You have decided to become a home owner…Congratulations! Most people are very excited when they buy their first home, with good reason. You have succeeded on huge decision and have a space to make your own. Others may be thinking:
Most people never think of the tax advantages now available once they become home owners.
One of the difficult parts of my job is not being able to answer questions simply. Nearly anytime one of my friends says, “Hey, I have a tax question. Is _____ deductible?” The vast majority of the time my answer is “It depends”. Nearly everything in the tax code is subject to some stipulation, income limit, or other qualifications. If you actually read the forms, it is like trying to follow the most lame “Choose your Own Adventure” book ever. The end of every story is “You owe more money”.
Following in this post and others to follow are a few areas where home owners can save money on their taxes. As always, these are general suggestions and may not be applicable to everyone. Pretty much every thing in the tax worlds can end with that disclaimer.
Mortgage Interest
For all of the excitement that owning a home brings, the downside is that it comes with a monthly mortgage payment. In case you are brand new, your mortgage payment is one payment that is generally paid to your mortgage lender to fund some of the costs of you home ownership. Your mortgage payment is generally a combination of 3 different payments sometimes 4 depending on your loan. It is always split between amounts applied to principle and interest and then usually another piece for escrow items. We’ll cover escrow in a minute. Depending on your loan situation, you may have a 4th piece that is for mortgage insurance. The portion of your payment designated as interest is deductible as an itemized deduction on your tax return. It is often one of the biggest deductions that people have.
Itemizing – what does that mean. When it comes to deductions on your tax returns, there are 2 primary categories: business and personal. Business expenses specifically reduce business income. We’ll go over those another time. For your personal expense, the IRS allows you 2 options: You may take the “standard deduction “or “itemize” your deductions. The standard deduction is a per person amount that is pre-determined. If you have specific expenses that exceed the standard deduction, you can file Schedule A and provide an itemized listing of these expenses. Mortgage Interest falls here.
Real Estate Taxes
Local municipalities generally assess a tax on real estate and the property owner is responsible for paying it. Most new homeowners pay this tax as a part of their mortgage payment. It is one of the things that is paid through the escrow account. The escrow account is an account with your mortgage holder where they administer certain funds to pay necessary costs of the home that protect their mortgage security. The funds you put into escrow are usually used to pay your real estate taxes and home owner’s insurance.
Real estate taxes are paid annually and are also deducted as an itemized deduction on Schedule A, just like your mortgage interest that we discussed earlier.
So here is the new downside about Real Estate Taxes, as a part of the recent Tax Cuts and Jobs Act, deductions for local taxes are limited to $10,000. Real Estate taxes are a piece of that. That sounds like a pretty generous deduction that most first time home buyers wouldn’t need to worry themselves with, except that other state income taxes are also included in this limitation. If you live in a state that has an income tax, it is pretty easy to hit that phaseout, especially if it is a state like New York or California that imposes a relatively high income tax combined with relatively high property taxes.
Mortgage Insurance Premiums
These have been around for a long time but really came to the forefront after the bottom fell out of the real estate market starting in 2008. Banks experienced dramatically higher rates of foreclosure and in order to help protect their exposure, began requiring more borrowers carry mortgage insurance. In most cases, unless you make a down payment of at least 20% of the cost of your house, you will be required to also pay mortgage insurance. Since more people were foreclosing, the rates on this insurance increased dramatically. As a way to help homeowner’s, Congress allowed this insurance premium to qualify as an itemized deduction. You are disallowed from taking this deduction if you are deemed to make too much money. We in the biz call this a “phaseout”. For a couple filing a joint return, it was $110,000 for 2017.
That covers all of the deductions incorporated into your new monthly payment. Generally most lenders will report all of these numbers on your annual Form 1098 mailed to you at the beginning each year. Each number is in a different box on the form. On this form moving forward, you will also find the balance of your mortgage, which becomes important if your balance is over $750,000 and didn’t originate before 2017. All of this should help put a little more money back in your pocket which is what this blog is all about. If you have any thoughts or questions, please leave me a comment below. I will follow up with you there, or potentially through a future blog post.