The Homeowner's Guide to Tax Deductions
When it comes to filing your taxes, owning a home has historically been a huge benefit. However, the recent tax law changes have left many homeowners wondering what is still available for mortgage interest, mortgage points, property taxes, and other deductions. So, how do you make the most of your deductions?
Of course everyone's financial situation is different, so make sure you consult with a tax advisor before making any major decisions about your taxes. * But you can begin doing your own research by reviewing each of these potential deductions, understanding what it takes to qualify, and learning the relevant tax laws that may affect your 2018 taxes.
Mortgage and HELOC Interest Deductions Changes
In order to claim any of the deductions mentioned in this guide, you have to itemize your deductions by filing a long-form 1040 tax return and attaching Schedule A. Rather than simply taking the standard deduction, itemizing your deductions gives you the opportunity to write off much more than just home mortgage interest and other home related expenses; you can deduct certain medical expenses, charitable contributions, and many other costs. As long as your total itemized expenses exceed the standard deduction amount, you will do yourself a financial favor by itemizing.
The standard deduction itself, however, is worth a closer look under regulations implemented last year. The Tax Cuts and Jobs Act (TJCA), which was signed into law on December 22, 2017, almost doubled the standard deduction for the 2018 tax year. The standard deduction increased from $6,200 to $12,000 for individuals, and from $12,400 to $24,000 for married couples filing jointly and surviving spouses. The standard deduction is now $18,000 for heads of household under the law.
Due to this change, more taxpayers are expected to take the standard deduction for their 2018 taxes, leaving fewer homeowners to itemize and take the mortgage interest deduction on their annual taxes. However, it's well worth your time to crunch the numbers for your mortgage to make sure you're not leaving money on the table come tax time.
Ryan McDonell, CPA and tax manager at O'Connor & Drew, focuses his work on tax research, high net worth individuals, and small businesses. He agrees that many homeowners need to plan carefully in order to evaluate whether or not to take the standard deduction.
The recent tax reform changes make it more difficult for current and prospective homeowners to benefit from paying real estate taxes and mortgage interest on their 2018 tax returns. This increased difficulty can be attributed in part to the nearly-doubled standard deduction, the $10,000 cap on state and local taxes, and the limited deductibility of mortgage interest on debt entered into [after December 14, 2017] exceeding $750,000.
Tax planning is more important now than ever before for some filers, as practitioners and taxpayers alike look to strategize and find a way for itemized deductions to be a feasible option.
What if I Still Plan to Itemize?
For those homeowners who still plan to itemize, there are additional changes that may impact what and how much you can deduct. The mortgage interest tax deduction is one of the most popular itemized deductions for homeowners, and the IRS still allows homeowners to deduct interest paid on their mortgage, as well as interest on home equity debt, up to certain limits.
Formerly, homeowners could deduct all of their interest on mortgages up to $1.1 million in value if filing jointly, or up to $500,000 for individuals.
Under the Tax Cuts and Jobs Act, however, borrowers can only deduct mortgage interest on mortgages up to $750,000 (if married and filing jointly) or $375,000 (if filing as an individual). And you can only deduct mortgage interest on the loan for your primary residence, not a second home
The new tax act also eliminated the home equity interest deduction (even for existing loans). Unless new legislation is signed, these changes—the reduced cap on the mortgage interest deduction and the elimination of the home equity interest deduction—will expire in 2026.
Homeowners that itemize with mortgages of less than $750,000 on their primary residence will not see a change in the mortgage interest deduction as a result of the new law. However, if you own a home worth more than $750,000, are considering upgrading to a home of that value, or are considering a new home equity line of credit, you should keep these changes in mind in order to avoid a larger tax burden.
In addition, even if your mortgage is less than $750,000, it's important to remember that changes to the standard deduction and property tax deductions may still affect your overall tax burden.
Steven Albert has been a public accountant since 1975. He is the director of tax services at Glass Jacobson, working with estate, divorce, and retirement planning; the purchase, sale, and liquidation of businesses; and individual and business taxation. Here are the dates and numbers that homeowners need to know regarding the changes to the home interest tax deduction:
Home buyers who are planning to file their taxes soon should be aware of a few changes in America's tax laws. For mortgages obtained after December 14, 2017, interest can only be deducted on the first $750,000 of debt. Loans taken out on that date and before are grandfathered in for up to a $1 million. Second homes are still eligible for mortgage interest deductions, but now have the $750,000/$1 million limits mentioned above.
Vincenzo Villamena is the managing partner of the CPA firm Global Expat Advisors, a boutique CPA firm specializing in tax preparation for entrepreneurs, U.S. expats and other people in unique financial situations. He has specific advice for homeowners with very large home loans.
With the new, larger standard deduction, the mortgage interest deduction becomes less common and less important. Furthermore, for people with big mortgages, the interest on a loan over $1M USD [or over $750,000 for loans taken out after Dec.14, 2017] is not deductible. So for example, if someone has a mortgage of $1.5M and they have interest of $10k, then only two thirds of that will be deductible.
Logan Allec,CPA and creator of the personal finance blog Money Done Right,after spending nearly 10 years as a tax adviser helping big businesses save money, launched Money Done Right in 2017 with a goal of helping others make more money via passive income streams. Here are the details that he wants homeowners to know about the elimination of the separate home equity line of credit deduction:
Under the old tax law, taxpayers who itemized their deductions could deduct the interest on a home equity line of credit (HELOC) and deduct all of the interest paid on it for a loan balance up to $100,000. In the past, it didn't matter what you used the HELOC proceeds for; the interest was deductible.
Now, however, any HELOC balance is simply applied to the $750,000 mortgage limitation, and interest on a HELOC is deductible only to the extent that the proceeds are used to improve your home.
Take a look at our guide to HELOCs and other second mortgages for more info on these types of loans.
Mortgage Insurance Premium Tax Deduction
Homeowners who tender a down payment of less than 20% or obtain a government-backed mortgage (such as an FHA loan) are often required to have mortgage insurance. Mortgage insurance is designed to give lenders more flexibility to safely offer loans to people who can't make a large down payment, but it comes with the additional cost of a monthly mortgage insurance premium.
Happily for homeowners with mortgage insurance, these premiums are tax-deductible in certain situations. Even with the new changes, homeowners can still claim a mortgage insurance premium tax deduction if:
- The loan was taken out on or after January 1, 2007.
- The loan was taken out for home acquisition debt on a first or second home or a refinance loan up to the amount of the original mortgage.
- Your adjusted gross income is $109,000 or less.
Homeowners with an annual income of $100,000 or more should note that the deduction decreases for every $1,000 of income you earn between $100,000 and $109,000. Talk to your tax advisor or your lender for more information about your specific situation.
Mortgage insurance is a complex topic! Get the facts straight.
Property Tax Deduction Changes for 2018
Another common deduction that was impacted by the TCJA is property taxes. Under the new tax law, deductions for property taxes, state income taxes, and local income taxes are limited to a combined $10,000. In states where home prices and property taxes are high, such as California or New York, homeowners may see a bigger 2018 tax bill as a result (if they still choose to itemize deductions). Be sure to check the rules of your city and state and talk with your financial advisor to learn more about property taxes.
Sarah A. Paquette is a CPA with more than 10 years of experience in both public accounting and private industry. She is also an Adjunct Accounting Professor at Bridgewater State University, and is a member of the Massachusetts Society of CPAs, where she sits on the Federal Taxation and Academic & Career Development committees. Here is her opinion on how the new tax laws may cost (or may benefit) homeowners:
For 2018, we are seeing the majority of our clients who historically have benefited from the real estate taxes paid on their personal residence or second homes no longer reaching the level of deductions needed to itemize on their personal returns.
The two main contributors under TCJA were: (1) the standard deduction for married filing joint homeowners nearly doubled from 2017 to 2018, and (2) a cap of $10,000 on state and local taxes (SALT) for itemized purposes. The latter, in my opinion, very well may be the largest negative to TCJA, particularly for those clients who own homes in higher property value areas where your average home real estate taxes alone exceed the $10,000 limit.
The upside however is many of our clients who may be limited by the $10,000 SALT cap and now take the standard deduction have ultimately benefited from lower income tax rates and bigger tax brackets, more often than not resulting in an overall lower effective tax rate on what are conceivably similar cash flow years (similar income and expense years).
Riley Adams is a licensed CPA in the state of Louisiana working as a Senior Financial Analyst for a Fortune 500 company in New Orleans. He is also the creator of Young and the Invested, a personal finance blog dedicated to helping young professionals find financial independence. He believes that certain homeowners will feel the impact of this change more than others.
A major change associated with tax reform is the treatment of state and local taxes, including property taxes. Under previous tax laws, there was no cap on how much SALT taxes could be deducted against your federal taxable income. However, the new law places a $10,000 cap on allowed SALT tax deductions.
The implications of this change are that states and localities with high tax burdens will find their citizens paying more in federal income tax, all things being equal. Once again, this falls on individuals facing high state income taxes or property taxes, or areas with high costs of living and higher incomes.
This also can impact homeowners who have high real estate, local, and other property taxes on their house. In years past, these higher levies were deductible, but now the $10,000 cap could make some homeowners feel the pinch as the cost of homeownership rise.
Mortgage Points Tax Deduction
When you purchased your home, you may have paid mortgage points to lower the interest rate on your home loan. Mortgage points are valuable because not only do they save you money over time, but in certain circumstances, they can also save you money right away.
Mortgage points can be deducted all at once or over the life of a loan. Typically, most homeowners must amortize their deductions over the loan term. However, if you meet all nine criteria from the Internal Revenue Service listed below, you may be eligible for a full deduction in the year of payment:
- The loan must be secured by your main home.
- Paying points is an established business practice in your area.
- The points are generally what are charged in your region.
- You use the cash method of accounting, meaning you record income in the year you receive it and deduct expenses in the year you pay them.
- The points are not paid in place of amounts ordinarily stated separately on the settlement sheet. That is, you cannot pay points in exchange for appraisal fees, inspection fees, title fees, legal fees, and property taxes.
- The funds you come up with at or before closing, plus any points the seller pays, must be at least as much as the points charged. In addition, you cannot have borrowed any of the settlement money from your lender, mortgage broker, or bank.
- The loan is used to buy or build your main home.
- The points are computed as a percentage of your mortgage principal amount.
- The amount is clearly shown on the settlement statement as points charged for the mortgage. The points may be shown as paid from either buyer or seller funds.
For those refinancing a mortgage, the IRS states all associated points must be deducted over the life of the loan. However, if any portion of those refinance points is used toward home improvements and meets criteria #1 through #6 (as listed above), those points may be fully deductible in the year paid.
The remaining refinance points, however, will not qualify for an immediate tax deduction; the leftover balance must be deducted over the life of the loan. This same tax rule also applies towards home equity lines of credit and home equity loans.
Home Office Tax Deduction
If you are self-employed or work from a dedicated space in your home (and you have a home office that qualifies), almost all of the expenses related to your home office are deductible. You can allocate a portion of your property tax and interest to your home office if you want, and you can write off the cost of anything you provide exclusively for the home office, such as a dedicated phone line.
The IRS also lets you write off a proportional share of any other expenses that benefit the home office. For example, if your home office is 15% of your house, you can write off 15% of repairs for the benefit of the whole house and 15% of your electric bill, among other things. If you don't want to do all of that paperwork, you can also choose to claim a flat-rate home office deduction, although it might be worth less than itemization.
Tax Deductions for Underwater Mortgages
Homeowners who owe more than their homes are worth can find some tax payment relief in the Mortgage Forgiveness Debt Relief Act. Prior to the Mortgage Forgiveness Debt Relief Act, debt forgiven by a lender was considered a gift by the IRS—and is therefore taxable income.
For example, if a borrower who owed $200,000 in the 25% tax bracket sold his home in a short sale for $150,000, he or she would typically pay $12,500 in taxes because the IRS views the $50,000 break as taxable. The only options to avoid paying these taxes were to declare bankruptcy or claim insolvency, stating your debts outweigh your assets. For many homeowners who experienced this taxation, it's a major financial burden in an already difficult situation.
The Mortgage Forgiveness Debt Relief Act, which was passed in 2007, helped homeowners avoid this extra tax if they meet the following criteria:
- Debt was forgiven on your principal residence.
- Debt was reduced or forgiven through mortgage restructuring, foreclosure, or short sale.
- The total amount of forgiven debt is less than or equal to $2 million.
- The forgiven or cancelled debt was only used to buy, build, or substantially improve the principal residence.
The Mortgage Forgiveness Debt Relief Act has been extended several times. In 2018, This Act was extended to include debt forgiven in calendar years through 2017, as well as debt forgiven in 2018 if there was a written agreement that began in 2017.
Making the Most of Your Mortgage Tax Deductions
The tax code can be complicated, and there are plenty of special situations that affect the deductions you can claim. Keeping good records of all transactions and partnering early with a tax expert are two simple tasks that will benefit nearly every homeowner once April 15th arrives. If you need more details about a specific deduction or other home-related tax rules, review the IRS guidelines or contact your tax advisor. If you currently have a PennyMac loan, you can also review the year-end mortgage tax statements PennyMac provides.
Before you purchase a home or refinance your existing mortgage, make sure to take these tax deductions into account as you plan for your financial future. If you're ready to take advantage of these potential savings with a new mortgage or a refi, apply online to get pre-approved or call a PennyMac Loan Officer today.
*Consult a tax adviser for further information regarding the deductibility of interest and charges.
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