Why Is the Average Tax Return Lower After Buying a House?

Purchasing a home is a significant financial milestone, but it can also bring unexpected changes to your tax return. Many new homeowners anticipate substantial tax savings from deductions tied to mortgage interest and property taxes. However, these benefits may not always meet expectations.

Understanding why the average tax return might be lower after buying a house requires examining the various factors that influence tax calculations for homeowners.

Mortgage Interest Factors

The mortgage interest deduction has historically been a key tax benefit for homeowners. However, the Tax Cuts and Jobs Act (TCJA) of 2017 reduced the maximum mortgage debt eligible for interest deduction from $1 million to $750,000 for loans taken out after December 15, 2017. This change particularly affects homeowners with larger loans, potentially reducing the deductions they can claim.

Timing also plays a role. Closing on a home late in the year may result in minimal interest paid before year-end, limiting the deduction for that tax year. Additionally, making extra payments or opting for bi-weekly payments can reduce the total interest paid over time, further shrinking potential deductions.

Another major consideration is the interplay between the mortgage interest deduction and the standard deduction. The TCJA nearly doubled the standard deduction, making it $13,850 for single filers and $27,700 for married couples filing jointly in 2024. As a result, fewer taxpayers benefit from itemizing deductions, as the standard deduction often provides greater savings.

Property Tax Considerations

Property taxes, assessed by local governments based on property value, can fluctuate due to market conditions, property upgrades, or changes in tax rates. These taxes may not align with a home’s purchase price, leading to unexpected bills.

Under current U.S. tax law, taxpayers can deduct up to $10,000 in state and local taxes, including property taxes, on federal income tax returns. This cap, introduced by the TCJA, limits tax benefits for homeowners in high-tax states or those with expensive properties. If property taxes exceed this cap, the excess amount is non-deductible, reducing potential tax savings.

Points and Closing Costs

Home purchases involve additional financial considerations like points and closing costs. Points, or discount points, are fees paid to lenders at closing in exchange for a reduced interest rate, typically equal to 1% of the loan amount. While they offer long-term savings on interest, points require an upfront cost.

Closing costs, which include fees for appraisals, title insurance, and legal services, typically range from 2% to 5% of the home’s purchase price. Some closing costs, like certain loan origination fees and mortgage insurance premiums, may be deductible in the year they are paid, while others are added to the home’s basis and deducted gradually. Homebuyers should review IRS guidelines to determine which costs are eligible for deductions.

Itemized and Standard Deductions

Homeowners often weigh the benefits of itemizing deductions against taking the standard deduction. While itemized deductions can include mortgage interest and property taxes, the standard deduction’s simplicity and potential for greater savings make it an appealing choice for many taxpayers.

The Internal Revenue Code provides guidelines for deciding between the two options. For example, taxpayers must surpass a two-percent threshold on certain miscellaneous itemized deductions to benefit from itemizing. Additionally, the Alternative Minimum Tax may disallow some deductions, such as state and local taxes, which could further reduce the benefits of itemizing.

Adjusting Withholding

Buying a home can change your financial situation, making it essential to adjust tax withholding. Withholding refers to the portion of your paycheck sent to the IRS to cover estimated taxes. Homeownership often introduces new deductions and credits, which may necessitate recalibrating withholding to avoid over- or underpayment.

Using IRS Form W-4, homeowners can update withholding allowances to reflect anticipated deductions for mortgage interest or property taxes. Failing to adjust withholding could result in a tax bill or a reduced refund at filing. Regularly reviewing withholding, particularly after major life changes like homeownership, helps prevent surprises.

The IRS Tax Withholding Estimator is a helpful tool for assessing whether current withholding matches expected tax liability. By inputting details like mortgage interest and property taxes, homeowners can receive customized recommendations to ensure they neither overpay nor underpay throughout the year. This proactive approach also helps avoid penalties for underpayment if taxes owed exceed $1,000.

Homeowner-Related Credits

Beyond deductions, tax credits can directly reduce the amount of tax owed, often providing more significant savings. For homeowners, certain credits may apply, particularly for property improvements or energy-efficient upgrades.

The Residential Clean Energy Credit allows homeowners to claim 30% of the cost of installing renewable energy systems, such as solar panels, through 2032. This credit includes expenses like labor and installation. For instance, a $20,000 solar energy system installation could yield a $6,000 credit. Similarly, the Energy Efficient Home Improvement Credit offers up to $3,200 annually for qualifying upgrades, such as energy-efficient windows, doors, and HVAC systems.

State and local governments may offer additional incentives, such as property tax abatements or rebates for energy-efficient upgrades. Homeowners should research programs in their area to maximize savings. Eligibility requirements, including certification of materials or systems, often apply, so keeping proper documentation is crucial. These credits not only offset homeownership costs but also encourage sustainable practices.