Is Buying a Home Tax Deductible?

Real estate is often described as a good investment, and in most cases, owning a home has more financial benefits than renting. But what about taxes? Is buying a home tax deductible? Unfortunately, if home buyers are expecting big tax write-offs, they are likely to be disappointed. 

Under current tax laws, very few costs associated with the actual purchase of the home are deductible. Instead, a homeowner will have some tax savings each year they own the house. Most homebuyers see more compelling reasons than the tax benefit to buy, such as doing as they please with the property, not dealing with a landlord, and most importantly, building equity in a capital asset. But taxes do play a part in the investment, so knowing what can and can’t be deducted is helpful information.

Before any further discussion of taxes, it’s important to note that nearly every year the IRS changes something in the tax code. Any information we provide here is based on the information available for the 2020 tax year. It’s always best to check the IRS website or consult with a tax professional, especially when considering an investment that could have an impact on your tax liability.

Most people find all of the tax rules and terminology confusing. They only know that they want to take advantage of every opportunity to lower the amount they have to pay. There are two ways to lower tax liability: Tax credits and tax deductions.

Tax credits are incentives that allow a taxpayer to subtract the amount of the credit directly from the tax that they owe. For example, the IRS offers a tax credit for some energy-saving things like solar panels. For panels installed in 2019, homeowners could get a credit for 30% of the cost (in 2020, it goes down to 26%). If the panels cost $12,000, their total tax payment in 2019 could be reduced by $3,600. 

Tax deductions are a bit different. Instead of lowering the final tax bill, they are subtracted from the taxpayer’s gross income. This lowers the amount of adjusted gross income, which is multiplied by the tax rate to come up with the tax liability. The lower the adjusted gross income, the less the person has to pay.

Standard vs. itemized deductions. Taxpayers have a choice each year of taking a standard deduction (an amount set by the IRS) or an itemized deduction (adding up all of their individual deductions) on their individual tax return. Whichever amount is greater will give them the best tax benefit. For 2020, the standard deduction is $12,400 for individuals and $24,800 for married couples filing jointly. If all of the deductions we discuss in this article, plus some others, such as medical expenses and charitable donations add up to more than that, it pays to itemize. It’s usually a good idea to calculate itemized deductions to ensure the lowest tax liability.

The majority of closing costs are covered by the seller in the transaction, but the buyer has a number of financial responsibilities, too. Buyer’s costs typically come out to 2-5% of the purchase price of the house. Unfortunately, these can not be deducted on the buyer’s tax return. They include:

• Appraisal and home inspection fees
• Credit reports
• Attorney fees
• Title and administrative fees

Having to come up with the cash for these things, and not being able to recoup any of them through a tax deduction, might be disappointing...but the news is not all bad. Closing costs are added to the home’s purchase price to come up with an amount called the cost basis. Later, when the buyer resells the house, the basis becomes important in calculating the capital gain on the sale. Most people do not make enough of a profit to have to pay capital gains tax, but if they do, those closing costs will lower the liability.

Many people may remember seeing a line item for moving expenses on tax returns in years past. Taxpayers were allowed to deduct the cost of moving, provided it was for a job-related relocation. That changed in 2018 with the Tax Cuts and Jobs Act. Since then, the deduction is only for members of the military and a “permanent change of station.” So, members of the armed forces can deduct moving expenses, but civilians can not.

The only item paid at closing that may be tax-deductible is prepaid mortgage interest, also called “points.” If the buyer meets certain criteria required by the IRS, the points can be listed as an itemized deduction in the year they are paid. If those criteria aren’t met, they must be deducted gradually over the life of the mortgage loan.

There are only a few other costs associated with a closing that home buyers can deduct on their first tax return after buying. These are the same things that can be claimed in future years of homeownership. Like the other deductions mentioned, these must be itemized and add up to more than the standard deduction to make a difference in the tax bill.

• State and local property taxes
• Home mortgage interest (and points, if not already deducted in full)
• Mortgage insurance premiums

When buying a home, the buyer may pay a prorated portion of these expenses at the closing. If that is the case, the amounts will be on the settlement sheet. In subsequent years, the homeowner will find these amounts on their property tax bill, insurance bills, and on Forms 1098 sent to them by the institution that holds their mortgage.

The tax situation when buying a home to rent out as an investment is quite different than when buying a home to live in. Rental property ownership is treated by the IRS as a business. Rent collected is income, and the cost of caring for the property is a business expense—most of which is deductible. Losses incurred can count as a tax write-off too.

For more information about tax-deductible items for property investors and landlords, you can read this article published by our partner company, Select Leasing & Management. 

The promise of a tax write-off should not be at the top of anyone’s list of reasons to buy a home. The way the current tax code is written, the tax implications of buying a home likely won’t make much of a difference on the average homebuyer’s tax return. That being said, knowing about, and taking advantage of available tax credits and tax deductions is a good idea. No one likes the idea of paying more tax than is absolutely necessary.