A home is the largest purchase most people ever make. The average home in the United States cost just over $410,000 in the third quarter of 2021, so it’s no surprise that people are looking to make homeownership more affordable.
To encourage people to buy homes, the U.S. government offers tax incentives that range from deducting mortgage interest and property tax payments from your taxable income, to limits on capital gains taxes that are paid when selling a home for a profit.
Here’s a breakdown of some of the top tax benefits of homeownership, and how owning a home can reduce your tax bill:
- How Tax Deductions Work for Homeowners
- Common Tax Breaks Available to Homeowners
- Other Tax Benefits of Homeownership
- Renting vs. Owning a Home
- The Bottom Line on the Tax Benefits of Owning a Home
As always, it’s best to consult with a qualified tax expert when making decisions that affect your tax liability.
How Tax Deductions Work for Homeowners
Before learning about the tax advantages of owning a home, it’s important to understand how tax deductions work.
Tax deductions decrease your taxable income, which reduces the amount of tax that you owe. For example, if you have $50,000 in taxable income and can take $5,000 in deductions, you only need to pay taxes on $45,000.
This differs from tax credits, which reduce your tax bill directly. If you owe $2,000 in taxes and get a $1,000 credit, you only have to pay $1,000.
That means deductions typically reduce your tax bill less than credits. Because deductions reduce your taxable income, how much you’ll save depends on your tax bracket. The higher your tax bracket, the more benefit you’ll get from a deduction.
When you file your taxes, you can take the standard deduction or itemize your deductions.
The standard deduction lets you reduce your taxable income by a flat amount. For the 2021 tax year, the standard deduction is $12,550 for individuals, $25,100 for married couples, and $18,800 for those who qualify as head of household. Those amounts increase for the 2022 tax year to $12,950 for individuals, $25,900 for married couples, and $19,400 for heads of households. So, a married couple that reports a gross income of $100,000 for 2022 and chooses the standard deduction will have a taxable income of $74,100.
The IRS allows taxpayers to take deductions for certain expenses, many of which apply to homeowners. To take advantage of most of these deductions, you need to itemize your deductions. That means skipping the standard deduction, and claiming deductions one by one.
Itemizing is more complicated than taking the standard deduction, and it’s only worth doing if your itemizable deductions add up to more than the standard deduction. Keep in mind that there are limits on some deductions, too.
If you have enough deductible expenses, you could reduce your tax bill significantly. In 2018, U.S. taxpayers claiming the mortgage interest deduction saved about $1,772 in taxes on average.
Deciding whether to itemize depends on your individual financial situation. If your itemized deductions exceed the standard deduction, then itemizing will save you money. If not, then the standard deduction will save you more.
The standard deduction has increased in recent years, so itemizing makes sense for fewer people.
Common Tax Breaks Available to Homeowners
If you’re a homeowner, here are some of the most significant tax deductions you may be able to claim.
Mortgage interest deduction
The mortgage interest deduction is one of the most common tax deductions. It’s available to almost any homeowner who has a mortgage or home equity loan.
The mortgage interest deduction is “one of the most important tax breaks for homeowners,” according to Sep Niakan, managing broker at Condo Black Book, a Miami-based real estate company.
The deduction “allows you to deduct the interest you pay on your mortgage to buy, build, or improve your primary or secondary residence,” he says. “If you are an individual taxpayer or a married couple filing a joint tax return, you can deduct the interest paid on up to $750,000 of mortgage debt.”
For example, if you have a mortgage balance of $600,000 and paid $15,600 in interest, you can deduct the full amount of the interest you paid. If your mortgage balance is $1 million and you paid $30,000 in interest, you can deduct the interest paid on the first $750,000 of debt, which will be less than $30,000.
Mortgage point deduction
Mortgage points are prepaid interest. When you take out a mortgage, you can buy points and reduce the interest rate on your loan.
Homeowners can deduct the money spent on mortgage points either over the life of the loan or in full in the year when they were paid.
To deduct them in the year when they were paid, the points must have been purchased for a loan on your primary home and itemized on your closing statement as mortgage points, and you cannot have borrowed money to buy the points.
Most local governments charge property taxes, which are based on the value of your home. These taxes can vary widely depending on where you live. For example, Boston charges 1.088% of your home’s value, while Concord, New Hampshire, charges 2.512%.
The IRS allows homeowners to deduct state and local taxes — including property taxes — from their taxable income. There’s a limit of $10,000 for a married couple filing a joint return, or $5,000 if you are married filing separately.
The average property tax bill is about $2,400, so most homeowners can deduct the entirety of their property taxes.
Home office expenses
If you have an office in your home, you’re allowed to deduct the cost of that office from your taxable income. There are strict eligibility requirements for taking this deduction, and two methods to calculate the deduction.
To be eligible, the space in your home must be your principal place of doing business, and be reserved for the regular and exclusive use of your business. For example, if you only use your office for work, it may be eligible. If you set up a laptop in your dining room once a week, and otherwise use the room for eating meals, it’s likely ineligible. Additionally, you cannot deduct home office expenses if you’re an employee of a business and work from home.
The two methods for calculating the deduction are the regular method and the simplified method.
With the regular method, you calculate the exact expenses related to your home office. This includes the portions of mortgage interest, homeowners insurance, utilities, and home repair costs associated with the office. So, if your office is 10% of the square footage of your home, you can deduct 10% of your utility bill as a home office expense.
The simplified method lets you deduct a flat $5 per square foot, but limits the amount of square footage you can use toward the deduction. It also limits your ability to deduct for depreciation and other costs.
If you own a home with someone who is not your spouse, you still get to take advantage of homeownership tax benefits, but you need to make sure you’re properly splitting the benefits.
The deductions each person may take are not limited by their ownership interest in the home. Instead, they are based on the amount each person pays toward the mortgage and maintenance of the home. For example, if two people co-own a home and each have a 50% interest, but one pays the full amount of the mortgage, the person who makes the mortgage payments can deduct the full amount of the interest paid.
Under the Tax Cuts and Jobs Act, the moving expenses deduction has been suspended for most taxpayers. The main group eligible for this deduction is members of the military.
If you move due to a military order or permanent change of station, you can deduct unreimbursed moving expenses. This includes costs related to transporting and storing your personal items, and travel from your old home to your new home.
Capital gains exclusions
You may be required to pay capital gains taxes if you sell your home for more than the original purchase price. Homeowners who sell their homes at a profit can exclude the first $250,000 of profit — or $500,000 if filing jointly — if they meet two requirements.
The first is that you must have owned the home and used it as your primary residence for at least two of the last five years.
The second is that you generally cannot have excluded gains on the sale of another home in the previous two years.
For example, if you bought your home for $250,000 and sold it for $600,000, you earned a capital gain of $350,000. If you qualify for the exclusion as a single person, you would only pay capital gains tax on $100,000 of your profit.
Private mortgage insurance
Private mortgage insurance is a fee some borrowers must pay to protect lenders if they default. Homeowners typically have to pay PMI if they make a down payment of less than 20%. They can stop paying PMI once they have more than 20% equity, which is the difference between the value of the home and what you owe on it.
“Not many people know or appreciate the fact that private mortgage insurance premiums are tax deductible,” says Cliff Auerswald, president of All Reverse Mortgage, a lender based in Orange, California.
Deducting these payments from your taxable income can make a home more affordable, especially if you’re making a lower down payment.
Other Tax Benefits of Homeownership
Many incentives are mortgage tax benefits that let you deduct the costs of borrowing money to buy a home. The rest generally relate to the upkeep of the home.
However, those aren’t all the tax benefits of owning a home. Here are a few more that apply only in select situations.
Renewable energy tax credit
The government offers a tax credit to homeowners who make energy-efficient improvements, such as adding solar energy production or fuel cells. Eligible energy improvements made between Jan. 1, 2020, and Dec. 31, 2022, qualify for a 26% tax credit. Those made between Jan. 1, 2023, and Dec. 31, 2023, will qualify for a 22% tax credit.
For example, if you paid $20,000 for a solar energy system installed in June 2021, you can receive a tax credit of 26%, which will reduce your tax bill by $5,200.
Home equity debt
Depending on how the loan is used, there are some tax deductions that can apply to home equity loans.
“Homeowners can also deduct interest on home equity loans and lines of credit, but only if the loan was used to buy, build, repair, or improve the home,” says Josh Zimmelman, managing director of Westwood Tax & Consulting, a New York-based financial company.
The deductions that taxpayers can take on home equity loans are largely the same as the deductions available for primary mortgages, including mortgage points and interest paid. For example, if you paid $10,000 in interest on an eligible home equity loan, you could take a $10,000 deduction.
Home improvements for medical needs
The IRS allows tax deductions for a variety of medical expenses. This includes changes and improvements made to your home based on medical needs.
Examples of such improvements include:
- Adding exit ramps.
- Widening doorways.
- Adding railings and support bars.
- Lowering kitchen cabinets.
- Modifying stairways.
- Grading the ground for improved accessibility.
If the improvements increase the value of your home, you may deduct only the cost in excess of the increase in value.
For example, if updating your kitchen for accessibility costs $25,000 and raises the value of your home by $15,000, you can deduct only $10,000.
Mortgage credit certificate
The mortgage credit certificate program helps lower-income families afford a home. This program provides a tax credit for up to $2,000 of mortgage interest paid each year, with the remaining interest paid eligible to be used as a deduction.
State and local housing finance agencies administer the programs. Each housing finance agency sets the credit rate at between 10% and 50%. The maximum deduction depends on the value of the home and the interest rate on the loan.
For example, if a borrower buys a $200,000 home and has a loan with an interest rate of 3%, and the credit rate is 25%, they can get a credit for $1,500.
To be eligible, borrowers must earn no more than the greater of the median income in their state or local area.
Renting vs. Owning a Home
Everyone needs a place to live, but that doesn’t mean that everyone has to own a home. Many people choose to rent vs. buy a home, either out of preference or because they can’t afford homeownership.
While homeowners get the benefit of significant tax incentives, the opportunity to build equity, and the tendency for home prices to increase, they also have to deal with drawbacks. Transaction costs in real estate are high, with average closing costs between 2% and 5% — not to mention commissions for real estate agents. That means that moving can be very expensive. Homeowners also have to consider the ongoing expenses of maintaining a home.
Renters benefit from greater freedom to move without paying significant costs, not having to pay for maintenance and repairs, and lower upfront costs. However, they lose out on the chance to build equity, and have less freedom to make changes to their home.
While the tax incentives of homeownership can be appealing, consider whether renting may be a better choice for you. For example, if you plan to move in a year or two, renting is likely a better choice.
The Bottom Line on the Tax Benefits of Owning a Home
With all the maintenance and other costs required, owning a home is complicated. It’s no surprise that the taxes related to homeownership also can be complicated. However, understanding the various tax incentives available to homeowners is important, because it could help you save money in the long run.