Owning a home carries several tax implications that you should know about before you decide to buy. The U.S. Tax Code provides a few tax benefits, including reducing your tax obligations to the IRS for buying and fixing up your home. Take a look at the following examples.
Mortgage Interest Deduction
Mortgage interest often constitutes a substantial portion of home ownership costs, yet it can also offer a tax advantage. If you itemize your tax deductions, you can lessen your annual tax liability through the mortgage interest tax deduction.
This deduction permits you to reduce your taxable income by the interest paid throughout the year on up to $750,000 of mortgage debt or $375,000 if you are married and filing separately. While there are caps on the deduction, it can serve as an effective strategy to decrease your annual tax burden.
Homeownership involves paying property taxes to local government entities or organizations in many regions. If you are required to pay these taxes, you can deduct them from your annual tax bill, provided you itemize your deductions. If you itemize your deductions, consult with your tax preparer to discuss any property taxes you have paid over the year.
Home Office Deduction
If you are self-employed and use part of your home exclusively or primarily for business purposes, you may qualify for the home office tax deduction. This deduction allows you to subtract a portion of your mortgage, insurance, and utility costs related to the designated office space from your taxable income, but only if you itemize your deductions on your annual tax return.
To be eligible, you must use this space regularly for business activities, such as meeting clients or conducting business operations.
Home Improvements and Energy Tax Credits
In some instances, enhancing your home elevates your living standards and promotes environmental conservation. The government encourages such eco-friendly initiatives by offering renewable energy tax credits, potentially reducing your tax bill. For instance, installing a solar energy system or upgrading to energy-efficient heating and cooling systems can qualify you for these deductions.
Moreover, if you undertake medically necessary home improvements, such as installing medical equipment for a bed-bound individual or making the home wheelchair accessible, you may deduct these expenses as medical deductions in your tax return for that year. The improvements must benefit you, your spouse, or dependents residing with you full-time to qualify for this deduction.
Capital Gains Exclusion
When you sell your home, you must consider potential capital gains, representing the increase in your home's value over time. Fortunately, if you have owned the home for a sufficient period, you can exclude up to $500,000 of the capital gains from your taxes. This exclusion means you don't have to report up to $500,000 of the profit as earned income the year you sell the home, lowering your tax liability for that year.
Tax Implications of Renting Out Your Home
If you decide to rent out your home, you'll need to inform the IRS of your income, as there are some tax implications to the cost of owning, maintaining, and operating the property. If you are a rental property owner, you can still take some deductions from the rental income you are paid by your tenant, including any costs associated with mortgage interest, operating expenses for the property, depreciation, updates, and repairs associated with the property, and property tax.
That also includes taking deductions for any ordinary and necessary expense that applies to the cost of managing the rental property, maintaining it, or conserving it, including interest, taxes, maintenance, advertising of available properties, insurance, and utilities.
The Importance of Record Keeping
While all of these tax deductions are a good thing, and they can reduce your taxes consistently, you have to be able to show proof of what you've spent money on to qualify for the tax deduction. That is why having a method for tracking your expenses is critical.
Establish an electronic or written record of all the money you spend on your home, including costs related to any of the above. Keep all receipts associated with those payments as well.
Owning a home comes with many costs, but tax deductions aim to make homeownership more affordable for many people. Without a doubt, having a way to lower your tax obligations is a good thing, but make sure you are working with a tax professional who can help you learn what your savings opportunities are.
Also, tax law changes frequently, and what are eligible tax deductions today may not be available in the future if tax codes change.