What Are the Tax Breaks for Home Buyers?

Owning a home can provide tax advantages that make homeownership more affordable. These benefits come in several forms, including deductions that lower your taxable income, credits that directly reduce your tax bill, and special provisions for using retirement funds. Understanding these breaks can save you a considerable amount of money.

Using Retirement Funds for Your Down Payment

One way to gather funds for a down payment is by tapping into your retirement savings. First-time homebuyers can withdraw up to $10,000 from a traditional IRA without facing the usual 10% early withdrawal penalty. For this purpose, the IRS defines a “first-time homebuyer” as anyone who has not owned a primary residence within the past two years.

After withdrawing the money, you must use it to buy or build a home within 120 days. It is important to remember that while you avoid the penalty, you will still owe regular income tax on the withdrawn amount from a traditional IRA. These rules also apply to withdrawals from Roth IRAs.

Tax Deductions for Homeowners

To take advantage of most homeowner-related deductions, you must itemize on your tax return using Schedule A. This strategy is only beneficial if your total itemized deductions are greater than the standard deduction available for your filing status.

The mortgage interest deduction allows you to deduct the interest paid on up to $750,000 of mortgage debt. This debt must be for a loan used to buy, build, or substantially improve your primary or second home. You can also deduct mortgage points, which are fees paid to the lender to secure a lower interest rate. These can either be deducted in the year they are paid or over the life of the loan.

The State and Local Tax (SALT) deduction includes property taxes, but the total amount you can claim is capped at $10,000 per household annually. If you use part of your home exclusively and regularly for business, you may qualify for the home office deduction. Costs for medically necessary home improvements can be deducted as a medical expense, but only to the extent that the cost exceeds any increase in your home’s value and the total medical expenses surpass 7.5% of your adjusted gross income (AGI).

Tax Credits for Homeowners

Unlike deductions, tax credits reduce your tax liability dollar-for-dollar. The Energy Efficient Home Improvement Credit offers a nonrefundable credit for certain upgrades. It has a general annual limit of $1,200 for improvements like new windows, doors, or energy audits, with a higher $2,000 limit for specific equipment like electric heat pumps.

A more substantial credit is the Residential Clean Energy Credit, which provides a 30% credit for the cost of new, qualified clean energy systems like solar panels, with no upper dollar limit. Another benefit is the Mortgage Credit Certificate (MCC), which is issued by state or local government agencies. An MCC provides a credit of 10% to 50% of your mortgage interest, though the credit is capped at $2,000 per year if the certificate’s rate is over 20%.

How to Claim These Tax Breaks

Proper documentation is necessary to claim these benefits. You will need to keep several records on hand.

• Form 1098 from your lender, which reports mortgage interest paid.
• Property tax records from your local government.
• Your closing disclosure statement to document any points paid.
• Receipts for any energy-efficient improvements or clean energy installations.

Most deductions are reported on Schedule A (Itemized Deductions), while the energy-related credits are claimed using Form 5695, Residential Energy Credits.