What if I can't afford to pay my taxes?
The IRS will agree to work with you to set up a payment plan so the liability can be paid off with minimal hardship.
Buying a home can be a lot of fun — it’s thrilling to admire those just-within-reach options on Zillow or Redfin. Could I see myself in this rancher? How about the backyard on that colonial? Any chance we could afford that one with the turret?
But as we all know, there’s much more to this life-changing transaction than deciding whether a walk-in closet or a home office is a must-have.
It’s a good idea to brush up on the financial details of this big decision before you start your home search in earnest. After all, these specifics will have a direct and unavoidable effect on your life as a homeowner.
The tax implications, especially, have a lot of ins and outs worth knowing.
The federal government has a long history of encouraging home buying through tax-breaks, incentives, and other means. One result of this orientation is several federal tax deductions that homeowners can claim to ease their tax burden.
Here are the key tax deductions to become familiar with as you enter the complex world of home financing.
The most significant tax deduction available to homeowners is on mortgage interest. This interest is a considerable expense in the early years of paying down the loan, so the ability to deduct this interest from your taxes could save you a truckload of money over the years.
IRS policy allows you to deduct interest paid on mortgages up to $750,000 (or $375,000 if married filing separately) if the loan originated after December 16, 2017. Higher limitations apply for mortgages originating before that date ($1 million, or $500,000 if married filing separately).
You’ll be able to claim this deduction on your federal taxes if you meet the following conditions:
You paid mortgage interest during the year.
The home in question is your principal residence.
You itemize your taxes.
Mortgage interest can be set at a fixed rate, an adjustable-rate, or a combination of the two. Remember that if you have an adjustable-rate mortgage, the amount of interest you pay every month will vary, making it harder to predict how much money you’ll be able to deduct at tax time.
Many buyers pay points when obtaining a mortgage. These are fees that you pay to a lender at closing to secure a lower interest rate. For this reason, paying fees is often referred to as “buying down your rate.”
Points payments amount to prepaid interest, so if you itemize, you may be able to deduct the full amount of these points as home mortgage interest in the year you purchased your home. In order to do so, however, you’ll need to meet the following conditions.
You used the loan on which you paid points to buy or build your principal residence.
Paying points is a common practice where you live, and you paid a typical amount.
You use a cash method of accounting (reporting income and expenses in the year you receive and spend them).
The points did not replace other fees, such as appraisal fees, title company fees, property taxes, or attorney’s fees.
You paid for points with cash at closing.
The lender calculated the points as a percentage of your mortgage principal.
The points you paid are clearly listed on your settlement statement.
If you pay less than 20 percent for a down payment, you will likely obtain mortgage insurance as part of your home buying process. You pay a monthly premium to reduce your lender’s financial risk if you default on the mortgage.
The IRS allows you to count that mortgage insurance premium as mortgage interest, which you deduct on Schedule A of Form 40 along with the rest of your mortgage interest. This is a nice benefit for those who may not be thrilled to be adding yet another insurance premium to their budget.
Property taxes are another key deduction for homeowners, providing some serious tax relief. Homeowners pay property taxes to their states and municipalities every year — or at least they better — and these taxes may well rise over time. The stress of those payments can be mitigated by knowing that at least some of them will be taken off your federal taxes.
The word “some” is critical in that last sentence: Be aware that since 2018, property taxes are part of the $10,000 limit on deductible state and local income taxes on your federal tax return.
Another thing to keep in mind in regards to property taxes is the role of escrow. Many homeowners pay their property taxes by putting money in escrow each month as a part of the mortgage payment. It’s important to only deduct the property tax portion of the mortgage payment, not the entire payment.
Low-income homebuyers may qualify for a mortgage interest credit on their federal taxes. The credit is contingent on a state or local governmental unit or agency providing a qualified Mortgage Credit Certificate (MCC) as part of a qualified mortgage credit certificate program. These programs vary from place to place and come with diverse rules.
The certificate provides a dollar-for-dollar reduction in the amount of tax you owe. However, it’s important to note that the credit will be taken out of your home mortgage interest deduction on your federal taxes.
Many first-time homebuyers are interested in getting credit for being a newbie. Is this possible?
The short answer is “no” (sorry) at the moment, though that might change any minute.
In 2008, the Obama Administration created a $7,500 first-time homebuyer credit, and Congress increased the amount to $8,000 in 2009. This was temporarily great for new home buyers, but the program expired in 2010.
The new Biden Administration is working to reinstate the first-time homebuyer credit — and this time at a scale twice as large. As of early 2021, Biden is proposing a $15,000 first-time homebuyer tax credit that can be used to contribute to a down payment.
If this policy is enacted, the answer to this question changes immediately to “yes,” and if you’re looking to buy, you should pop the bubbly.
While deductions get all the attention, there are a variety of tax-related elements that are likely to show up on your closing documents.
Did you know that sales taxes sometimes have a role in buying and selling a house? This role depends on the specifics of the negotiations and where the home is located. Many states do not apply sales tax to home purchases, and in those that do, it’s often a cost borne by the seller.
Real estate transfer taxes might show up under other names, such as deed tax, mortgage registry tax, or stamp tax. Whatever it’s called, this is a state tax on the change in ownership of the property. Derived as a percentage of the purchase price, it might be paid by the buyer or the seller — depending on the jurisdiction.
Regardless of who pays, the real estate transfer tax might affect the cost of the purchase. You are not allowed to deduct these taxes from your federal income tax filing but they are included in the cost basis used to determine your home’s value in the future.
There are some tax implications for sellers as well as for homebuyers, the chief of which is the capital gains exclusion of $250,000 ($500,000 for some married taxpayers). You’ll qualify for this exclusion if the property is a principal residence for two of the five years prior to the sale.
This exclusion, which you can claim once every two years, is a way to avoid hefty taxes if the value of your property has increased since you bought it. That sounds like a win-win.
The tax considerations covered in this post are federal, but keep an eye out for applicable tax breaks that you might be able to claim at the local, state, and county levels. These breaks might be triggered by your income, veteran status, your status as retired or disabled, or some other factor of your situation.
Make a point of saving your closing statement after you’ve signed on the dotted line. During your filing process for the year of your purchase, you may be able to find tax deductions you weren’t initially aware of. It’s a good idea to have a professional analyze your situation and maximize your deductions.
Homebuying and home-owning is ripe territory for the Tax Man — such large and complex transactions provide many opportunities to both charge taxes and excuse people from taxes. Not only are the rules many, but they are apt to change, so keeping an eye on the tax landscape is a good idea if you’re planning to buy or sell a home in the near future.
That being said, don’t focus on taxes too much. The tax implications of a home purchase shouldn’t be the driving force behind your decision to buy or your choice of which home is right for you. (If you find that taxes have that much bearing on your real estate decision-making, maybe reconsider whether homebuying is the right choice for you at the moment.)
If all this appears overwhelming, don’t stress! There are many tax professionals available to guide you through the process. As long as your documentation is in order, you’ll have everything you need to make the most of tax time.
If you’re looking for the perfect tax Pro to make sure you get all the credits and deductions you qualify for, fill out the Taxfyle questionnaire today.
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