How Does Buying a House Affect Your Taxes?

Purchasing a home is a significant financial decision with substantial tax implications. Understanding these can lead to savings and influence your financial planning strategy. Homeownership offers tax deductions and benefits that can reduce taxable income and support long-term wealth accumulation.

Potential Deductions

When buying a home, several tax deductions can reduce taxable income and help optimize financial planning. Knowing these deductions is key to maximizing savings.

Mortgage Interest

The mortgage interest deduction is a major benefit for homeowners. Interest paid on mortgage debt up to $750,000 (for loans taken after December 15, 2017) is deductible for primary and secondary homes. For example, $10,000 in annual mortgage interest can be deducted from taxable income. Accurate records, such as Form 1098 from lenders, are necessary for claiming this deduction. For those with debts exceeding the threshold, the deduction is limited, so understanding these limits is essential.

Mortgage Points

Mortgage points, or prepaid interest paid at closing to lower the mortgage interest rate, are deductible for taxpayers who itemize. If the home is a primary residence, the full amount of points paid can be deducted in the purchase year. For instance, paying $3,000 in points on a $300,000 loan allows homeowners to deduct this amount from taxable income. This deduction is particularly helpful in the early years of homeownership when interest payments are higher.

Property Taxes

Property taxes are deductible, making this especially beneficial in states with high tax rates. The Tax Cuts and Jobs Act of 2017 capped the state and local tax (SALT) deduction, including property taxes, at $10,000 ($5,000 if married filing separately). Despite this cap, deducting property taxes is still valuable when combined with other eligible deductions. Taxpayers should maintain detailed records of property tax payments, often found on Form 1098 or local government receipts.

Private Mortgage Insurance

Private Mortgage Insurance (PMI) premiums are deductible for taxpayers financing more than 80% of a home’s value. This deduction, extended through the Taxpayer Certainty and Disaster Tax Relief Act of 2019, applies to policies issued after 2006 and through the 2021 tax year. However, it phases out at higher income levels, starting at an adjusted gross income (AGI) of $100,000 and ending at $109,000. Reviewing Form 1098 can help homeowners identify PMI payments for itemizing deductions.

Capital Gains Exclusion

The capital gains exclusion is a significant tax benefit when selling a primary residence. Homeowners can exclude up to $250,000 of capital gains if single, or $500,000 if married filing jointly, provided they’ve owned and lived in the home as their primary residence for at least two of the past five years. For example, a couple who bought a home for $300,000 and sold it for $800,000 can exclude the $500,000 gain from taxable income if they meet the residency and ownership criteria.

However, this exclusion is limited. Homeowners who have used it within the past two years are ineligible until the period lapses. Additionally, depreciation claimed for home office or rental use must be recaptured and cannot be excluded.

Itemizing vs. Standard Deduction

Choosing between itemizing deductions and taking the standard deduction is a critical decision for homeowners. The standard deduction for 2024 is $13,850 for single filers and $27,700 for married couples filing jointly. Taxpayers whose itemized deductions, such as mortgage interest and property taxes, exceed these thresholds may benefit from itemizing. Schedule A of Form 1040 helps taxpayers determine if itemizing is advantageous.

Transfer Taxes on Real Estate Purchases

Transfer taxes, also known as deed or real estate transfer taxes, are often overlooked but can add to the cost of purchasing property. These taxes, levied by state or local governments, vary widely by jurisdiction. For example, New York City imposes rates as high as 2.625% for properties over $500,000, significantly increasing closing costs. In contrast, California’s rates are lower, typically around 0.11%, though local municipalities may impose additional taxes.

Documentation for Filing

Accurate documentation is essential for homeowners to claim tax benefits. Key documents include the HUD-1 Settlement Statement or Closing Disclosure, detailing the transaction, and Form 1098, which reports mortgage interest and PMI payments. These are critical for itemizing deductions on Schedule A of Form 1040.

Homeowners should also retain receipts for home improvements, as these can increase the property’s adjusted basis and reduce taxable gains upon sale. Maintaining electronic backups of documents ensures easy access and compliance, especially if required during an audit. Organizing records for refinancing or home equity loans is equally important, as these can affect deductible interest.