Whether you’re gearing up to file your taxes this year, researching what’s ahead for next year or simply contemplating the benefits to buying a house in the future, there’s a lot to consider.
Under the Tax Cuts and Jobs Act affecting tax filings for the 2018 calendar year, standard deduction increases mean far fewer Americans will need to itemize their filing to receive the maximum amount of money back. As many as 27 million fewer taxpayers will need to itemize their taxes, according to an estimate from the Tax Policy Center.
Of course, that still leaves 19 million taxpayers who will benefit from itemized deductions not just this year, but next year as well. If you’re considering purchasing a home or making changes to your home or current mortgage debt, it’s important to know how your tax return may be affected.
Here’s a breakdown of tax breaks available to homeowners if they itemize.
Mortgage Interest
A major benefit of homeownership is the fact that you can deduct your mortgage interest on your taxes.
There are monetary limits to the total amount of debt, of course: Interest paid throughout the year is deductible on your taxes for mortgages up to $1 million for a loan issued prior to Dec. 14, 2017, and up to $750,000 for any loans issued after that date. The limits count as your total housing-related debt, including the mortgage on your home, a mortgage for a second home or home equity loan or line of credit (which come with additional limitations outlined below).
At the start of tax season, you should receive a 1098 form from your mortgage servicer. This form helps make the mortgage interest deduction process easy because it specifies the amount of interest you paid throughout the year, explains Kevin McCormally, chief content officer and senior vice president for Kiplinger Washington Editors.
In the same way it contributes to your total mortgage debt, the interest on a refinanced mortgage can also be deductible, following the debt limitations depending on when it was issued.
However, if homeowners are looking to refinance an existing mortgage in the near future, they may want to rethink that decision. “Unless [they’ve] been asleep for the last seven to 10 years on the refi boat, they probably have a cheaper rate than what’s out there right now, unless they need cash out,” says Matt Murphy, chief marketing officer of Chime Technologies, a vertical real estate platform.
Historically low interest rates from recent years are now almost certainly behind us, so opting to refinance an existing mortgage – especially one prior to the 2017 cutoff date – doesn’t make much financial sense. If you’ve got a mortgage worth more than $750,000, “You definitely lose your grandfathered interest rate,” Murphy points out.
Home Equity Line of Credit Interest
In line with your mortgage interest, the interest on a home equity loan or home equity line of credit can also be deducted when you file your taxes.
Like with your mortgage, the rules change between 2017 and 2018 tax filings. For your 2017 filing, you can deduct your HELOC interest, up to $1 million.
Following the reform for 2018, if you borrow against the equity in your home, the interest deduction is subject to the same $750,000 limit for total mortgage debt and only applies when the money borrowed goes toward the home itself. While you can no longer deduct interest for a HELOC to pay for personal property like a car, “if you used a home equity line of credit to pay for improvements on your home like an addition or new kitchen, it’s still deductible,” McCormally says.
State and Local Property Taxes
Historically speaking, deducting state and local property taxes on your federal tax filing is another primary financial benefit to owning a home. As McCormally notes, “Mortgage interest and property taxes are the big ones.”
For 2017, the total amount of your state and local property taxes is deductible from your federal tax filing.
From 2018 onward, the total deduction for your property taxes is capped at $10,000. While this is expected to have a larger impact in states with high property taxes, such as California and New York, the majority of homeowners won’t be affected because their property taxes are below the limit.
“For the average American in the heartland, I don’t think this will have as big of an impact on them,” Murphy says.
Rental Income
It’s becoming increasingly common for homeowners to harness the earning potential of their property by renting out space to tenants or tourists. Rentership in the U.S. hit a 50-year high in 2017, with 35 percent of the population renting rather than owning a home, and the U.S. is the No. 1 country for Airbnb listings, with 660,000 active listings as of August 2017, according to the company. Whether you have an English basement you rent to a tenant or a guest house to market on Airbnb, you’re required to report the additional income you receive on your taxes, explains Thomas Bayles, senior vice president of Mortgage Capital Partners in Los Angeles.
The benefit, however, comes from being able to deduct the cost of repairs and improvements made to that rental space.
“Let’s say you only made $5,000 on rental income, but you spent $30,000 repairing [the rental space] that year,” Bayles says. “You can take that $30,000 deduction on your tax return, so that will reduce your taxable income dollar-for-dollar, which is huge. For [for] someone making $100,000 on paper, it’ll look like you made $70,000, so your taxes are reduced.”
If you own commercial or residential property as an investment, repairs to these properties are also deductible, but tax laws are separate from those for homeowners.
Home Office Expenses
Working from home is another increasingly popular way homeowners are maximizing their space. If you work exclusively from home, you may be able to deduct costs for the space on your itemized tax return.
“That’s a big deduction for a lot of people who work at home,” McCormally says. “There’s a lot of tough rules on that – they have to use the space, basically, only for the business, but a lot of people take that deduction. It’s often considered a red flag for an audit.”
The requirements for this home office deduction change between the 2017 and 2018 filings as well. For 2017, you can work for yourself or an employer and operate from a home office, although you have to be able to prove your telecommute is for the employer’s benefit, not just your own. For 2018, deductions are limited to self-employed workers. Regardless of the year you’re filing, your home office can’t be in a guest bedroom or other space used for a dual purpose, and it must be used regularly.
But strict requirements shouldn’t deter you from filing for a home office deduction if you do, in fact, use your home office within the guidelines. “If you deserve it and have the records to show it, take it,” McCormally says.
Capital Gains From a Home Sale
There are certainly tax benefits to owning a home, but selling your house, in most cases, gives the kind of tax break few people expect or realize. The capital gains exclusion rule allows home sellers to keep the profit from a home sale without paying taxes on it.
Bayles notes the requirements for the rule: “If you’ve lived in the property as your primary residence two years in the last five years … you can make $250,000 profit as a single person, tax free, or $500,000 as a married couple.”
The majority of home sales fall under these stipulations, which means most home sellers are able to profit from their home without having to report those earnings to the IRS.
Of course, most people who sell their house take the profits to purchase their next home. Bayles says roughly three-quarters of his clients buy their next house with profits from the last one. The rest often use the extra funds to pay off debt or add to their retirement savings.
“[The equity is] a pretty powerful tool when done right,” he says.
