From mortgage points to PMI, unlock the essential info about how homeownership affects your tax burden.
Hours after we closed on our first house, my husband and I sat in our empty new living room and stared at the walls. He was the first to speak, saying simply, “I thought it was painted.”
We learned a lot about that old house over the next 15 years. While we knew to expect some of the work, other tasks, such as needing to paint the walls, we figured out as we went along. One of the changes we didn’t anticipate was needing to make some adjustments to our tax forms.
The forms you fill out when you buy your house are just the beginning. We quickly understood that first-time homeowners have years of mortgage and insurance paperwork to look forward to. Then, of course, there are the taxes. To help you sort through that pile of paperwork and ensure you’re saving as much money as possible we did some research into tax benefits that can come from buying.
Six Tax Benefits for New Homeowners
1. You can deduct the interest you pay on your mortgage.
The home mortgage interest deduction is probably the best-known tax benefit for homeowners. This deduction allows you to deduct all the interest you pay toward your home mortgage with a few exceptions, including these big ones:
- Your mortgage can’t be more than $1 million.
- Your mortgage must be secured by your home (unsecured loans don’t count).
- Your mortgage must be on a qualified home, meaning your main or second home (vacation homes count too).
Don’t assume that if you are married and file a joint tax return, you have to own your home together to claim the interest. For purposes of the deduction, the home can be owned by you, your spouse, or jointly. The deduction counts the same either way.
And don’t worry about keeping track of how much you’re paying in interest versus principal each month. At the end of the year, your lender should issue you a form 1098, which reports the amount of interest you’ve paid during the year.
Warning: Since, as a first-time homeowner, you pay more interest than principal in the first few years. That number can be fairly sobering.
2. You may be able to deduct points.
Points are essentially prepaid interest that you offer upfront at closing to improve your mortgage rate. The more points you pay, the better deal you get.
You can deduct points in the year you pay them if you meet certain criteria. Included in the list (and it’s a long one): Points must be paid on a loan secured by your main home, and that loan must be to purchase or build your main home.
Pro tip: Points that you pay must also be within the range of what’s expected where you live — unusual transactions may cause you to lose the deduction.
3. Depending on the year and your income level, you may be able to deduct PMI.
Private mortgage insurance, or PMI, protects the bank in the event you default. PMI may be required as a condition of a mortgage for first-time homebuyers, especially if they can’t afford a large down payment.
For most years, PMI is not generally deductible, but the specific rules around it change annually. In 2016, if you made less than $109,000 a year as a household, you could claim a tax deduction for the cost of PMI for both their primary home and any vacation homes. Check to see if the PMI deduction is a possibility as you are working on your taxes.
Questions? Ask a Local Lender
Discuss your home loan options with a lender near you.
4. Real estate taxes are deductible.
Real estate taxes are imposed by state or local governments on the value of your property. Most banks or other mortgage lenders will factor the cost of your real estate taxes into your mortgage and put those amounts into an escrow account.
You can’t deduct the amounts paid into the escrow, but you can deduct the amounts paid out of it to cover the taxes (you’ll see this amount on a form 1098 issued by your lender at the end of the year).
If you don’t escrow for real estate taxes, you’ll deduct what you pay out of pocket directly to the tax authority.
And don’t forget about those taxes you paid at settlement. If you reimburse the seller for taxes already paid for the year, you get to deduct those too.
Those amounts won’t show up on a form 1098; you’ll need to check your settlement sheet for the totals.
5. Your other tax deductions may matter more.
To take advantage of these tax benefits, you have to itemize your deductions on your tax return.
For most taxpayers, this is a huge shift: in many cases, you’re moving from a form 1040-EZ to a form 1040 to list expenses on Schedule A.
In addition to interest, points, and taxes, Schedule A is where you would report deductions for charitable donations, medical expenses, and unreimbursed job expenses.
For itemizing deductions to make good financial sense, you generally want to have more total deductions than the standard deduction (for 2015, it’s $6,300 for individuals and $12,600 for married couples). Most taxpayers don’t reach those numbers — unless they’re homeowners.
The home mortgage interest deduction, in particular, tends to tip most homeowners over the standard deduction amount, making those other deductions (such as medical expenses) that might otherwise go unclaimed more valuable.
6. You’ll get capital gains tax relief down the road.
I know you just bought your home, but admit it: Resale value is something you considered when you chose your home. And different from other investments for which you’re taxed on the full value of any gain, you can exclude some of the gain attributable to your home when you sell.
Under current law, you can avoid paying tax on up to $250,000 of gain ($500,000 for married filing jointly) so long as you have owned and lived in the property for two of the last five years (those years of owning and inhabiting don’t have to be consecutive).
Gain over that amount is taxed at capital gains rates, which are generally more favorable than ordinary income tax rates.
Originally published September 16, 2015. Updated September 1, 2017.