The holidays and joyous celebrations are fading into our memories. It is hard to believe, but the tax season is upon us. While many look upon this with dread, homeowners and prospective buyers should not have this sense. The IRS looks favorably upon those that have delved into home ownership. There may even be a special “gift” when you file your income taxes, in the form of a larger than expected refund. However, there are plenty of misconceptions, with many not fully understanding the ramifications.
There is plenty of good news for homeowners. It starts with deductions for mortgage interest and real estate taxes for those that itemize, rather than take the standard deduction.
It can be on first or second mortgages (including a home equity loan or line of credit). The loan must also be for the main home or a second home. Moreover, the mortgage must be secured by your house. However, this will be the case in the overwhelming majority of instances.
During the first half of your mortgage term, the majority of your payment goes towards interest. This may not seem fair, but bankers make the rules and therefore receive payment first. On the flip side, this is beneficial for tax purposes since interest is deductible while principal payments are not. As principal is slowly paid down, more of your payment is applied to principal and less to interest.
There are special rules that apply to co-ops. If you are a tenant-stockholder, you can also deduct your share of the interest paid by the cooperative.
Homeowners can also deduct real estate taxes. These are levied by state and local governments on real property for the general welfare.
The amounts paid for mortgage interest and taxes are easy to find. The bank will send a statement at the end of the year. Your locality may also send a property tax statement.
Dollars and Cents
We will now turn to some numbers to demonstrate your tax savings. As your marginal tax rate increases, it will have a greater the impact on your taxes.
As an example, take a fictitious couple married with a combined adjusted gross income (wages, business income, interest and dividends along with some other items) of $175,000. This places them in the 28% marginal tax bracket, based on the further assumptions we lay out below.
Suppose their mortgage interest and real estate taxes were $25,000 in 2014. Furthermore, for the sake of simplicity, there are no other itemized deductions for things such as state and local income taxes and charitable contributions.
Instead of it costing $25,000, the after-tax payout would be $17,000. The federal tax savings is $8,000.
The federal government places limits on itemized deductions at certain income levels. If your adjusted gross income is more than $305,050 and your filing status is married filing jointly (lower income levels for other filing statuses), certain itemized deductions, including taxes and interest.
As always, readers should use this article for informational purposes and not rely on it for specific tax advice. We have also just covered federal taxes and not included how state and local income taxes (e.g. NYC) will be affected. It is always wise to consult an expert in the area for more detailed concerns.