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A Guide to Homeowner Tax Deductions

02/26/2018 Kristin Demshki


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When it comes to filing your taxes, owning a home is a huge benefit. There are deductions available for mortgage interest, mortgage points, property taxes and more—but some homeowners fail to take full advantage.

Follow our guide to review your potential deductions, see what it takes to qualify and learn what the new tax law might mean for your 2018 taxes. (Everyone’s financial situation is different, so make sure you consult with a tax advisor before making any major decisions about your taxes.)

Tax Deductions Available to Homeowners

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. Itemizing your deductions gives you the opportunity to write off much more than just home mortgage interest; you can deduct property taxes, charitable contributions, and plenty of other costs. As long as your total itemized expenses exceed the standard deduction amount, you will do yourself a favor by itemizing.

The standard deduction itself, however, is worth a closer look under new regulations. The Tax Cuts and Jobs Act*, which was signed into law on December 22, 2017, significantly increases the standard deduction for the 2018 tax year. The standard deduction will increase 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 will be $18,000 for heads of household under the new law.

With that in mind, more people are expected to take the standard deduction for their 2018 taxes, leaving fewer homeowners to 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.

*Note: This post was written after the passage of the Tax Cuts and Jobs Act, but before official 2018 tax tables were released by the IRS. Rates and numbers are based on the law as written.

Mortgage Interest Tax Deduction

The mortgage interest tax deduction is one of the most popular deductions for homeowners. The IRS allows homeowners to deduct interest paid on your mortgage, as well as interest on home equity debt, up to certain limits.*

For first or second homes purchased before December 14, 2017, homeowners can deduct all of their interest on mortgages up to $1.1 million if filing jointly or up to $500,000 for individuals. The limit is technically $1 million, but since you can deduct up to $100,000 in home equity debt, the IRS allowed for deductions on mortgages up to $1.1 million. This limit will still apply for 2017 taxes.

The Tax Cuts and Jobs Act will bring changes to the mortgage interest tax deduction for 2018 taxes. For homes purchased on or after December 14, 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). You can only deduct mortgage interest on the loan for your primary residence, not a second home. The new tax law also eliminates the home equity interest deduction (even for existing loans) starting in 2018. Unless new legislation is signed, these changes—the reduced cap on mortgage interest deduction and the elimination of the home equity interest deduction—will expire in 2026.

If you live in an expensive housing market, you live in a million-dollar home and are looking to move, you are considering an upgrade to a $750,000+ home or you are considering a new home equity line of credit, you should keep these changes in mind to avoid a larger tax burden. Plus, even if your mortgage is less than $750,000, it’s important to remember how the changes to the standard deduction and property tax deductions may affect your overall tax burden.

*Consult a tax adviser for further information regarding the deductibility of interest and charges.

Mortgage Insurance Premium Tax Deduction

Homeowners who put down a down payment of less than 20% or obtain a government-backed mortgage like an FHA loan are often required to have mortgage insurance. Mortgage insurance is designed to give lenders more flexibility to offer loans to people who can’t make a large down payment.

Luckily for homeowners with mortgage insurance, these premiums are tax-deductible in certain situations. Homeowners can 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 about your specific situation.

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 lots of 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:

  • 1. The loan must be secured by your main home.
  • 2. aying points is an established business practice in your area.
  • 3. The points are generally what are charged in your region.
  • 4. 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.
  • 5. 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, attorney fees and property taxes.
  • 6. 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.
  • 7. The loan is used to buy or build your main home.
  • 8. The points are computed as a percentage of your mortgage principal amount.
  • 9. 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 1-6 (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.

Property Tax Deduction

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).

The law does not allow homeowners to prepay state and local taxes to take advantage of the current, more favorable law. However, it does not specifically prohibit prepaying property taxes to take advantage of current law. Be sure to check the rules of your city and state and talk with your financial advisor before making any prepayments.

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 fax 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 percent of your house, you can write off 15 percent of repairs for the benefit of the whole house and 15 percent 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 breaking everything out.

Tax Deductions for Underwater Mortgages

Homeowners who owe more than their homes are worth can find some relief in the Mortgage Forgiveness Debt Relief Act if it is renewed for 2018. The law was subject to several last-minute extensions but it has yet to make it through either house of Congress or to the president’s desk. At this point, homeowners must wait and see if the law will provide any tax relief for their underwater mortgages going forward.

Prior to the Mortgage Forgiveness Debt 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.

Making the Most of Your Mortgage Tax Deductions

The tax code is complicated, and there are plenty of special situations (late payment charges, prepayment penalties, divorce, and more) that affect the deductions you can claim. 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 are looking to 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 tax deductions with a new mortgage or a refi, call a PennyMac Loan Officer today.