How Mortgage Interest Deductions Can Help You Save on Taxes
Filing taxes is never what most rational folks would call “fun.” But if you have a mortgage, you could still have something to smile about. You could be getting a federal tax break in the form of a mortgage interest deduction.
The great benefit of the mortgage interest deduction is that it allows you to subtract whatever you’re paying toward mortgage interest from your taxable income. Homeowners may deduct both mortgage interest and property tax payments as well as certain other expenses from their federal income tax.
What Can You Deduct?
What you can deduct depends on your particular financial circumstances. However, in general, you can deduct any mortgage interest that you pay (up to $1 million), any interest you pay on a home equity loan (up to $100,000), any points you had to pay to get your mortgage or to pre-pay interest, and any property taxes you pay.
Other Potential Deductions
If you work from home for any part of the time, you can also deduct your mortgage expenses from your taxes. The deduction has complicated rules, but essentially, you must deduct the proportion of your mortgage that is equal to the proportion of the space you use for your work.
Because this deduction has many complex rules, it is important that you work with a certified tax professional to determine exactly what it is permissible for you to claim.
There are mortgage tax benefits calculators that can give you an idea of your expected tax savings for each individual year and for the total time you plan to stay in your home.
Generally speaking, repairs or improvements made on the home cannot be deducted; however, home improvements made can make the house last longer, change it to be acceptable for a different use, or simply increase the home’s value, resulting in the consumer’s home becoming more tax valuable if the improvement is funded through refinancing or a second mortgage.
Simply by adding features like an additional bathroom, swimming pool or covered porch, consumers can add value to their homes.
Deducting Points and Closing Costs
Closing costs are comprised of fees to process the sale, fees to check the title, points charged by the lender, fees to have the property appraised, fees to draft the contract, and fees to record the sale.
It is important to be aware of the deductibility of these fees, as some could be attributed to the cost basis of the new home, whereas some can be deducted either partially or completely on the consumer’s Federal Tax Return.
When a consumer takes out a mortgage, they are often charged costs by the lender called points. If you are interested in lowering your interst rate, you can purchase discount points. Most often, points can be deducted as long as it is within the year that you bought the home and your deductions are itemized.
The average cost to purchase point is about 1% of the loan amount, but you may be able to deduct that cost. So if you take out a $200,000 mortgage and buy one discount point for $2,000, you’d get a one-time $500 tax savings, assuming you’re in the 25% tax bracket ($2,000 x 0.25 = $500). The additional benefit to buying points is that you’ll be lowering your monthly mortgage payment because your interest rate will be lower.
Selling a Home and Capital Gains
One of the biggest tax benefits homeowners enjoy is the capital gains exclusion. Plus, they can use it more than once (but not more than once every two years) to be exempt from paying taxes on profits of up to $500,000 (filing jointly) from selling their home.
All of these benefits are worth more to taxpayers in higher-income tax brackets than to those in lower brackets.
Tax Credit for Going Green
Thinking of making your home green? If you make your home more energy-efficient by installing (eligible) windows, doors, insulation, and an efficient heating and cooling system, homeowners can potentially claim up to $500 in tax credits.