The tax guide to buying, owning your dream home
The Big Tax Break When You Borrow
Nearly everyone has to take out a mortgage to help them buy a home. Although the interest on most loans that you take out for personal purposes aren't deductible on your tax return, tax laws make an exception for mortgage debt. You can take any interest you pay on up to $1 million you borrow to purchase your home and use it as an itemized deduction on your tax return. In addition, you can get an additional $100,000 in home equity indebtedness and deduct interest on that amount as well. You can also deduct at least a portion of any points you pay on your original mortgage, with a full deduction available in most cases for a home purchase that is your primary residence.
Itemizing mortgage interest can save you as much as 40 cents for every $1 in interest that you pay. The higher your tax bracket, the more valuable the deduction, and therefore the greater the incentive to borrow to buy a home. Conversely, for lower-income homeowners, the itemized deduction might be worth nothing at all if your total mortgage interest and other itemized deductions don't exceed your standard deduction. It's therefore important to look at your full tax picture to determine what value the mortgage-interest deduction has to you.
Getting Back Part of Your Property Taxes
Another deductible expense is property tax you pay for your home. State and local property taxes are eligible for you to itemize, with the deduction coming in when you actually pay your tax bill.
One thing to keep in mind with property taxes is that if you're subject to the Alternative Minimum Tax, you're not allowed to deduct property taxes against your AMT liability. That's not a problem for most homeowners, but many upper-middle-income households run into AMT issues and must take the limits on deducting property taxes into account when considering the tax consequences of homeownership.
Keep More of Your Gains
One of the biggest tax breaks homeowners get comes when it's time to sell. Ordinarily, selling property involves paying tax on capital gains. But homeowners get to exclude up to $250,000 for single filers or $500,000 for joint filers in capital gains when they sell.
To qualify, you have to have lived in the home for at least two of the five years before you sell, with pro-rated exclusions available for those who've spent less time in the property. Nevertheless, this provision can save you tens or even hundreds of thousands of dollars at tax time.
Get Extra Credit
In addition to basic homeowner expenses, some special purchases you make can qualify for tax credits. Specifically, the Residential Renewable Energy Credit gives you tax credits of up to 30 percent when you install energy-efficient upgrades such as solar-energy systems. Meanwhile, the similar Residential Energy Efficiency Credit offers up to $500 in credits against expenses for other improvements, such as adding insulation, replacing windows or doors, or buying more efficient heating and cooling equipment for your home. Although the Renewable Energy Credit is in effect through 2016, the Energy Efficiency Credit was only recently renewed through the end of 2014, with the potential to be renewed in 2015 and beyond.
Motley Fool contributor Dan Caplinger thinks homeownership is overrated, but that didn't stop him from buying a house. You can follow him on Twitter @DanCaplinger or on Google+. To read about our favorite high-yielding dividend stocks for any investor, check out our free report.