In “How Much Do Taxes Change When You Buy a House?,” we briefly outlined a number of taxes owed by property owners. We also explained which IRS forms they must file during tax season. From property taxes each year to real estate transfer taxes due at closing, new homeowners are often shocked by how their tax bill. However, we also pointed out the deductions, credits and other tax benefits available to homeowners. For first-time home buyers, there are even more tax breaks to take advantage of – both when filing federal taxes and state taxes. First-time homeowners can shrink their tax bill with penalty-free IRA payouts, mortgage insurance premium deductions and so much more. Of course, homeowners should keep in mind that most of these deductions are only applicable when itemized. Homeowners who take the standard deduction instead of itemized deductions will not be eligible for most of these deductions. Follow below to learn all about tax deductions and credits for first-time homeowners and state-specific programs in Massachusetts, New Hampshire and California.
Tax Deductions for Homeowners in 2022
Home Mortgage Interest Deduction (HMID) or Mortgage Interest Tax Credit
As a first-time homeowner, you likely qualify for the home mortgage interest deduction. In her article “Mortgage Interest Deduction: What Qualifies in 2022” for NerdWallet, Tina Orem explains how to deduct home mortgage interest paid in 2021. Orem writes that “the mortgage interest deduction allows you to reduce your taxable income.” You can do so “by the amount of money you’ve paid in mortgage interest” over the last year. If you bought your home before 2017, you can deduct mortgage interest up to $1M of the mortgage debt. If married filing separately, you can only deduct up to $500k each.
However, you can only deduct up to $750K if you bought the house after 2017. To file for this deduction, Orem notes that you will need Form 1098. You should have received this form from your mortgage lender by the end of January or the beginning of February. This form will enumerate “how much you paid in mortgage interest and points during the tax year.” Your lender will also send this form to the IRS. As such, you should make sure that the amount listed on your tax return is the same as that which your lender reports.
Exceptions to the Mortgage Interest Deduction
Of course, not all properties are eligible for the home mortgage interest deduction. In some cases, you can only deduct some of your mortgage interest payments but not all. For example, if you operate a business from a designated part of your house or if you rent out your entire home. However, there is a separate deduction for those who work from home — the home office expenses deduction.
There are other exceptions as well, which Lisa Smith outlines in her article “Calculating the Home Mortgage Interest Deduction (HMID)” for Investopedia. Smith writes that “mortgage interest is only deductible if your mortgage is secured by your home – not if it is a personal loan.” Your mortgage will only qualify for this deduction if “secured by your primary or secondary home.”
Home Equity Loan Interest Deduction or Home Equity Line of Credit Deduction
In some cases, you might also be able to deduct home equity loan interest payments and/or home equity line of credit interest payments. IRS Publication 936 – entitled “Home Mortgage Interest Deduction for Use in Preparing 2021 Tax Returns” – explains. According to the IRS, HELOCs and loans are deductible if “used to buy, build, or substantially improve the taxpayer’s home that secures the loan.” As with interest payments related to traditional mortgages, home equity loans only qualify if they are secured by your principal residence. In some cases, this extends to second homes as well.
When Can You Deduct HELOC and Home Equity Loan Interest Payments?
David Rae explains further in his article “Can I Still Get A Tax Deduction For My HELOC Mortgage?” for Forbes. According to Rae, whether your HELOC or home equity loan interest payments are deductible “depends on your specific situation.” It is based primarily “on your mortgage balance and what the mortgage debt was used for.” Unfortunately for many homeowners, changes made by the Tax Cuts and Jobs Act of 2017 severely limit which HELOCs and home equity loans qualify.
You can still deduct interest on your HELOC or home equity loan payments “if you are using the home equity loan for home improvements.” If you borrowed against the equity you have in your home to fund other things, you cannot deduct these interest payments. In general, homeowners can only deduct interest paid on qualified HELOC debt up to $100k.
Mortgage Prepayment Penalty Deduction
If you paid off your home loan before the term of 10, 15 or 30-year mortgage ended, you might have incurred a prepayment penalty. Your lender might have included a prepayment penalty clause in your home loan to discourage you from paying off the loan too early. These penalties are designed to protect lenders from missing out on valuable interest payments. The good news is that you might be able to deduct mortgage prepayment penalties on your tax return.
Jeannine Mancini explains in her article “Mortgage Prepayment Penalty Tax Deduction” for The Nest. Mancini writes that lenders often charge one of two penalties, commonly called soft and hard prepayment penalties. The former “is only assessed when the borrower refinances.” A hard prepayment penalty is incurred “regardless of how the loan is paid off early.” In order to qualify for a prepayment penalty deduction, you must have already paid the entire penalty. However, “if you refinance and roll the penalty into your new loan, you can deduct the penalty over the life of the loan.” Those who refinanced their home but paid the entire penalty at closing can deduct the whole penalty incurred.
Property Tax Deduction
Another common tax deduction for homeowners is the property tax deduction. These state and local taxes are usually deductible on your federal tax return, but might also reduce your state tax bill. In California for example, a certain amount of real property taxes charged by the state are also deductible. You can find out more about this specific example in the H&R Block resource “Property Tax – California.” Writing for RocketMortgage, Andrew Dehan explains further in his article “Property Tax Deduction: A Guide To Writing Off Real Estate Tax.”
First, Dehan defines the deduction. He notes that the property tax deduction lets you “deduct the state and local taxes you’ve paid on your property from federal income taxes.” Both annual property taxes based on your home’s assessed value and prepaid property taxes due at closing are deductible.
How Much Can You Deduct?
But how much can you deduct? Unfortunately, the 2017 Tax Cuts and Jobs Act limited deductible property taxes. Today, they are limited to $10k if you are filing as a single person or $5k if you are married filing separately. You can only claim up to $10k in property taxes for all properties you own. This means that if you pay taxes on multiple properties, you can only claim $10k in total — not $10k in property taxes on each.
Property taxes related to your principal residence, vacation home, vacant land, cars and even your boats are deductible. There are a number of exceptions, however. According to Dehan, you cannot deduct property taxes paid on a house you do not own or on a rental property. You cannot deduct local property taxes “you haven’t yet paid.” Nor can you deduct those related to utilities provided by your state or local government such as “trash collection or water.”
Medical Deduction for Home Improvements
Next on our list of tax credits and deductions for homeowners is the medical deduction. If you made improvements to your home over the last year with accessibility in mind, these payments could qualify for a deduction. Medically necessary home improvements are pretty much the only type of home improvements that qualify for federal tax deductions. In his article “Deducting Medical Home Improvements” for NOLO, Stephen Fishman, J.D. explains. Fishman writes that “home improvements can be deductible as a medical expense if their main purpose is medical care.”
These medically necessary home improvements “are fully deductible…if they don’t increase the value of your home.” If the accessibility improvement does increase the value of your home, “you must reduce the amount of your deduction by the increase in value.” Examples of these types of improvements are “installing an elevator” or “installing a new bathroom on the ground floor of your home.” Even though these improvements are made to improve accessibility, they would not qualify for a full deduction.
Tax Credits for Accessibility Modifications
There are also some tax credits available to homeowners who make their property more accessible to seniors or disabled persons. Most of these tax credits are granted by state and local governments. Jenni Bergal explains in her article “Tax Credits for Ramps, Grab Bars to Help Seniors Stay at Home” for the Pew Charitable Trusts. According to Bergal, many states and counties across the U.S. “have approved tax credits for residents who make their homes more accessible.” Today, states are motivated to provide homeowners with these accessibility tax credits. This is because “it’s much more expensive for Medicaid…to pay for nursing home care” than to help people stay in their homes.
Moving Expenses Deduction
In rare cases, you could qualify for a moving expenses deduction. In “What Kind of Tax Deduction Do You Get if You Pay Cash for a Home Purchase?” for SF Gate, Michelle Miley explains. Miley writes that homeowners might claim a deduction for moving expenses like “cost of packing materials, storage fees and overnight lodging during your move.”
In order to qualify, homeowners must have moved because their job required them to relocate. Homeowners must also be full-time employees both in the year they moved and in the following year. If self-employed, homeowners must “work at least 78 weeks in the two years following their move.” How far you moved could also impact whether you qualify for this deduction. Miley notes that “in order to claim the moving expense deduction, your new job must be at least 50 miles further” from your home.
Home Office Expenses Deduction
If you are self-employed, and you work remotely, you could qualify for the home office deduction. If you are employed by someone else, however, you cannot deduct home office expenses – even if you work from a designated home office. Kimberly Lankford and Jennifer Ortiz explain in their article “Can You Take the Home Office Deduction?” for US News. Lankford and Ortiz note that while “you can only qualify for the home office deduction if you’re self-employed…this wasn’t always the case.” In 2017, the tax code was altered and the home office deduction was eliminated for “people who work for an employer.” This change will affect employees until 2025, after which it will be removed from the tax code if not renewed by Congress.
However, employees who also take freelance projects on the side could qualify for a partial deduction. According to Lankford and Ortiz, “if you did some consulting for a few months…you can take the home office deduction.” The deduction is only applicable “for the months when you were self-employed and working from home.” In order to qualify, “you must have some Schedule C income from self-employment.” Your home office must also meet certain criteria. Your home office can simply be a corner of your bedroom or basement instead of a separate room. However, you must use that part of your house “‘regularly and exclusively’ for business.”
Choosing the Standard or Simplified Deduction
You can take either a standard deduction or simplified deduction related to home office expenses. Lankford writes that with the standard deduction, “you can deduct 100% of some of your home office expenses.” If you choose this method, you can deduct a percentage of your mortgage payment interest.” You can deduct a percentage of “rent, utilities (such as electric, water and gas bills) and homeowners insurance.” With the standard deduction, you can also deduct a percentage of depreciation and property taxes.
With a simplified deduction, “you can deduct $5 per square foot of your home office…for a maximum deduction of $1,500.” This is the method most homeowners choose. Those who choose the simplified deduction do not have to file a separate form and can take their deduction “directly on Schedule C.” Those who pick the standard method, however, “must submit Form 8829 with [their] income tax return.” They must then report the “total deduction…on Schedule C.”
Private Mortgage Insurance Deduction
Mortgage insurance premiums might also be tax-deductible. According to H&R Block, you can take a mortgage insurance premium deduction if you meet certain criteria. First, you must have “paid or accrued premiums on a qualified mortgage insurance contract issued after Dec. 31, 2006.” Second, the mortgage in question must be home acquisition debt “for a qualified residence (a new mortgage).” Third, you must “itemize your deductions” instead of choosing the standard deduction.
In “Private mortgage insurance (PMI) federal income tax deduction returns” for Bankrate.com, R.H. Bierck explains in further detail. Bierck writes that while “the federal tax deduction for private mortgage insurance (PMI) [was] eliminated by Congress in 2017,” it was reinstated in 2019. Those who filed in 2020 were able to claim this deduction retroactively for 2018 and 2019. Though PMI deductions are intended for primary residences, “you might be able to deduct private mortgage insurance payments on a second home, too.” If you do not rent out the entire property, your vacation home could qualify for deductible private mortgage insurance.
Homeowners Insurance Deduction
In some cases, homeowners could deduct their homeowners insurance payments. However, this deduction is conditional. Damian Davila explains in his article “Is Homeowners Insurance Tax-Deductible?” for Investopedia. Davila writes that homeowners’ insurance is not usually tax-deductible, “nor are premiums, even though your premiums may be included in your mortgage payments.” Homeowners insurance usually isn’t deductible “because homeowners insurance is not considered nondeductible expenses by the Internal Revenue Service (IRS).” This means that homeowners are unable to “itemize any payments for home insurance…nor title insurance” on their tax returns.
There are certain circumstances under which homeowners insurance payments are in fact deductible, however. Davila writes that “if you use your home or part of it for business,” you might be able to take the deduction. Homeowners who also act as landlords and report rental income could also claim this deduction. According to Davila, “your homeowners insurance on the portion of the property used as a rental becomes tax-deductible.” Homeowners can deduct all of their homeowners insurance when they “own several properties and those properties are used only for rental income.”
Other Rental Property Tax Deductions
Homeowners who rent out their property could qualify for a number of other tax deductions as well. Even if you rent out a single room in your house, you could still qualify. Stephen Fishman, J.D. explains in his article “Tax Issues When Renting Out a Room in Your House” for NOLO. According to Fishman, renting a room grants you the same tax benefits as those granted to a landlord who rents their entire property. As such, you can deduct a percentage of “the expenses arising from your rental activity.”
To claim these deductions, “you must divide certain expenses between the part of the property you rent out and the part you live in.” Expenses you can deduct on your taxes as long as you divide them properly include “mortgage interest and repairs for your entire home.” They also include “utilities such as electricity, gas, and heating oil, housecleaning or gardening services for your whole home.” Other deductible expenses include services like trash and snow removal.
Another common deduction claimed by homeowners who rent out part of their property is the pass-through tax deduction. In his article “What Is the Pass-Through Tax Deduction?” for MillionAcres, Matt Frankel, CFP defines this tax break. Frankel writes that the pass-through deduction is also called the Qualified Business Income Deduction. QBI allows qualified individuals to “get as much as a 20% deduction from their income from pass-through entities.” These include entities like “LLC’s and partnerships” but not C-corporations. According to Frankel, those who make rental income off just one room in their house qualify for this deduction.
In recent months, Democratic members of Congress have argued for removal of the pass-through deduction. In her October 2021 article “As Tax Changes Brew In Congress, Outlook Is Grim For Pass-Through Owners” for Forbes, Lynn Mucenski Keck explains. According to Keck, a tax proposal recently issued by the House Ways and Means Committee would limit this deduction if passed. So far, the bill has not passed and the pass-through deduction remains unchanged. Check with your accountant before claiming this deduction just in case.
Mortgage Points Deduction
Next on our list of tax deductions for homeowners is the Mortgage Points Deduction. Mortgage points are a type of prepaid interest home buyers might pay at closing. They do so in order to lower their mortgage interest rate and therefore their monthly mortgage payments. Sometimes, mortgage points are also called maximum loan charges, discount points, loan discounts or loan origination fees. Each mortgage point is equal to 1% of your mortgage debt or home loan.
The H&R Block resource “Deducting Mortgage Points” explains how and when you can deduct discount points on your tax return. You can deduct discount points in full if you bought a house in 2021 if the following criteria apply. In order to qualify you must have “used a cash method” and “secured the mortgage loan with your main home.” You can also deduct discount points if you used them to build a primary residence. If you borrowed money to pay for discount points, you cannot claim these tax deductions. According to H&R Block, you cannot deduct mortgage points if they were used to “cover services.” These services could include a “lender’s appraisal fee, notary fees [or] mortgage note preparation.”
Residential Energy Efficient Property Credit
In “How Do Taxes Change When You Buy a House?,” we explain the energy efficient credit by referencing IRS resource “Energy Incentives for Individuals.” We note that “an individual may claim a credit for (1) 10% of the cost of qualified energy efficiency improvements.” This credit is called the “residential energy efficient property credit.”
Improvements that qualify for this credit include “solar electric properties, solar water heaters and geothermal heat pumps.” Others like “small wind turbines, fuel cell properties and…qualified biomass fuel properties” also qualify. In some cases, so could updating windows, skylights and doors, adding insulation and replacing your HVAC system. Consult your tax professional for a complete list of qualifying properties.
Qualified Mortgage Credit Certificate
Second to last on our list of tax credits and tax deductions for homeowners is a mortgage tax credit. With a qualified mortgage credit certificate, homeowners can claim a federal mortgage tax credit. This could be as much as 40% of the mortgage interest paid within one year. The Federal Deposit Insurance Corporation or FDIC resource “Mortgage Tax Credit Certificate (MCC)” explains how this tax credit works and who is eligible. According to the resource, many HFA’s “manage a program that provides home purchasers with a significant credit in connection with their home loans.” Homeowners can use this mortgage interest tax credit to lower their monthly mortgage payments “for as long as the home remains their primary residence.”
Mortgage lenders that participate in these programs inform borrowers “and apply to the HFA for the mortgage credit certificate on the borrower’s behalf.” Unlike a tax deduction, an MCC “provides a dollar-for-dollar tax credit to recipients to increase housing payment affordability.” The FDIC notes that “the maximum tax credit that may be taken for any given year [is] $2,000 for each MCC recipient.” You can deduct mortgage interest that remains after the mortgage interest credit “as a standard home mortgage interest deduction.” Both reduce the homeowner’s tax bill significantly by allowing the homeowner to deduct their mortgage interest. Of course, you can only claim these tax deductions for homeowners if you itemized deductions when you pay taxes each year.
Waived IRA Withdrawal Fees
Last on our list of tax breaks for homeowners is the ability to waive IRA withdrawal fees. You can do this if you used the money for a down payment. In his article “13 Tax Breaks for Homeowners and Home Buyers” for Kiplinger, Rocky Mengle explains. Mengle writes that homeowners with IRAs or 401(k) accounts often choose to “tap into those funds to help them buy a home.” Homeowners who have invested in a “traditional IRA can withdraw up to $10,000 from the account.” They can use this money “to buy, build or rebuild a first home without paying the 10% early-withdrawal penalty.”
This is true “even if you’re younger than age 59½.” If you are married filing separately, “both you and your spouse can each withdraw $10,000 from separate IRAs” without incurring a 10% penalty. Of course, you must still pay tax on what you withdraw to use as a down payment. On your tax return, this amount will be included in your adjusted gross income.
State-Specific Tax Credits for Homeowners in Massachusetts, New Hampshire and California
Like the mortgage interest credit, there are a number of state specific tax credits and deductions available to homeowners. Below, we explore a number of deductions and credits available to homeowners in Massachusetts, New Hampshire and California. Some of these credits and deductions are related to necessary improvements while others are related to property taxes.
Tax Deductions and Credits for Homeowners in Massachusetts
First on our list is Massachusetts, which offers a bunch of credits to homeowners in the state. According to the state government, homeowners could qualify for a lead paint removal credit or a credit to repair a failed septic system. They could also qualify for a renewable energy source property credit or a circuit breaker credit. This last credit is part of the state’s Income Tax Reduction Program for Massachusetts homeowners. With this credit, taxpayers over the age of 65 who live exclusively in Massachusetts could receive a special credit. This credit reduces how much they owe in state income tax. These credits could reduce the amount homeowners pay for real estate tax, mortgage interest or their mortgage insurance premiums. Learn all about these credits here.
Tax Deductions and Credits for Homeowners in New Hampshire
Finally, there are a few credits available to first-time home buyers in New Hampshire. New Hampshire’s housing authority also participates in the mortgage credit certificate program. The state also offers property tax relief to homeowners with low and moderate income. According to the DRA, “eligible low to moderate income claimants who own a homestead in New Hampshire” could qualify for reduced property taxes. In order to qualify, you must meet the following criteria. First, homeowners “must own a homestead subject to the state education property tax.” Second, homeowners must “have resided in such homestead on April 1 of the year for which the claim for relief is made.” Third, homeowners must “have a total household income of (1) $37,000 or less if a single person or (2) $47,000 or less if married or head of a New Hampshire household.”
Certain property owners could also qualify for Low Income Housing Tax Credits (LIHTC) through the Affordable Housing Fund (AHF). According to New Hampshire Housing, this program “provides a strong incentive for private investment in affordable rental housing.” Qualified investors can receive “a dollar-for-dollar reduction in federal tax liability in exchange for providing funding to affordable housing developments.”
Tax Deductions and Credits for Homeowners in California
In California, homeowners could qualify for a tax credit that reduces their property tax burden. Qualifying homeowners could see a taxable value reduction of as much as $7k. The state also offers a tax credit to first-time home buyers in California. Tonya Morena, CPA explains in her article “The California Tax Credit for First-Time Homebuyers” for The Balance. Morena writes that California “has allowed participants to deduct up to 20% of their interest payments from their federal income tax liability.” However, there is an income limit for this credit. According to Morena, “California’s income limit is no more than 115% of the area median income.”