9 Tax Breaks Every First-Time Home Buyer Must Know

first home tax credits

Americans’ wallets are in much better shape since the Great Recession. And with higher pay and steadier job security, tax breaks for homeowners can make the prospect of buying a home attractive.

“Tax-wise, this is a good time to buy,” said Yvette Best of tax preparation company Best Services Unlimited. “Homeownership offers tax breaks that renters do not have.”

For new homeowners, a house is an asset that can lower their tax liability. First-time homebuyers should be aware of the housing tax deductions and credits that can save them thousands and offset the cost of ownership. It might require a little more paperwork to claim these benefits, but the savings can make the effort well worth it. Whether you bought a home for the first time in 2015 or are planning to do so next year, find out how these homeowner tax breaks can keep more money in your pocket.

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1. Mortgage Payment Interest Deduction

The biggest tax break after buying a home is often the mortgage interest deduction. This deduction covers interest paid on up to $1 million worth of loans and is especially beneficial for borrowers with new mortgages, since they pay more interest.

“The way that loan amortization works, your first payments will have the highest ratio of interest to principal so you will receive the majority of the tax benefit upfront,” said Andrew Christakos, an accredited investment fiduciary with Westfield Wealth Management.

A homeowner will need to file an itemized tax return to claim the mortgage interest payment deduction. “For most people, especially first-time buyers that have never itemized deductions prior to owning a home, the incentive to itemize deductions when filing their taxes comes from the large deduction they get from making payments on their mortgage interest,” said Lisa Greene-Lewis, a certified public accountant and tax expert for TurboTax. Your loan provider should send you Form 1040 shortly after the tax year ends. It will outline the interest you’ve paid for that year.

2. Mortgage Credit Certification

The Mortgage Credit Certificate Program can provide another opportunity for first-time buyers to get a tax break on mortgage interest. According to the IRS, this program “is intended to help lower-income individuals afford home ownership.” Unlike a deduction which reduces your taxable income, this credit directly counts against your tax bill and lowers what you owe.

“It’s a little-known but very cool program,” said Deb Tomaro, a broker with RE/MAX Acclaimed Properties in Indiana. “Depending on the purchase price of your home, a buyer can get 20 to 30 percent of the interest they pay every year on their mortgage back as a straight tax credit — straight back into their pocket.”  While this is a federal credit, it’s administered by state and local governments and can vary by state and county.

To get this credit, you will need to qualify for and be issued a Mortgage Credit Certificate by your state or local government, usually at the time you originate your mortgage to purchase your home. This certificate will include your mortgage and credit details, including the amount of interest you can claim as a credit. With a certificate, you’ll qualify for this credit for the life of the mortgage and can claim each year using IRS Form 8396.

3. Mortgage Points Deduction

But it’s not just the interest paid in monthly mortgage payments that qualify for a tax deduction. “Most homeowners overlook the deduction of points paid to secure a mortgage loan,” Best said. Mortgage points are prepaid interest that also qualifies the borrower for a lower interest rate over the life of the loan. Because it’s still a payment against interest, it qualifies for deductions.

“This deduction could be worth thousands,” Best said. “Although interest rates are low, buying points to lower the interest rate on your mortgage loan is one of the best tax breaks available right now. The return on investment is two-fold — you get to deduct the cost of the points and the amount paid in interest in the same year as the home purchase.”

4. Tax-Free IRA Withdrawals

As you’re getting ready to buy a home, consider pulling some funds from an IRA to help cover a down payment or other costs. “First-time homebuyers who break into their IRAs to come up with the down payment do not have to pay the 10 percent penalty normally applied to pre-age 59 ½ withdrawals,” Greene-Lewis said. “This incentive also applies to current homeowners as well, since you are eligible for first-time buyer status if you have not purchased a home in two years.”

5. Real Estate Tax Deduction

“Taxpayers who itemize their deductions on Schedule A are also eligible to deduct real estate taxes paid on their primary and secondary residences,” said Laurie Samay, a certified financial planner with Palisades Hudson Financial Group. You can even deduct real estate taxes, as long as they were paid within the year for which you’re filing. The tax paid must also be for a home you own; you can’t claim taxes you paid for someone else’s property.

6. Home Improvements

Home improvements can qualify for deductions in two ways. If you use a home equity loan or other loan secured by your home to finance home improvements, these loans will qualify for the same mortgage interest deductions as your main mortgage. While it might be smarter to pay in cash if you can afford it, claiming this deduction will still help you save if you choose a loan.

Second, tracking home improvements can help you out when the time comes to sell. “When you sell your home, you can include the cost of improvements made to the property in the cost basis when determining your capital gains or losses on the sale,” Christakos said. If your home sells for more than you paid for it, that extra money is considered taxable income. But you can lessen your tax liability by writing off home improvement costs.

“This could help save thousands in taxes at the time of sale,” Christakos said. “Make sure that you keep your receipts for major improvements,” so you can prove the costs you claim, he added.

7. Home Office Deduction

“If you work from home, you can take a deduction for the room or space used as your office,” said Ryan Saltz, Esq., a licensed tax professional for Tax Defense Network in Jacksonville, Fla. “This includes working from your garage, if you have your own repair business,” as well as a typical office space.

This deduction can include expenses like mortgage interest, insurance, utilities and repairs, and is calculated based on “the percentage of your home devoted to your business activities,” according to the IRS. “Just make sure that the workspace information you provide is as accurate as possible,” Saltz said. “Be aware that there are specific requirements for taking this type of deduction.”

8. Home Energy Tax Credits

For homebuyers or homeowners looking to make their home a little greener, the Residential Energy Efficiency Property Credit can help offset the cost of energy efficiency improvements. “You could save up to 30 percent of the total cost of installing certain renewable energy sources in your home,” said Jayson Mullin, founder of Top Tax Defenders. Even better, this is a credit, which means it directly lowers your tax bill. Currently, this tax credit is extended through 2016.

This credit applies to technology that harnesses off-the-grid energy, like wind turbines, solar panels, geothermal heat pumps and fuel cells. “The 30 percent credit applies to the cost, including labor and installation, and must be taken in the year the item was placed in service,” Mullin said. Keep all receipts and contracts from the installation, and file for this credit using Form 5695.

9. Private Mortgage Insurance Deductions

Private mortgage insurance premiums are added to mortgage payments when the loan’s value exceeds 80 percent of the home’s value. While PMI payments have been tax deductible in recent years, this tax break isn’t part of the tax code and Congress has to renew it for homeowners to deduct those costs.

Congress voted at the last minute to extend the PMI deduction through the tax year of 2014. Chances are pretty good that lawmakers will opt to extend this benefit for the 2015 tax year as well, though they’ll have to act fast as the end of the year is drawing near. Homeowners will want to stay aware of the latest developments to know if they’ll be able to claim this significant deduction for 2015 and beyond.

Owning a home is still a big part of the American dream, even if it’s costly. Luckily, America’s tax code still includes several homeowner tax benefits that can help families afford to buy a home.

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