As Dorothy famously said in the Wizard of Oz, "There’s no place like home," but she wasn’t talking about taxes. Yet, the tax benefits associated with homeownership are undeniable. Not only can clients reap a windfall when they eventually sell their home, especially if they’ve have lived for a number of years in a desirable area, they may collect a bevy of tax breaks along the way. What follows is a brief roundup.
Home sale exclusion: This is one of the biggest tax breaks you can find on the books.
Under Section 121 of the tax code, you can pocket hundreds of thousands of dollars from a home sale without paying a single penny of federal income tax on your gain.
As long you’ve owned and used your home as your principal residence for at least two of the five years prior to the sale, you can exclude from tax up to $250,000 of gain if you’re a single filer and $500,000 for joint filers. This exclusion can be claimed an unlimited number of times. When you’re forced to sell earlier due to certain reasons—such as a change in employment, health issues or other unforeseen circumstances— you may be eligible for a partial exclusion.
Any excess gain is taxed at favorable capital gain rates. For 2019, the maximum tax rate on a long-term capital gain is 15 or 20 percent for high-income taxpayers. Still a good deal.
Property taxes: Prior to the Tax Cuts and Jobs Act (TCJA), you could generally deduct the full amount of property taxes you paid on your principal residence during the year if you were an itemizer. But now the TCJA limits deductions for state and local tax (SALT) payments, including property taxes.
For 2018 through, the maximum SALT deduction for any combination of state and local property taxes and income or sales taxes is $10,000 a year. Nevertheless, you still derive some tax benefit from your property tax payments, especially if your state and local income taxes are relatively low or nonexistent.
Note also that the TCJA essentially doubled the standard deduction, so some taxpayers may not be itemizing deductions, even though they consistently did so in the past. If you claim the standard deduction, you get zero tax benefit from property tax payments.
Mortgage interest: The TCJA also modifies the deduction for qualified residence interest for 2018 through 2025. Previously, you could deduct interest on acquisition debts up to $1 million, but the TCJA lowers the threshold to $750,000 (although prior debts are grandfathered). In addition, the deduction for interest paid on the first $100,000 of home equity debt is suspended.
However, if you take out a home equity debt and use the proceeds for a home improvement, it may therefore qualify as an acquisition debt, allowing you to deduct interest on the debt up to the stated threshold. As with property taxes, itemizers can continue to realize sizeable benefits under the current rules.
Home improvements: The tax breaks for home improvements don’t necessarily stop with mortgage interest deductions. I you make an improvement for medical reasons (e.g., installing a pool to help alleviate a child’s asthma), the increase in the home’s value is added to your other deductible medical expenses (plus any annual costs). This provides extra tax incentive for some itemizers.
Rental properties: When you own a home as a rental property, you’re entitled to deduct depreciation plus other expenses attributable to the rental activity, such as insurance, repairs, property taxes, mortgage interest, etc. These deductions can help offset tax on the rental income you receive. Note, however, that special rules apply to a “vacation home” you rent to others and also use personally. If your personal use exceeds the greater of 14 days or 10 percent of the days the home is rented out, you can’t claim a loss for the year.
Home office expenses: If you use part of your home for business purposes, you may be eligible for for home office deductions. To qualify, you must use the office regularly and exclusively as your principal place of business or a place where you meet or deal with clients, patients or customers in the normal course of business. If you’re an employee, the home office must be used for the employer’s convenience.
This may entitle you to deduct direct expenses as well as certain indirect home office expenses—including utilities, repairs, insurance, mortgage interest and property taxes—based on the percentage of the business use of the home.
We’ve only outlined some of the key tax breaks of homeownership in this brief article. Explain all the implications and opportunities available to your clients.
Ken Berry, Esq., is a nationally known writer and editor specializing in tax, financial, and legal matters. During his long career, he has served as managing editor of a publisher of content-based marketing tools and vice president of an online continuing education company. As a freelance writer, Ken has authored thousands of articles for a...