Mortgage Tax Benefits 101: A Guide for Homeowners

Contribution by 1 expert

Updated: July 16, 2024

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A mortgage is more than just a loan — it's a commitment that shapes homeowners' lives. Taking out a mortgage means making monthly payments until you've repaid it. And while it helps you build home equity, mortgage payments can weigh heavily on your budget. However, it's not all about the obligations.

Owning a home with a mortgage comes with numerous benefits, from creating a home that's uniquely yours to the financial advantages of growing equity over time. One aspect of homeownership most borrowers are unfamiliar with is the tax benefits it brings.

Your mortgage can help reduce your tax burden. From mortgage interest deductions to potential tax credits for energy-efficient home upgrades, these make your homeownership experience even more rewarding. Let's explore how your mortgage can provide significant tax advantages, making those monthly payments a bit easier on your wallet.

The Value of Understanding the Tax Benefits of a Mortgage

The tax benefits that come with a mortgage can affect your financial health significantly. By reducing taxable income and offering potential tax credits, you can turn these into considerable savings. For example, mortgage interest payments and property taxes, often considered burdensome, can turn into deductions that lower your taxable income. Certain decisions, like making energy-efficient home upgrades, may unlock further tax credits.

Every homeowner's financial circumstances are unique, so the impact of tax benefits may vary depending on factors such as income, mortgage size and the amount of interest paid. Understanding these benefits helps you see your mortgage not just as a debt but also as a tool to optimize your finances. The more knowledge you have about them, the better you can manage your financial well-being.

Mortgage Tax Deductions and Tax Credits for Homeowners

Mortgage tax savings stem from two sources: tax deductions and tax credits.

Tax deductions work by reducing your taxable income. The more deductions you have, the lower your taxable income, and consequently, your tax liability. That translates to more of your money staying in your pocket. Many homeownership costs, including mortgage interest and property taxes, qualify as tax deductions.

Tax credits provide a dollar-for-dollar reduction in your tax bill. Qualifying for a tax credit directly reduces the amount of tax you owe. It may even sometimes result in a refund, which you can use for other financial uses. Homeowners get tax credits for specific actions like purchasing energy-efficient appliances or making certain improvements to the home.

Exploring both tax deductions and tax credits helps you make the most of your homeownership. Let's delve deeper into what each one has to offer.

Tax Deductions for Homeowners

As a homeowner, you have multiple avenues to access tax deductions that help lower your taxable income. Some, like mortgage interest payments and property tax, are well-known and widely claimed. Others may be lesser-known but equally beneficial. It’s best to be familiar with all of them so you can determine which ones apply to you.

Deducting Mortgage Interest Payments

Mortgage interest payments are typically tax-deductible. You can subtract the amount you spend on it over the year from your taxable income. That reduces the amount of income tax you owe.

For example, if you paid $10,000 in mortgage interest over the course of a year, you could potentially reduce your taxable income by that same amount. It may save you a substantial sum, especially if it places you in a lower tax bracket.

Understanding Points Deduction

"Points" in the context of a mortgage are a charge you pay to a lender at the time of closing in exchange for a reduced interest rate (it’s also known as "buying down the rate"). One mortgage point is equivalent to 1% of your loan amount. So, if you have a mortgage of $300,000, one point would cost you $3,000. This upfront payment allows you to pay some interest in advance for a lower rate over the life of the loan.

Like mortgage interest, mortgage points are tax-deductible in the year they are paid. If you paid 2 points on a $300,000 mortgage ($6,000), you could deduct it from your taxable income, provided you meet the conditions set by the IRS. It can lead to significant tax savings, especially for new homeowners who pay points at the closing of their home purchase.

Property Tax Deduction

Property taxes, or real estate taxes, are those homeowners pay to local governments. You do this annually, and the amount depends on the assessed value of your property and your area’s tax rate. The tax rate varies by locality, and the assessed value is usually a portion of the property's market value. Once these taxes are paid, they are generally tax-deductible. You can deduct them from your taxable income, lowering your tax bill.

Let's say your home’s assessed value is $300,000, and your local property tax rate is 1%. You'd pay $3,000 in property taxes for the year. You can subtract it from taxable income when you file your tax return, reducing your tax liability.

Tax Benefits for Home Equity Loans and Lines of Credit

Home equity loans and Home Equity Lines of Credit (HELOCs) borrow against your home equity, which is the difference between your home's current market value and what you still owe on your mortgage. IRS guidelines state that the amount you pay in interest can be taxable if you use it for home improvements. It’s an attractive option if you’re considering a large project.

For instance, if you take a $25,000 home equity loan at a 5% interest rate for a kitchen remodel, you’ll pay roughly $7,800 in interest over 10 years. You could deduct that from your taxable income.

Medically Necessary Home Improvements

Sometimes, you may need to modify your home for medical reasons. The IRS allows for these medically-necessary modifications to be tax-deductible under certain conditions. These include, but are not limited to:

  • Installing ramps for home entrances or exits
  • Widening doorways at entrances or exits
  • Modifying hallways and interior doorways for accessibility
  • Putting railings or support bars in bathrooms
  • Making kitchen cabinets and equipment accessible by lowering them

Remember, you can only deduct the part of the cost that doesn't increase your home's value. This can be tricky, so talking to a tax professional can help you determine how much you can deduct.

Claiming Home Office Deductions

Whether you're a small business owner, a freelancer or working remotely, using a part of your home exclusively for business purposes allows you to qualify for this tax benefit.

The IRS allows a home office deduction based on the portion of your home used — a room or part of a space specifically for conducting your business regularly. You can deduct part of your housing expenses like a portion of your utility bills, homeowners insurance, home repairs or maintenance costs directly related to the office space.

For example, if your home office occupies 15% of your home, you can deduct 15% of your expenses like mortgage interest, property tax, insurance and utilities. It's essential to keep precise records and receipts to validate your deduction in the event of an audit.

Tax Credits for Homeowners

While tax deductions reduce your taxable income, tax credits decrease your tax bill dollar for dollar, making it valuable for qualified homeowners. Here are some key tax credits that homeowners should know about:

Mortgage Interest Credit and Mortgage Credit Certificates (MCCs)

First-time homebuyers with a low to moderate income may find homeownership challenging, but a Mortgage Interest Credit may help them save thousands on their taxes. This possible when the state or local government issues a Mortgage Credit Certificate (MCC).

Once you have an MCC, you could qualify for a credit on a portion of your mortgage interest, which directly reduces your tax liability. For example, let's say your mortgage interest for the year is $8,000, and your MCC rate is 20%. You can get a credit of $1,600 ($8,000 * 20%) taken directly off your tax bill.

Energy-Efficient Home Improvements

You can get a 30% tax credit for making your home more energy-efficient (only for qualified expenses). However, there are annual limits and restrictions to some expenses. For example, you can only claim up to $1,200 for certain energy-efficient home improvements and energy property costs. You must also consider individual limits on windows, doors and home energy audits. If you installed qualified heat pumps, biomass boilers or stoves, you can claim up to $2,000 annually.

You can claim the maximum amount you invest in qualified improvements each year until 2033. Remember that the credit isn’t refundable, so you won't get a refund for the difference if your tax liability is less than your credit. You can't carry over the excess credit to future years, either.

Tax Implications of Selling Your Home

After covering the potential tax benefits of owning a home, let's look at another significant financial event – selling it. Unlike mortgage interest deductions or energy-efficient tax credits, the tax implications of selling a home are a bit different.

When you sell your home for more than what you paid, the profit you make is known as a capital gain. The IRS requires homeowners to report capital gains from a home sale on their tax returns. However, you can exclude up to $250,000 of these gains from your taxable income if you're single, or $500,000 if you're married filing jointly.

Take this as an example:

Janet is a single homeowner. She bought a two-bedroom house in a popular neighborhood about 10 years ago for $200,000. With property values rising, she recently sold the house for an impressive $500,000. Her capital gain amounted to $300,000.

The IRS allows individuals like Janet to exclude up to $250,000 of the capital gain from their taxable income. So, instead of facing taxes on the full $300,000 gain, Janet only needs to report a capital gain of $50,000 on her tax return.

Remember, certain conditions must apply for you to qualify for this exclusion, such as owning the home and using it as your primary residence for at least two years during the five years immediately before the sale.

Leveraging Homeowner Tax Benefits

The tax code offers several advantages to homeowners, from buying a home to making energy-efficient improvements to eventually selling your property. Adopting a few strategies can help you maximize these tax benefits.

  • Stay Organized with Your Documents: Maintaining a systematic record of your financial documents, such as mortgage interest statements, property tax bills and receipts for home improvements, can simplify your tax filing process and help ensure you don't miss out on any deductions.

  • Consult with a Professional: Tax laws are complex and can change year-to-year. To fully take advantage of tax benefits as a homeowner, consider consulting a tax professional or financial advisor. They can provide advice tailored to your personal situation.

  • Monitor Your Capital Gains: If you plan to sell your home and it has significantly appreciated in value, keep an eye on potential capital gains. Depending on your situation, you may be able to minimize your tax liability.

Remember, you have several tax benefits at your disposal. Recognizing and actively leveraging these opportunities can enhance your overall financial health.

Frequently Asked Questions

Learning about mortgage tax benefits can raise several questions. We addressed some common inquiries to provide you with additional information.

What is excess mortgage interest, and how does it impact my taxes?
Can I deduct mortgage interest on a second home or vacation property?
What are the tax benefits of having a mortgage?
Can I deduct property taxes on my primary residence from my taxable income?
What are points in relation to a mortgage, and are they eligible for tax deductions?
How does the Mortgage Interest Credit (MCC) work, and am I eligible for this tax credit?
Are there any specific tax benefits for home equity loans and lines of credit?
What are the tax implications when selling my home, and can I exclude capital gains from taxation?
How does the home office deduction apply to homeowners who run a business from their residence?
Are there any other lesser-known tax incentives available to homeowners?

Experts' Guide on Mortgage Tax Benefits 

  1. The term 'points' is often used in mortgages. Can you explain this and whether they are eligible for tax deductions?
  2. How can homeowners leverage these tax benefits to their advantage?
Job Hammond
Job HammondAssociate Professor of Real Estate & Finance at Austin Community College

About Christopher Boston

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Christopher (Croix) Boston was the Head of Loans content at MoneyGeek, with over five years of experience researching higher education, mortgage and personal loans.

Boston has a bachelor's degree from the Seattle Pacific University. They pride themselves in using their skills and experience to create quality content that helps people save and spend efficiently.