Owning a home comes with incredible benefits beyond building equity and personalizing your space. One of the best perks? Tax deductions. Homeownership allows you to potentially reduce your taxable income through several key deductions, which can mean a smaller bill to Uncle Sam—or maybe even a larger tax refund.
In this guide, we’ll walk you through three major tax deductions homeowners can potentially claim. Each can help reduce your overall tax burden, but you’ll want to consult with a tax professional to confirm your eligibility for each deduction, as specific rules and limits apply. Let’s dive into the details!
Property Taxes
Understanding Property Taxes and How They Work
Every homeowner in the U.S. pays property taxes, which are used to fund services like schools, emergency services, and road maintenance in their community. The amount you pay annually depends on both the assessed value of your property and the local tax rate. In states like California, where property values tend to be high, this can mean thousands of dollars annually. But here’s the good news: a significant portion of those property taxes might be deductible on your federal income taxes.
California Property Tax Breakdown
While California has a relatively low average property tax rate (around 0.81% compared to the national average of 1.1%), homeowners in California typically pay more in taxes due to the state’s high property values. For instance, if you own a condo in San Francisco valued at $833,000, with the city’s real estate tax rate of 1.1792%, you would pay roughly $9,822 annually. Being able to deduct that amount from your taxable income can provide substantial savings, especially when combined with other deductions.
How the Property Tax Deduction Works
Here’s how you can take advantage of this deduction:
- Itemize Your Deductions: To claim property taxes, you’ll need to itemize deductions on your federal tax return, rather than taking the standard deduction. For many homeowners, this can yield greater tax savings.
- Escrow Payments: If you have an escrow account with your mortgage, a portion of each mortgage payment goes toward covering your annual property taxes. At the start of the year, your loan servicer typically provides a document detailing the total property tax paid from your escrow. This information will be essential when filing your tax return.
- State and Local Tax (SALT) Cap: Keep in mind there’s a limit to how much you can deduct for state and local taxes, which includes property taxes. As of 2023, the SALT deduction cap is $10,000 ($5,000 for married individuals filing separately). This means that if you pay more than this cap in property and state income taxes, you may only deduct up to $10,000 on your federal return.
Example Calculation for Clarity
Let’s walk through a simplified example: If your property tax payment for the year is $9,822 (as in the San Francisco condo example), this amount can reduce your taxable income directly. For a taxpayer in the 22% tax bracket, this deduction could result in a tax savings of around $2,160. That’s a considerable amount, and it’s one of the reasons many people prefer to own rather than rent!
Private Mortgage Insurance (PMI)
What is Private Mortgage Insurance?
Private mortgage insurance (PMI) is a type of insurance that homeowners might pay if they put down less than 20% of the home’s purchase price at closing. It’s there to protect the lender in case the borrower defaults on their mortgage. But while PMI adds an additional monthly cost, it can also offer a potential tax deduction for qualifying homeowners.
Deducting PMI Premiums
If you meet certain income requirements, the cost of PMI premiums can be deducted, helping offset that monthly expense. However, this deduction is income-sensitive, so higher earners may not qualify. Let’s take a look at how these thresholds work:
- Income Limits: For married taxpayers filing jointly, the deduction begins to phase out once your adjusted gross income (AGI) hits $100,000 ($50,000 for single filers). If your AGI surpasses $109,000 (or $54,500 for single filers), you’re not eligible to deduct PMI at all.
- Common Mortgage Types and PMI: PMI is common with FHA loans, where the insurance can be significant. For instance, if you have an FHA loan of $350,000, PMI premiums might cost about 1.75% annually. This would amount to $6,125 in PMI premiums—a significant amount to potentially deduct if you qualify based on income limits.
Example Calculation
If you’re eligible for the deduction and paid $6,125 in PMI, this could reduce your taxable income by that same amount. For a homeowner in the 22% tax bracket, that would mean around $1,347 in tax savings—money you could use toward home improvements, savings, or even a family trip.
Note on PMI Deduction Expiry
It’s worth noting that the PMI deduction has been subject to periodic expiration and renewal by Congress. As of the most recent update, it’s available, but homeowners should keep an eye on any changes to the tax code in future years, as this deduction might not always be available.
Mortgage Points
What are Mortgage Points?
When you close on a mortgage, you may have the option to pay “points” to reduce your interest rate. Each point typically costs 1% of your loan amount and generally reduces your mortgage interest rate, saving you money over the life of the loan. Mortgage points, often referred to as “discount points” or “origination points,” are not only a tool for lowering interest rates but can also be tax-deductible.
Two Types of Deductible Points
- Origination Points: These are fees that lenders charge for originating your loan. They can sometimes be deducted, but their deductibility depends on your loan terms and how they’re structured.
- Discount Points: These points lower your interest rate. If you pay these at closing, they may be deductible if certain criteria are met.
Deducting Mortgage Points: Lump Sum vs. Spread Over Loan Term
The IRS allows two methods for deducting mortgage points:
- Deduct All at Once: If you meet specific requirements, such as using the loan to buy or improve your primary residence, you may be eligible to deduct all mortgage points in the tax year you paid them.
- Amortized Deduction Over Loan Term: If you don’t meet the criteria for a lump-sum deduction, you can spread out the deduction over the life of the loan. For example, if you paid $3,000 in points for a 30-year mortgage, you’d deduct $100 each year.
Example of Mortgage Points Deduction
Let’s say you bought a home with a $300,000 mortgage and paid one discount point (1%), which would be $3,000. If you’re eligible to deduct the full $3,000 in your first year, and you’re in the 22% tax bracket, you could save around $660 in taxes just from this one deduction.
Refinancing Points Deduction
If you refinance your mortgage and pay points, you’ll typically need to deduct those points over the life of the new loan. So, if you refinance a 15-year mortgage and pay $2,500 in points, you’d deduct about $167 per year over 15 years. While it’s a smaller deduction annually, it still adds up to meaningful tax savings.
Maximizing Your Homeowner Tax Benefits
Beyond these top three deductions, homeowners may be eligible for additional tax benefits. For example, energy-efficient home improvements, such as solar panels or energy-saving windows, may qualify for tax credits, which directly reduce the amount of tax owed rather than just your taxable income. Here are some tips for making the most of your tax situation as a homeowner:
- Keep Good Records: Save all documents related to your mortgage, property taxes, and any improvements. When tax season arrives, having these organized and readily available can simplify the filing process and help ensure you don’t miss any deductions.
- Consult a Tax Professional: Tax laws change frequently, and specific rules around deductions can be complex. A tax professional can help ensure you’re not leaving any savings on the table and advise on the best way to maximize deductions based on your unique financial situation.
- Consider Prepaying Property Taxes or Mortgage Interest: If you expect to be close to the standard deduction amount, prepaying next year’s property tax bill or mortgage interest can help increase your itemized deductions for the current year.
Final Thoughts on Homeowner Tax Deductions
Taking advantage of these deductions can significantly impact your annual tax bill, allowing you to keep more money in your pocket. Just remember, tax laws are complex and change over time, so it’s always wise to consult with a tax professional to confirm you’re taking full advantage of every tax benefit you’re eligible for.
By staying informed and working with professionals, you’ll be in a stronger position to maximize your savings year after year.