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Understand Your Tax Write-Offs
More than 75 years ago, the U.S. government decided to award homeowners a lucrative tax break and permit them to deduct home loan interest from personal taxable income. Most states that have income taxes permit the same deduction. This benefit is particularly useful to first-time home buyers because during the early years of the loan, most of each monthly payment goes to pay deductible interest, rather than principal. For example, at the end of the first year of a 30-year fixed mortgage at 8 percent, less than 1 percent of the principal is repaid. As you continue to pay on an amortized loan, more of each monthly payment goes to pay principal, and less goes toward interest. You progressively lose some of your interest write-off as you build equity in the property.
What's Deductible?
- Interest on your mortgage. Whether you pay it to a lender or to a home seller or other party, interest on your mortgage is deductible as long as it's for debt secured by real property. Interest is deductible on a second or home equity loan up to $100,000.
- Property taxes. Your property taxes are completely deductible, but special government fees such as water or sewer assessment may not be.
- Loan points. The IRS ruled in 1995 that a buyer may deduct points paid at the time of purchase, even if the seller paid them. If you bought a house after December 31, 1990, and the seller paid points for you that you didn't deduct, you may be entitled to an unexpected refund. If you qualify for such a refund, file an amended return on Form 1040X, available at your local IRS office. Write "seller-paid points" in the top right-hand corner of the form and attach a copy of your closing settlement sheet (called a HUD-1 Settlement Statement).
What Isn't Deductible?
- Homeowner’s insurance
- Fire insurance premiums
- Title or mortgage insurance
- FHA mortgage insurance premiums
- Principal payments made on your mortgage
- Utilities, such as gas, electricity, water or trash collection
- Homeowners’ association/co-op dues and fees
- Loan processing fees
Are Home Improvements Deductible?
Not now, but when you SELL your house, home improvements can help you lower your taxes. Save receipts for whatever you spend to fix up, expand, or repair your house including:
- Landscaping
- Additions
- Storm windows
- Driveway
- Fencing
- Electrical updates
- Deck
How do these improvements lower my taxes?
If you make a profit when you sell your house, you need to pay taxes on any capital gain above certain amount. ($250 K for an individual or $500 for a married couple filling jointly)
So what’s a capital gain? Well, you take everything you paid for the house— the original purchase prices, sales taxes, fees, and so on— to get a grand total, which is known as the “cost basis.” Then compare your cost basis with the money you get for the house. If you’ve made a profit, that gain may be taxable—if it is more than $250,000 for an individual, or $500,000 for a married couple filing jointly. (Sadly, if you lose money on a house, your loss is not deductible).
If you save your receipts from home improvements, you can ADD all those expenses to your costs basis. Therefore, according to the government, the profit you made from selling your home is reduced- so likewise- your taxes will be reduced accordingly.
Example:
- If you buy a house…
- Make home improvements/addition…
- When you sell, you will be taxed on any profit over $250K.
- But you can deduct all improvements from your profit.
Tips:
- Make a special folder to save all your receipts and records for any improvements you make to your home.
- If you’ve lived in your house for many years, and if area housing prices have been gradually going up, over all those years, you may be facing a fairly large gain that would be minimized by including the improvements in the cost basis of the house.
- If you operate a business from your home or rent a portion of your home to someone, you may be able to deduct part of your home improvements as business expenses through depreciation.
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Lets say your mortgage interest payments are $6,740 for the first year. This is tax deductible. In addition, deduct your property taxes and purchase points. So in this instance, that’s a savings of $9,240.
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