Mistake to Avoid: Not Understanding Home Ownership Tax Implications

Owning a home can provide financial and income tax benefits as well as emotional satisfaction. While a home is usually viewed as shelter and a place to live, for decades, many homeowners saw the value of their homes rise significantly. These homeowners reaped the gains when they sold their homes. Since most homeowners use mortgages to finance a portion of the cost of the home, the gains were leveraged even more. But remember that home values do not always rise.

model home on table next to a calculator

Income Tax Benefits

The income tax laws provide special breaks for homeowners. These breaks are in the form of tax deductions for mortgage interest and property taxes and preferential treatment of gains when the home is sold. As always, you may want to consult with your tax advisor to get a complete understanding of how the tax laws may apply to your situation.

Benefits from Deductions

Some taxpayers will find that the interest on their mortgage and the annual property taxes they pay are large enough to enable them to itemize their deductions instead of using what is commonly referred to as the "standard deduction." However, beginning back in 2018, the deductions for some mortgage interest and state and local taxes were limited. The standard deduction for single filers on their 2021 tax return is $12,550 and $25,100 for joint filers..

Be sure to keep track of when you pay your property taxes. Some areas have due dates close to the end of the year and you must have paid the tax by December 31 to get the deduction.

Since the passage of the Tax Cuts and Jobs Act (TCJA), property tax is still deductible, but subject to limitations. For 2018 through 2025, taxpayers can deduct a maximum of $10,000 of a combination of property taxes, state and local income taxes and sales taxes.

Prior to the passage of the TCJA, interest on home equity debt was also generally deductible. But under the TCJA, for tax years beginning after December 31, 2017 and before January 1, 2026, there's generally no longer a deduction for this type of home equity loan interest. The elimination of the deduction applies regardless of when the home equity debt was incurred. However, the IRS issued a clarification stating that under the new law, interest on a home equity loan that is used to substantially improve a taxpayer's home is still typically deductible, while interest on the same loan used to pay personal living expenses, such as credit card debts, is not. Consult your tax advisor about your situation.

Benefits on the Sale of Your Home

The law now generally allows a married couple filing a joint tax return to exclude up to $500,000 of gains on the sale of their home. For single return filers the limit is $250,000. You must have lived in the home as your principal residence for at least two of the five years before the sale. You can claim this benefit every two years. There are some special rules if you do not meet that requirement for job changes or health reasons. Consult your tax advisor for more details.

Summary: The tax benefits of home ownership can be significant. Be sure to keep good records about the purchase price and any improvements you make to the home. Pay attention to when you make property tax and mortgage payments to ensure they fall into the year you want to take them as itemized deductions. Finally, if you have special circumstances (including a potential large gain if selling your home), be sure to get expert advice to help you get the maximum benefits you are allowed under the tax laws.

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