Deciding to buy or build your first home is a huge decision and a landmark life event. While the majority of people agree that home ownership continues to be a solid investment, most of the information available to home buyers focuses on the steep costs associated with a home purchase. Because of this, few people fully understand the tax benefits they may be entitled to as a future home owner. By understanding these helpful programs from Uncle Sam, you may learn that you can actually afford to build that new home you’ve been dreaming of, instead of settling for the used home down the street.
Understanding Mortgage Interest Deductions
Did you know that when tax time comes around, you can deduct your interest on up to $1 million of debt used to purchase or improve your home? That’s right.
According to TurboTax, your lender will send you Form 1098 each year in January. This form will list any mortgage interest you paid during the previous year, to be deducted on Schedule A of your itemized deduction. If not included on the 1098, you can still deduct any of the interest you paid on the date that you closed on your home. This should be listed on the settlement sheet for your home purchase.
The ability to deduct paid mortgage interest form your taxes is particularly noteworthy in the earliest stages of your home loan, when a majority of your monthly mortgage payment is attributed to paying down the interest on your home loan. Joe DeLorenzo from RE/MAX of New Jersey provided a great example regarding mortgage interest deduction in a blog post earlier this year:
If your mortgage payment, including interest, is $1,800 per month and you also owe $700 in taxes, than your total monthly payment would be $2,500 each month. Of your $1,800 mortgage payment each month, approximately $1,200 is attributed to interest and $600 goes toward paying down the loan principal (this ratio will shift throughout the life of your loan). Assuming that you are able to deduct your real estate taxes, as well as your interest, your annual deduction would be $22,800.
If your Gross Income is $90,000 and you subtract your deduction, your Adjusted Gross Income becomes $67,200. In this scenario, you will have overpaid your taxes and the refund you would be entitled to weighs in at around $5,700, which equates to approximately $475 per month.
While your potential for a refund depends on several variables, including your loan amount, whether or not you need Private Mortgage Insurance (PMI) and your Gross Income, the example above illustrates the positive potential in deducting your mortgage interest.In contrast, when you rent a home or an apartment, you can deduct exactly $0 of your total rent payments each year. Which scenario do you prefer?
Be sure to check back with us next week for Tax Advantages of Home Ownership: Part Two.