The tax landscape changes yearly. Congress meets occasionally to review and adjust the tax code, so first-time homebuyers must stay on their toes to understand year-to-year tax changes.
The government provides tax breaks for existing and new homeowners to incentivize buying homes. Homeownership offers multiple home tax deductions, tax credits and other breaks that aren't available to those who rent. If you bought your first home in 2016 — or you're hoping to buy one in 2017 — it can pay to familiarize yourself with first-time homebuyer tax credits so you can take advantage of tax breaks that lower your tax bill.
Home Mortgage Interest Deduction
The mortgage interest deduction is one of the biggest home tax breaks and is a crucial new homeowner tax credit. It covers interest paid on loans of up to $1 million, or $500,000 if you're married but filing a separate return.
The deduction can be especially beneficial for borrowers with new loans because interest charges on mortgages are typically steeper in the early years of the mortgage's term.
"The way loan amortization works, your first payments have the highest ratio of interest to principal," said Andrew Christakos, an accredited investment fiduciary with Westfield Wealth Management in Westfield, N.J.
You must itemize on Schedule A of your tax return to claim the home mortgage interest deduction. To do so, add up all deductible expenses for the year, including those related to homeownership as well as other categories. Claiming the mortgage interest deduction can save you tax dollars if your itemized deductions are greater than your standard deduction.
Don't miss this new homebuyer tax credit. Your loan provider should send you Form 1098 shortly after the tax year ends. It will show the amount of interest you paid the previous year.
Mortgage Interest Credit
The federal government's mortgage interest credit provides another opportunity for first-time homebuyers to claim a tax break for the mortgage interest they paid. Unlike the mortgage interest deduction — which reduces your taxable income — this mortgage interest credit directly counts against your tax bill, lowering what you owe.
"It's a little-known but very cool program," said Deb Tomaro, a Bloomington, Ind.-based broker with RE/MAX Acclaimed Properties. "Depending on the purchase price of your home, a buyer can get 20 to 30 percent of the interest they pay every year back as a straight tax credit."
For example, imagine you prepare a return and find that you owe the IRS $1,000 in taxes. However, completing IRS Form 8396 for the mortgage interest credit shows that you're eligible for a $1,000 credit. In that situation, you can apply the credit and not owe the IRS anything.
The credit is not refundable, so you won't receive a check if the credit is larger than what you owe in taxes.
To be eligible for this strategic tax break, a state or local government must have issued you a Mortgage Credit Certificate. Typically, this certificate is issued at the time you originate the mortgage. The certificate tells you how much interest you can claim as a credit. If you also claim a mortgage interest deduction when you file your taxes, you must reduce the credit by that amount — no double-dipping is allowed.
Mortgage Points Deduction
You can also deduct what you pay in points to obtain the mortgage loan in the first place. Mortgage points are prepaid interest that can help a borrower qualify for a lower interest rate over the life of the loan. And, they can qualify for a tax deduction as well.
"Most homeowners overlook the deduction of points they pay to secure a mortgage loan," said Yvette Best, controller and senior tax accountant at Best Services Unlimited, a tax preparation company based in Fayetteville, Ga. "Buying points to lower the interest rate on your mortgage loan is one of the best tax breaks available right now. The return on investment is twofold because you get to deduct the cost of the points and the amount on interest paid in the same year as the home purchase."
You must itemize on your return to claim this deduction, and your settlement disclosure statement must specifically cite these fees as "points." Your home loan must be for $1 million or less, just as with the mortgage interest deduction.
Tax-Free IRA Withdrawals
Saving money for a down payment and closing costs is a major consideration for most people when they're getting ready to buy a home. The IRS says you can pull funds from your IRA to help.
"First-time homebuyers who break into their IRAs to come up with the down payment do not have to pay the 10 percent penalty normally applied to withdrawals taken before age 59½," said Lisa Greene-Lewis, a certified public accountant and blog editor at TurboTax. "This incentive applies to current homeowners as well because you're eligible for first-time buyer status if you haven't owned a home in two years."
You can take up to $10,000 from your IRA without penalty to buy a home, although you'll still need to pay taxes on the money. Your 401k plan does not qualify for the exception to the 10 percent penalty.
Property Tax Deduction
Property taxes are one of the many lucrative tax breaks for first-time homebuyers. Taxpayers who itemize deductions on Schedule A are also eligible to deduct real estate taxes paid on a primary residence, said Laurie Samay, a New York-based certified financial planner with Palisades Hudson Financial Group.
You can deduct property taxes paid during the year for which you're filing. If you purchase a home midway through the tax year, you can claim all taxes paid from the date of sale onward.
Home Improvement Tax Breaks
Improvements you make to a home can qualify for a tax break. If you use a home equity loan or other loan secured by your home to finance improvements, the loan will qualify for the same mortgage interest deductions as your main mortgage.
Keeping track of capital improvements to the home also can help you out when you sell the home. If your home sells for more than you paid for it — your tax or cost basis — that extra money can be considered taxable income at capital gains rates subject to certain thresholds and rules. But home improvements can lower your taxes by increasing your tax basis.
"You can include the cost of improvements made to the property in the cost basis of the property when you're determining any capital gains on the sale," Christakos said. "Make sure you keep your receipts for major improvements so you can prove the costs you claim."
Home Energy Tax Credits
Now for the bad news: Two property-related home improvement tax credits have been eliminated as of Jan. 1, 2017. That means both credits will no longer apply beginning with the 2017 tax year.
You can still claim these credits if you made qualifying improvements to your home during the 2016 tax year. However, you won't qualify for the credit if you write the check before the clock runs out and the contractor does the actual work in 2017.
"The 30 percent Residential Energy Property Tax Credit applies to the cost of installing these products, including labor and installation, but must be taken in the year the item was placed in service," said Jayson Mullin, founder of Top Tax Defenders in Houston.
Keep all receipts and contracts from the installation, and file for this credit using Form 5695. This benefit is for existing homeowners and can also be claimed as a first-time homebuyer credit.
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