The Tax Benefits of Homeownership and Steps Homeowners Should Take Ahead of Filing Their Tax Returns

Owning a home is a significant achievement for many people, not only because of the personal and emotional satisfaction it brings but also because of the financial advantages it offers. Homeownership can provide several tax benefits that help reduce the burden of taxes each year, making it a smart financial decision in many cases. However, understanding these benefits and properly preparing for tax season is crucial to ensuring homeowners can take full advantage of them. In this blog post, we will explore the tax benefits of homeownership and what steps homeowners should take before filing their tax returns to maximize their savings.

The Tax Benefits of Homeownership

1. Mortgage Interest Deduction

One of the primary tax benefits of homeownership is the ability to deduct mortgage interest payments on your tax return. If you have a mortgage on your home, you can deduct the interest you pay on the loan, which can result in significant savings, especially during the early years of the loan when most of your payment is applied to interest rather than the principal balance.

The IRS allows homeowners to deduct the interest on mortgages up to $750,000 for loans taken out after December 15, 2017. If you took out your mortgage before that date, the limit is higher—up to $1 million in mortgage debt. This deduction can be especially valuable for homeowners with large mortgage loans, as it reduces taxable income and, in turn, the amount of taxes owed.

It's important to note that the mortgage interest deduction is only available if you itemize your deductions. For many homeowners, especially those with smaller mortgages or those who have a simpler tax situation, the standard deduction might offer more savings. However, for those with larger mortgages, itemizing can lead to substantial tax benefits.

2. Property Tax Deduction

Property taxes are another expense that homeowners can potentially deduct from their taxable income. The property tax deduction allows homeowners to deduct the amount they pay in property taxes on their primary residence and any other real estate they own.

However, there is a limit to how much you can deduct. The Tax Cuts and Jobs Act (TCJA) of 2017 placed a cap on the total amount of state and local taxes (SALT) that can be deducted, including property taxes, income taxes, and sales taxes. The maximum SALT deduction is currently set at $10,000 ($5,000 for married individuals filing separately). For homeowners in areas with high property taxes, this cap can be a limiting factor. Even with this limitation, the property tax deduction can still provide valuable savings.

3. Private Mortgage Insurance (PMI) Deduction

If you put less than 20% down when purchasing your home, you may have been required to pay for private mortgage insurance (PMI). PMI protects the lender in case you default on the loan, and while it's an additional cost, it can also be deductible under certain circumstances.

PMI deductions were extended under the Taxpayer Certainty and Disaster Tax Relief Act of 2019, allowing homeowners to deduct PMI premiums if their income falls below a certain threshold. This deduction was subject to phase-outs based on income, with the benefit gradually disappearing for higher earners. However, taxpayers need to be aware of current eligibility requirements and income limits, as these factors can change annually.

4. Home Office Deduction

For homeowners who operate a business out of their home, the home office deduction is another potential tax benefit. If you use part of your home regularly and exclusively for business purposes, you may qualify for this deduction. The deduction applies to both homeowners and renters, but for homeowners, it may allow them to deduct a portion of their mortgage interest, property taxes, and utilities based on the size of their home office compared to the total square footage of the home.

The IRS provides two methods to calculate the home office deduction: the simplified method and the regular method. The simplified method allows a flat deduction of $5 per square foot of the home used for business (up to a maximum of 300 square feet). The regular method requires homeowners to allocate a portion of their actual expenses to the business use of their home.

5. Energy Efficiency Tax Credits

Many homeowners can also take advantage of tax credits for making energy-efficient improvements to their homes. These credits are designed to incentivize homeowners to make their homes more energy-efficient, which can help reduce energy consumption and lower utility bills in the long term.

For example, homeowners who install energy-efficient windows, insulation, or solar panels may qualify for tax credits under the Residential Energy Efficient Property Credit or the Nonbusiness Energy Property Credit. These credits can be significant, with the solar panel credit covering up to 26% of the cost of installation, though the percentage has been phased out gradually.

It’s important to keep records of any energy-efficient improvements and consult with a tax professional to ensure you’re claiming all available credits.

Steps Homeowners Should Take Ahead of Filing Their Tax Returns

Now that we’ve outlined some of the primary tax benefits of homeownership, let's dive into the practical steps homeowners should take to ensure they are well-prepared when tax season arrives.

1. Gather Your Mortgage and Property Tax Information

Before filing your tax return, you will need to gather all relevant documents related to your mortgage and property taxes. This includes:

• Form 1098: Your lender will send you a Form 1098, which details the mortgage interest you paid during the tax year. This is essential for claiming the mortgage interest deduction.
• Property Tax Statements: Obtain your property tax bills or statements from your local taxing authority. These will provide the information needed to claim the property tax deduction.
• PMI Information: If you paid PMI during the year, ensure you have documentation from your lender detailing the amount you paid. This will help you determine if you're eligible for the PMI deduction.

2. Review Your Mortgage Insurance Premiums

If you paid PMI during the year, make sure you have the proper documentation to claim this deduction. If the deduction is still available for your tax bracket, ensure that your income falls below the phase-out threshold.

3. Track Energy-Efficient Home Improvements

If you made energy-efficient improvements to your home, gather receipts, invoices, and any other documentation showing the costs of the improvements. This will be important for claiming the energy-efficient tax credits. You may need to file specific forms (such as IRS Form 5695) to claim these credits.

4. Determine Whether to Itemize or Take the Standard Deduction

Before filing your taxes, you’ll need to decide whether it’s more beneficial to itemize your deductions or take the standard deduction. If your total mortgage interest, property taxes, and other deductible expenses (such as charitable contributions) exceed the standard deduction for your filing status, it may make sense to itemize.

For the 2024 tax year, the standard deduction is:

• $29,200 for married couples filing jointly
• $14,600 for single filers

If you’re unsure, a tax professional or tax software can help you determine which option will result in the greatest tax savings.

5. Consult a Tax Professional

The tax benefits of homeownership can be complex, especially if you have multiple properties or have made significant energy-efficient improvements. Consulting a tax professional can help ensure that you are maximizing your deductions and credits and complying with all relevant tax laws. A tax professional can also help you stay up to date on any changes to tax laws that might affect your filing.

6. Consider Timing Your Home Sale

If you plan on selling your home, the timing of the sale can have tax implications. Homeowners who meet certain requirements may qualify for the capital gains exclusion, which allows them to exclude up to $250,000 in capital gains ($500,000 for married couples filing jointly) from the sale of their primary residence. However, if you sell your home within a short period after purchasing it or if you don’t meet the residency requirements, you may not qualify for this exclusion.

Conclusion

Homeownership offers several valuable tax benefits, from mortgage interest deductions to energy-efficient credits. However, to fully benefit from these advantages, homeowners need to be proactive in gathering the necessary documentation and understanding the tax rules that apply to their specific situation. By following the steps outlined above—gathering relevant documents, considering whether to itemize, and consulting a tax professional—homeowners can ensure they are maximizing their tax savings when filing their tax returns.

With the right preparation, homeownership can be not only a rewarding personal achievement but also a significant financial asset come tax season.