How to make the most of tax deductions for homeowners
As the homeownership rate has declined slowly since peaking in 2006 at almost 70 percent, the tax benefits of owning a home have also declined. In 2006, more than 40 million homeowners deducted $443 billion in mortgage interest. But in 2014, 33 million homeowners deducted just $287 billion in mortgage interest and almost $6 billion in mortgage insurance premiums.
With fewer homeowners claiming fewer tax benefits, the tax advantages of homeownership are changing again. Changes to the mortgage interest tax deduction and the cap on certain itemized deductions, including real estate taxes, could alter the tax benefits of owning a home. Here is a look at tax breaks homeowners can take advantage of to make sure they get the most out of homeownership at tax time.
Tax tip for homeowners #1: itemize all possible deductions
Taxpayers only benefit from itemizing if their itemized deductions are bigger than the standard deduction. The standard deduction for 2017 is $6,350 for single taxpayers and $12,700 for married taxpayers filing jointly. But the standard deduction increases to $12,000 for single taxpayers and $24,000 for married taxpayers filing jointly in 2018. This increase could mean that fewer taxpayers will have enough itemized expenses to make itemizing worthwhile. In addition, starting on their 2018 tax returns, taxpayers are limited to deducting no more than $10,000 in all state and local taxes combined. That includes property tax, real estate tax, income tax and sales tax.
If they itemize, taxpayers can deduct mortgage interest on up to two homes: one primary and one second home. For mortgages taken out on or before Dec. 15, 2017, interest on up to $1 million in acquisition debt qualifies for deduction. Mortgages taken out after Dec. 15 are limited to $750,000 for the mortgage interest tax deduction.
Once itemizing is worthwhile for taxpayers, they can also deduct other qualifying expenses, like:
- charitable donations,
- personal property tax,
- state and local income taxes or sales taxes,
- medical expenses (exceeding 7.5 percent of adjusted gross income) and
- employee business expenses and other miscellaneous expenses (exceeding 2 percent of adjusted gross income) in 2017.
Even if the individual expenses are small, adding them all up can make a difference to the taxpayer’s bottom line and be well worth the extra recordkeeping. For example, a taxpayer with a marginal tax rate of 25 percent could save up to $25 for every extra $100 they can itemize.
Tax tip for homeowners #2: keep records for eventual sales
When the time comes to sell a home, taxpayers could find their gain from a sale taxed. But taxpayers can decrease or eliminate that tax if they can show they gained less than certain amount. If the seller owned and used the home as a main residence for at least two of the past five years before selling it, they can usually exclude up to $250,000 ($500,000 for joint filers) of the gain from taxable income.
Most people will of course have their HUD or closing disclosure statement showing their original cost, but they also need to keep records of substantial improvements and their costs. To qualify for this tax benefit of homeownership, an improvement must add to the value of the home, prolong its life or adapt it to new uses. Maintenance costs, such as painting the home, do not count as upgrades increasing a homeowner’s basis.
For example, a couple who files jointly bought a home for $50,000 in 1965 and sold it for $700,000 in 2017. They used the home as their main residence for the entire time. The gain is $650,000. They can exclude $500,000 but $150,000 is taxable. Now suppose that over the years they remodeled their kitchen and two bathrooms for a total cost of $100,000. That brings their basis up to $150,000, their gain down to $550,000 and their taxable gain down to $50,000. If they also had records of $50,000 in expenses finishing the basement and installing a new furnace and air conditioner, they would have no taxable gain.
While the gain on the sale of a house can be taxed, the loss on the sale of a personal residence is not deductible.
Tax tip for homeowners #3: make working at home work on the tax return
Taxpayers who work from home, including employees who work from home for the convenience of their employer, may be able to claim a home office deduction. If they qualify, they could either deduct actual expenses based on a percentage calculation of how much space the office takes up of the home or they could deduct $5 a square foot for up to 300 square feet, maxing out at $1,500. This safe harbor calculation doesn’t require tracking home expenses individually and adding them up, so it is convenient for most taxpayers.
Either way, the office would need to meet a few criteria to qualify. First, the taxpayer must use the office regularly and exclusively for business. That means the taxpayer must not use the area – whether a separate room or a corner or portion of a room – for personal reasons. The taxpayer must also use the office only for business.
If the home office qualifies, all expenses directly related to the room are deductible, such as painting or decorating. Additionally, general expenses that apply to the house as a whole, such as mortgage interest, utilities and insurance, should be prorated based on the square footage used for the office relative to the home’s total living space. They can also depreciate their home office.
For example, if the office is 200 square feet and total living space is 2,000 square feet, the taxpayer can deduct 10 percent of mortgage interest, homeowner’s insurance, utilities and other eligible expenses on Schedule C if they are self-employed. If they are an employee working from home for the convenience of their employer, they could deduct their 2017 expenses that exceed 2 percent of their adjusted gross income on Schedule A. Or they could deduct $1,000 using the safe harbor calculation. Keep in mind that 2017 is the last year in which unreimbursed employee business expenses are deductible.
Homeownership can add some complexity to taxpayers’ financial lives, but the tax benefits of owning a home can also open up hundreds or thousands of dollars in savings. Taxpayers can learn more about tax deductions for homeowners and other tax situations they may face, like taxes on forgiven mortgage debt and deciding to rent out their home.
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