Tax Benefits of Homeownership

Although homeownership is perhaps best known for the numerous costs associated with it, owning a home can also have a host of financial benefits. In the United States, those include benefits in the form of tax deductions and credits that can be claimed on federal income taxes. Deductions reduce people’s taxable income, thus lowering the amount of taxes they owes for the year and often increasing the amount of refund received, while tax credits directly reduce the amount of tax owed. Although the US tax code allows for deductions and credits in numerous areas, certain ones are most relevant to homeowners, including the mortgage interest deduction, credits promoting energy-efficient home improvements, and deductions for self-employed taxpayers and remote workers who maintain home offices. When filing income taxes, taxpayers have the opportunity to choose between taking the standard deduction, a set figure by which their taxable income is reduced, and itemizing their deductions. As the deductions and credits geared toward homeowners can be claimed only through itemizing, many homeowners choose the latter option.

Background

Though first introduced in the previous century, federal income tax has been a fixture of life in the United States since 1913, when the Sixteenth Amendment declared it constitutional. The collection of federal taxes is overseen by the Internal Revenue Service (IRS), originally known as the Bureau of Internal Revenue, which processes tax paperwork, collects payments, and issues refunds to taxpayers who overpay. Since the IRS’s early years, US tax code has granted taxpayers the ability to deduct certain expenses from their taxable income, thus decreasing the amount of taxes they owe for the year in question. The 1940s saw the introduction of a deduction known as the standard deduction, designed to simplify the tax process. By the early twenty-first century, the standard deduction had become a set monetary figure by which taxable income would be lowered. Choosing the standard deduction both allows individuals who do not have many individual deductions to pay less in taxes than they otherwise would have and makes the process of completing a tax return significantly less complex. However, taxpayers whose individual deductions and credits add up to an amount greater than the standard deduction do not benefit from taking it and thus choose to itemize their deductions when filing their taxes.

Among the many deductions and credits available to taxpayers are several of particular interest to homeowners. Some of those deductions have a long history in the United States; mortgage interest, for instance, has been deductible since the IRS’s founding in 1913. Others were prompted by changes in the US economy. During the global recession that began in 2007, the US government sought to boost the economy and particularly the struggling housing market by enabling lower-income and middle-class Americans to purchase homes. To that end, the Housing and Economic Recovery Act of 2008 introduced a first-time homebuyer credit of up to $7,500 for eligible taxpayers who bought their first home in 2008. Later legislation, including the American Recovery and Reinvestment Act of 2009 (ARRA) and the Worker, Homeownership and Business Assistance Act of 2009, extended the credit’s availability through June 2010 and altered its terms significantly. Other deductions and credits were influenced by environmental concerns; for example, a variety of credits are available to homeowners who make certain energy-efficient or alternative-energy improvements to their homes, reflecting the desire among many Americans to reduce energy use and dependence on traditional energy sources such as fossil fuels.

Overview

A variety of deductions and credits are available to homeowners who choose to itemize their deductions rather than take the standard deduction. While some are available only to those who meet certain specific requirements, others are available to the majority of homeowners. As the tax code is complex and mistakes when filing one’s taxes can have significant financial consequences, one may wish to consult with a trained tax professional to determine whether one qualifies for a particular deduction or credit.

One of the best-known tax deductions for homeowners is the mortgage interest deduction, which has existed in one form or another since the establishment of the IRS in 1913. This deduction allows homeowners to deduct all or a portion of the mortgage interest paid during a specific year. This deduction is not based on the entire mortgage payment paid each month, which often includes principal, taxes, and insurance in addition to interest. However, for many homeowners, interest makes up a significant percentage of their mortgage payments each year, so taking the mortgage interest deduction can be extremely beneficial.

Eligibility for the mortgage interest deduction is based on several factors, as of the 2014 tax year. First, the deduction applies only to an individual’s primary and secondary residences. Individuals may deduct all of the interest they paid during the tax year if the mortgage was taken out before October 13, 1987. For mortgages taken out after that date, taxpayers may deduct all of the interest if the mortgage loan amount was for less than $1 million, or $500,000 if the individual is one half of a married couple filing separately. If a mortgage taken out after October 13, 1987, was for an amount greater than $1 million or $500,000, the taxpayer may be eligible to deduct only a portion of the interest. In addition, in order to be eligible, the mortgage must be a secured debt that uses one’s home as collateral. Most mortgages fall within that category, although select loans may not.

In addition to mortgage interest, a homeowner who purchased a home during the tax year in question may be able to deduct any points he or she paid at closing. Points are essentially prepaid interest and are a component of the closing costs required by some lenders. A homeowner may likewise be eligible to deduct any interest paid on a home-equity loan, which is a loan based on one’s ownership interest in one’s home. Homeowners may also deduct real-estate tax payments made to the state or town in which the home is located.

In light of increasing government and public interest in alternative energy and a desire among many Americans to reduce the nation’s dependence on fossil fuels, US tax code also allows for a number of tax credits that incentivize American homeowners to improve the energy efficiency of their homes. Some of the tax credits introduced during the early twenty-first century, including one for homeowners who improved the energy efficiency of their homes by installing new, energy-efficient insulation, windows, or cooling or heating systems, expired at the end of 2014. As of 2015, however, some energy-related credits remain in effect. Homeowners who install alternative energy systems such as eligible geothermal heat pumps, wind turbines, solar panels, and solar water heaters in their primary or secondary residences may claim a tax credit equal to 30 percent of the amount of money spent on the equipment and installation. Another credit applies to homeowners who purchased certain fuel cells during the tax year. The amount of this credit varies and is based on both the cost of the fuel cells and their power capacity. Like other energy-related credits before them, those two credits are set to expire, at the end of 2016, although future legislation could potentially extend them.

While the majority of deductions and credits targeted toward homeowners concern the home’s status as a residence, the tax code also makes provisions for homes that are used in part for business activities. Some homeowners who work from their homes, whether as small-business owners or as remote employees, may be eligible for additional deductions if they maintain a dedicated home office that is exclusively used for business purposes. The IRS permits such individuals to deduct 100 percent of expenses related solely to the home office, such as improvements made to that particular room or portion of a room. Such taxpayers may also be able to deduct a portion of expenses that apply to the entire house, such as payments for homeowners insurance or utilities. A number of deduction limits apply, based on business income and other factors, and regulations regarding whether a space qualifies as a home office are strict. As such, homeowners seeking to claim home-office deductions should consider consulting professionals to determine whether their office space is truly eligible.

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