Real Estate
Tax Breaks for Buying a Home
From mortgage interest deductions to closing cost write-offs, find out the tax relief benefits for homeowners.
December 2008
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Buying your first home is a huge step. When you leave the world of renting behind, you begin building equity in an investment. And Uncle Sam is there to help ease the pain of high mortgage payments.
The deductions now available to you as a homeowner will reduce your tax bill substantially. And, if you have been claiming the standard deduction up until now, the extra write-offs from owning a home almost certainly will make you an itemizer. Suddenly, the state taxes you pay and your charitable gifts will earn you tax-saving deductions, too.
Mortgage interest. For most people, the biggest tax break from owning a home comes from deducting mortgage interest. You can deduct interest on up to $1 million of debt used to acquire your home. Your lender will send you Form 1098 in January listing the mortgage interest you paid during the previous year. That is the amount you deduct on Schedule A. Be sure the 1098 includes any interest you paid from the date you closed on the home to the end of that month. This amount is listed on your settlement sheet for the home purchase. You can deduct it even if the lender does not include it on the Form 1098. If you are in the 25% tax bracket, deducting the interest basically means Uncle Sam is paying 25% of it for you. A $1,000 deduction will reduce your tax bill by $250.
Points. When you buy a house, you usually have to pay "points" to the lender to get your mortgage. This charge is usually expressed as a percentage of the loan amount. If the loan is secured by your home and the number of points you pay is typical for your area, the points are deductible as interest if you paid enough cash at closing -- via your down payment, for example -- to cover the points. For example, if you paid two points on a $300,000 mortgage -- $6,000 -- you can deduct the points as long as you put at least $6,000 into the deal. And, believe it or not, you get to deduct the points even if you persuaded the seller to pay them for you as part of the deal. The deductible amount should be shown on your 1098 form.
Real-estate taxes. You can deduct the local property taxes you pay each year, too. The amount may be shown on a form you receive from your lender, if you pay your taxes through an escrow account. If you pay them directly to the municipality, though, check your records or your checkbook registry.
In the year you purchase your residence, you probably reimbursed the seller for real estate taxes he or she had prepaid for time you actually owned the home. If so, that amount will be shown on your settlement sheet. Include this amount in your real-estate tax deduction. Note that you can't deduct payments into your escrow account as real-estate taxes. Your deposits are simply money put aside to cover future tax payments. You can deduct only the actual real-estate tax payments made from the account by your lender.
New for 2008: For the first time, homeowners who take the standard deduction instead of itemizing can deduct part of their property taxes. Joint filers can add in up to $1,000 of property taxes paid to the amounts shown above. Singles can add in up to $500 of real estate tax payments.
PMI premiums. Buyers who make a down payment of less than 20% of a home's cost usually get stuck paying premiums for private mortgage insurance (PMI), an extra fee that protects the lender if the borrower fails to repay the loan. For mortgages issued after 2006, PMI premiums can be deducted by home buyers.
This write-off phases out as income increases above $50,000 on married filing separate returns and above $100,000 on all other returns. (If you're paying PMI on a mortgage issued before 2007, you're out of luck on this one.) As it stands now, the write-off is set to expire at the end of 2010, although Congress may extend it.
Credit for first-time home buyers. If you purchased a primary residence after April 8, 2008, and before Jan. 1, 2009, and are a "first-time" home buyer, you can qualify for a new tax credit for 10% of up to $75,000 of the purchase price. For 2009, the credit is for 10% up to $80,000. To be eligible, you must not have owned a residence in the U.S. in the previous three years. Nor can the credit be taken if your mortgage is funded with tax-free bonds that states and localities issue to give below-market mortgages.
The credit phases out between $150,000 and $170,000 of AGI for married couples and $75,000 to $95,000 for single filers. It is refundable to the extent it exceeds your regular tax liability -- which means that if the credit more than offsets your tax liability for the year, you'll get a refund check for the balance -- but does not offset the AMT. If you buy your home in the first five months of 2009, you can elect to take the credit on your 2008 income tax return.
If the tax credit is for a 2009 purchase, it doesn't have to be paid back. But for 2008, this credit is more like an interest-free loan from Uncle Sam rather than a gift, because it will be recaptured ratably over 15 years. The recapture period starts two years after the year the credit is claimed. Thus, if you claim a $7,500 tax credit for a purchase in 2008, you will have to pay an extra $500 of income tax in 2010 and in subsequent years until you have repaid the full $7,500. If you sell the residence before the credit is fully repaid, the balance is due in the year of the sale. (If your profit on the sale is less than the unrecaptured credit, though, the amount due is limited to the amount of your profit.)