Tax Breaks for Mortgage Expenses

If you've previously taken the standard deduction, buying a home may shift you to itemizing deductions. This change lets you benefit from additional tax-saving deductions on state taxes and charitable contributions as well.

Mortgage Interest Deduction

One of the most substantial tax benefits for homeowners is the ability to deduct mortgage interest. For mortgages prior to 2018, interest on up to $1 million of debt used to buy, build, or improve a home can be deducted. For mortgages originated after December 16, 2017, this limit is reduced to $750,000. Your lender will provide Form 1098 in January, which details the mortgage interest you paid the previous year, typically deductible on Schedule A. Don’t forget to check your settlement sheet for any prepaid interest not listed on the 1098, as it may also be deductible.

Points Paid on Your Mortgage

When obtaining a mortgage, you might pay “points” to reduce the loan interest rate. These points, expressed as a percentage of the loan, are deductible as long as the amount paid at closing (like your down payment) is equal to or greater than the points. For example, on a $300,000 loan, two points equal $6,000, which is deductible if you put at least $6,000 down. Even if the seller covers these points, they are still deductible, and the amount should appear on Form 1098.

Property Taxes

Local property taxes you pay each year are also deductible, with amounts typically shown on Form 1098 if managed through an escrow account. For direct payments, check your records or bank account. If you reimbursed the seller for prepaid property taxes at purchase, this amount can be added to your deduction. However, only actual tax payments are deductible; escrow deposits set aside for future taxes are not. Note that as of 2018, total state and local tax deductions, including property taxes, are capped at $10,000 per tax year.

Mortgage Insurance Premiums

For buyers making down payments below 20%, mortgage insurance premiums may also be deductible for mortgages taken out in 2007 or later. This deduction is phased out as adjusted gross income exceeds $50,000 (for married separate filers) or $100,000 (for other filers) and was last extended through 2021.

Penalty-Free IRA Withdrawals for First-Time Home Buyers

To aid first-time buyers, the usual 10% penalty for IRA withdrawals before age 59½ doesn’t apply if funds are used for a down payment. This penalty-free withdrawal limit is $10,000 lifetime per individual and must be used within 120 days of withdrawal. Although the 10% penalty is waived, the withdrawal is subject to income tax, potentially reducing its value for your down payment.

For Roth IRAs, contributions can be withdrawn tax- and penalty-free at any time, and after five years, up to $10,000 of earnings can be withdrawn tax-free for a first home purchase.

Home Improvement Costs

Save records for all improvements, such as landscaping, energy-efficient installations, and home additions. Though not immediately deductible, these costs are added to your home’s cost basis, which may reduce taxable profit when you sell.

Energy Tax Credits

Energy-efficient home improvements to your primary residence may qualify for an energy tax credit, providing up to 10% back on items like doors, windows, insulation, and heating systems, capped at $500. A separate credit offers 30% for solar electric systems, making these investments valuable both financially and environmentally.

Tax-Free Profit on Sale of Your Home

If you meet certain conditions, the IRS allows a portion of your home-sale profit to be tax-free. For single filers, up to $250,000 of profit is excluded, while married couples filing jointly can exclude up to $500,000. This exclusion is available every time you sell a home, provided you meet the residency and use tests.

If you need to sell before meeting the two-out-of-five-year test, you may qualify for a partial exclusion due to certain life events like job changes, health issues, or unforeseen circumstances.

Adjusting Your Tax Withholding

If your new home purchase will increase your itemized deductions, consider adjusting your federal income tax withholding to see immediate savings in your take-home pay. You can request a W-4 form from your employer or find it on the IRS website to make these adjustments.

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