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Choosing to purchase a home is a big decision. For many, buying a home is one of the largest investments they will make in their lifetime. While owning a home has great financial responsibility, it also offers certain benefits. If you own a home, learn what the homeowners tax credit is and what tax benefits are available to you as a homeowner in 2020.
What is the homeowners' tax credit?
Homeowners tax credits are specific tax benefits made available to those who own a home. They allow you to reduce your income tax rate, deduct certain home-related expenses, or receive a tax credit through a tax credit program. In 2020, homeowners tax credits include:
- Mortgage interest deduction.
- Local and state tax credit.
- Capital appreciation from the qualified sale of your home.
These credits can be taken by electing to itemize deductions on your taxes. The Tax Cut and Jobs Act (TJCA) of 2017 made significant changes to our tax law, including decreasing certain itemized deductions while increasing the standard deduction amount. This change has motivated more homeowners to elect the standard deduction because oftentimes the amount is higher than their qualified itemized deductions. However, if you do choose to itemize your deductions, below are the homeowner's tax credits that are available this year.
How does the mortgage interest deduction work?
One of the most well-known deductions for owning a home, the mortgage interest deduction allows homeowners to deduct interest paid on a qualified mortgage. Those who have a mortgage on their principal residence that is dated after Dec. 15, 2017, for $750,000 ($375,000 if married filing separately) or less are able to deduct their mortgage interest. Mortgages dated Dec. 14, 2017, or earlier have a limit of up to $1 million ($500,000 if married filing separately) of mortgage interest.
How do local and state property tax credits work?
Property taxes are one of the financial responsibilities of owning a home. However, homeowners who itemize their deductions may be able to deduct their homeowners' property taxes on a local and state level, deducting up to $10,000, or $5,000 if married filing separately. The goal of this property tax credit is to transfer federal funds to the local or state municipality, allowing local jurisdictions to raise and impose taxes without it being a financial burden to its citizens.
Will I owe taxes on the qualified sale of my home?
One of the largest tax benefits available to homeowners comes from the sale of the property. If a homeowner has lived in a home for two of the previous five years, they do not have to pay tax on the profit of the sale -- as long as it is below $500,000 for married couples or $250,000 for single filers.
Home improvements that specifically enhance or improve your property's value like a new roof, a kitchen renovation, or hurricane-resistant windows cannot be deducted. But they can be used to help improve your cost basis upon the sale of your home.
For example, if you are a single filer and purchased a primary residence for $250,000, then sold it for $550,000 ten years later, your profit would be $300,000. You're allowed up to $250,000 tax-free profit, so you would be subject to paying taxes on the surplus $50,000 in profit. However, if you can prove that you made at least $50,000 in qualified home improvements over the past ten years, you can increase your cost basis, eliminating any profit you have to claim.
How do I calculate tax credit deductions?
If you want to calculate your tax credit deductions to see whether itemized deductions or the standard deduction is better to take, calculate the total amount you are qualified to deduct based on the above homeowners' tax credit.
Let's say you are married filing jointly and will pay $2,200 in property taxes, $3,980 in state taxes, and $5,900 in mortgage interest. Your total itemized deduction would be $12,080.
Compare your total itemized deduction amount to the current standard deduction limits to determine which is more beneficial for you. As of 2020, those who are:
- Single or married filing separately can deduct $12,200.
- Married filing jointly can deduct $24,400.
- Head of household can deduct $18,350.
In this example, taking the standard deduction would provide a larger benefit for everyone than taking itemized deductions.
It's important to keep in mind that homeowners' tax credits change frequently. In years past there were credits for first time home buyers that have since been eliminated, and it's likely new policies and limits will change as tax policies change. The tax credits that are available to homeowners shouldn't be a deciding factor in purchasing a home, but rather an added benefit to being a homeowner. Always make sure the purchase of a home is a sustainable financial investment and will be something you can afford in the long run.
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