Home values are surging in many areas, and rents are going up too. These factors make buying a home seem more attractive than ever. As a bonus, the cost of ownership is reduced by any tax savings. But those tax savings may be less than you expect or even nothing after the new Tax Cuts and Jobs Act (TCJA). Here’s what you need to know about federal income tax advantages for home ownership after the new law.
Home ownership write-offs that are still allowed under the TCJA
The cost of renting a personal residence is generally a nondeductible personal expense (an exception is when you use part of a rented home for business purposes, such as a deductible home office).
In contrast, our beloved Internal Revenue Code allows you to write off some home ownership expenses as itemized deductions. But for 2018-2025, the TCJA seriously curtailed deductions for home mortgage interest and property taxes.
• If you buy a home now, you can claim an itemized deduction for the interest on up to $750,000 of mortgage debt that is used to acquire or improve your new residence, or $375,000 if you use married filing separate status. These limits apply for 2018-2025. Under prior law, the debt limits were $1 million and $500,000. Plus under prior law, you could also deduct the interest on up to $100,000 of home equity debt, or $50,000 if you used married filing separate status, regardless of how you used the loan proceeds. For 2018-2025, you can only deduct interest on home equity debt that is used to acquire or improve your residence, subject to the overall $750,000/$375,000 limit.
• You can claim an itemized deduction for state and local real property taxes. However for 2018-2025, you cannot deduct more than $10,000 for state and local property and state and local income taxes combined, or $5,000 if you use married filing separate status.
This sounds not as good as before the TCJA, but still OK. But maybe not so OK for your specific situation. Please keep reading.
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The standard deduction factor
Because the standard deduction is a tax-law “freebie,” you don’t need any actual deductible expenses to claim it. For 2018-2025, the TCJA almost doubled the standard deduction amounts. For 2018, they are:
• $24,000 for married joint-filing couples (up from $12,700 for 2017)
• $18,000 for heads of households (up from $9,350 for 2017)
• $12,000 for singles (up from $6,350 for 2017)
Here’s how this seemingly benign change can adversely affect new homeowners.
If your total itemized write-offs for the year add up to less than the new greatly-increased standard deduction, you claim the standard deduction. Before the TCJA, most folks claimed the standard deduction until they bought a home. Then, thanks to their new itemized deductions for mortgage interest and property taxes, they often had enough write-offs to come out ahead by itemizing. However, only the excess of your itemized deductions over your allowable standard deduction actually delivers any tax-saving benefit. Here’s an example to demonstrate the point.
Don’t give your real estate agent a fist bump just yet
Let’s say you’re a married joint-filer and will claim the joint-filer standard deduction amount of $24,000 in 2018 if you don’t buy a home. But if you do buy, you’ll be able to claim itemized deductions for your mortgage interest of $25,000 and property taxes of $5,000. But that’s not all. Say you also pay $5,000 of state income taxes and donate $2,000 to charity. If you itemize, you can write off those amounts too (and any other itemized deductions you’re entitled to). In this example, your itemized write-offs would total $37,000 ($25,000 + $5,000 + $5,000 + $2,000).
So if you’re in the 24% federal income tax bracket, you might think buying a home would cut your tax bill by $8,880 (24% x $37,000). Great! You’re ready to give your realtor a fist bump, but please curb your enthusiasm.
In fact, home ownership would only reduce your taxable income by $13,000. That’s the difference between the $37,000 of itemized write-offs you could claim if you buy a home and the $24,000 standard deduction you could claim without buying. So your actual federal income tax savings would be only $3,120 (24% x $13,000). While that’s a meaningful amount, it might be offset by the higher cost of home ownership. Now you’re ready to slap your realtor, but it’s not the realtor’s fault. Congress and President Trump increased the standard deduction.
When the standard deduction factor doesn’t matter
If you’re already itemizing beforebuying a home (or are close to being able to itemize), the additional write-offs for mortgage interest and property taxes will reduce your taxable income dollar-for-dollar, or nearly so. So in this scenario, you would collect most or all of the tax savings you were hoping for. But if you’re not close to itemizing before buying, beware of the standard deduction factor explained in the example. Otherwise, you could face an unpleasant surprise at tax return time.
The bottom line
Now you know some home ownership tax angles that your friendly neighborhood realtor may have failed to mention. Still, buying a home usually works out to be a pretty good proposition tax-wise. And if you eventually sell for a nice gain down the road, the tax results can be excellent. If you qualify for the valuable principal residence gain exclusion break, a married couple can avoid paying any federal income tax on up to $500,000 of home-sale profit. For unmarried individuals, the maximum tax-free profit is $250,000.
Another tip: the home equity loan factor under the new law
Once you own a home, you may want to take out a home equity loan. Under the Tax Cuts and Jobs Act rules that apply for 2018-2025, you generally can deduct interest on a home equity loan as long as: (1) you use the loan proceeds to buy or improve your first or second residence and (2) the combined balance of your first mortgage(s) and your home equity loan(s) does not exceed $750,000, or $375,000 if you used married filing separate status. Interest on debt beyond these limits is generally non-deductible for 2018-2025. And if you take out a home equity loan and do not use the proceeds to buy or improve a first or second residence, the interest is flat out non-deductible for 2018-2025.