Unlock 8 Tax Breaks for Home Ownership

Over the last year, home prices have soared in many parts of the country. In addition to benefitting from an appreciating asset, eligible homeowners enjoy several tax advantages. Here are eight reasons why it's better to be an owner, rather than a renter, from a federal income tax perspective.

1. Home Sale Gain Exclusion

If you sell a home that you've owned and used as your principal residence at least two out of the last five years, you may exclude from tax up to $250,000 of gain ($500,000 for married people who file joint tax returns). To qualify for the larger $500,000 joint-filer exclusion, at least one spouse must pass the ownership test and both spouses must pass the use test.

Your principal residence for the year is the one where you spend the majority of time during that year. According to IRS regulations, other relevant factors can include:

  • Where you work,
  • The mailing address used for your bills and correspondence,
  • The address shown on your income tax returns, driver's license, and auto and voter registration cards,
  • Where you maintain bank accounts,
  • Where you maintain religious affiliations and club memberships, and
  • Where family members and pets live.

In addition, the gain exclusion privilege generally can't be "recycled" until two years have passed since you used it last. For married couples, the larger $500,000 joint-filer exclusion is only available when neither spouse excluded a gain from an earlier sale within the two-year period.

For purposes of the home sale gain exclusion, your gain equals the sales price less your adjusted basis. Documented home improvements increase your basis, thereby reducing any taxable gain.

You may qualify for a partial exclusion if you don't meet the two-out-of-five-year rule but the sale is due to an employment change, the need for medical care or other unforeseen circumstances.

2. Mortgage Interest Deduction

If you have a mortgage on your home, you can generally claim an itemized deduction for mortgage interest — although the rules are less favorable under the Tax Cuts and Jobs Act (TCJA). For the 2018 through 2025 tax years, you're generally allowed to deduct interest on only up to $750,000 of mortgage debt incurred to buy or improve a first or second residence. This limit applies to "home acquisition indebtedness" incurred after December 15, 2017, with some limited exceptions. (For married individuals who file separately, the home acquisition indebtedness limit is $375,000 for 2018 through 2025.)

Under pre-TCJA law, you could deduct interest on up to $1 million of home acquisition indebtedness (or $500,000 for those who use married filing separate status).

The TCJA "grandfathers" in existing home mortgage debt under the old rules. That is, the new law doesn't affect home acquisition indebtedness of up to $1 million (or $500,000 for married-separate filers) that was taken out:

  • Before December 16, 2017, or
  • Under a binding contract that was in effect before December 16, 2017, so long as the home purchase closed before April 1, 2018.

Under another grandfather provision, the previous home acquisition indebtedness limits of $1 million (or $500,000 for married-separate filers) continue to apply to home acquisition indebtedness that was taken out before December 16, 2017, and then refinanced during the period extending from December 16, 2017, through 2025. But the grandfather provision applies only to the extent that the initial principal balance of the new loan doesn't exceed the principal balance of the old loan at the time of the refinancing.

In addition, for 2018 through 2025, the TCJA effectively limits the home equity interest deduction to debt that would qualify for the home mortgage interest deduction. (For married individuals who file separately, this limit is $50,000 for 2018 through 2025.)

Under pre-TCJA law, interest was deductible on up to $100,000 of home equity debt used for any purpose, such as to pay off credit card debt or to buy a car.

3. Property Tax Deduction

If you own a home in a state that levies property tax, you can generally claim an itemized deduction for property taxes paid on your principal residence (plus a second home). But the TCJA limits these deductions for 2018 through 2025.

Currently, your deduction for state and local tax (SALT) payments, including property taxes, can't exceed $10,000 for the year. So many homeowners don't get the full tax benefit from paying these expenses. Also, note that only itemizers can claim the SALT deduction, and writing off property taxes precludes any deduction for state and local sales taxes. In addition, under the TCJA, personal foreign real property taxes can no longer be deducted.

Important: Under pre-TCJA law, in addition to being allowed to deduct 100% of state and local income (or sales) taxes, homeowners could deduct 100% of their state and local personal property taxes. In other words, there was previously no limit on the amount of personal (nonbusiness) SALT deductions you could take, if you itemized. The limits on deducting property taxes will expire at the end of 2025, unless Congress passes legislation to extend them.

4. Home Office Deduction

If you work from home as a self-employed individual, you may be eligible for a home office deduction. To qualify, you must use the office space regularly and exclusively as your principal place of business or a place where you meet or deal with customers, clients or patients in the normal course of business.

This enables you to write off direct home office expenses and a portion of indirect expenses, including:

  • Utilities,
  • Insurance,
  • Repairs,
  • Depreciation,
  • Mortgage interest, and
  • Property taxes.

Write-offs for these expenses are based on the percentage of your home's square footage that's used for business purposes. When you sell the home, you must recapture depreciation attributable to the period after May 6, 1997, taxable at a 25% rate.

Or, if you don't want to track these expenses, there's a simplified method that can be used to calculate the home office deduction. Under this alternative method, you can simply deduct $5 for each square foot of home office space, up to a maximum total of $1,500. But note that the actual expense method generally provides a bigger deduction than the simplified method. 

5. Deduction for Certain Home Improvements

Home improvements may be added to your tax basis in a home and reduce the amount of any taxable gain when you eventually sell your home. But you may derive other tax benefits for home improvements made for medical reasons.

For instance, if you build an in-ground swimming pool to help alleviate your child's asthma based on a physician's advice, the cost above the increase in the home's value qualifies for a medical deduction. Similarly, you may deduct costs for ramps and lifts for a disabled person. However, medical expenses can be claimed as an itemized deduction only to the extent the annual total exceeds 7.5% of adjusted gross income (AGI).

6. Deduction for Mortgage Points

When you acquire a home and take out a mortgage, you may decide to pay one or more "points" on the loan. Each point is equal to 1% of the borrowed amount. This may entitle you to a more favorable rate for the life of the loan.

Generally, mortgage points are currently deductible as an itemized deduction if certain requirements are met. For example, the loan must be secured by the residence and be used to buy or build the home.

Important: If you refinance an existing loan and pay points, the deduction for the points is amortized over the loan term, rather than deducting the entire cost in the current tax year.

7. Private Mortgage Insurance

For 2021, homeowners who itemize may deduct private mortgage insurance, within certain limits. This deduction has expired and been reinstated several times. It most recently extended through 2021 by the Consolidated Appropriations Act (CAA). As of this writing, it hasn't been extended for 2022.

The deduction is phased out if your AGI exceeds $100,000. The phase-out is complete when AGI reaches $109,000.

8. Energy Credits for Certain Home Improvements

The CAA extended the basic home energy credit through 2021. As of this writing, it hasn't been extended for 2022. This credit is equal to 10% of the cost of qualified energy-saving improvements such as:

  • Central air conditioning,
  • Insulation,
  • Exterior windows and skylights,
  • Exterior doors,
  • Natural gas, propane and oil water heaters or furnaces,
  • Hot water boilers,
  • Electric heat pump water heaters,
  • Metal roofs,
  • Biomass stoves, and
  • Advanced main air circulating fans.

This credit is capped at the following amounts:

  • $50 for advanced main air circulating fans,
  • $150 for furnaces and boilers, and
  • $300 for any item of energy-efficient building property.

Plus, there's an overall lifetime limit of $500 ($200 lifetime limit for windows). An alternative 26% credit may be available for certain energy-efficient property, including solar and water heating panels, fuel cell projects, small-wind energy projects and geothermal heat pumps.

Stay Tuned

The federal tax laws continue to evolve, but there are currently a host of tax incentives for homeowners. You also may realize tax breaks on the state level. Consult with your HK tax advisor to maximize the tax benefits of home ownership.

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