The 2015 tax year is underway, but it won’t be for a few months until consumers are receiving tax-related forms such as the W-2 and 1099, and for homeowners the 1098. Another name for the 1098 is the Mortgage Interest Statement. Even though it is still months away, it is never to soon to start planning for your annual federal and state income tax deductions.
The U.S. tax code presents many incentives for U.S. homeowners. It is strongly recommended for homeowners to take advantage of these breaks, allowing 1040-filing citizens to maximize their financial investment in homeownership. With current mortgage rates the lowest since May of 2013, there are a multitude of tax-saving opportunities associated with owning a home; even if a home is financed with mortgage or paid-in-full in cash. It is obvious that every homeowner’s situation is different, so please consult with a tax profession regarding your tax liability before proceeding.
The first tax deduction we will cover is the mortgage interest paid. This interest payment to a lender is tax-deductible, and for some homeowners, interest paid can present a large tax break. If done correctly, you can make large strides in the early years of a home loan by taking advantage of this tax break. The reason being, the standard mortgage amortization schedule is front-loaded with mortgage interest. At today’s current mortgage rates, your annual interest payment on a 30-year loan term will exceed principal payments until the loan’s 10th year.
Other loan options such as the refinance loan, home equity loans (HELOAN), and home equity lines of credit (HELOC) are all tax-deductible loans as well, but are more restricted than the front-loaded amortized loan. These types of loans are restricted in the sense that the homeowner may not raise their mortgage debt beyond their property’s fair market value. The Internal Revenue Service, also known as the IRS, imposes a $1 million loan size cap. Loans for more than one million dollars sacrifice their right for mortgage interest tax deductions. This is one reason why homeowners with jumbo mortgages limit themselves to one million dollars per loan.
The second mortgage tax deduction we advise to seek out is discount points. Mortgage tax deductions can extend far beyond your monthly payment. Discount points paid in connection with a home purchase or a refinance is typically tax-deductible too. A discount point is a one-time, at-closing fee which allows a borrower access to rates lower than the current “market rates” available. A discount point is costs a borrower one percent of their loan size.
An example of how the discount points works is if the current market mortgage rate is 3.5%, paying one discount point on the loan may get you access to a mortgage rate of 3.00%. You can check your local 2015 conforming loan limit, but an example would be a house cost of $625,000, one discount point would cost $6,250.
According to the IRS, discount points are considered a “prepaid mortgage interest”. This is because paying discount points is an advanced payment on a mortgage in exchange for lower interest payments over time. This classification, of paying these points early, can render discount points tax-deductible depending on your loan type.
When discount points are paid at the same time as with a home purchase, the cost may be deducted in full in the year the discounts were paid, dollar-for-dollar. For a refinance, it is a little different. Discount points are not fully tax-deductible in the year in which they are paid. They are typically amortized over the life of the loan. The cost of one discount point on a 30-year loan can be deducted at 1/30 of its value per tax-calendar year.
There are still other tax deductions besides just the two mentioned above. Real Estate taxes, home improvements, and home offices can all be considered and used under tax deduction. Homeowners typically pay local and state entities real estate taxes. These taxes can often be deducted in the year in which they are paid similar to discount points. If your lender currently escrows your taxes and insurance, they will be able to send you an annual statement to you, which you can file with your complete federal tax returns.
For tax-paying homeowners, certain types of home improvement projects are tax-deductible. Home improvements made for medical reasons, for example, can be tax-deductible. If you are making home renovations to accommodate a chronically ill or disabled person, and the renovations do not add to the overall value of the home, the project costs are typically 100% tax deductible. Repairs and improvements made for aesthetic purposes are not tax-deductible.
Homeowners who work from their residence can typically deduct the expenses of maintaining a qualified home office. Allowable tax deductions for a home office include renovations to the rooms, telephone lines, and the cost of heat and electric. Before claiming a home office on your returns, though, be sure to speak with an accountant to understand the benefits and liabilities. There are caveats to claiming home office tax deductions on your tax returns, and the rules can be tricky.
Tax deductions will reduce your annual costs of homeownership and, for some homeowners, mortgage interest tax deductions affect the math of the “Should I Rent or Should I Buy?” question.
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