Tax Credits vs Tax Deductions
In the tax world today, there are deductions and credits.
Credits constitute money taken off your tax bill. They are like coupons. Your tax due will decrease by $1,000 if you get a $1,000 tax credit.
A tax deduction decreases the adjusted gross income (AGI), successively reducing tax liability.
For instance, if you are in the 22% tax bracket, your tax liability will be decreased by 22% of the total claimed deduction. Therefore, if you claim a $1,000 deduction, you can anticipate your tax liability to drop by $220 ($1,000 x 22%).
Residential Tax Benefits
You are entitled to many different deductions and credits if you own a home. Here are some of the most common:
Mortgage Interest Deduction
The mortgage interest deduction is one of the homeowners' most valuable tax benefits. It will allow you to deduct the interest you pay on your mortgage to build, buy, or even improve your primary or second home.
If you're a single taxpayer or a married couple filing a joint tax return, the reduction of interest paid is up to $750,000, but $375,000 if you are a married couple filing separately.
However, the old limit of mortgage interest deductions, such as $1 million for single filers and a married couple filing jointly and $500,000 for a married couple filing separately, applies if your home was bought on or before December 15, 2017.
Mortgage Points Deduction
Another valuable tax benefit of buying a home is the capacity to deduct mortgage points when taking out your mortgage and paying using discount points.
Usually, over the life of your loan, you can deduct points gradually. You will need to meet several tests to be an exception to this rule and deduct points in full on the year when they were paid.
These include requirements such as owning a mortgage secured by your main home or paying for less costly points than what is generally charged locally.
Private Mortgage Insurance (PMI)
When the down payment of a mortgage borrower is lesser than expected, some lenders require private mortgage insurance.
This mortgage insurance protects the lenders if you stop or cannot make mortgage payments.
The PMI can fill the gap if the property falls into foreclosure auction or a short sale and there isn't enough equity to cover the loss.
But you can't claim this deduction if your income is too high. Also, before you count on these savings, check first the tax rules for the current year, as this tax deduction is subject to expiration.
State and Local Tax (SALT)
The State and Local Tax or SALT allows taxpayers to deduct certain taxes paid to local and state governments when they itemize their deductions on federal returns.
As for single taxpayers and married couples filing taxes jointly, the deduction is limited to $10,000, while $5,000 is for married couples filing separately.
Tax-Free Profits on Home Sales
If you're single, selling your house at a profit, your capital gains are tax-free up to $250,000, and up to $500,000 if you're married, filing jointly.
To qualify for the tax perk, you must have lived and used the home as your original residence for at least two of the five years before the sale date.
Standard Deduction
When taking the standard deduction, you allow deducting a set amount from your taxable income.
Also, it means that you can't itemize your deductions. The deductions you meet as a homeowner must be higher than the standard deduction amount bound to your tax filing status if you wish to itemize your deductions instead.
The standard deduction for 2022 of each taxpayer is as follows. For single and married filing separately, the amount is $12,950 ($13,850 in 2023); $25,900 ($27,700 in 2023) for married filing jointly and a qualified widow, and; $19,400 ($27,700 in 2023) for the head of household.
Home Office Deduction
To qualify for the home office deduction, make sure you are a home-based business owner and exclusively work from home.
But you can't claim this deduction if you're an employee working from home.
It applies to both renters and homeowners, provided that they will use their home for regular business purposes and the primary location of where you conduct your business.
There are two methods of claiming this deduction. First is the regular method, which requires determining the percentage of your home used for business activities.
Second is the simplified option, which allows you to deduct $5 per square foot- up to 300 square feet for the business use of your home.
Residential Energy Credits for Renewable Energy
The Inflation Reduction Act has made relevant changes to the credits for energy-efficient home improvements and residences with clean energy equipment, expanding its value and encouraging more homeowners to invest in renewable energy sources.
Energy Efficient Home Improvement Credit
The credit value has increased to up to $1,200 every year for qualifying property placed in service from January 1, 2023, until January 1, 2033. Unlike the previous lifetime limit, the new credit can be applied annually.
Thus, spreading out your qualifying home improvements over the 10-year credit period allows you to receive up to $12,000 back on your taxes, a significant increase from the previous limit while contributing to a more sustainable energy future.
Starting January 1, 2023, the Energy Efficient Home Improvement Credit will be equal to the lesser of 30% of the sum of amounts paid for qualifying home improvements or the annual credit limit of $1,200.
There are also annual dollar credit limits for specific items, such as $150 for home energy audits, $250 per door for exterior doors (up to $500 per year), and $600 for exterior windows and skylights, central A/C units, electric panels and related equipment.
You can also claim up to $2,000 in tax credits for electric or natural gas heat pump water heaters, electric or natural gas heat pumps, and biomass stoves and biomass boilers.
This means that you can claim a maximum total yearly energy-efficient home improvement credit amount up to $3,200.
Residential Clean Energy (RCE) Credit
Aside from the Energy Efficient Home Improvement Credit, the Inflation Reduction Act also made changes to the Residential Clean Energy (RCE) Credit. Specifically, its duration was extended and its coverage was extended.
This revision means that you can claim a tax credit of 30% of certain qualified expenses for residential clean energy properties, such as solar panels, solar-powered water heaters, wind turbines, geothermal heat pumps, fuel cells and attery storage technologies.
The credit is applicable to properties that are put into service between December 31, 2021, and January 1, 2033. From 2033 onwards, the credit percentage rate will decrease, 26% for the year 2033, then dropping to 22% for 2034, and ultimately no more credit after December 31, 2034.
Final Thoughts
Homeownership comes with a lot of financial responsibility. But being a homeowner also has its perks, especially regarding taxes. Knowing which deductions and credits you're eligible for can save a significant amount on your taxes each year.
If you have any questions about the tax benefits of homeownership, be sure to speak with a tax professional. They can help you maximize your deductions and ensure that you take advantage of all the benefits available.
FAQs
1. What is the mortgage interest deduction?
The mortgage interest deduction is a tax deduction that allows homeowners to deduct the interest they pay on their mortgage to build, buy, or even improve their primary home or second home.
2. How much can I deduct for the mortgage interest deduction?
You can deduct the interest you paid on your mortgage up to $750,000 if you're married filing jointly or $375,000 if you're married filing separately.
Suppose your home was purchased on or before December 15, 2017. In that case, you can deduct the interest paid on a mortgage up to $1 million for single filers and a married couple filing jointly and $500,000 for a married couple filing separately.
3. What is the State and Local Tax (SALT)?
The State and Local Tax (SALT) is a tax deduction that allows taxpayers to deduct the amount of state and local taxes they paid, given that they itemize their deductions on federal returns.
4. How much can I deduct for the SALT deduction?
For the 2020 tax year, you can deduct up to $10,000 in state and local taxes if you're married filing jointly or $5,000 if you're married filing separately.
5. What is the standard deduction?
The standard deduction is a set amount you can deduct from your taxable income if you do not itemize your deductions. The deductions you meet as a homeowner must be higher than the standard deduction amount bound to your tax filing status if you wish to itemize your deductions instead.
