22 Jan The Wonderful Tax Benefits of Owning your California Home
Buying a home is a complex journey, especially for first-time home buyers. However, after the hundreds of forms, signatures and time involved with purchasing your new home, you’ll be happy to know that the investment pays off in not just (hopefully) equity, but in the various tax benefits that homeownership brings.
This blog post will familiarize you with some of the most common tax deductions, credits, and benefits for California homeowners, from the moment of purchase, all the way to after the sale of your home. If you bought your first home in 2016, or you’re hoping to purchase in 2017, you should familiarize yourself with these deductions and credits.
Keep in mind that the government is constantly adjusting the tax code, thus, the following tax breaks or its conditions are subject to change. There’s no substitute for working with an income tax professional, especially when moving away from the simple 1040-EZ and starting to take part in these benefits by itemizing your deductions.
Property Tax Deduction
Homeowners who itemize deductions are eligible for a reduction of their taxable income by deducting property taxes paid on their homes. You may deduct property taxes paid throughout the year for which you are filing your return. If you purchased your home midway into the tax year, you can only claim property taxes paid from the date you purchased the property onward. It’s important to note that at the time of purchasing your home; if you agreed to pay any of the seller’s delinquent property taxes from earlier in the year, you cannot deduct those payments. Such payments are simply considered part of the expense of purchasing the home, not a tax deduction.
The Joint Committee on Taxation (JCT) estimated that in the fiscal year of 2016, this property tax deduction had saved homeowners a total of $35 billion in income tax.
Mortgage Interest Deduction
For Homeowners, the recurring mortgage interest deduction is typically the most significant home-based deduction to reduce income for tax purposes. By the end of January, you will receive a statement from your mortgage lender on Form 1098, showing you how much interest you paid on your loan during the previous income tax year. Homeowners can deduct the interest portion of the monthly mortgage payments made that year.
Mortgage Insurance Premiums Deduction
Buyers can deduct mortgage insurance premiums (such as PMI) as long as the loans they’re attached to were issued during or after 2007. On tax returns listed as “Married Filing Separate” the deduction starts to phase out as the adjusted gross income rises above $50,000, and on all other type tax returns when the adjusted gross income rises above $100,000.
The California Constitution provides a $7,000 reduction in the taxable value for an owner-occupied home. The home must have been the principal place of residence of the owner on the lien date of January 1st. To claim the exemption, the homeowner must make a one-time filing of a simple form with the county assessor where the property is located. A person filing for the first time on a property may file anytime after eligibility, but no later than February 15th to receive the full exemption for that year.
Tax & Penalty-Free IRA Withdrawals
Sometimes the most significant challenge when purchasing your dream home is setting aside sufficient money for your down payment and closing costs. Well here’s some helpful good news for buyers who have an Individual Retirement Account (IRA). The IRS will allow you to pull up to $10,000 individually (married couples can each pull $10,000, giving you $20,000) from your IRA for down payment funds without incurring the 10% penalty that’s normally applied to withdrawals taken before age of 59-1/2. You must use the IRA funds within 120 days of withdrawal, and although this benefit typically applies to first-time home buyers, current homeowners can utilize this incentive as well if they haven’t owned a home in two years.
Mortgage Points Deduction
When you obtained your mortgage to buy your home, your lender may have required you to pay a variety of fees, one of which is known as “points”. Mortgage points are prepaid interest that can help a borrower qualify for a better interest rate on the loan. Points that you pay are calculated as a percentage of the total loan. One point is equal to 1% of the loan principal. One-to-three points are typical on home loans. Deducting what you paid in points can really help come tax time and most homeowners overlook this excellent deduction.
Mortgage Tax Credit Program
CalHFA has partnered with local certain counties to create the Mortgage Credit Certificate (MCC) program. The MCC Tax Credit can reduce potential federal income tax. The MCC Tax Credit enables first-time homebuyers with specific qualifications, to convert a portion of their annual mortgage interest into a direct dollar for dollar tax credit on their income tax returns. See the CalHFA site for more details, and contact me if you’d like to talk with a lender who understands and can qualify you for the program.
Home Energy Credits
You may be eligible for tax credits related to energy saving home improvements performed during the preceding tax year. Check tax form 5695 for specific guidelines. You may also benefit from renewable energy credits with solar panel installation at your home. You can potentially receive up to 30% of installation and solar equipment costs as tax credits. Note that beginning with the 2017 tax year, some of the home energy tax credits have changed or been altogether eliminated. Check with your tax/accounting professionals for more information.
Home Improvement Tax Breaks
Improvements you make to a home can qualify for a tax break. Furthermore, if you use a home equity loan to finance such improvements, the loan can also qualify for the same mortgage interest deductions as your primary mortgage does. Keeping track of capital improvements to the home will help you out when you sell the home (see the following “Home Sale Profits” section) since improvements can lower your taxes by increasing your tax basis. Be sure to keep accurate records of all improvements made to your home, keep track of your basis, and you’ll potentially help reduce your taxes.
Home Sale Profits and Costs
Thinking about selling your home? Under current law as of December 2016, the first $250,000 of profit on the sale of your principal residence is tax-free ($500,000 for married couples who file joint returns). Great news right? Selling can net you a great return on investment, however taxes on capital gains can be tough to handle in certain more complex situations. So it is essential to learn how capital gains applies to the sale of your home. In the event that certain requirements are met, you may be able to significantly reduce your taxable capital gain by the amount of your selling costs. Selling costs such as legal fees, real estate broker commissions, title insurance, escrow fees, and inspections are all items of which can be deducted from your gain. Your gain is your home’s selling price, minus deductible closing costs, selling costs, and your tax “basis” in the property. The basis is the agreed upon purchase price, plus the cost of capital improvements, minus any depreciation. Among other requirements, you must have maintained the home as your primary residence in two out of the preceding five years to qualify.
Each homeowners situation and ability to partake in some or any of these tax benefits varies. I am not a certified tax specialist, and this blog post is for informational purposes only. Before making any decisions or taking action with these tax benefits, please make sure to consult with an attorney and or CPA on how to implement them in a safe and compliant manner.