The federal government has blessed homeowners with tax benefits, primarily in the form of income-tax deductions. However, the complexities of these deductions often cause homeowners to miss out on these savings when calculating their taxes. In addition to interest on mortgage payments, major deductions for a home include costs of improvements and home office expenses.
Deductions and credits on your income taxes routinely require detailed records, but this is especially true of home-related expenses. Start saving these records now to ensure you’re organized before you need to file your taxes. You can also use this time to scan your physical documents and store them digitally.
Retain your documentation after filing your taxes in the event you get audited. The Internal Revenue Service (IRS) requires you to keep records for at least three years from the time you file the return. An audit may need to go back as far as six years if the IRS identifies a substantial error on a tax return.
Itemized deductions can lower your taxes if they total more than the federal standard deduction , which can change from year to year. The standard deduction for 2019 is $12,200 if you’re single or filing separately from your spouse. It’s $24,400 if you’re married and filing jointly, and $18,350 if you’re filing as head of household.
Most people who don’t own homes won’t have enough deductions to make it worthwhile to itemize. However, homeowners often benefit by itemizing deductions. Deductible home-related expenses include mortgage interest and non-federal taxes. The Tax Cuts and Jobs Act of 2017 placed lower limits on many deductions, generally making it more difficult to exceed the standard deduction. On the other hand, this legislation also removed the income-based limits on itemized deductions, which may benefit high-income households with a large number of deductions.
You may be able to take a deduction up to a certain limit for the interest you paid on a mortgage for your primary residence. This limit is currently $1M for mortgages that you took out before December 15, 2017, and $750K for mortgages taken out on or after this date. State income taxes and local property taxes may also be deductible to some extent, which is particularly beneficial if you live in a state with a high income tax or an area with high property taxes. Taxpayers can deduct a maximum of $10K for their property taxes if they’re married and filing jointly and $5K if they’re single or filing separately. They can also deduct all of their state and local income taxes or all of their state and local sales taxes, but not both.
Home improvement expenses generally aren’t deductible unless otherwise specified. However, they may lower your tax bill after you sell your home because you can add home improvement expenses when declaring the adjusted basis on your tax return. The adjusted basis of your house is essentially its original cost, increased by capital expenditures such as improvements and decreased by depreciation such as unrepaired damage.
The taxes you pay on the sale of a home are based on the sale price minus selling expenses plus any concessions from the seller such as picking up the closing costs. You would have a capital gain on the sale if this total is higher than your adjusted basis. A higher adjusted basis reduces your profit on the sale and therefore the taxes you pay.
Improvements made to the energy efficiency of your home are among the few that are tax-deductible. Installing a solar energy system entitles you to a tax credit equivalent to 30% of the cost of the system for the 2019 tax year. It’s in your best interest to take advantage of this credit as quickly as possible, as it will decrease in subsequent tax years. It will drop to 26% for the year 2020 and then to 22% for 2021. The cost of solar energy systems won’t be deductible at all after 2021.
Home office expenses
Some homeowners who use their home for business purposes will be able to deduct those expenses from their taxable income. This benefit requires the homeowner to be self-employed and work from home. They must also regularly use a part of the house exclusively as an office, and that office must be the homeowner’s primary place of business. You generally can’t take a home office deduction if you’re an employee, because the IRS is suspending deductions for unreimbursed employee expenses until Dec. 31, 2025, although there are some exceptions. One specific expense that you can deduct is depreciation on the portion of the house that you use as a home office.
Cash-out refinancing can also provide some tax advantages for homeowners. This type of refinancing involves taking out a loan for an amount greater than what you owe on the house and getting the difference in cash. The cash you receive from cash-out refinancing is just like any other loan. You haven’t realized any income from it because you have to pay it back, so you don’t have to pay taxes on it.
The maximum amount you can borrow through a refinance typically is based on the value of your home and the equity you have in it. For example, Figure’s mortgage refinance allows you to borrow up to 80% of your home's value, with a limit of $500K on the cash-back amount. The Federal Housing Finance Agency (FHFA) places additional limits on the maximum amount of a mortgage refinance. Figure can approve your online application for a refinance in as little as 10 minutes, depending on your situation. Closing can occur in as few as 10 days*, primarily depending on the scheduling and completion of the appraisal.
Tax breaks can offset much of the expense of owning a house. The primary tax advantage is that you don’t pay taxes on the interest for your mortgage. Other common deductions are for home improvement and home office expenses. It’s important to understand the specific deductions that apply to you, as the rules can be complex.
*Closing in 10 days is dependent upon timely completion of the application process and timely scheduling and completion of the appraisal and closing. For primary residences, funding will occur three business days after closing.