10 Essential Tax Questions & Answers For Homeowners

Albert Einstein once lamented, “The hardest thing in the world to understand is the income tax.” If you buy, sell, finance or own real estate, it gets even harder.

Yet there’s no reason to pay more than the minimum, and the Internal Revenue Code actually gives property owners lots of tax breaks.

According to Art Ford, a certified public accountant in Boston, “For many homeowners, real estate taxes and mortgage interest are by far some of their biggest tax deductions. If I pay $1,500 a month in mortgage interest, that’s an $18,000-a-year deduction.”

For some homeowners, especially those with small mortgage balances who live in places with low state income and property tax areas, the good news is that the new standard deductions ($12,000 if filing single or married filing separately, $24,000 if married filing jointly) may mean that you no longer need to itemize deductions for the purpose of lowering your taxable income. These larger deductions may already exceed the amount of income-lowering that itemization would bring, and may simplify the filing process for you. For others, the changes aren’t as beneficial.

10 tax questions and answers for homeowners

Current and aspiring homeowners should know the impacts that 2018 tax changes have on their tax returns in order to keep their tax bill as low as possible. Here are some commonly asked questions and answers about taxes and homeownership

1. Can I still deduct mortgage interest?

One of the most popular and lucrative tax breaks for homeowners has always been the deduction for mortgage interest. Fortunately, although tax reform did modify it, the deduction wasn’t eliminated.

As with all things tax-related, however, the changes to the tax code did add certain complications.

For homes purchased after December 15, 2017, mortgage interest on total principal of as much as $750,000 on qualified residence loans can be deducted. For married taxpayers filing a separate return, the new principal limit is $375,000.

For homes owned before December 16, 2017, the older limits are “grandfathered in” — that is, carried forward, so the maximum principal balance on which interest can be deducted remains $1,000,000 — and marrieds filing separately can deduct $500,000 each.

Any mortgage interest you pay will be reported to on the Form 1098 your lender or servicer will send to you.

2. Is home equity loan mortgage interest still deductible?

In a word, no. Or, probably not. One of the biggest tax changes in 2018 and beyond was the elimination of the separate provision that allowed Americans to deduct interest on home equity debt of as much as $100,000 no matter what the money was used for. Starting in tax year 2018, the change in the tax law strictly limits instances where interest on home equity loans can be deducted.

The deductibility of home equity interest is now only allowed where the funds have been used to “buy, build or substantially improve” a qualified residence. Interest deductibility is still limited to not more than $100,000 in second lien debt, and is subject to the total mortgage debt limits discussed in item number 1 above. If a home equity loan or line of credit was used for any other purpose, such as to cover personal expenses, the interest is no longer deductible.

3. Are mortgage closing costs tax deductible?

In general, the only settlement or closing costs you can deduct are home mortgage interest and certain real estate taxes. You deduct them in the year you buy your home if you itemize your deductions. Certain other settlement or mortgage closing costs aren’t deductible right away, but rather are added to the “basis” value of your home and may provide some tax offset should you sell your home.

“Basis” is the value of your home for the purposes of calculating future capital gains taxes. Essentially, when you sell your home, your gain (profit) or loss for tax purposes is determined by subtracting its basis (original calculated value when you bought it) plus the cost of any improvements from the sales price (plus sales expenses, such as real estate commissions). The larger your basis, the smaller the gap to the current value of the home. In turn, this reduces the profit on which taxes are levied.

Mortgage-related items you’ll pay that can be added to the basis include things like abstract fees (abstract of title fees), legal fees (including fees for the title search and preparation of the sales contract and deed), recording fees, owner’s title insurance and more.

See IRS Publication 530, “Tax Information for Homeowners” and look for “Settlement or closing costs” for more details.

4. Is mortgage insurance tax deductible?

If you put down less than 20 percent when you purchased your home, chances are you’re paying mortgage insurance. At the moment, premiums paid for private mortgage insurance in 2018 are not deductible.

Deductions for PMI (or MIP for FHA-backed loans) are not part of the tax code, but since the financial crisis have generally been authorized by Congress as parts of other bills and “extended” for the most recent tax year. However, that’s not yet been the case for tax year 2018, but may change.

According to the official IRS page:

“Mortgage insurance premiums. The itemized deduction for mortgage insurance premiums expired on December 31, 2017. At the time this [Publication 936] publication went to print, Congress was considering legislation to extend the itemized deduction for mortgage insurance premiums.” As well, from the IRS’ instructions page for Schedule 1040A, where you would itemize such costs to deduct them, the document currently states “…the deduction for mortgage insurance premiums expired. You can’t claim a deduction for amounts paid or accrued after 2017.”

When it was last available, covering premiums paid though 2017, there were limitations. The PMI policy’s mortgage had to be originated after 2006; the deduction was reduced once your Adjusted Gross Income (AGI) exceeded $100,000 ($50,000 if married filing separately) and completely eliminated with an AGI above $109,000 ($54,400 married filing separately). When available, premiums for mortgage insurance were treated exactly the same as mortgage interest for deduction purposes.

If you are itemizing on Schedule A, have already filed your tax returns for the year and Congress retroactively authorizes the deductibility for PMI or MIP, you can file an amended return, if it is worth it in your situation.

5. Are mortgage points deductible?

The IRS has a flowchart that you can use to see if points are fully deductible. In general, you must have paid points to build, buy or improve your primary residence in order to deduct the entire amount in the year they were paid. Otherwise, they may still be deducted but on a prorated basis.

Are points I paid to refinance deducted differently?

This deduction is often overlooked, and it could be worth a lot. When you pay points on a refinance, they have to be prorated.

For example, if you paid $3,000 in points on a 30-year mortgage, you can deduct $100 a year for 30 years. But if you refinanced again this year and have prorated points that have not yet been deducted — for example, you are 10 years into a 30-year loan and have only deducted $1,000 of $3,000 in points paid — you can deduct the remaining $2,000 in the year you refinance.

If you paid points for a mortgage in 2018, these will also be reported to you on Form 1098.

6. Can I deduct my property taxes in 2018?

In addition to the new tax law limitations pertaining to mortgage interest deductions, they may also limit your property tax deduction. Moving forward, your total state and local tax (SALT) deduction will max out at $10,000, as opposed to being unlimited prior to 2018.

In a low-or no-income tax state, where your property tax bill isn’t particularly high, the $10,000 cap may not impact you. However, if you’re buying a home in, New York (or other high-tax state), you may find that a portion of your property tax bill is no longer deductible.

7. Will I owe capital gains tax if I sold my home in 2018?

Until 1997, once you hit the age of 55, you had the one-time option of excluding up to $125,000 of gain on the sale of your home providing it was your primary residence.

Now, anyone, regardless of age, can exclude up to $250,000 of gain or $500,000 for a married couple filing jointly on the sale of a home. This means most people may pay no tax unless they lived in their home for less than 2 out of the last 5 years.

It’s important to remember that capital gains are just that: gains. These are increases in value above the original purchase price plus any improvements (so-called “basis”, as above). For example, if you bought a home to live in for $250,000, made $100,000 in improvements to it and sold it for $600,000 just three years after you bought it, your “basis” cost would be $350,000, so the amount of capital gain you would have earned in this case would be $250,000, and you wouldn’t owe any tax on the amount.

That said, IRS Publication 523 notes that you generally can’t deduct repairs or maintenance, only “improvements” that are designed to increase your home’s value. Unfortunately, the rules for what’s a “repair” versus an “improvement” are pretty vague.

For instance, the IRS says fixing a broken windowpane is a repair, but replacing it as part of a project to swap out all of your home’s windows is an improvement. So, consult with a tax professional or read IRS Publication 523 for further guidance.

If you still have taxable profits on your home after factoring in all of the above, you’ll report your gains on a Schedule D, Capital Gains and Losses. Note: Capital losses on primary residences are not deductible.

8. Should I itemize home-related deductions or use the standard deduction?

To get an idea as to whether you should still itemize or consider switching to using the standard deduction, start with your tax returns for 2017. If your situation is similar in 2018, and your total itemized deductions 2017 were below the new standard deduction, you probably no longer need to itemize to get the biggest deduction. However, if your total deductions still exceed the new standard deduction, you’ll want to consider the new rules for deduction, including any SALT limitations that may impact you.

By way of example, for 2017, the standard deduction for a married couple was $12,700. Using this deduction, a married couple that paid $15,000 in mortgage interest and also had $3,000 in charitable contributions and $6,000 in state and local taxes would have been able to reduce their taxable income by an additional $11,300 by itemizing. For 2018, however, the standard deduction for a married couple is $24,000, so this example couple wouldn’t be any better off by itemizing.

Given recent mortgage interest rates, a homebuyer might need a pretty big mortgage and high state and local property taxes to make it worth itemizing. For example, to get to the $24,000 married-filing-jointly standard deduction using mortgage interest alone, a homeowner with a 4.5% interest rate would need a mortgage amount of about $537,000. A homeowner with a 4.5%, $300,000 loan would spend only $13,400 in interest in the first year, and so would have a $10,600 gap to cover using state and local taxes just to get to the $24,000 threshold.

While typically about 30 percent of taxpayers have itemized deductions each year, forecasts from early 2018 predict that this may drop to just 5 percent. As such, 25% of the U.S. population may no longer itemize deductions, and therefore won’t be able to (or need to) use the mortgage interest deduction.

9. What home expenses are tax deductible?

When it comes to home expenses, from a tax standpoint, they’re broken down into two categories: the cost of any improvements and the cost of any repairs.

In general, you can deduct the cost of improvements. You can’t deduct the cost of repairs.

There are a number of home improvement expenses you can deduct on your taxes. Most big-ticket items, such as additions to the house, a swimming pool, a new roof or a new central air-conditioning system, are considered tax deductible. Other tax-deductible home expense items include adding an extra water heater, storm windows, an intercom, or a home security system.

When you make home improvements, such as installing central air conditioning, adding a sun-room or replacing the roof, you can’t deduct the cost in the year you spend the money. However, if you keep track of those payments, they may help you reduce your taxes in the year you sell your home, as these improvements become part of your home’s basis.

Unless your property is a rental or investment, you don’t get tax breaks for items such as Hazard insurance, Homeowners association (HOA) dues, any principal payments you make, general closing costs like appraisal fees or title insurance or any local assessments to improve your neighborhood.

10. Do deductions phase out as income rises?

The Tax Reform and Jobs Act eliminated through 2025 the income-based phase-out of itemized deductions (the so-called “Pease limitation”, named for the congressman who introduced the legislation in 1991). Formerly, deductibility was reduced for single filers with adjusted gross incomes above $261,500 and $313,800 for married persons filing jointly and there were other complicated components as well.

The bottom line for homeowner tax changes in 2018

The Tax Reform and Jobs Act was a game-changer for many homeowners, especially those in states with high state and local property taxes, and for people using home equity as a portion of their day-to-day finances. For many folks, the changes mean that they will no longer need to endure the hassle (and possibly expense) of itemization, simplifying their tax filing process.

Of course, as is always the case with taxes, consider consulting a tax professional who can help you understand how these changes impact your situation.


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