Another $2,000 per year can be claimed for qualified heat pumps, biomass stoves or biomass boilers
More extensive energy improvements might let you claim a tax credit of up to 30 percent of qualified expenses, which include solar water heaters and geothermal heat pumps.
Review instructions for Form 5695 to determine which home improvements qualify. And while it takes a bit more tax work, it’s usually worth it. A tax credit is a dollar-for-dollar reduction of any tax you owe, making it a better tax break than a deduction.
As for other home improvements, such as adding a room, landscaping, or updating an old kitchen or bath are not tax deductible. But these permanent changes that increase your home's value could pay off from a tax standpoint when you sell your home.
And that takes us to the ultimate homeownership tax break.
Tax-free home sale profit: Your home is a capital asset. That means when you sell it, you’ll owe capital gains tax on any profit. But homeowners can exclude from taxable income up to $250,000 if they are single home-selling taxpayers or $500,000 if married filing jointly of their home sale profit from federal tax.
Of course, it’s taxes, so there are some considerations. You can qualify for the home sale tax exclusion as long as you meet the following three conditions.
- You must own the house for at least two years. Married couples need to note who's on the deed. If it's just one spouse, then that owner must meet this ownership time. But both of you must live in the house the requisite length of time — two years — to pass this so-called use test.
- You must live in the house as your primary residence for two of five years before you sell it. The good news here is that that the two years don't have to be consecutive. But unlike the ownership rule for a married jointly filing couple, the time living there requirement applies to both spouses, even if only one is the owner.
- You haven't used this sales tax break for at least two years. This limit was created to keep house flippers from serial selling at a rapid pace and avoiding capital gains tax on their profits. And married couples again need to be careful here. If either spouse sold a home and used the capital gains tax exemption within the last two years, you can take advantage of it again on your jointly sold home.
When it comes to determining if your sale profit is tax free, those permanent improvements you made to your home come into play. They add to the home’s basis, which could reduce your taxable profit. Here’s a very simple example:
You bought your home for $250,000. A few years later, you spent $50,000 to modernize your kitchen and add another bed- and bathroom for visiting friends and family. Your adjusted basis now is $300,000.
You finally sold your home for $550,000. When you subtract your $300,000 basis from the sales price, your profit is $250,000. But thanks to the home-sale exclusion, you don’t owe any tax on that money.
Again, unless you live in a place where home prices have really escalated over a short term or you've lived in your home long enough to see significant appreciation in your home's value, staying under the $250,000/$500,000 profit exclusion amount shouldn’t be a problem. Especially if you keep good records and track of your basis-adding improvements.
TCJA’s future: One final note when it comes to the various housing tax breaks changed by the GOP tax reform bill. Those TCJA provisions expire at the end of 2025.
There’s already been much debate as to whether all or part of the TCJA should be renewed, let lapse, or continue in a modified form. That discussion will continue into 2025. Given how Congress tends to operate, the talks probably will go into late 2025.
And any changes will depend on who we voters elect on Nov. 5. You might want to keep that in mind as you go to the polls.
You also might find these items of interest:
- Comparing property taxes across the United States
- Tax difference between home repairs & home improvements
- Some home rentals are tax-free federally, but don't overlook state and local levies
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