A Realistic Look At Homeowner Tax Breaks

A Realistic Look At Homeowner Tax Breaks

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By Bill Bischoff

Thinking about purchasing your first home? Then you’re probably well aware of the potential tax breaks coming your way.

In case you’re not, let’s review. While the cost of renting is generally a nondeductible expense (except for when part of the home is used for business purposes), homeowners can claim an itemized deduction for interest on up to $1 million worth of mortgage debt used to acquire or improve their principal residence. Ditto for interest on up to $100,000 of home-equity debt secured by their principal residence. Real estate property taxes can be claimed as an itemized deduction, too. You also can generally deduct any points you paid (or the seller paid on your behalf) to take out the mortgage.

But you probably knew all that, right? Don’t worry: What’s detailed below probably won’t have you running back into the arms of your landlord. But it just might give you a more realistic expectation of how homeownership will affect your future tax bills.

  The standard-deduction factor

The first thing to understand is that your actual tax breaks from home ownership may be less than expected if you were claiming the standard deduction before you bought. Why? Because the standard deduction is a tax-law freebie. You don’t need to have any personal deductions whatsoever to claim it. For 2017, the standard deduction amounts are $12,700 for joint filers, $6,350 for singles, and $9,350 for heads of households.

When your itemized deductions are less than the standard deduction, you simply forgo itemizing and claim the standard allowance instead. Many folks are in this situation until home ownership triggers deductions for mortgage interest and property taxes. Those write-offs — when added to other itemized deductions for state and local income taxes, personal property taxes, and charitable donations — are usually enough to exceed the standard-deduction amount.

The question is: How much of a tax break did you really reap from your home ownership write-offs? For example, say you’re married and would have claimed the joint standard deduction of $12,700. Then you buy a house and pay $12,000 a year for mortgage interest and $2,500 for property taxes. On first blush, you might think you’ve just lowered your taxable income by a whopping $14,500 ($12,000 + $2,500). Not so fast! Assume you also pay state income taxes of $2,000 and contribute $500 to charities. So your total itemized deductions add up to $17,000 ($12,000 + $2,500 + $2,000 + 500). That’s only $4,300 above the $12,700 standard deduction you would have claimed in the absence of buying a home. So you only netted $4,300 in additional write-offs vs. the $14,500 you might have expected.

Now, if you were already itemizing before you bought or were very close to doing so, your additional deductions from mortgage interest and property taxes will reduce your taxable income dollar for dollar (or nearly so). The point is: Be sure to consider the standard-deduction factor when calculating your anticipated tax savings. That way, you won’t be shocked by an unforeseen tax bill next April.

The home-equity-loan factor

Once you’re ensconced in your new home, you may decide to take out a home-equity loan. As mentioned above, you can generally claim an itemized deduction for interest on up to $100,000 worth of home-equity debt.

A cause for concern is the rule that disallows any alternative minimum tax, or AMT, deduction for home-equity-loan interest unless the loan proceeds were used to buy or improve your property. For example, say you take out a $50,000 home-equity loan and use the money to pay off a car loan and some credit-card balances. For regular tax purposes, that’s fine. You can deduct the home-equity-loan interest on Schedule A, along with the interest on your first mortgage. However, if you’re in the AMT mode, you can’t deduct any of the home-equity-loan interest in calculating your AMT bill. Note that one of President Trump’s tax proposals would abolish the AMT, which would eliminate this consideration. That said, believe the AMT is gone when you see it here.

On the other hand, if you spend your $50,000 home-equity-loan proceeds on a new pool and covered patio, you’re good to go for both regular tax and AMT purposes.

Home sweet home

Now you know some the homeownership tax angles that your realtor was afraid to reveal. Still, buying a home usually works out to be at least a decent proposition tax-wise. And it will be much better than decent if you eventually sell for a big tax-free gain down the road. If you’re married, you can potentially rake in a federal income-tax free profit of up to $500,000, or up to $250,000 if you’re unhitched. Now that’s a sweet deal!

This story has been updated.

Steve Coale Headshot
Phone: 561-702-9837
Dated: March 1st 2017
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