Written by Marc R Barnes EA
October 27, 2009
Buying a home is a great way to reduce your income tax. The qualified mortgage interest you pay and your real estate taxes are both deductible for income tax purposes.

Real Property Tax Deduction.

Nonitemizers may claim an additional standard tax deduction for state and local real property taxes (2008 & 2009). The maximum additional tax deduction is $500 ($1,000 on a joint return).

Refundable First-time Homebuyer Credit

Individuals who purchased a principal residence from an unrelated party at fair market value after April 8, 2008, and before Jan. 1, 2009, and who did not own a principal residence during the 3-year period ending on the date of purchase may claim a refundable tax credit for 10% of the purchase price. The maximum credit is $7,500 ($3,750 Married Filing Separately). The credit is reduced when modified adjusted gross income (AGI) exceeds $75,000 ($150,000 if Married Filing Jointly) and is eliminated when modified AGI reaches $95,000 ($190,000 if Married Filing Jointly).

The tax credit is repaid in 15 equal installments starting in 2010. Repayment is accelerated if the home is sold or no longer used as a principal residence. However, the amount required to be repaid for a sale to an unrelated party is limited to the gain on the sale. Taxpayers whose home financing comes from tax-exempt revenue bonds may not claim the credit.

Individuals who purchase a principal residence from an unrelated party after Dec. 31, 2008, and before Dec. 1, 2009, may claim a credit on their 2008 return or 2009 return using the above rules with the following exceptions:
  • The maximum credit is $8,000 ($4,000 Married Filing Separately).
  • The tax credit need not be repaid unless the home is sold or ceases to be your principal residence within 36 months of purchase.
  • Taxpayers whose home financing comes from tax-exempt mortgage bonds may claim the credit.
Individuals who purchased a home in early 2009 have 2 choices:
  • e-file the 2008 return now with the revised Form 5405.
  • Wait to claim the $8,000 First-time Homebuyer Credit on the 2009 return.
Individuals, who have already filed their 2008 return, claiming the $7,500 credit, may amend their return by filing Form 1040X and attaching Form 5405. This will allow them to claim any additional credit to which they are entitled (up to $500).

Itemize Tax Deductions

When you purchase a home, you're more likely to be able to itemize tax deductions on Schedule A. The following are more common itemized tax deductions not related to your home:
  • medical and dental expenses
  • state and local income tax or sales tax
  • personal property taxes (usually on your car)
  • gifts of cash and property to qualified religious and charitable organizations
  • casualty and theft losses
  • tax preparation fees
  • investment expenses
  • business use of home or car
  • unreimbursed expenses required by your employer
Some of these tax deductions are subject to limitations, so follow the instructions for Schedule A carefully.

Claim the Mortgage Interest Tax Deduction

Mortgage interest you pay on loans up to $1 million ($500,000 Married Filing Separately) is tax deductible, provided you used the money to buy, build or improve your home and the loan is secured by your home.

Plus, the interest you pay on loans secured by your home and used for a purpose other than to buy, build or improve your home is tax deductible for loans up to $100,000 ($50,000 Married Filing Separately). The limit may be reduced depending on the market value of the home at the time you take out the loan. Use equity lines of credit wisely. If you fail to make the payments, you put your home at risk.

If your income meets the requirements and your state or local government issued you a mortgage certificate credit, you may be eligible to claim a tax credit (the mortgage interest tax credit) based on the amount of interest you paid. If you claim the tax credit, you must reduce your interest tax deduction by the amount of the credit.

Deduct Loan Origination Fees

Points, also called loan origination fees. One point equals 1% of your loan. Points you pay (and even points the seller pays) when you purchase your home are generally tax deductible in full the year you pay them.

Alternatively, you may choose to amortize the points over the term of your mortgage. This choice is usually made only when your itemized deductions are less than the standard deduction for the year you bought the home.

Points paid to refinance a loan must be deducted over the term of the loan. If you deduct points over the term of the loan and sell the home or refinance it again before the loan expires, you can deduct in the year of the sale or refinancing any points that you didn't previously deduct.

Mortgage Insurance Premiums

If you took out a first mortgage in 2007 or 2008, you may be able to deduct qualified mortgage insurance premiums you pay in connection with the loan. Qualified mortgage insurance is mortgage insurance provided by the Veterans Administration, the Federal Housing Administration, or the Rural Housing Administration, and private mortgage insurance (as defined in section 2 of the Home Protection Act of 1998 as in effect Dec. 20, 2006). Prepaid mortgage insurance premiums generally must be deducted over the period to which they apply.

Gain on the Sale of Your Home

When you sell your home, the IRS allows you to exclude gain on the sale from taxable income, up to $250,000 ($500,000 Married Filing Jointly and you both meet the use requirement).

You can claim the exclusion if you own and use the home as your main home for at least 2 years during the 5-year period ending on the date of sale. You may claim this exclusion only once in any 2-year period.

If you don't meet the 2-year requirement, you may be eligible to claim a reduced exclusion if you sell your home because of an "unforeseen circumstance," such as a change in employment or a divorce. A loss on the sale of your home, however, isn't tax deductible.

Topic: Homes