The secret to saving on taxes: Your home!
Your home isn’t just your castle, it can be an important source of tax savings. You’re probably familiar with mortgage interest deductions, but there are a number of other potential tax benefits built into home ownership. Even your second home — or RV, or boat — can qualify.
Here’s how to get started.
New home or improvements? Take this pointer on points
Mortgage points can be confusing. While “one point” is the same as saying “1% of your mortgage,” there are different kinds of points which can trigger different tax deduction rates. Discount points are the same as prepaid interest, while origination fees are the service charges associated with getting a mortgage.
Origination fees are deductible if they only cover the cost of the mortgage and don’t include other expenses, like inspections or notary services. Discount points are deductible, but you might not be able to take the full deduction in the year you purchase your home. If you don’t meet the requirements allowing you to take the full deduction right away, don’t worry: you can still deduct the discount points you paid by amortizing them over the life of your loan.
You might also be able to take a deduction if you pay points on a home equity loan or refinancing. Again, you may have to amortize the cost; it depends on whether you you meet the criteria for taking the full deduction right away.
To find out which rules apply to your situation, you should start by taking a look at the IRS website or reaching out to a qualified accountant.
Take an interest in your interest deductions — all of them!
The standard mortgage interest payment deduction allows you to fully deduct interest paid on mortgages — with a mortgage limit is $500,000 for individuals or married couples filing separately, and up to $1 million for married filers. But did you know that you can also deduct interest paid on equity lines of credit or mortgages on second homes?
Interest paid on home equity loans is fully deductible for loans up to $50,000 ($100,000 for married filers). You can also fully deduct interest charges on mortgages for your vacation home as long as you meet certain residence requirements. The general rule is that you have to spend two weeks in residence per year; if you rent the property out while you’re not there, your tenure has to be equal to 10% of the total amount of time the property was rented. These deductions and residence rules also apply to RVs and boats — any accommodation with a bathroom, sleeping area, and cooking facilities.
Similarly, just as discount points are deductible, so is prepaid interest paid at any other time. So, if you’re able to make some extra mortgage payments, be sure to keep records for your tax deduction! Just be careful: if you prepay beyond the current year, you may have to split the interest paid across the years to which it applies. In other words, the amount that you prepay can only be deducted in the year in which it was “supposed” to be paid.
Ensure that you understand your insurance deduction
While you can’t deduct home insurance premiums from your taxes, you can deduct any premiums you pay towards mortgage insurance. Mortgage insurance is usually required when borrowers provide less than 20% as a down payment, and it’s designed to protect lenders from the risk of default.
This means that mortgage insurance isn’t for your benefit, which makes it all the more important to deduct it from your taxes. The amount you pay will be included on your statements; just keep in mind that the amount you can deduct is phased out once your income rises above $50,000 per year ($100,000 for married filers).
Improvements and remodels don’t just help to make your house a home, they can help you avoid a larger tax bill down the line. While the home improvements themselves aren’t tax deductible, they can change the cost basis of your house, which reduces the amount of taxable profit you’ll report in the case of a sale.
Say, for example, that you bought your home for $200,000, and over the years you put in new carpets, remodeled the kitchen, and replaced the windows for a total cost of $20,000. With those records, if you were to sell your house today for $800,000, your profit wouldn’t be $600,000 — it would be $580,000.
It’s an important distinction. Generally, up to $250,000 in profit from the sale of a home is tax-free ($500,000 for married filers), as long as you’ve owned the home for over two years and have lived in it for two out of the last five years. Any gains on top of that are taxable — unless you can show that your cost basis is higher than the original purchase price.
Storing and tracking all those receipts is an easy — and critical — way of ensuring that you can reap the full tax benefit of the investments you make over the years.
Make a system, keep your records — and get help if needed
To make the most of these favorable rules, you’ll need to do a little more legwork. Generally, homeowners who want to take all their deductions will need to itemize and keep great records of their loans, improvements, and payments. However, the effort is worth it: even a little bit of money saved on taxes here and there adds up over the years, and it’s good financial sense to make the most of the place that you call home.