Key takeaways:
- Buying a home comes with increased tax responsibilities, such as property taxes, mortgage insurance, and capital gains tax.
- However, homeownership can also provide large tax benefits adding up to thousands of dollars, such as deductions, credits, and more.
- Tax codes change frequently, and most states have their own specific rules; do your research and talk with a certified tax professional before filing your taxes.
Buying a home is a major life milestone and can provide numerous benefits. However, along with lifestyle changes, there are important tax implications to be aware of.
Whether it’s your first time filing taxes after buying a house in Buffalo, NY or you just bought your second home in Phoenix, AZ, there is a lot to keep in mind. In this Redfin article, we’ll provide a brief overview, then review the tax benefits of owning a home, the forms you’ll need for each benefit, and more.
6 tax benefits of owning a home
One of the most exciting aspects of buying a house are the tax breaks. These range from deductions to credits and are a major plus of buying instead of renting a home.
Here’s a quick breakdown:
- Mortgage interest deduction: Homeowners who itemize can deduct interest paid on their mortgage, up to IRS loan limits
- Property tax deduction: Deducts state and local property taxes paid on a primary residence, up to $10,000 ($5,000 if married filing separately).
- Home equity loan deduction: Interest on home equity loans or HELOCs is deductible if the loan is used for home improvements.
- Home office deduction: Allows self-employed homeowners to deduct expenses for a dedicated home office space.
- Mortgage credit certificate: A tax credit for qualifying homebuyers that reduces the cost of taxes.
- Capital gains exclusions: Homeowners can exclude up to $250,000 ($500,000 for married couples) in profit from capital gains tax when selling a primary residence, if they meet ownership and residency requirements.
Let’s dive into all of the tax benefits homeowners can take advantage of when filing taxes after buying a house.
1. Mortgage interest deduction
Mortgage interest deductions are probably the most common tax benefit for homeowners. If you have a mortgage, you can deduct the interest you paid throughout the year, which can add up to thousands in savings. You can only take advantage of the mortgage interest benefit if you itemize your deduction.
The maximum mortgage principal eligible for deductible interest is $750,000, or $375,000 if you’re married and filing separately. But if your mortgage started before December 15, 2017, when the Tax Cuts Jobs Act (TCJA) was passed, the limit is higher – $1 million, or $500,000 if filing separately.
Note: If you had a binding written contract in place before December 15, 2017 to close by January 1, 2018, and you closed on the home before April 1, 2018, the IRS will treat your mortgage as if it were obtained before December 16, 2017.
As of 2022, you can no longer deduct mortgage insurance premiums.
Required tax forms:
- Schedule A (Form 1040): Section A is used to itemize your deductions. You don’t need this if you take the standard deduction.
- Form 1098: Your mortgage lender typically sends this form every January. It details how much mortgage interest you paid over the previous year, which you’ll use when filling out Schedule A.
2. Property tax deduction
Another key tax break for homeowners is the State and Local Tax (SALT) deduction, which helps offset property taxes. In short, you can deduct two of three types of taxes you paid during the year, up to $10,000 ($5,000 if filing separately).
The three types of taxes you can deduct are property tax, income tax, and sales tax. You can only deduct two of the three tax types, though, one of which can always be property tax. Here are two examples of how you can choose to deduct:
- Property taxes + state and local income taxes
- Property taxes + state and local sales taxes
If you live in a co-op (cooperative housing), you have special rules. Instead of you paying taxes directly, the co-op itself will usually pay the property tax and pass the cost on to you in your monthly fees.
Required tax forms:
- Schedule A (Form 1040): Only necessary if you’re itemizing your deductions.
- For co-ops, required co-op documentation
3. Home equity loan interest deduction
A home equity loan is a second mortgage that allows you to borrow a large sum of money against your home’s equity. Home equity is the difference between your home’s current value and the money you own on your mortgage. If you take out a home equity loan, you may be able to deduct the interest on it.
The limits are the same as the mortgage interest deduction: $750,000 of total mortgage debt if filing jointly and $375,000 if filing separately. Important note: you can only deduct interest if you use the money to buy, build, or improve your home. If you used it for debt, medical bills, or investing, the interest isn’t deductible. However, If you received your home equity loan before 2017, you can continue to claim the deduction regardless of what you use it for.
The same deductions apply to home equity lines of credit (HELOCs), too. And, since HELOCs often have lower interest rates than home equity loans, it may be the cheapest way to borrow large sums of money.
Tax form:
- Schedule A (Form 1040): For itemizing your deductions.
4. Mortgage credit certificate
The Mortgage Tax Credit Certificate (MCC) is a program offered through state or local housing finance agencies. Its primary goal is to increase access to homeownership for low to moderately low income first-time homebuyers. The MCC is not available in every state.
The MCC allows qualifying homebuyers to convert up to $2,000 of their mortgage interest into a dollar-for-dollar tax credit. Unlike a deduction, which reduces taxable income, a credit directly lowers your tax bill.
An MCC will typically only cover a percentage of your annual mortgage interest, but you can usually claim the credit every year. You may still be able to deduct the remaining interest on Schedule A. You can carry over unused MCC credit to future years, too.
Note: You need to apply for an MCC at the time you bought your home; it’s not something you can claim after the fact.
Tax Forms:
- Schedule A (Form 1040): For itemizing your deductions.
- Form 8396: Available on the IRS website, this form is where you claim the mortgage credit certificate.
5. Capital gains exclusions
When it comes time to sell your home, you can generally exclude up to $250,000 of capital gains ($500,000 if filing jointly) from your taxable income – provided you’ve owned and lived in the home for at least two out of the last five years. If your gains exceed those amounts, you’ll owe capital gains tax on the difference. If you did not make a profit on the sale of your home, you cannot deduct anything.
You may be able to lower your taxed gains by increasing your home’s “cost basis” – the original price you paid for the property. Certain closing costs and qualified home improvements can be added to this amount. Since a higher cost basis means a lower taxable profit, this can help you stay under the capital gains exclusion limit or reduce the tax you owe. Be sure to check IRS guidelines or consult a tax professional to confirm which costs qualify.
If you don’t qualify for the capital gains exclusion – perhaps you didn’t live in your home for at least two out of five years – you can still qualify for a partial exclusion.
Tax forms:
- Schedule D (Form 1040): If you sell your home, this is where you report any capital gains (or losses).
- Form 8949: You may need this form to report additional information related to investments or renovations.
6. Home office deduction
If you use part of your home exclusively and regularly for business, you may qualify for the home office deduction. This applies to self-employed individuals and small business owners; you may not be a W-2 employee reporting to someone else, unless you’re an independent contractor.
In order to claim the deduction, your home office must meet two criteria:
- Exclusive and regular use: The workspace must be used regularly and exclusively for conducting business. You can’t also use it as a gym or for other personal use.
- Principal place of business: The home office should be your primary place of work, or a place where you regularly meet with clients or patients.
There are two ways to calculate the deduction, each with their own benefits:
- Simplified method: Deduct $5 per square foot of your office space, up to 300 square feet (a maximum of $1,500).
- Regular method (aka “standard” or “actual expense” method): Deduct a portion of mortgage interest, utilities, home insurance, and other costs based on the percentage of your home’s square footage used for business.
The regular method can yield a larger deduction but requires detailed recordkeeping. With both methods, the deduction cannot exceed your business’s net income after expenses.
Tax forms:
- Form 8829 + Schedule C (Form 1040): For the regular method, Schedule C is where you report the deduction from Form 8829 if you’re self-employed. It also covers business income and other business-related expenses.
- The simplified method only requires Schedule C.
3 homeownership tax benefits that require an investment
There are ways to invest in your home to get even more benefits. Many involve upfront costs, but could pay off over time through tax credits and deductions.
1. Renewable energy credits
Solar energy is booming and accounted for over half of all new electricity on the grid last year. Part of the reason for its success is the tax credit or exemption people can claim when installing them, which provides a major incentive. Plus, it’s a clean, green energy source.
The primary solar benefit is called the Investment Tax Credit (ITC) – often referred to as the Residential Clean Energy Tax Credit – provides a 30% federal tax credit for the cost of installing solar panels on a home. The full credit lasts until 2032, before it decreases to 26% in 2033 and 22% in 2034. It is nonrefundable and has no limit, except for fuel cell property.
Other renewables like geothermal heat pumps, small wind turbines, and biomass stoves also qualify for federal tax credits, typically at the same 30% rate through 2032. Specific limits may apply.
Some states offer additional credits and exemptions, but these vary widely and can change with new legislation. For example, Washington State offers a sales tax exemption on the purchase of new solar energy systems, through 2029. Importantly, renewable energy tax credits could change or disappear under the Trump Administration.
Tax forms:
- Form 1040: The standard individual income tax form
- Form 5695: If you install renewable energy systems, use this form to claim federal energy credits.
- Additional state-specific forms
2. Home improvement credits
Home improvements can be expensive and time-consuming, but they’re often worth it in the long run: they add value to your home and may help reduce capital gains taxes when you sell. In order for a home improvement to count towards a tax benefit, it must be a “capital improvement”. The IRS defines capital improvements as:
- Tangible: It must be a physical, long-lasting change rather than routine maintenance, usually involving structural alterations or major renovations.
- Value-adding: It increases your home’s market value and/or substantially enhances its functionality, like installing solar panels or adding a home office.
- Life-extending: It prolongs the useful life of your property or adapts it to new or different uses, such as making it earthquake resistant or adding medical upgrades.
Now for tax benefits. Let’s say you sell your principal residence and your net profit is over $500,000 (filing jointly) or $250,000 (for single filers). In that situation, you’d generally owe capital gains tax on the amount above those thresholds.
For example, if you bought a home for $300,000 and spent $50,000 on renovations, your adjusted cost basis becomes $350,000. When you sell, your gain is then calculated from $350,000 instead of $300,000, potentially reducing or eliminating capital gains tax.
Importantly, you must have lived in the home for at least two years, and there are exceptions for things like inherited properties and rented homes.
Tax forms:
- Schedule D (Form 1040): Schedule D is where you summarize these gains (or losses) on your annual tax return. If you’ve increased your cost basis by documenting eligible home improvements, you’ll account for that higher basis here, reducing your taxable gain.
- Form 8949: If you need to provide more detailed information about your home sale, like cost basis adjustments, you’ll first fill out Form 8949
- Others for self-employed individuals, medical upgrades, and rental improvements
3. Rental deductions
Renting out a spare room, garage apartment, or basement can be a great way to generate income, but it also comes with tax considerations.
When you rent out part of your primary residence, you typically need to allocate expenses – like mortgage interest, utilities, and property taxes – between personal and rental use based on the portion of the home you’re renting. You can deduct most of these expenses – what the IRS calls ordinary and necessary – along with expenses paid by the tenant.
You can also deduct expenses for managing, conserving, and maintaining your rental property, including maintenance and repairs. However, you can’t deduct the cost of improvements unless they are a qualifying capital improvement.
Note that turning your home into a rental may require renovations, which may add to your home’s cost basis and help offset capital gains tax if you sell.
Tax form:
- Schedule E (Form 1040): If you rent out part (or all) of your home, you’ll use this schedule to report rental income, expenses, and depreciation.
Should I choose the standard deduction or itemize?
For most taxpayers, the standard deduction provides the biggest tax benefit with minimal paperwork. If your itemized deductions don’t exceed the standard deduction for your filing status, taking the standard deduction generally results in a larger overall write-off.
However, itemizing may be beneficial if you own a home and pay mortgage interest and property taxes, have high medical expenses, pay significant state and local taxes, or make substantial charitable contributions. If you’re unsure which option provides the greatest tax benefit, consider running the numbers or consulting a tax professional.
What if I purchased a second home?
Many tax benefits extend to a second home but are usually lumped together with the primary residence. Investment properties (aka rental property) have separate rules.
You may still deduct mortgage interest on a second home, but the overall limit ($750,000 if after 2017, $1 million before 2017) applies to the combined total of both your first and second home loans. For State and Local Taxes (SALT), you can deduct up to $10,000 between both homes (there is a $10,000 cap per return).
If you plan to rent out your second home for more than 14 days, you’ll need to report any rental income and related expenses on Schedule E (Form 1040). Anything fewer than 14 days and you can pocket the rental income tax-free. You can still deduct expenses like you would with a single home.
For capital gains, a second home does not qualify for the $250,000/$500,000 exclusion unless you have lived there as your primary residence for at least two of the last five years. If you don’t meet this requirement, you may still be eligible for a partial exclusion in certain cases, such as selling due to unforeseen circumstances.
The bottom line of homeownership tax benefits
When it comes time to file taxes after buying a house, there is a lot to know. Your tax process immediately changes, with more benefits available than if you were a renter. From mortgage interest deductions to home improvement credits, you can now save thousands per year.
To make sure you can claim all the tax breaks you’re eligible for, consider setting up a system to track and itemize every possible deduction throughout the year. You can always choose the standard deduction if you discover that itemizing doesn’t pay off.
It may be a good idea to hire a certified tax advisor or preparer, especially if you’re unsure. Tax laws and deductions can be complex, often vary by state, and are always changing, which can make it difficult to understand.
