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Tax Deductions For A First-Time Home Buyer

6-minute readMarch 18, 2021

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Purchasing a home is a life-changing event. You’re responsible for many things you may not have been responsible for if you rented, including mowing the lawn, shoveling the driveway or repairing a leaky roof. There’s a whole other aspect to owning a house apart from a few chores, though. Your home also affects how the IRS taxes you.

If you’re already a homeowner, this isn’t news to you. However, if you’re in the market for your new home or your first home, we've got valuable information for you.

Below you can find information about what you can and can’t deduct, available tax credits and other tips for you to become a tax savvy homeowner.

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What Is A Tax Deduction?

Tax deductions apply to your federal income tax filed yearly with the IRS. Put simply, a tax deduction lowers your taxable income. With a lower taxable income, you are responsible for less taxes. 

Tax deductions come in two main types: itemized deductions and standard deductions. Standard deductions are the simplest. The IRS sets a standard dollar amount each year depending on your income. Going with the standard deduction is the easy choice, requiring less paperwork, but you may pay more taxes or not get as large of a rebate.

Itemized deductions are tax deductions that fall under categories the IRS sets. These categories change depending on tax law. If you're filing with itemized deductions, it may be best to contact a tax accountant or tax expert to cover the bases and help you file correctly.

Can I Deduct My Property Taxes?

In the past, homeowners were able to deduct their property taxes as an itemized deduction on their yearly income taxes. Since the passing of the 2017 Tax Cuts and Jobs Act, this deduction has been removed from your federal income taxes. You can no longer deduct your property taxes from your yearly income taxes.

What Is Tax Deductible?

Tax deductions aren’t money you get back on your refund, but they do reduce your taxable income, thereby potentially lowering your tax bill. Let’s go over some of the deductions homeowners can take.

Mortgage Interest

A new mortgage means a little more work for you when it comes time to file your taxes. However, the extra work is worth it in the end. Perhaps the most important tax deduction you need to be aware of is your home mortgage interest. At year-end, check out Form 1098 from your lender to see how much mortgage interest you’ve paid.

In most cases, home loan interest is fully deductible. There are limits, though. First, the mortgage must be for the purpose of building, buying or remodeling your home. This is referred to as home acquisition debt. You can also only deduct interest on your primary home and a single vacation residence.

Secondly, there are limits on the amount of the mortgage loan you can take out.

Because of changes that came in with the 2017 Tax Cuts and Jobs Act, if you got a mortgage on or after December 15, 2017, the limit on the amount of mortgage loan debt you can claim is $750,000 for single people, heads of household or joint filers (or $375,000 for people who are married and filing separately).

If you purchased your home before that date, your grandfathered in under the old limits, which were $1 million or $500,000 if married and filing separately.

If you take the mortgage interest credit mentioned above, you can still deduct your interest, but you need to reduce the deduction by the amount of the credit.

Mortgage Points

Simply put, mortgage points are prepaid interest. You can purchase points to lower your interest rate when you get your loan. By purchasing points, you can save money in the long run if you stay in the home for a certain period of time, depending on the amount of points you purchase.

For example, if you have a $200,000 mortgage and buy two points, you’ll owe $4,000 for those points at closing. (Each point is 1% of the value of your mortgage.) These points become part of your closing costs.

If buying the points lowers your mortgage payment $250 a month, you’ll have to stay in your home for at least 16 months to break even. After that time passes, you’ll start putting money back in your pocket.

One thing to note is that you can’t deduct mortgage points all at once in most cases. You must spread the deduction over the term of the mortgage. There are limited exceptions.

State And Local Tax Deductions (SALT)

You can also deduct your state and local taxes as well as real estate taxes. There’s now a limit of $10,000 on this deduction. This limit is the total of combined state and local property taxes and income taxes or sales taxes, but not both income/property taxes and sales taxes.

Prior to the 2017 Tax Cuts and Jobs Act, you could write off every dollar of state and local taxes.

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Do You Get A Tax Credit For Buying A House?

The answer to this question is maybe. It depends on what you qualify for, and things are a bit nuanced. For now, let’s start with a more basic question: What is a tax credit?

Tax credits are items that’ll lower your overall tax bill. These credits can be refundable or nonrefundable.

Nonrefundable tax credits can be used to reduce someone’s individual tax liability down to $0. This means that if you owed $500 in taxes and qualified for a $700 credit, you wouldn’t owe any taxes, but you also don’t get the $200 back. 

If the credit is refundable, you’re entitled to the full amount if you qualify no matter what your tax bill is. This can be used to increase the size of your refund. For that reason, refundable credits are considered to have the biggest benefits for the taxpayer.

Is There A Tax Credit Available For First-Time Home Buyers?

When it comes to your federal taxes, the answer to this question is technically yes. Although the refundable first-time home buyer tax credit existed between 2008 and 2010, if you entered into a contract to buy a primary residence before April 30, 2010 and closed by September 30 of that year, you may still be eligible if you’ve never claimed the credit before.

If you bought a home in 2008 with the credit, it functions like an interest-free loan. If you claimed the full amount of the credit, $7,500, you must repay it in $500 installments over the next 15 years, beginning with the year after the credit is claimed – we have more information on repayment.

If the house is to become your primary residence at any point during that 15-year period, whatever balance you have left is owed on your next tax return.

If you bought a home in 2009 or 2010, you don’t have to repay the credit unless you stop using the home as your principal residence within three years of the date you closed. If you did, you pay off the full balance.

Home Buying Assistance And Other Tax Credits

There are a couple programs you can take advantage of as a first-time home buyer to make your purchase easier. If you're already a homeowner, there are a couple other tax credits you could take advantage of in the right situation.

HomePath 

HomePath is a program set up by the government-sponsored enterprise (GSE) Fannie Mae. HomePath allows potential homeowners to buy Fannie Mae-owned foreclosed property with a low down payment of 3%.  

With this program, you could get more home for at a lower purchase price, translating to a lower mortgage payment. Just remember, these homes are sold as-is, and since they're foreclosed properties, the condition may be worse than standard-market properties.

The HomePath program is its own fixed-rate loan program. You will need to be approved for the mortgage, with factors like your debt-to-income (DTI) ratio and your credit score coming into play. 

The absolute minimum credit score is 580, though your rate may be worse with this score. If you have a low credit score, another option to consider is an FHA loan. An FHA loan is a government-backed loan designed to help you buy a home with looser financial requirements.

HUD Grant Assistance/Programs

The U.S. Department of Housing and Urban Development (HUD) offers many different programs from housing counseling to specific mortgage programs. Many of these home buying programs are offered by state.

Individual states may have their own credits available for first-time home buyers, but down payment assistance is far more common. Whether you live in California, New York or somewhere in between, a good place to start your search is HUD’s local home buying page.

How you qualify depends on the program and factors like your location, gross income and the loan amount. 

Want to reach out to someone directly? Contact your local HUD office to see what programs you may qualify for.

Home Improvement And Energy Credits

While there aren't any direct tax benefits to home improvement, there are two different areas where you could receive tax benefits. The first area is if you make home improvements for medical reasons. These include installing ramps, widening hallways and doorways, adding handrails and more. These deductions are made as Schedule A medical expense deductions.

The other way you could receive tax benefits from home improvement is through energy credits. These are tax credits that apply to improvements like solar panels, wind turbines, fuel cells, geothermal heat pumps and solar-powered water heaters.

Unfortunately, other improvements you make for aesthetic reasons or to increase your home value are not tax deductible.

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Mortgage Interest Credit

The other type of credit that’s available on federal taxes is the mortgage interest credit. It’s intended to help low-to-moderate income families afford homeownership. Unlike the mortgage interest deduction, mentioned earlier in this article, this can directly lower your tax bill.

To claim the deduction, you must get a mortgage credit certificate (MCC) from an authorized state or local government agency. The credit is limited to up to $2,000.

Is PMI Tax Deductible In 2020?

Due to some recent changes to the tax law, private mortgage insurance (PMI) is deductible for tax years 2018, 2019 and 2020. This is due to The Mortgage Insurance Tax Deduction Act of 2019.

Do some research and consult a tax professional to see how you can deduct this from previous year's taxes.

Are There Any Tax Breaks For Homeowners?

We’ve included this category because this last tip doesn’t fall into being a credit or deduction.

You can withdraw from your IRA once to fund a down payment as a first-time home buyer. If it’s a traditional IRA, you’ll need to pay income tax on the withdrawal, but there’s no penalty. If it’s a Roth IRA, you don’t have to pay income tax on the withdrawal because you paid income tax already when you put in the money.

You can also borrow from your 401(k), but you do have to pay it back.

Summary

While we’ve tried to provide general tax advice here, everyone’s situation is different. Tax laws change and what was deductible one year may no longer be. Whether you're a first-time home buyer or looking to refinance, knowing how the IRS taxes you is part of being a responsible homeowner.

If you have any doubts, consult a financial advisor, tax professional or tax preparation software. With a tax professional, the amount of money you pay them can come back in large amounts on your federal tax return or savings on your tax bill.

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