Purchasing a home is a life-changing experience. The moment you make the decision to become a home owner, your priorities, focus and budget change as you prepare for what will most likely be the largest purchase of your life. An important part of this process involves gaining an understanding of what it means to be a home owner and getting answers to questions. As an item that affects every phase of home ownership, taxes are a topic you definitely want to include in pre-purchase search for knowledge.
When you sit down at the closing table and write out a check to pay out-of-pocket closing costs, parts of these costs may be tax deductible. As of 2011, if you pay discount points as a way to reduce your interest rate, you can deduct the full amount, including any amount the seller pays on your behalf, either in the current year or depending on your circumstances, over the life of the loan. Other situations where points are tax deductible include points you pay on the purchase of a vacation home, as long as it is not investment property, and on home equity loan or refinance where you use all or part of the proceeds for home improvement purposes.
The interest you pay as part of your monthly house payment is fully tax deductible as long as your mortgage is not more than $1 million. In addition, private mortgage insurance premiums or the alternative funding fee you pay on a VA, HUD or Rural Housing Services loan is also tax deductible, according to IRS 2010 tax instructions. If you decide later to take out a home equity loan, mortgage interest you pay on loans of up to $100,000 is, in most cases, also tax deductible. One thing to watch for, however, is if your first mortgage and equity loan in combination amount to more than the current value of your home, the IRS will limit the amount of interest that is deductible. Finally, property taxes you pay to the city or town in which you live are a fully deductible expense.
When it comes time to sell your home, you can avoid paying taxes on the first $250,000 of profit you make if you own and live in the home for a minimum of two years or sell your home before this time for a qualifying reason. This can include reasons the IRS defines as "unforeseen circumstances," such as death, divorce or legal separation, loss of your job if it makes you eligible for unemployment compensation, a pay cut that makes it impossible for you to maintain your home or multiple births from a single pregnancy.
To take advantage of the tax deductions home ownership provides you must use form 1040 and itemize deductions when filing your annual tax return. If your mortgage is small and you have few to no other deductions, taking the standard deduction cam make more sense. Because the standard deduction for you depends on factors such as your filing status, age, number of dependents and whether you have a disability, consider talking to your tax adviser now or before filling out your annual return.
- Internal Revenue Service: Publication 936: Home Mortgage Interest Deduction
- "Bankrate.com"; Your Changing Tax Life: Owning a Home; Kay Bell; March 2004
- IRS.gov: Publication 523 - Main Content
- "HousingEconomics.com"; The Tax Benefits of Home Ownership; Robert D. Dietz, Ph.D.; March 2009
- IRS.gov: Standard Deduction
- Luxury Vacation Home image by weberfoto from Fotolia.com