Tax & Financial Benefits of Owning a Home

Tax & Financial Benefits of Owning a Home

Are you thinking about buying a house? It isn’t a secret that homeownership can be a big financial commitment. You may feel overwhelmed by the down payment, mortgage payments, property taxes, and maintenance costs. However, before you get discouraged, numerous financial and tax advantages await you to discover.

These tax benefits of owning a home can be a smart investment in the long run. Although there are drawbacks, you must understand the potential for building wealth through real estate. Here, we’ll list insights into the tax benefits of homeownership, while acknowledging some financial downsides to keep in mind.

Building Wealth Through Homeownership Tax Advantages

Tax breaks or deductions help reduce your taxable income. You can opt for either standard or itemized deductions when filing taxes. The standard deduction is a fixed dollar amount you can remove from your income, regardless of your true expenses.

The Internal Revenue Service (IRS) determines this amount, providing a straightforward approach. For 2024, it's $14,600 for single filers and $29,200 for married couples filing jointly.

Conversely, itemizing deductions allow you to deduct specific expenses like mortgage interest, property taxes, and home improvement costs. However, the total value of your itemized deductions must exceed the standard deduction for it to be beneficial. Below is more info on these tax deductions:

Mortgage Interest Deduction

Homeownership presents a significant tax advantage through the home mortgage interest deduction. This itemized deduction allows you to subtract the interest you pay on your mortgage from your taxable income. The deduction applies to various home loan types used to purchase, construct, or improve your primary or secondary residence.

The Tax Cuts and Jobs Act (TCJA) of 2017 changed the home mortgage interest deduction, lowering the limit from $1 million to $750,000 for eligible loans. Married couples filing jointly and single filers can deduct up to $750,000 for the 2024 tax year. Meanwhile, married taxpayers filing taxes separately can deduct up to $375,000 each. This deduction reduces your tax burden by effectively lowering the amount you owe in taxes.

Property Tax Deduction

Like mortgage interest, you can also deduct your annual property taxes. This property tax deduction helps offset the ongoing cost of owning a home against your tax obligations to the government.

It includes deducting property taxes from your federal income tax return. Property tax deductions apply to primary residences, vacation homes, and land. However, there are limitations based on tax brackets and the total property tax amount paid. The TCJA capped the total state and local tax deduction, including property taxes, at $10,000 for individuals and married couples filing jointly.

Additionally, new homeowners can benefit from deducting property taxes paid at the time of purchase. Understanding these property tax deductions is crucial for optimizing the financial advantages of homeownership.

Home Equity Loan Interest Deduction

One key advantage of homeownership is building equity over time. Equity refers to the difference between your house’s value and mortgage balance. You can leverage this equity to access low-cost financing options like home equity loans or home equity lines of credit (HELOCs).

  • Home Equity Loan. It provides a lump sum of cash, ideal for substantial one-time expenses like a major home improvement project. They come with fixed interest rates, offering predictable monthly payments throughout the loan term.
  • HELOCs. It functions similarly to a credit card by providing a line of credit that is accessible when needed. You can withdraw the funds through online transfers, checks, or even a dedicated HELOC credit card. HELOCs often have minimal to no closing costs, but the interest rates are usually variable.

If utilized for home improvements, your interest on these loans may qualify for tax deductions. As a result, you get the dual advantage of accessing funds for renovations while enjoying potential tax benefits.

Discount Points Deduction

As a homeowner, you can lower mortgage interest rates by paying mortgage points. There are two main types of mortgage points.

  1. Discount points. These refer to the prepayment of interest you make to lenders in exchange for a reduced mortgage interest rate. The beauty of discount points lies in their tax deductibility, allowing you to subtract them from your taxes in the year of payment. Essentially, you pay more upfront to lower the mortgage interest rate over time.
  2. Origination points. These represent fees paid to lenders for extending the loan and are deductible if used specifically for the mortgage, excluding closing costs. Each origination point typically equals 1% of the mortgage amount, with fees varying among lenders.

Deductible Home Improvements

Owning a home allows you to deduct the cost of certain improvements from your taxes. These improvements must generally add value and extend the life of your home, like new siding, roofs, or energy-saving upgrades.

For instance, the energy efficiency tax credits encourage homeowners to invest in eco-friendly upgrades that reduce energy bills and lower your carbon footprint. These tax credits are time-sensitive, hence the need to act promptly in making the home improvements.

Mortgage Insurance Deduction

Homeowners with private mortgage insurance (PMI) payments might qualify for a tax deduction. Typically, PMI is mandatory for homebuyers who pay less than 20% on their home purchase. This deduction, however, is subject to income limitations as it applies to homeowners with an adjusted gross income (AGI) below $100,000.

The deductible starts phasing out when the AGI surpasses $100,000 for single filers or $50,000 for married individuals filing separately. Complete ineligibility sets in once the AGI exceeds $109,000 for singles or $54,500 for married couples filing separately.

Capital Gains Exclusion on Home Sale

When you sell your primary residence, you may qualify to exclude a portion of the capital gains from your taxable income. This earned income tax credit can be substantial, especially if you're a long-time homeowner whose property has significantly appreciated.

The IRS permits a tax-free profit of up to $250,000 for single homeowners and $500,000 for married couples. The capital gains exclusion applies solely to the primary residence, not secondary or vacation properties.

To qualify, you must have owned and resided in the property for at least two of the five years leading up to the sale date. Moreover, you shouldn't have benefited from selling another primary residence in the two years preceding the current sale.

Building Credit with On-Time Mortgage Payments

Renting payments don’t impact your credit score. Meanwhile, making on-time mortgage payments is one of the best ways to build and improve your credit score. The credit score is crucial in determining your interest rates for future loans, including mortgages, car loans, and even credit cards. By consistently making your mortgage payment on time, you demonstrate your creditworthiness and qualify for better interest rates.

Drawbacks of Homeownership

Buying a home offers a variety of financial advantages, but it's important to be aware of the drawbacks as well. They include:

High Debt Burden

Homeownership comes with upfront costs beyond the purchase price. The down payment for buying a house may range from 3.5% to 20% of the purchase price. Meanwhile, the closing costs can add another 2-5% to the total expense. These closing costs cover fees like appraisals, applications, inspections, and insurance. While the long-term benefits can be significant, prepare for the initial financial impact.

Potential for Depreciation

While you may typically anticipate your property's value to appreciate, this isn't guaranteed. Market declines or changes in the neighborhood can decrease the home's value. Additionally, the property's physical structure can naturally depreciate over time due to wear or insufficient maintenance.

Limited Liquidity

Unlike stocks or bonds you can quickly buy and sell, homes are illiquid assets. Selling a house can take months, and the final sale price may not match your expectations. This lack of immediate access to your money can be inconvenient, especially if you need to relocate unexpectedly.

Make Informed Decisions: Partner with AFC Home Warranty

Owning a home is a significant financial decision with both pros and cons. Weighing the tax benefits of owning a house and the financial obligations involved is essential for making an informed choice.

In this dynamic real estate landscape, safeguarding your investment is critical. Here's where AFC Home Warranty steps in. With our comprehensive AFC home warranty plans, we offer peace of mind and protection against unexpected expenses related to home repairs and maintenance.

Whether you're a homebuyer seeking added assurance during the purchasing process or a real estate agent committed to providing exceptional service to your clients, AFC Home Warranty supports you at every step. Get a quote today to invest in your home and financial future.

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